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Return on Equity Pacific Packaging's ROE last year was only 5%; but its management has developed...

Return on Equity

Pacific Packaging's ROE last year was only 5%; but its management has developed a new operating plan that calls for a debt-to-capital ratio of 60%, which will result in annual interest charges of $245,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $756,000 on sales of $7,000,000, and it expects to have a total assets turnover ratio of 1.4. Under these conditions, the tax rate will be 30%. If the changes are made, what will be the company's return on equity? Do not round intermediate calculations. Round your answer to two decimal places.

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Answer #1

Return on equity = Net Income/ Equity

EBIT    756000

Less Interest 245000

EBT   511000

Less Tax at 30% 153300

Net Income $357700

Calculate equity using Total asset turnover ratio and debt to equity ratio

Sales/total assets = 1.4

total assets= $7,000,000/1.4 = $5000000

Debt/total asset = 60%, Equity/total asset=40%

Equity= $5000000*40% = $2000000

ROE = $357700/$2000000 = 17.88%

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