Last year "ABC" Company had $121646 of assets, $76058 of sales, $19170 of net income, and an equity multiplier of 1.81369. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets to $99391, Sales, costs and net income would not be affected, and the firm would maintain the equity multiplier at the same level (1.81369). By how much would the reduction in assets will change the ROE value?

Answer:

ABC Company

The reduction in assets will change the ROE value by 6% increase, from 29% to 35%.

Explanation:

a) Data and Calculations:

Equity multiplier = total assets divided by stockholders equity

Last year's figures:

Assets = $121,646

Sales = $76,058

Net income = $19,170

Equity multiplier = 1.81369

Equity = Assets/Equity multiplier

= $67,071 ($121,646/1.81369)

Return on equity = $19,170/$67,071 * 100

= 28.6%

= 29%

New figures:

Assets reduced to $99,391

Sales = $76,058

Net income = $19,170

Equity multiplier = 1.81369

Equity = $54,800 ($99,391/1.81369)

Return on equity = $19,170/$54,800 * 100

= 35%

b) The reduction in assets changes the ROE value from 29% to 35%.

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