Question

1. Based on the following information, answer the questions.

Korean Electronics
2017 Income Statement
Sales Costs of goods sold EBIT Taxes (50%) Net income		1,000,000 800,000   200,000 (100,000)              (100,000)
2017 Balance Sheet
Assets		Liabilities and Equity
Current assets Net fixed assets Total	(1,000,000) (6,000,000) (7,000,000)	Debt Equity Total	(5,000,000) (2,000,000) (7,000,000)

1. If Profit Margin (PM) is 10 percent, i) what is the net income? If ROEis 5 percent, ii) what is the total equity? Use the net income that you figured out in the previous question. (40points)

PM=Net Income/Sales,  0.1=NI/1,000,000   èNI=100,000

            ROE=Net Income/Total Equity,   0.05=100,000/TE èTE=2,000,000

2. If the firm has a debt-to-equity ratioof 2.5, what is the Total Debt ratio (TD/TA)?(30 points)

Debt-to-equity ratio=TD/TE, 2.5=TD/2,000,000 èTD=5,000,000

TD/TA=5,000,000/7,000,000=5/7

3. The firm plans to reduceits equity multiplier (EM). Other things equal, what will happen to its return on equity (ROE)? Does it increase or decrease?  (30points)

          ROE=NI/TE = (NI/Sales)*(Sales/Total Asset)*(Total Asset/Total Equity)

      = PM*TAT*EM      If EM decreases, then ROE will decrease

Answer 1

All calculations and answers are correct.

If Profit Margin (PM) is 10 percent then the net income is:

Profit margin = net income/sales

0.10 = net income/1,000,000

net income = 1,000,000*0.10 = 100,000

If ROE is 5 percent then the total equity is:

ROE = net income/total equity or total equity = net income/ROE

Total equity = 100,000/0.05 = 2,000,000

If the firm has a debt-to-equity ratio of 2.5 then the Total Debt ratio is:

Debt to equity ratio = total debt/total equity or total debt = total equity*debt to equity ratio

total debt = 2,000,000*2.5 = 5,000,000

Total debt ratio = total debt/total assets = 5,000,000/7,000,000 = 0.71

Return on equity (ROE) = Profit margin*total assets turnover*equity multiplier

If there is no change in Profit margin and total assets turnover but equity multiplier decreases then ROE will also decrease.

For example, Profit margin is 10%, total assets turnover is 1.5 and equity multiplier is 2.5.

ROE = 0.10*1.5*2.5 = 0.375

Now equity multiplier decreases to 1.9 then ROE will also decrease.

ROE = 0.10*1.5*1.9 = 0.285