Last year a company had $355,000 of assets, $28,875 of net income, and a debt-to
ID: 2637049 • Letter: L
Question
Last year a company had $355,000 of assets, $28,875 of net income, and a debt-to-total-assets ratio of 46%. Now suppose the newly hired CFO convinces the president to increase the debt ratio to 56%. Sales and total assets will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and therefore keep net income unchanged.
What was the original return on equity (ROE) for this company? Assuming the president of the firm allows the CFO to increase the debt ratio to 56%, what will be the new ROE
Explanation / Answer
Original Value of equity = $355,000 * 54% = $191,700
Original return on equity = ($28,875 / $191,700) * 100% = 15.06%
New Value of equity = $355,000 * 44% = $156,200
New return on equity = ($28,875 / $156,200) * 100% = 18.49%
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