Last year a company had $355,000 of assets, $26,275 of net income, and a debt-to

Question

Last year a company had $355,000 of assets, $26,275 of net income, and a debt-to-total-assets ratio of 44%. Now suppose the newly hired CFO convinces the president to increase the debt ratio to 58%. 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 58%, what will be the new ROE

Explanation / Answer

old debt ratio= 44% old equity ratio = 1-44% = 56% old equity = 56%*355000 =198800 Original ROE = 26275/198800 =13.22% New debt ratio = 58% new equity ratio = 1-58% = 42% new equity = 42%*355000 =149100 New ROE = 26275/149100 =17.62%

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