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16 February, 13:51

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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  1. 16 February, 14:31
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    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%
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