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20 July, 22:43

Last year Urbana Corp. had $197,500 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

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  1. 20 July, 22:52
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    Increase in Return on equity = 10.876%

    Explanation:

    Given:

    Assets = $197,500

    Sales = $307,500

    Old net income = $19,575

    New net income = $33,000

    Debt-to-total-assets ratio = 37.5% = 37.5 / 100 = 0.375

    Computation of total debt:

    Debt-to-total-assets ratio = Debt / Assets

    0.375 = Debt / $197,500

    Debt = 74,063 (approx)

    Equity-to-total-assets ratio = 1 - Debt-to-total-assets ratio

    Equity-to-total-assets ratio = 1 - 0.375

    Equity-to-total-assets ratio = 0.625

    Computation of total Equity:

    Equity-to-total-assets ratio = Equity / Assets

    0.625 = Equity / $197,500

    Equity = $123,438 (approx)

    Return on equity = (Net income / Equity) * 100

    Return on equity (Old net income) = ($19,575 / $123,438) * 100

    Return on equity (Old net income) = 15.858%

    Return on equity (New net income) = ($33,000 / $123,438) * 100

    Return on equity (New net income) = 26.734%

    Increase in Return on equity = 26.734% - 15.858%

    Increase in Return on equity = 10.876%
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