Question

Pacific Packaging's ROE last year was only 3%; but its management has developed a new operating plan that calls for a debt-to-capital ratio of 60%, which will result in annual interest charges of $765,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $1,802,000 on sales of $17,000,000, and it expects to have a total assets turnover ratio of 1.2. Under these conditions, the tax rate will be 30%. If the changes are made, what will be the company's return on equity? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Step 1: Total asset

Total assets turnover ratio = Turnover / Total assets = 1.2

Total assets = Turnover/1.2

= 17000000/1.2

= 14166666.6667

Step 2: Shareholder's Equity

Question specifically says that total assets equal total invested capital and 60% of invested capital consist of debt

Shareholder's Equity = Total assets*(1-.6)

= 14166666.6667*.4

= 5666666.66668

Step 3: Net income

a	EBIT	1,802,000
b	Less: Interest	765,000
c	EBT (a-b)	1,037,000
d	Less: Tax @ 30%	311,100
e	Net Income (c-d)	725,900

Step 4: Return on equity

Return on equity ROE = Net Income / Shareholder's Equity

= 725900 / 5666666.66668

= .1281

= 12.81%