Last year Kruse Corp had $305,000 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?
A)2.85%
B)3.00%
C)3.16%
D)3.31%
E)3.48%

Question

Quizplus · Accepted Answer

Firstly, let's calculate the current ROE:

ROE = Net Income / Shareholders' Equity

We know that Total Invested Capital = Assets = $305,000

And Debt-to-Total-Capital Ratio = Debt / (Debt + Equity) = 39%

Therefore, Equity / Total Invested Capital = 1 - Debt-to-Total-Capital Ratio = 61%

Equity = 61% x $305,000 = $186,050

ROE = $28,250 / $186,050 = 15.17%

Now, let's calculate the new ROE assuming the reduction in assets:

Total Invested Capital = Assets = $252,500

Equity / Total Invested Capital = 61%

Equity = 61% x $252,500 = $154,025

ROE = $28,250 / $154,025 = 18.33%

The improvement in ROE = New ROE - Current ROE = 18.33% - 15.17% = 3.16%

Therefore, the answer is (C) 3.16%.

Last Year Kruse Corp Had $305,000 of Assets (Which Is