Pacific Packaging's ROE last year was only 6%; but its management has developed a new operating plan that calls for a debt-to-capital ratio of 40%, which will result in annual interest charges of $336,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $560,000 on sales of $8,000,000, and it expects to have a total assets turnover ratio of 3.4. Under these conditions, the tax rate will be 30%. If the changes are made, what will be the company's return on equity

Question

Whiskey

Business

1 May, 10:35

Pacific Packaging's ROE last year was only 6%; but its management has developed a new operating plan that calls for a debt-to-capital ratio of 40%, which will result in annual interest charges of $336,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $560,000 on sales of $8,000,000, and it expects to have a total assets turnover ratio of 3.4. Under these conditions, the tax rate will be 30%. If the changes are made, what will be the company's return on equity

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Leyla Holland · Answer 1

0.11%

Explanation:

Given that

Earning before interest and tax = $560,000

Interest = $336,000

The computation of company's return on equity is shown below:-

So, the Earning before tax

= $560,000 - $336,000

= $224,000

Tax = $224,000 * 30%

= $67,200

Earnings after interest and taxes = Earning before tax - Tax

= $224,000 - $67,200

= $156,800

Asset turnover ratio = total revenue : total assets

3.4 = $8,000,000 : total assets

Total assets = 2,352,941.18

Equity ratio = 1 - debt ratio

= 1 - 0.40

= 0.60

Total Equity = equity ratio * total assets

= 0.60 * 2,352,941.18

= 1,411,764.71

Return on Equity = Net income : Equity

= $156,800 : 1,411,764.71

= 0.11%