The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.75, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change? a. 11.26% b. 11.85% c. 13.07% d. 13.72% e. 12.45%

Question

Business

Francesca Potter

13 April, 03:18

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.75, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change? a. 11.26% b. 11.85% c. 13.07% d. 13.72% e. 12.45%

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Lila Decker · Answer 1

B 11.85%

Explanation:

Target current ratio = Current assets/current liabilities = 2.75

Target current assets = 2.75*70,000 = 192500

Inventory to sell = Exiting current asset - required current asset = 364,000-192500 = 171,500

New common equity = 280,000-171,500 = 108,500

Old ROE = 21,000/280,000 = 7.5%

New ROE = 21,000/108,500 = 19.35%%

ROE change = 11.85%