Return on Equity Midwest Packaging\'s ROE last year was only 5%; but its managem

Question

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 55%, which will result in annual interest charges of $184,000. The firm has no plans to use preferred stock. Management projects an EBIT of $404,000 on sales of $4,000,000, and it expects to have a total assets turnover ratio of 1.6. Under these conditions, the tax rate will be 30%. If the changes are made, what will be the company's return on equity? Round your answer to two decimal places.

_____ %

Explanation / Answer

Total Assets:

= Sales/1.6

= $4,000,000/1.6

= $2,500,000

Total Debt:

= 55%×$2,500,000

=$1,3750,000
So Equity = Total assets -Debt

= $2,500,000 - $1,3750,000

= $1,125,000

ROE:

Net income/Equity

= ($404,000-$184,000)×(1-30%)/$1,125,000

= 13.69%

Hence, companies return on equity is 13.69%

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