Question

Gambona Inc. has sales of $200, net income of $20, total assets of $500, and common equity of $250, all in millions. The new CFO thinks the firm's current asset investment policy is too relaxed, and she proposes to tighten it, reducing inventories and receivables enough to bring total assets down to $300. The total liabilities/assets ratio will be kept at 50%, so common equity will decline from $250 to $150. Assume that this change has no effect on either sales or net income. Using the DuPont equation, by how much would Gambona's ROE increase

Answer 1

ROE increase = 5.33%

Step-by-step explanation:

DuPont Equation (ROE): (Net Income / Sales) x (Sales / Total Assets) x (Total Assets / Average Shareholders Equity)

ROE = ($20 / $200) x ($200 / $500) x ($500 / $250) = 8%

New ROE = ($20 / $200) x ($200 / $300) x ($300 / $150) = 13.33%

Gambona´s ROE would increase by 5.33%