Pacific Packaging\'s ROE last year was only 6%; but its management has developed
ID: 2814252 • Letter: P
Question
Pacific Packaging's ROE last year was only 6%; but its management has developed a new operating plan that calls for a debt-to-capital ratio of 50%, which will result in annual interest charges of $598,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $1,053,000 on sales of $13,000,000, and it expects to have a total assets turnover ratio of 3.0. Under these conditions, the tax rate will be 35%. If the changes are made, what will be the company's return on equity? Do not round intermediate calculations. Round your answer to two decimal places.
Explanation / Answer
1. Computation of ROE
Net income = (EBIT - Interest) * ( 1 - Tax Rate)
Net income = ($1053000 - $598000) * ( 1 - 0.35)
Net income = $295750
total assets turnover ratio = 3.0
Turnover / Assets = 3
Assets = $13000000 / 3 = $4333333.33
Debt Ratio = 50%
Debt / Total Capital = 50%
Debt = $4333333.33 *0.50 = $2166666.67
Equity = Total Assets - Debt = $4333333.33 - $2166666.67 = $2166666.67
ROE = Net Income / Total Equity = $295750 / $2166666.67
ROE = 13.65%
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