Question

The Sooner Equipment Company has total assets of $110 million. Of this total, $40 million was financed with common equity and $70 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 60 days without affecting sales or the dollar amount of net income after taxes (currently $6 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: 64% New debt ratio: 67% Old return on assets:  % New return on assets:  % Old return on common equity: 15% New return on common equity:  % Need answers to the old return of assets, new return of assets, and new return on common equity. round to two decimals if necessary.

Answer 1

Average Daily Amount of Uncollected Sales = $300,000

If Average Collection period is reduced to 60 days from 80 days

Then Accounts Receivable Balance will be reduced to

Accounts Receivable Balance = $18,000,000

Original Return on Investments = 5.45%

Since the accounts receivable balance is now reduced by 6,000,000 i.e., (24,000,000 - 18,000,000)

Total Assets are reduced to = $110,000,000 - $6,000,000 = $104,000,000

Revised Return on Investments = 5.77%

Original Return on Shareholder's Equity = 15%

Revised Return on Shareholder's Equity = 17.65%

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