Hint: ROE in this test is calculated using the beginning value of owner\'s equit

Question

Hint: ROE in this test is calculated using the beginning value of owner's equity. That said, ROE Profit/ (Equity at the beginning of the fiscal year). YEAR1 You start company ABC with 100,000 of your own money and 50,000 from your friends You borrow 50,000 from a bank. You use the funds to buy 125,000 in equipment, 50,000 in (intermediate) parts (inventory) and keep 25,000 in a bank account (cash). Show the initial balance sheet. During your first year in business your profit is 15,000. What's the ROE? Out of this 15,000, you distribute 10,000 in dividends and retain the rest in the company bank account. Show the new balance sheet for year two (at the end of year 1) YEAR 2 Continue with this new balance sheet. Suppose the second year profit is the same as the first. What's the ROE? You use the entire profit for this second year to purchase 20,000 in additional equipment. You'll need to borrow the difference from your bank. Show the new balance sheet for year three. YEAR 3 Third year profit increases to 18,000. What's the ROE? You pay out all year three profit to owners (dividends),. But you take all the cash in the bank account and use it to purchase new equipment. Show the new balance sheet. YEAR 4 Profit increases by 25% from the previous year. But the IRS enters and taxes profits at a 20% rate, what is the ROE?

Explanation / Answer

As per rules I will answer the first 4 subparts of this question

1:

2: ROE= Net Income/ Equity = 15000/150,000 = 10%

3: Retained earnings= 15000-10000 = $5000. This is added to bank account and equity.

4: ROE= 15,000/ 155000 = 9.68%

OPening Balance Sheet Liabilities Assets Equipment $125,000.00 Bank loan 50000 Inventory $50,000.00 Equity $150,000.00 Bank balance $25,000.00 Total $200,000.00 Total $200,000.00

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