Question

In: Finance

The Sooner Equipment Company has total assets of $100 million. Of this total, $45 million was...

The Sooner Equipment Company has total assets of $100 million. Of this total, $45 million was financed with common equity and $55 million with debt (both long and short-term). Its average accounts receivable balance is $24 million, and this represents an 80-day average collection period. Sooner believes it can reduce its average collection period from 80 to 65 days without affecting sales or the dollar amount of net income after taxes (currently $4.5 million). What will be the effect of this action on Sooner’s return on investment and its return on stockholders’ equity if the funds received by reducing the average collection period are used to buy back its common stock at book value? What impact will this action have on Sooner’s debt ratio? Round your answers to two decimal places.

Old debt ratio:  %

New debt ratio:  %

Old return on assets:  %

New return on assets:  %

Old return on common equity:  %

New return on common equity:  %

Solutions

Expert Solution

Based on the question details,

Old Assets = $ 100 Million; Old Debt = $55 Million; Old Common Equity = $45 Million. Old Net Profit = $4.5 Million

Old Receivables = $24 Million. Old average receivable days = 80.

New average receivable days = 65. New Net Sales = Old Net Sales. New Net Profit = Old Net Profit = $4.5 Million. Therefore, New Receivables = Old Receivables/Old Receivable days * New Receivable Days = $24 Million *65/80 = $ 19.5 Million.

Cash increase = Old Receivable - New Receivables = $24 - $19.5 = $4.5 Million. This cash is used to buy back common stock, therefore New Common Equity = Old Common Equity - Common Stock bought back = $45 - $4.5 = $40.5 Million.

There is no change in Debt, New Debt = $ 55 Million, New Assets = New common Stock + New Debt = $55 + $40.5 = $95.5 Million.

Old Debt Ratio = Old Debt/Old Assets = $55 Million/$100 Million = 55%

New Debt Ratio = New Debt/New Assets = $55 Million/$95.5 Million = 57.59%

Old Return on Assets = Old Net Profit/Old Assets = $4.5 Million/$100 Million = 4.5%

New Return on Assets = New Net Profit/New Assets = $4.5 Million/$95.5 Million = 4.71%

Old Return on Common Equity = Old Net Profit/Old Common Equtiy = $4.5 Million/$45 Million = 10%

New Return on Common Equity = New Net Profit/New Common Equity = $4.5 Million/$40.5 Million = 11.11%


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