Question

Schumacher Corporation had $1,000 in total assets, $800 in total debt (liabilities) and $200 in total...

  1. Schumacher Corporation had $1,000 in total assets, $800 in total debt (liabilities) and $200 in total equity at the end of 2018, and in 2019 it generated 1,500 in sales, $500 in EBIT and $150 in net income. The company did not distribute any 2019 net income.
  1. What was Schumacher’s return on equity in 2019

  1. Calculate Schumacher’s change in leverage from 2018 to 2019 and describe the effect on its probability of financial distress
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Answer #1

The return on equity is also known as ROI is a measure of the profitability of a business in relation to the equity. ROE measures how many dollars of profit are generated for each dollar of shareholder’s equity.

2018 (in dollars)

Equity=200

Liability=800

Assets=1000

In 2019( in dollars)

Equity=200

R. E=150

Liability=800

Total liability is 1150

Calculation of ROE (in dollars)

ROE= Net income ÷ Shareholders equity

2019= 150/350

=0.42

Leverage= Debt ÷ Shareholders equity

In 2018 ( in dollars)

Leverage=800/200

=4

In 2019 ( in dollars)

Leverage=800/350

=2.28

The probability of financial distress is reduced.

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