Lloyd Inc has sales of $200,000, a net income of $15,000 and the following balan

Question

Lloyd Inc has sales of $200,000, a net income of $15,000 and the following balance sheet:

Cash 10,000
Receivables 50,000
Inventories 150,000
Net Fixed Assets 90,000
Total Assets = 300,000

Acct. Payable 30,000
Other Current Liabilities 20,000
Long Term Debt 50,000
Common Equity 200,000
Total Liabilities and Equity = 300,000

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. If inventories are sold off and not replaced (thus reducing the current ratio to 2.5), if the funds generated are used to reduce common equity (stock can be repurchased at book value) and if no other changes occur, by how much will the ROE change? What will be the firm's new quick ratio?

Explanation / Answer

Acct. Payable 30,000 Other Current Liabilities 20,000 Long Term Debt 50,000 Common Equity 200,000 Total Liabilities and Equity = 300,000 Current ROE = 15,000/200,000 Expected ROE = 15,000/50,000 Current current ratio = 210,000/50,000 Expected current ratio = 60,000/50,000 Current quick ratio = 60,000/50,000 Expected quick ratio = 60,000/50,000

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