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23 May, 08:52

Last year Ann Arbor Corp had $155,000 of assets, $305,000 of sales, $20,000 of net income, and a debt-to-total-assets 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. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE

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  1. 23 May, 09:08
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    13.42%

    Explanation:

    The computation of return on equity is shown below:-

    Debt = Assets * (Debt to assets ratio)

    $155,000 * 37.5%

    = $58,125

    Equity = Total Assets - Debt

    = $155,000 - $58,125

    = $96,875

    Old Return on equity = Old Net Income : Equity

    =$20,000 : $96,875

    = 20.64%

    New Return on equity = New Net Income : Equity

    = $33,000 : $96,875

    = 34.06%

    Increased in Return on equity = New Return on equity - Old Return on equity

    = 34.06% - 20.64%

    = 13.42%
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