RETURN ON EQUITY AND QUICK RATIO Lloyd Inc. has sales of $150,000, a net income
ID: 2815868 • Letter: R
Question
RETURN ON EQUITY AND QUICK RATIO Lloyd Inc. has sales of $150,000, a net income of $18,000, and the following balance sheet: Cash Receivables Inventories Total current assets Net fixed assets Total assets 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, 2x, without affecting sales or net income a. If inventories are sold and not replaced (thus reducing the current ratio to 2x); if the funds generated are used to reduce common equity (stock can be repurchased at $32,805 27,540 $60,345 58,320 286,335 $405,000 $35,235 Accounts payable 68,445 Notes payable to bank 182,250 Total current liabilities $285,930 Long-term debt 119,070 Common equity $405,000 Total liabilities and equity book value); and if no other changes occur, by how much will the ROE change? Do not round intermediate calculations. Round your answer to two decimal places. b. What will be the firm's new quick ratio? Do not round intermediate calculations. Round your answer to two decimal placesExplanation / Answer
a) Current ratio = Current assets / Current liabilities
Desired current ratio is 2 and only way that is possible is that if current assets are 2 times the current liabilities.
Required current assets = 2 x current liabilities = 2 x $60345 = $120690
Inventory to be reduced = Total current assets - required current assets = $285930 - $120690 = $165240
This amount is used to repurchase stock.
New common equity = $286335 - $165240 = $121095
Existing ROE = Net Income / Existing common equity = $18000 / $286335 = 0.0628634292 or 6.28634292%
New ROE = $18000 / $121095 = 0.1486436269 or 14.86436269%
Change in ROE = 14.86436269% - 6.28634292% = 8.57801977% or 8.58%
b) Quick Ratio = Quick assets / Current liabilities = (cash + Receivables) / Current liabilities
This ratio will remain the same as their will be no change in cash and receivables.
Quick Ratio = ($35235 + $68445) / $60345 = 1.72
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