Problem 4-14 Return on Equity Midwest Packaging\'s ROE last year was only 5%; bu

Question

Problem 4-14
Return on Equity

Midwest Packaging's ROE last year was only 5%; but its management has developed a new operating plan that calls for a debt-to-assets ratio of 45%, which will result in annual interest charges of $238,000. The firm has no plans to use preferred stock. Management projects an EBIT of $525,000 on sales of $7,000,000, and it expects to have a total assets turnover ratio of 2.6. Under these conditions, the tax rate will be 35%. If the changes are made, what will be the company's return on equity? Round your answer to two decimal places.

%

Explanation / Answer

ROE = (EBIT - Int)*(1 -T) / Equity

Equity = Sales / Asset turnover * (1 - debt ratio)

= 7000000 / 2.6 * (1 - .45)

= 1480769

ROE = (525000 - 238000) * (1 - .35) / 1480769

= 12.60%

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