Return on Equity and Quick Ratio Lloyd Inc. has sales of $250,000, a net income

Question

Return on Equity and Quick Ratio

Lloyd Inc. has sales of $250,000, a net income of $25,000, and the following balance sheet:

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, 2.5x, without affecting sales or net income.

Cash $69,750 Accounts payable $79,500 Receivables 112,500 Other current liabilities 45,000 Inventories 435,000 Long-term debt 94,500 Net fixed assets 132,750 Common equity 531,000 Total assets $750,000 Total liabilities and equity $750,000

Explanation / Answer

Hi,

Please find the answers as follows:

Selling the inventory will have no effect on quick ratio as inventory is not included while calculating quick ratio.

Current ROE = Net Income /Equity = 25000/(531000) = 4.71%

Expected ROE = 25000/(531000 - 435000) = 26.04 or 26%

So the ROE will change by = 26 - 4.71 = 21.29%

Current Quick Ratio = Cash + Receivables/Current Liabilities = (69750 + 112500)/(79500 + 45000) = 1.46

Expected Quick Ratio = Selling the inventory will have no effect on quick ratio as inventory is not included while calculating quick ratio. Therefore, quick ratio would continue to be 1.46

Thanks.

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