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 55%, which will result in annual interest charges of $833,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $1,938,000 on sales of $17,000,000, and it expects to have a total assets turnover ratio of 1.9. Under these conditions, the tax rate will be 25%. 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

EBIT	$1,938,000
Interest	($833,000)
Earnings before tax	$1,105,000
Tax($1,105,000 * 25%)	($276,250)
Earnings after interest and taxes	$828,750

Asset turnover ratio = total revenue / total assets

1.9 = $17,000,000 / total assets

total assets = $8,947,368.42

Equity ratio = 1 - debt ratio

Equity ratio = 1 - 0.55 = 0.45

Total Equity = equity ratio * total assets

Total Equity = 0.45 * $8,947,368.42

Total Equity = $4,026,315.79

Return on Equity = Net income / Equity

Return on Equity = $828,750 / $4,026,315.79

Return on Equity = 0.2058 or 20.58%