Midwest Packaging\'s ROE last year was only 2%; but its management has developed
ID: 2695010 • Letter: M
Question
Midwest Packaging's ROE last year was only 2%; but its management has developed a new operating plan that calls for a debt-to-assets ratio of 60%, which will result in annual interest charges of $592,000. The firm has no plans to use preferred stock. Management projects an EBIT of $1,856,000 on sales of $16,000,000, and it expects to have a total assets turnover ratio of 4.0. Under these conditions, the tax rate will be 30%. If the changes are made, what will be the company's return on equity? Round your answer to two decimal places.Explanation / Answer
Equity + Debt = Total Assets ; Equity / Assts = 1 - debt/assets = 1 - 0.6 = 0.4 ; Assets turnover ratio = Net sales / Avg. Total assets = 4 ; EBIT/Sales = 0.116 ; EBT/EBIT = (1,856,000 - 592,000)/1,856,000 = 0.681 ; PAT/EBT = (0.7*EBT)/EBT = 0.7 ; Avg. Total Assests /Avg. Total Equity = 1/0.4 ; so PAT/Equity = ROE = multiplying 5 ratios = 0.5529 = 55.29 % ;