Last year Ann Arbor Corp had $250,000 of assets (which equals total invested capital), $305,000 of...
Last year Ann Arbor Corp had $250,000 of assets (which equals total invested capital), $305,000 of sales, $20,000 of net income, and a debt-to-total-capital ratio of 37.5%. The new CFO believes that a new computer program will enable the company to reduce costs and thus raise net income to $33,000. The firm finances using only debt and common equity. Assets, total invested capital, sales, and the debt to capital ratio would not be affected. By how much would the cost reduction improve the ROE? Do not round your intermediate calculations.
| a. |
6.74% |
|
| b. |
8.82% |
|
| c. |
8.32% |
|
| d. |
8.15% |
|
| e. |
8.57% |
Homework Answers
Ans)
Assets= Total invested capital = $250,000
Debt Rate = 37.5%
Debt= capital X Debt % = 93750
Equity= Assets – Debt = 250,000 - 93750 = 156250
Sales = $305000
Old NI = $20000
New NI =$33000
New ROE= New NI/Equity =33000/156250 = 21.12%
Old ROE= Old NI/Equity= 20,0000/156250 = 12.8%
Increase in ROE= New ROE- Old ROE = 21.12 - 12.8 = 8.32%
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