Pacific Packaging's ROE last year was only 3%, but its management has developed a new operating plan that calls for a debt-to-capital ratio of 45%, which will result in annual interest charges of $546,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $1,344,000 on sales of $14,000,000, and it expects to have a total assets turnover ratio of 3.2. Under these conditions, the tax rate will be 25%. If the changes are made, what will be the company's return on equity?

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Business

Maximo Collins

11 December, 11:51

Pacific Packaging's ROE last year was only 3%, but its management has developed a new operating plan that calls for a debt-to-capital ratio of 45%, which will result in annual interest charges of $546,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $1,344,000 on sales of $14,000,000, and it expects to have a total assets turnover ratio of 3.2. Under these conditions, the tax rate will be 25%. If the changes are made, what will be the company's return on equity?

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Charlie Ochoa · Answer 1

Total asset turnover = Sales/total assets

3.2 = 14000000/Total assets

Total assets = 4375000

E/A = 1-D/A = 1-0.45 = 0.55

Equity = E/A*assets = 0.55*4375000=2406250

Net income = (EBIT-interest) * (1-tax rate)

= (1344000-546000) * (1-0.25) = 598500

ROE = Net income/total equity

ROE% = 598500/2406250=0.248

ROE% = 24.8