Question

Last year Kruse Corp had $380,000 of assets (which is equal to its total invested capital), $403,000 of sales, $28,250 of net income, and a debt-to-total-capital ratio of 39%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets and total invested capital to $252,500. The firm finances using only debt and common equity. Sales, costs, and net income would not be affected, and the firm would maintain the same capital structure (but with less total debt). By how much would the reduction in assets improve the ROE (percentage point change)

Answer 1

Answer:

 =6.154%

Explanation:

                               Original                                New

Assets                   $380,000                              $252,500

Sales                      $403,000                              $403,000

Net income            $28,250                                $28,250

Debt ratio                39.00%                                39.00%

Debt = Assets × debt % = $148,200                    $98,475

Equity = Assets − Debt =  $231,800                   $154,025

ROE = NI/Equity =      12.187%                               18.341%

Increase in ROE = 18.341%-12.187%

                        = 6.154%

Therefore,  the reduction in assets improve the ROE  (percentage point change)  is 6.154%