Question

In 2019, the company CC Tbk. reported sales of $ 205,000 with assets of $ 127,500. In addition, the profit margin was 5.3% and the equity multiplier was 1.2. The board of directors of the company had confidence that the company's assets could be reduced by a total of $ 21,000 without affecting sales and costs.

Question

With this policy of reducing assets, while the debt ratio, sales and costs remain constant, how many changes in ROE (Return on Equity) will occur? Make calculations with explanations!

Answer 1

Reported Sales = $ 205,000

Assets = $ 127,500

Profit Margin = 5.3%

Equity Multiplier = 1.2 Return on Assets = Sales / Assets -> $205,000/$127,500 = 1.6078

Return on Equity = Net Profit Margin X Return on Assets X Financial Leverage

=0.053 * 1.6078 * 1.2

= 0.102256 or 0.1023

When the company's assets is reduced by a total of $ 21,000 without affecting sales and costs the

New Return on Equity is

Reported Sales = $ 205,000

Assets = $ 127,500 - $21,000 = $106,500

Profit Margin = 5.3%

Equity Multiplier = 1.2 Return on Assets = Sales / Assets -> $205,000/$106,500 = 1.92488 or 1.925

New Return on Equity = Net Profit Margin X Return on Assets X Financial Leverage

= 0.053 * 1.925 * 1.2

= 0.1224

Therefore Change in Return on Equity = New Return on Equity - Old Return On Equity

=  0.1224 - 0.1023

= 0.0201

= 2.01%