Pacific Packaging's ROE last year was only 6%, but its management has developed a new operating plan that calls for a debt-to-capital ratio of 60%, which will result in annual interest charges of $627,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $2,261,000 on sales of $19,000,000, and it expects to have a total assets turnover ratio of 1.4. Under these conditions, the tax rate will be 25%. If the changes are made, what will be the company's return on equity

Pacific Packaging

The company's return on equity will be:

= 11.63%

Explanation:

a) Data and Calculations:

Debt-to-capital ratio = 60%

Annual Interest charges on debt = $627,000

Projected EBIT = $2,261,000

Sales = $19,000,000

Total assets turnover ratio = 1.4

Tax rate = 25%

Assets = $19,000,000 * 1.4 = $26,500,000

Debt = $26,500,000 * 60% = $15,960,000

Equity = $26,500,000 * 40% = $10,540,000

Net Income:

Projected EBIT = $2,261,000

Interest expense   (627,000)

EBT                     $1,634,000

Taxes (25%)          (408,500)

EAT                    $1,225,500

Return on Equity = $1,225,500/$10,540,000 * 100

= 11.63%

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