Question

Your sister is thinking about starting a new business. The company would require $425,000 of assets, and it would be financed entirely with common stock. She will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to warrant starting the business?

Answer 1

Net income = $133,875

Step-by-step explanation:

The amount of net income that must be earned to proceed with the investment is that which produces a return on equity of 13.5%

Return on equity is the proportion of the equity investment that is earned as net income. It is computed as follows:

Return on equity (ROE) = net income /equity capital

Equity capital in this case is the same as the total asset value of 425,000 because the assets were financed entirely with common stock.

We substitute the values as follows:

13.5% = Net income/425,00

Cross multiply

Net income = 0.135 × 425,000 = $133,875

Net income = $133,875