Question

LeCompte Corp. has $312,900 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $620,000, and its net income after taxes was $24,655. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15%. What profit margin would LeCompte need in order to achieve the 15% ROE, holding everything else constant?

Answer 1

According to the balance sheet equation:

Assets = Liabilities + Equity

In the case of LeCompte Corp., the Liabilities is zero.

Assets = Equity = $312,900

In order to maintain 15% ROE, LeCompte Corp. will have to achieve a net profit of:

Required Net Profit for 15% ROE = $312,900 * 15% = $46,935

If everything else is constant, the profits would be increased only by lowering the costs, the Sales for the next year is assumed to be again $620,000

Thus, the required Profit Margin = ($46,935 / $620,000) * 100 = 7.57%