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25 September, 11:51

Primavera Holding has a profit margin of 25%, an asset turnover of 0.5 and financial leverage (assets to equity) of 1.5. Primavera has $20 billion in assets, of which half is in cash and marketable securities. Assume that primavera earns a 3 percent after-tax return on cash and marketable securities as a dividend to shareholders?

Negative

Between 0% and 20%

Between 20% and 40%

between 40% and 60%

Greater than 60%

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Answers (1)
  1. 25 September, 12:04
    0
    Between 40% and 60%.

    Explanation:

    The equity of Primavera Holding will be determined by using financial leverage formula;

    Financial Leverage = Asset / Equity

    1.5 = $20 billion / Equity

    Equity = $20/1.5 = $13.33 billion.

    To find out net Income we need to determine sales of the company, for this we will use asset turnover ratio;

    Asset turnover = Sales / Assets

    0.5 = Sales / $20 billion

    Sales = $10 billion.

    Profit margin of Primavera Holdings is 25% so net income will be 25% of Sales which is $2.5 billion.

    If the company has 90% payout ratio then $9 billion will be given to shareholders as dividend, its assets will reduce to ($20 - $9) $11 billion and equity will be ($13.33 - $9) $4.33 billion and net income will fall by 3% of $9 billion which is $0.27 billion.

    The net income after the dividend will become ($2.5 - $0.27) $2.23 billion

    The Return On Equity of the company will be = (Net Income / Equity) * 100

    ROE = ($2.23 / $4.33) * 100

    ROE = 51.50%

    The ROE is between 40% and 60% so this is correct answer.
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