Question

In a previous homework assignment you were provided with the following information.

A company has the following ratios:

Current ratio - .85

Inventory to Sales Conversion Period – 180 days

Sales to Cash Conversion Period – 75 days

Purchases to Payments Conversion Period - 7 days

The accountant also reports that the gross profit margin is 15% and the next profit margin is 3%.  

Now you are being provided with this additional information on the company.

The company also has a bank line of credit that allows the company to borrow any shortfall it might have in cash. Interest on the loan is 10%. Assume the loan remained constant throughout the year. The company likes to keep no less than $25,000 in its bank account.

The company has $1,000,000 of equity and $120,000 in retained earnings at the end of the year.

Sales in the most recent year were $2,500,000.

Ignore income tax for purposes of this problem.

Question: Based on all of the above information, will this company have a good return on equity or a poor return on equity?

Build a balance sheet and income statement financial model to prove your answer.

Bonus Points: What changes can managing make that will have the greatest impact on ROI?

Answer 1

ANSWER :

Return of equity =[ Net Income/ Share holder's equity ]

=[ ($2,500,000*3%) / ($1,000,000 + $ 120,000) ]

=[ $75,000 / $1,120,000 ]

= 0.06696

= 0.06696 * 100

= 6.69%

= 6.7%

BALANCE SHEET

Assets	Amount	Liabilities	Amount
Creditors	$65,625	Debtors	$277,778
Short term loan	$1,731,761	Inventory	$1,250,000
equity	$1,000,000	Fixed Asset
Retained Earnings	$120,000	Long Term Liabilities	$1,389,608
Total Assets	$ 2,917,386	Total Liabilities	$ 2,917,386

INCOME STATEMENT

PARTICULARS	AMOUNT
Sales	$2,500,000
Cost of Goods Sold	$ 2,125,000
Gross Profit	$375,000
Interest Expense	$300,000
Net Income	$75,000

Net Income = SALES - COST OF GOODS SOLD - INTEREST EXPENSE

= $2,500,000 - $2,125,000 - $300,000

= $375,000 - $300,000

Net income = $75,000

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