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Projected Return on Equity

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You have been provided financial information (see following page) of the Crum Company (CC). The firm expects sales to grow by 50% next year, and operating costs should increase at the same rate. Fixed assets were being operated at 40% of capacity this past year, but all other assets were used to full capacity. Underutilized fixed assets cannot be sold. Current assets and spontaneous liabilities (A/P and Accruals) should increase at the same rate as sales next year. CC plans to finance any Additional Funds Needed (AFN) as 35% Notes Payable (short-term debt) and 65% common stock (Common Equity). After taking financial feedbacks (refer to pages 497-505) into account, and after the 2nd pass, determine CC's projected Return on Equity (ROE = Net Income / Common Equity) using the Percent of Sales Method.

Is the ROE:

a. 16.98%
b. 23.73%
c. 25.68%
d. 19.61%
e. 23.24%

SHOW ALL WORK.

See following page for the format.

Crum Company Financial Information: Growth rate = 50%
(NOTE COLUMNS ARE NOT LINED UP RIGHT ON THIS SO SEE ATTACHMENT)
INCOME STATEMENT Past Year Next Year
1st Pass Next Year
2nd Pass Next Year
Final
Sales $ 1,000.00
Operating Costs, 80% 800.00
EBIT 200.00
Interest 16.00
EBT 184.00
Taxes, 40% 73.60
Net Income 110.40
Dividends, 60% 66.24
Addition to Retained Earnings 44.16
BALANCE SHEET
Current Assets $ 700.00
Net Fixed Assets 300.00
Total Assets $ 1,000.00

A/P and Accruals $ 150.00
N/P, 8% 200.00
Common Stock 150.00
Retained Earnings 500.00
Total Liabilities & Common Equity $ 1,000.00

AFN Past Year Next Year, 1st Pass Next Year, 2nd Pass
Profit Margin 11.04%
ROE 16.98%
Debt / Assets 35.00%
Current Ratio 2.0 times
Payout Ratio 60.00%

AFN Financing Weights Dollars Interest Expense
Notes Payable 0.3500
Common Stock 0.6500
TOTAL 1.0000

(Check format on attachment for clearer column line ups)

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The solution explains how to calculate the projected ROE using the percentage of sales method

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