Question

Last year Meyer Corp had $415,000 of assets, $403,000 of sales, $28,500 of net income, and a debt-to-total-capital ratio of 39%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets and total invested capital to $254,000. Sales, costs, and net income would not be affected, and the firm would maintain the same % capital structure but with less total debt. By how much would the reduction in assets improve the ROE of the company?

Answer 1

Given information

Assets =$415000

sales = $403000

Net Income = $28500

Debt to capital ratio will be 39%

i.e debt is 39% and capital 61%

As per Balance sheet Total Assets = Total liabilities

Here Total Liabilities = Capital + Debt

As per given information we have Assets amounts to $415000

Hence Total Liabilities also $415000

Share of capital = $415000*61/100

= $253150

Share of Debt = $415000*39/100

=161850

Calculation of present Return on equity :

Return on equity = Net income/Total capital employed*100

= 28500/253150*100

=11.25%

Calculation of Return on equity based on New CFO proposal:

As New CFO advise we selling the assets and inventory and reduce its total assets and total invested capital to $254,000

Hence Sale proceeds worth will be =$161000 ($415000-$254000)

In order to maintain same Debt to Capital ration we use sale proceed funds to repay the debt and Capital in the ratio of 39% & 61%.

New Capital structure will be as follows

Capital Structure
Particulas	Before CFO proposal	Sale proceeds	After CFO proposal
Capital	253150	98210	154940
Debt	161850	62790	99060

New ROE = Net income/capital employed*100

= 28500/154940*100

=18.40%

Conclusion:

By selling Assets and inventory worth $161000 the ROE is increased from 11.25% to 18.40%