Last year Rosenberg Corp. had $195,000 of assets, $18,775 of net income, and a debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales and total assets will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE

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Business

Jensen Cummings

20 March, 23:58

Last year Rosenberg Corp. had $195,000 of assets, $18,775 of net income, and a debt-to-total-assets ratio of 32%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales and total assets will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE

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Santiago Rivers · Answer 1

Increase in ROE 4.36%

Explanation:

Assets $195,000

Old debt ratio 32%

Old debt (32%*$195,000) $62,400

Old equity ($195,000-$62,400) $132,600

New debt ratio 48%

New debt (48% * $195,000) $93,600

New Equity ($195,000-$93,600) $101,400

Net income $18,775

New ROE 18.52%

Old ROE 14.16%

Increase in ROE 4.36%