The most recent annual report lists company sales revenue at $94,600. Cost analy
ID: 2635183 • Letter: T
Question
The most recent annual report lists company sales revenue at $94,600. Cost analysis suggests that annual total fixed costs equal $42,750 and total variable costs equal $40,600. the annual interest expense is $2,125 and there is no preferred stock. the company pays 30% of taxable income as taxes. the annual report also shows roe, that is return on equity, equal 16.6%. the company wants to increase its ROE to a target of 22.0%. they plan to hold constant stockholders' equity, total assets, total fixed costs, interest, and the ratio of sales revenue to total variable costs. find the target sales revenue and net profit margin that provides the target ROE.
I know the ANSWER: Target Sales revenue equals $99,800 and the net profit margin is 8.5%. Please explain this problems calculations step-by-step in detail.
Explanation / Answer
As per the given information:
Sales
94600
Less: Fixed cost
Variable cost
42750
40600
Earning before Interest and Tax (EBIT)
11250
Less: Interest
2125
Earning before Tax (EBT)
9125
Less: Tax @ 30% of EBT
2737.5
Net Profit i.e PAT
6387.5
Return on Equity (ROE)
16.60%
Hence, Net Worth= (PAT / ROE)
38478.92
If the Target ROE is 22% with all other factors remaining the same, the target sales revenue can be computed as follows:
Target ROE
22%
Net Worth (as above)
38478.92
Thus, Target PAT = (ROE * Net Worth)
8465.361
Tax expense
=(PAT / 70%) * 30%
3628.012
EBT= PAT + Tax
12093.37
Interest
2125
Hence, EBIT= EBT + Interest
14218.37
Fixed cost
42750
Variable cost
40600
Thus, Target Sales
= EBIT + Fixed Cost + Variable Cost
97568.37
Thus, Net Profit Margin = PAT/ Sales
8.7%
{Note: Return on Equity= PAT/ Net Worth}
To be Noted: If the answer given by you is taken into account and sales target is taken to be $99800, the ROE when computed is coming to 26.06%, as shown below:
Sales
99800
Less: Fixed cost
Variable cost
42750
40600
Earning before Interest and Tax (EBIT)
16450
Less: Interest
2125
Earning before Tax (EBT)
14325
Less: Tax @ 30% of EBT
4297.5
Net Profit i.e PAT
10027.5
Net Worth
38478.92
Return on Equity (ROE) = PAT/ Net Worth
26.06%
Sales
94600
Less: Fixed cost
Variable cost
42750
40600
Earning before Interest and Tax (EBIT)
11250
Less: Interest
2125
Earning before Tax (EBT)
9125
Less: Tax @ 30% of EBT
2737.5
Net Profit i.e PAT
6387.5
Return on Equity (ROE)
16.60%
Hence, Net Worth= (PAT / ROE)
38478.92