Question

Target ROE problem You are given the following information regarding KTC for 2019: RETURN ON ASSETS = 7.5% NET PROFIT MARGIN = 6.0% DEBT EQUITY RATIO = 1.5x SALES = $550,000.00 GROSS PROFIT RATE = 50.0% TAX RATE = 34.0% 1) What must KTC project as its 2020's sales in order to generate an additional 5% Return on Equity above last year’s levels (2019’s ROE + 5%, not 2019’s ROE x 105%) 2) Prepare a projected 2020 Profit and Loss Statement and Balance Sheet (general categories are fine). 3) Calculate: 2020’s projected RETURN ON EQUITY (use the DuPont model) 2020’s projected RETURN ON ASSETS 2020’s projected NET PROFIT MARGIN 2020’s projected EQUITY MULTIPLIER 2020’s projected TOTAL ASSET TURNOVER 4) In addition to the above, determine the increase in sales necessary to also provide for dividends to be paid at the rate of 30% of 2020’s after-tax profits.

Answer 1

Details of 2019

Sales	5,50,000
Net Profit Margin %	6%
Net Profit	$               33,000
Return on Asset	7.50%
So , Net income/Asset =7.5%
Asset =(Net income /7.5%), Asset =	$             440,000
Debt/Equity	1.50

Asset = Debt + equity

If debt = 1.5x and equity = 1x, then

Asset = 1.5x + 1x

440,000 = 2.5x

x = 176,000

Equity = 176,000

Debt = 264,000

Return on Equity =Net Profit Margin*Revenue/Total Asset(Asset turnover)*Total Asset /Equity(Equity multiplier)

ROE = 6% * (550000/440000) * (440000/176000)

ROE = 18.75%

ROE in 2019 =18.75%

ROE in 2020 =18.75% + 5% = 23.75%

ROE = Net income / Equity

Net income = 176,000 * 23.75% = $41,800

Assuming Net profit margin of 6%,

i) Sales = 41,800 / 6% = $696,666.67

ii) Projected Profit and Loss Statement for the year 2020

Particulars	Amt
Sales revenue	$       696,666.67
Less Cost of Goods Sold (@50%)	$       348,333.33
Gross Profit	$       348,333.33
Operating Expense	$       285,000.00
EBT	$         63,333.33
Tax @34%	$         21,533.33
Net Income	$         41,800.00

Projected Balance Sheet as on Dec 31
Assets	Amt	Liabilities	Amt
Total assets	4,40,000	Debt	2,64,000
		Equity	1,76,000
Total	4,40,000	Total	4,40,000

iii) ROE in 2020 = Net Margin * Revenue/Total Asset * Total Asset /Equity

ROE=41800/696666.67 * 696666.67/440000 * 440000/176000 = 23.75%

Return on asset = 41,800/440,000 = 9.50%

Profit margin = 41800/696666.67 = 6%

Equity multiplier = 440000/17600 = 2.50%

Asset turnover = 696666.67/440000 = 1.58

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