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RETURN ON EQUITY AND QUICK RATIO Lloyd Inc. has sales of $150,000, a net income of...

RETURN ON EQUITY AND QUICK RATIO

Lloyd Inc. has sales of $150,000, a net income of $15,000, and the following balance sheet:

Cash	$48,285	Accounts payable	$51,330
Receivables	77,430	Notes payable to bank	26,535
Inventories	191,400	Total current liabilities	$77,865
Total current assets	$317,115	Long-term debt	70,470
Net fixed assets	117,885	Common equity	286,665
Total assets	$435,000	Total liabilities and equity	$435,000

The new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average, 2x, without affecting sales or net income.

If inventories are sold and not replaced (thus reducing the current ratio to 2x); if the funds generated are used to reduce common equity (stock can be repurchased at book value); and if no other changes occur, by how much will the ROE change? Do not round intermediate calculations. Round your answer to two decimal places.

%

What will be the firm's new quick ratio? Do not round intermediate calculations. Round your answer to two decimal places.

x

Expert Solution

solution:

Current ratio = Current Assets / Current Liabilities

Current Assets at present= cash + Receivables+ inventory = 48285 + 77430+ 191400= $317115

Current Liabilities = Account Payable + notes payable to bank= 51330+26535= $77865

Future current ratio = NewCurrent assets / Current liabilities

2 = New Current Assets /77865

Therefore, new current Assets = $77865*2= $155730

At present, current Assets amounts to $317115, therefore they can be reduced by $317115-$155730= $161385

If $161385 generated are used to reduce common equity then the new common equity = $286665 - $161385= $125280.

New Inventories = $191400-$161385=$30015

Now, Current ROE= (Net Income/ common equity)*100= ($15000 / $286665)*100 =5.23%

New ROE= (Net income/ New common Equity)*100= ($15000/ $125280)*100= 11.97%

Therefore, ROE increased from 5.23% to 11.97%.

Now, New Quick ratio = (New Current Assets-New Inventories)/ Current liabilities=($155730-$30015)/$77865=1.61x

jeff jeffy answered 2 years ago

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