Question

Question 211 pts

Garamond Corporation reported the following income statement and balance sheet for the previous year:

Balance Sheet
Cash	P   100,000
Inventories	1,000,000
Accounts receivable	500,000
Current assets	P1,600,000
			Total debt	P4,000,000
Net fixed assets	4,400,000		Total equity	2,000,000
Total assets	P6,000,000		Total claims	P6,000,000

Income Statement
Sales	P3,000,000
Operating costs	1,600,000
Operating income (EBIT)	P1,400,000
Interest	400,000
Taxable income (EBT)	P1,000,000
Taxes (40%)	400,000
Net income	P   600,000

The company’s interest cost is 10%, so the company’s interest expense each year is 10% of its total debt. While the company’s financial performance is quite strong, its CFO is always looking for ways to improve. The CFO has noticed that the company’s inventory turnover ratio is considerably weaker than the industry average, which is 6.0. The CFO asks what the company’s ROE would have been last year if the following had occurred:

• The company maintained the sale sales, but was able to reduce inventories enough to achieve the industry average inventory turnover ratio.
• The cash that was generated from the reduction in inventories was used to reduce part of the company’s outstanding debt. So, the company’s total debt would have been P4 million less the freed-up cash from the improvement in inventory policy. The company’s interest expense would have been 10% of new total debt.
• Assume equity does not change. (The company pays all net income as dividends.)

What would have been the company’s ROE last year?

Group of answer choices

31.5%

30.3%

27.0%

29.5%

Answer 1

Income Statement given
Sales	30,00,000
Operating costs	16,00,000
Operating income (EBIT)	14,00,000
Interest	4,00,000
Taxable income (EBT)	10,00,000
Taxes (40%)	4,00,000
Net income	6,00,000
Company Inventory Turnover Ratio	Sales / Inventory
	3000000/100000
Invetory Turnover ratio	3
Industry average	6
Therefore reduce Inventory 50%	1000000 x 50%
Invetory level	500000
Revised Investory TOR	3000000/500000
	6
Redused Investory cash used to reduced debt	500000
Debt	4000000
Revised debt	4000000-500000
	3500000
Interst on debt will be	3500000 x 10%
	350000
Income Statement Revised to find ROE
Sales	30,00,000
Operating costs	16,00,000
Operating income (EBIT)	14,00,000
Interest	3,50,000
Taxable income (EBT)	10,50,000
Taxes (40%)	4,20,000
Net income	6,30,000
ROE	Net Income / Share Capital x 100
	630000/2000000 x 100
ROE	31.5
ROE Previous Year	31.50%