Answer:
If inventories are sold and not replaced (thus reducing the current ratio to 2.5x); if the funds generated are used to reduce common equity (stock can be repurchased at book value); and if no other changes occur The ROE will be of 9.4%
The firm's new quick ratio is 3.95
Explanation:
To calculate how much will the ROE change we have to calculate first the current ratio as follows:
Current ratio = Current assets / Current liabilities
2.5 times = (Cash + receivables + Inventories ) / (Accounts payable + Other current liabilities)
2.5 = ($51,000 + $118,800 + Inventories) / $104,400
$169,000 + inventories = $261,000
Inventories = $92,000
Therefore, $202,000 worth of inventories were sold off.
If the funds generated are used to reduce the common equity that is by repurchasing the equity at book value.
Hence, the common equity amounts to $210,800
Calculating the ROE before the inventory is sold off:
ROE = Net income / Steockholder's equity
= $20,000 / $412,800
= 0.048 or 4.8%
Calculating the ROE after selling off the inventory:
ROE = $20,000 / $210,800
= 0.094 or 9.4%
If inventories are sold and not replaced (thus reducing the current ratio to 2.5x); if the funds generated are used to reduce common equity (stock can be repurchased at book value); and if no other changes occur The ROE will be of 9.4%
The firm's new quick ratio is
Quick ratio = (Current assets - Inventories) / Current liabilities
= ($463,800 - $92,000) / $104,400
= 3.95
