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

KTC
Particulars	Amt $/ %
Details of 2019
Sales	$             550,000
Net Profit Margin %	6%
Net Profit Margin $ Amount	$               33,000
Return on Asset	7.5%
So , Net income/Asset =7.5%
Asset =Net income /7.5%=	$             440,000
Debt/Equity =	1.50
Asset =Debt+Equity
Assune Debt =1.5x , so Equity =1x
So 2.5x=440000
x=	$             176,000
Equity =	$             176,000
Debt =	$             264,000

Return on Equity =Net Margin*Revenue/Total Asset*Total Asset /Equity
ROE =6%*550000/440000*440000/176000=	18.75%
So 2019 ROE =18.75%
2020 ROE =18.75%+5%=	23.75%

	2020 ROE =23.75%
	so Net Income /Equity=23.75%
	Net Income =176000*23.75%=	$         41,800.00
	Assuming net Margin unchanged =6%
	So Sales =41800/6%=	$       696,666.67
Ans 1	So projected sales for 2020 would be $696,666.67

Ans 2
	KTC
	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

Ans 2 ( Assuming Assets /Liabilities at 2019 level, additional profit paid as dividend)
KTC
Projected Balance Sheet as on Dec 31 2020
Assets	Amt $	Liabilities
Total Asset	$           440,000	Debt	$ 264,000
		Equity	$ 176,000
Total	$           440,000	Total	$ 440,000

Ans 3
	In the absence of detailed information.assuming that
	the asset and Liabilities are not changing in 2020 and
	additional profit paid out as dividend.
	ROE in 2020 =Net Margin*Revenue/Total Asset*Total Asset /Equity
	ROE=41800/696666.67*696666.67/440000*440000/176000
	ROE =23.75%
	Return on Asset =41800/440000=	9.50%
	2020 Net Margin	6%
	2020 Projected Equity Multiplier=Total Asset/Equity=	2.50
	2020 total Asset Turnover =Revenue/Total Asset=	1.58