RETURN ON EQUITY Pacific Packaging\'s ROE last year was only 3%; but its managem
ID: 2815866 • Letter: R
Question
RETURN ON EQUITY Pacific Packaging's ROE last year was only 3%; 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 $620,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $2,320,000 on sales of $20,000,000, and it expects to have a total assets turnover ratio of 3.1. Under these conditions, the tax rate will be 30%. 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
Step-1, Calculation of Net Income
Net Income [EBIT – Interest] x (1-tax rate)
= [$23,20,000 – 620,000] x (1-0.30)
= $17,00,000 x 0.70
= $11,90,000
Step-2, Calculation of Total Assets
Total Asset Turnover = Sales / Total Assets
3.10 = $2,00,00,000 / Total Assets
Total Assets = $200,00,000 / 3.10
Total Assets = $ 64,51,612.90
Step-3, Calculation of Equity
Debt to Capital Ratio = Debt / Total Assets
0.50 = Debt / $ 64,51,612.90
Therefore, Debt = $ 64,51,612.90 x 0.50 = $ 32,25,806.45
Equity = Total Assets – Debt
= $ 64,51,612.90 - $ 32,25,806.45
= $ 32,25,806.45
Step-4, Return on Equity (ROE)
Return on Equity (ROE) = [Net Income / Equity] x 100
= [$11,90,000 / $ 32,25,806.45] x 100
= 36.89%
“HENCE, THE Return on Equity (ROE) = 36.89%”
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