Question

Return on Equity and Quick Ratio Lloyd Inc. has sales of $350,000, a net income of $42,000, and the following balance sheet: Cash Receivables Inventories Net fixed assets Total assets The new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average, 2.25x, without affecting sales or net income a. If inventories are sold and not replaced (thus reducing the current ratio to 2.25x), if the funds $46,200 141,120 302,400 350,280 $840,000 Accounts payable Other current liabilities Long-term debt Common equity Total liabilities and equity $82,320 30,240 133,560 593,880 $840,000 generated are used to reduce common equity (stock can be repurchased at book value), and if no other changes occur, by how much will the ROE change? Round your answer to two decimal places. b. What will be the firm's new quick ratio? Round your answer to two decimal places

Answer 1

Current Expected $42,000 $42,000 [No change] $593,880 $291,480 [$593,880 $302,400] Net income Common Equity Return on Equity (ROE) 7.07% 14.41% Net Income / Common Equity [Current $42,000 / $593,880-7.0796; Expected-$42,000 / $291,480-14.41%) Therefore, Change in ROE 103.75% (14.41%-7.07%) / 7.07%-7.34% / 7.07%-103.75%) Cash $141,120 $187,320 [$46,200+ $141,120] Quick Assets Accounts payable Other current liabilities $82,320 $30,240 $112,560 IS82,320+$30,240] Current liabilities New Quick Ratio 1.66 TQuick Assets/ Current liabilities] ($187,320/$112,560)