5. Mont, Inc has a new plan to improve its ROE. EBIT is expected to be $50,000 o

Question

5. Mont, Inc has a new plan to improve its ROE. EBIT is expected to be $50,000 on sales of $520,000. The firm expects to have a total assets turnover ratio of 3 and a debt ratio of 55%, which will result in interest charges of $14,000 per year. The tax rate is 40%, what will be the new ROE? Victoria has $3.2mi. of accounts receivables and $5mi, of current assets. Its DSO (days sales outstanding in receivables) is 40 (based on a 365-day year), and its current ratio is 1.5. The firm plans to reduce its DSO to the industry average of 30 without causing a decline in sales. The resulting decrease in accounts receivable will free up cash that will be used to reduce current liabilities. If this plan succeeds, what will be the new current ratio? 6.

Explanation / Answer

Answer to Question 5:

Total Asset Turnover Ratio = Sales / Total Assets
3 = $520,000 / Total Assets
Total Assets = $173,333.33

Equity Ratio = 100% - Debt Ratio
Equity Ratio = 100% - 55%
Equity Ratio = 45%

Equity = Equity Ratio * Total Assets
Equity = 45% * $173,333.33
Equity = $78,000

Net Income = (EBIT - Interest Expense) * (1 - tax)
Net Income = ($50,000 - $14,000) * (1 - 0.40)
Net Income = $21,600

Return on Equity = Net Income / Equity
Return on Equity = $21,600 / $78,000
Return on Equity = 27.69%

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