Question

Last year Urbana Corp. had $160,000 of assets, $307,500 of sales, $19,575 of net income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE?

Answer 1

The difference in the ROE is computed as shown below:

ROE is computed by using the below mentioned formula:

ROE = Net Income / Equity

Old ROE is computed as follows:

Equity is computed as follows:

= Total Assets x ( 1 - debt to total asset ratio )

= $ 160,000 ( 1 - 0.375 )

= $ 100,000

So the ROE will be:

= $ 19575 / $ 100,000

= 19.575%

New ROE is computed as follows:

Equity is computed as follows:

= Total Assets x ( 1 - debt to total asset ratio )

= $ 160,000 ( 1 - 0.375 )

= $ 100,000

So the ROE will be:

= $ 33,000 / $ 100,000

= 33%

So the difference in the ROE is:

= 33% - 19.575%

= 13.525%

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