Question

ROE

Carson Electronics is a company based in California. It produces electronic equipment and components and sells them within USA and other countries. It considers BGT Electronics, also located in California, as the industry leader.

ват SHID MAL 3.4A ww.a BGT

The income statement and balance sheet of Carson Electronics and BGT Electronics are shown in Exhibit 1. Carson is planning to introduce a new equipment that would reduce electricity consumption by 40%. It has already conducted a market research study at a cost of $3 million and the results of the study were encouraging.

The details of the revenue and costs relating to this new product are shown in Exhibit 2. Carson feels that its debt ratio is very high at 48%. It would like to reduce the debt ratio to 35% by issuing additional equity through a rights issue.

The beta of Carson Electronics is estimated as 1.25. The risk-free rate based on the T-bill rate is 3% and the market risk premium is estimated as 8%.

Exhibit 1 –

Income Statement (in $’000)

	Carson	BGT
Net Sales (All Credit)	48,000	70,000
COGS
Variable Costs	30,000	38,500
Fixed Costs	6,000	3,500
Gross Profit	12,000	28,000
Operating Expenses (Fixed Costs)	8,000	12,000
Net Operating Income	4,000	16,000
Interest Expense	1,150	550
Earnings Before Tax	2,850	15,450
Income Tax (40%)	1,140	6,180
NI	1,710	9,270

Balance Sheet (in $’000)

	Carson	BGT
Cash	2,000	1,500
Accounts Receivable	4,500	6,000
Inventories	1,500	2,500
Current Assets	8,000	10,000
Net fixed Assets	16,000	25,000
Total Assets	24,000	35,000
Accounts Payables	2,500	5,000
Accrued Expenses	1,000	1,500
Short-Term Note Payables	3,500	1,500
Current Liabilities	7,000	8,000
Long-Term Debt	8,000	4,000
Shareholders’ Equity	9,000	23,000
Total Liabilities and Equities	24,000	35,000
	Carson	BGT
Number of Shares Outstanding	1,000,000	5,000,000
Market Price Per share	$12	$7.50

Exhibit 2 – Project Details

Exhibit 3 - Ratios

1. Identify the reasons why the ROE of Carson is different from that of BGT.

Answer 1

ROE (DuPont analysis) = net profit margin * total asset turnover * equity multiplier.

Carson ROE = 3.56% * 2.00 * 2.67 = 19.01%

BGT ROE = 13.24% * 2.00 * 1.52 = 40.25%

The ROE of BGT is higher because it's net profit margin is higher. Although the equity multiplier of BGT is lower, the net profit margin is much higher, which results in a ROE that is around twice that of Carlson.