Pacific Packaging\'s ROE last year was only 6%; but its management has developed
ID: 2621038 • Letter: P
Question
Pacific Packaging's ROE last year was only 6%; but its management has developed a new operating plan that calls for a debt-to-capital ratio of 40%, which will result in annual interest charges of $528,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $1,456,000 on sales of $16,000,000, and it expects to have a total assets turnover ratio of 2.9. Under these conditions, the tax rate will be 35%. If the changes are made, what will be the company's return on equity? Do not round intermediate calculations. Round your answer to two decimal places.
Explanation / Answer
Total assets turnover ratio = Sales/Total assets
2.9 = $16,000,000/Total assets
Total assets = $5,517,241.38
Equity = $5,517,241.38×(1-40%) = $3,310,344.83
ROE:
= Net income/Equity
= ($1,456,000-$528,000)×(1-35%)/$3,310,344.83
= 18.22%
Hence, return on equity is 18.22%
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