Question

Last year Central Chemicals had sales of $205,000, assets of $127,500, a profit margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $21,000 without affecting either sales or costs. Had it reduced its assets in this amount, and had the debt-to-assets ratio, sales, and costs remained constant, by how much would the ROE have changed?

Answer 1

Answer:

ROE change is  2.01%

Explanation:

given data

sales = $205000

assets = $127500

profit = 5.3%

equity = 1.2

assets = $21000

to find out

how much ROE have changed

solution

we know that assets is 127500 - 21000

assets = $106500

so here current return of equity is

return of equity = profit × asset turnover × equity    ................1

here asset turnover = sales / total assets = 205000 / 127500 = 1.607

so

return of equity = 0.053 × 1.607 × 1.2

so current return of equity = 0.1023

and new return of equity will be

assets turnover = 205000 / 106500 = 1.924

so from equation 1

new return of equity = 0.53 × 1.924 × 1.2

so new return of equity = 0.1224

and so here

ROE change = new - current

ROE change = 0.1224 - 0.1023

so ROE change is 0.0201 = 2.01%