Last year Ann Arbor Corp had $195,000 of assets (which equals total invested capital),$305,000 of sales,$20,000 of net income,and a debt-to-total-capital ratio of 37.5%.The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000.The firm finances using only debt and common equity.Assets,total invested capital,sales,and the debt to capital ratio would not be affected.By how much would the cost reduction improve the ROE? Do not round your intermediate calculations.
A) 8.85%
B) 10.88%
C) 10.45%
D) 12.37%
E) 10.67%

Question

Quizplus · Accepted Answer

The initial ROE is calculated as Net Income / Equity. With a debt-to-total-capital ratio of 37.5%, equity is 62.5% of total capital, which is $195,000. So, equity = $195,000 * 0.625 = $121,875. Initial ROE = $20,000 / $121,875 = 16.41%. With the new net income of $33,000, the new ROE = $33,000 / $121,875 = 27.07%. The improvement in ROE is 27.07% - 16.41% = 10.67%.

Last Year Ann Arbor Corp Had $195,000 of Assets (Which