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Common equity

Last year, Urbana Corp. had $197,500 of assets, $307,500 of sales, $19,575 of net income, and a debt-to-total assets ratio of 37.5%. The new CFO believes a new computer software application 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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Below are my answers.


Debt-to-total assets = 37.5%
Assets = $197,500
Old ROE = $19,575/$123,437.50 = 15.86%

Equity = (1 - 37.5%)*$197,500 = $123,437.50
New ROE = $33,000/$123,437.50 = 26.73%

ROE improved by 68.58%.

Please double check your formula. Equity multiplier is total assets / total ...

Solution Summary

Effects of cost reduction are studied.