Understanding Business Finance

Ilovemyboo asked:


I’m studying two identical companies, but with different working capital investments.
Can someone show me how to figure out the ROE’s for the two companies and tell me which one earns the most for its
OWNERS. Use the data below

Both companies have
$1,200,000 in fixed assets
pay 10% in interest expense
pay taxes of 35%
and have EBIT’s of 12% of Assets
Sales for both are $2,000,000
the Debt to Assets ratio is 60%

Company A has decided to invest 40% of sales in Current Assets
Company B has decided to invest 55% of sales in Current Assets

Adrian

2 Responses to “Business Finance?”

1. bizzbagg Says:
   October 21st, 2011 at 2:42 pm

   The net income divided by shareholders equity on both companies net income and shareholders equity on both companies net income divided by shareholders equity roe need the net income and shareholders equity roe need the net income and shareholders.
   The net income divided by shareholders equity roe need the net income divided by shareholders equity on both companies net income and shareholders equity roe need the net income and shareholders equity on both companies net income and shareholders equity on both companies net income and shareholders equity on both companies net income.

2. Someguy Says:
   October 23rd, 2011 at 11:26 am

   Intuitively, since the main difference is that A invested less in current assets, we know A has less assets and also less equity (equity = asset - debt = assets * (1-60%)). So since both have the same income, A has a higher ROE.

   The details:

   ROE = return/equity = net profit / assets - liabilities

   net profit = EBIT - interest - taxes
   EBIT = earning before interest and taxes
   EBIT = $1.2m * 12% = $144k
   interest = $1.2m * 10% = $120k
   EBT = $144k-120k=24k
   taxes = 24k*35%= $8.4
   net profit = $15600

   assets = current assets + fixed assets
   A current assets = 40% sales = (assumed) 40% EBIT = $57.6k
   B current assets = 55% sales = (assumed) 55% EBIT = $79.2k
   A assets = $57.6k + $1.2m = $1.2576m
   B assets = $79.2k + $1.2m = $1.2792m

   liabilities = (assumed) debt = assets * 60%
   A liabilities = $1.2576m * 60% = $754.56k
   B liabilities = $1.2792m * 60% = $767.52k

   ROE = $15600 / assets-liabilities
   A ROE = $15600 /($1.2576m-$754.56k)
   =$15600/503,040=3.101%
   B ROE = $15600 /($1.2792m-$767.52k)
   =$15600/511,680=3.049%