Return on Equity and Quick Ratio Lloyd Inc. has sales of $500,000, a net income
ID: 2718807 • Letter: R
Question
Return on Equity and Quick Ratio
Lloyd Inc. has sales of $500,000, a net income of $60,000, and the following balance sheet:
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, 2.25x, without affecting sales or net income.
If inventories are sold and not replaced (thus reducing the current ratio to 2.25x), 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? Round your answer to two decimal places.
%
What will be the firm's new quick ratio? Round your answer to two decimal places.
x
Return on Equity and Quick Ratio
Lloyd Inc. has sales of $500,000, a net income of $60,000, and the following balance sheet:
Cash $68,400 Accounts payable $99,000 Receivables 155,700 Other current liabilities 29,700 Inventories 531,000 Long-term debt 117,900 Net fixed assets 144,900 Common equity 653,400 Total assets $900,000 Total liabilities and equity $900,000The new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average, 2.25x, without affecting sales or net income.
If inventories are sold and not replaced (thus reducing the current ratio to 2.25x), 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? Round your answer to two decimal places.
%
What will be the firm's new quick ratio? Round your answer to two decimal places.
x
Explanation / Answer
Answer:
Present current ratio:
Present return on equity:
Net income/Shareholder's equity = $60,000/$653,400 = 9.18%
The target current ratio = 2.25X
=> 2.25 = Inventory + (Cash + receivable)/Total Current liabilities
=>2.25 = {Inventory +(68,400+155,700)} / 128,700
=> Inventory + $224,100 = $289,575
=> Inventory = $289,575 - $224,100 = $65,475
Funds generated by not replacing the inventory= $531,000 - $65,475 = $465,525 = Value of shares bought back
So the revised common equity = $653,400 - $465,525 = $187,875
The revised ROE = $60,000/$187,875 = 31.94%
ROE changes by = 31.94%- 9.18% = 22.75% (ans)
New quick ratio = (Cash+Receivable)/Total current laiblity
= ($68,400+155,700)/($99,000+$29,700) = 1.74 (ans)
A Current Asset In $ In $ Cash 68,400 Receivables 1,55,700 Inventories 5,31,000 Total 7,55,100 B Current liability Accounts payable 99000 Other current liabilities 29700 Total 128700 C Current Ratio (A/B) 5.87Related Questions
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