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Last year Elite Tech had $205,000 of assets, $303,500 of sales, $18,250 of net income, and...

Last year Elite Tech had $205,000 of assets, $303,500 of sales, $18,250 of net income, and a debt-to-total-assets ratio of 41%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets to $155,500. Sales, costs, and net income would not be affected, and the firm would maintain the 41% debt ratio. By how much would the reduction in assets improve the ROE?
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Answer #1

Total assets $ 205000

Inventory is sold which enabled the total assets to reduce to $ 155,500

Previous debt to total assets = 41 %

Debt/total assets = 41 %

Debt / 205000 = 41 %

Debt = 205000 * 41 %

= 84050

Current scenario

Total assets = $ 155500

Debt = $ 84050

Equity holders fund = $ 155500 - $ 84050

= $ 71,450

Previously ROE = Net Income/ equity

= $18150/ (205000-84050)

= $ 18150/ 120950

= 15 %

Current ROE = Net Income / Equity

= $ 18150/ 71450

= 25.4 %

Thus, reduction in assets will improve the ROE by 10.4 %

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