Question

Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $205,000 and its net income was $10,600. The firm finances using only debt and common equity and its total assets equal total invested capital. The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $10,250 without changing its sales, assets, or capital structure. Had it cut costs and increased its net income by this amount, how much would the ROE have changed? Do not round your intermediate calculations.

Answer 1

First, the ROE is calculated without lowering costs and operating efficiently.

Information provided:

Asset turnover= 1.33

Equity multiplier= 1.75

Sales= $205,000

Net income= $10,600

Net profit margin is calculated as below:

Net profit margin= Net income/ Revenue

                                  = $10,600/ $205,000

                                  = 0.0517*100

                                  = 5.17%

ROE is calculated using the below formula:

ROE= Net profit margin*Asset turnover*Equity multiplier

ROE= 0.0517*1.33*1.75

        = 0.1203*100

        = 12.03%

The new net profit margin is calculated as below:

New net income= $10,600 + $10,250= $20,850

New net profit margin= $20,850/ $205,000

                                           = 0.1017*100= 10.17%

New ROE= 0.1017*1.33*1.75

                  = 0.2367*100

                  = 23.67%

Change in ROE:

= New ROE – Old ROE

= 23.67% - 12.03%

= 11.64%

Therefore, the ROE has increased by 11.67%.

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