UM Graduation Supplies has debt-to-equity ratio of 80%, profit margin of 10%, to
ID: 2720149 • Letter: U
Question
UM Graduation Supplies has debt-to-equity ratio of 80%, profit margin of 10%, total sales of 10 million and total assets of 5 million. The president is unhappy with the current return on equity, and he thinks it could be doubled. This could be accomplished by (1) increasing the profit margin to 15% and (2) increasing debt utilization. Total asset turnover will not change. What new equity multiplier is required to double the return on equity?
FORMAT TO 4 DECIMAL PLACES
3.2
2.7
1.1
2.4
1.4
Explanation / Answer
Total asset Turnover = sales /asset
= 10 /5
= 2
weight of Debt = 80 /180 = .44
Weight of equity = 1-.44 = .56
Shareholders equity = 5 *.56 = 2.8 million
equity multiplier (old) = Total asset /shareholders equity
= 5/ 2.8
= 1.7857
ROI = Profit margin * Total asset turnover * equity multiplier
= 10 * 2 * 1.7857
= 35.714
Now ,to double ROI = 35.714 *2 = 71.428
Equity multiplier = ROI / Profit margin * Total asset turnover
= 71.42 8/ 15 * 2
= 71.428 /30
= 2.38 (approx 2.4)
correct option is "D"
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