Question

The Sooner Equipment Company has total assets of $90 million. Of this total, $40 million was financed with common equity and $50 million with debt (both long and short-term). Its average accounts receivable balance is $20 million, and this represents an 85-day average collection period. Sooner believes it can reduce its average collection period from 85 to 65 days without affecting sales or the dollar amount of net income after taxes (currently $4.71 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: %

New debt ratio: %

Old return on assets: %

New return on assets: %

Old return on common equity: %

New return on common equity: %

Answer 1

Reduction in accounts receivable = $4.71 million (20 days x $0.2355 million per day)

New total assets after stock repurchase = $85.29 million ( $ 90 - $ 4.71 ) .

New common equity after stock repurchase = $35 million

Debt ratio:                               Old = 55.56%

New = 58.62% ($50/$85.29)

Return on assets: Old = 5.23% ($4.71/$90)

New = 5.52% ($4.71/$85.29)

Return on common equity:     Old = 11.775% ($4.71/$40)

                                                New = 13.35% ($4.71/$35.29)