Question

Pacific Packaging's ROE last year was only 4%, but its management has developed a new operating plan that calls for a debt-to-capital ratio of 55%, which will result in annual interest charges of $330,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $880,000 on sales of $11,000,000, and it expects to have a total assets turnover ratio of 1.3. Under these conditions, the tax rate will be 25%. If the changes are made, what will be the company's return on equity

Answer 1

Based on the various entries and measures, the return on equity would be 10.82%.

First find the profit margin

Profit margin

= Net income / Total sales

Net income =  (EBIT - Interest expense) x (1 - Tax Rate)

= (880,000 - 330,000) x (1 - 25%)

= $412,500

Profit margin = 412,500 / 11,000,000

= 3.75%

Then find the Equity Multiplier

Equity Multiplier

= 1 / ( 1 - Debt to capital ratio)

= 1 / ( 1 - 55%)

= 2.22

Return on Equity

This can be found by the formula:

= Asset Turnover x Profit margin x Equity Multiplier

= 1.3 x 0.375 x 2.22

= 10.82%

In conclusion, the ROE is 10.82%.

Find out more on the ROE at brainly.com/question/25738546.