Finance question…?

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Midwest Packaging’s ROE last year was only 3 percent, but its management has developed a new operating plan that calls for a total debt ratio of 60 percent, which will result in annual interest charges of $ 300,000. Management projects an EBIT of $ 1,000,000 on sales of $ 10,000,000, and it expects to have a total assets turnover ratio of 2.0. Under these conditions, the tax rate will be 34 percent. If the changes are made, what will be its return on equity?

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  1. Reply
    EJMA (Philippines)
    July 21, 2011 at 2:59 am

    ANSWER: 23.10%

    EBIT $ 1000000
    Interest 300000
    Earnings before tax $ 700000
    Tax (34%) $ 238000
    Earnings after interest and taxes $ 462000

    Asset turnover ratio = total revenue / total assets
    2 = $ 10000000 / total assets
    Total Assets = $ 5000000

    Equity ratio = 1 – debt ratio
    Equity ratio = 40%

    Total Equity = equity ratio x total assets
    Total equity = 40% x $ 5000000
    Total equity = $ 2000000

    Return on Equity = $ 462000 / $ 2000000
    Return on Equity = 23.10%

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