Question

Primavera Holding has a profit margin of 25%, an asset turnover of 0.5 and financial leverage (assets to equity) of 1.5. Primavera has $20 billion in assets, of which half is in cash and marketable securities. Assume that primavera earns a 3 percent after-tax return on cash and marketable securities as a dividend to shareholders?

Negative
Between 0% and 20%
Between 20% and 40%
between 40% and 60%
Greater than 60%

Answer 1

Between 40% and 60%.

Step-by-step explanation:

The equity of Primavera Holding will be determined by using financial leverage formula;

Financial Leverage = Asset / Equity

1.5 = $20 billion / Equity

Equity = $20/1.5 = $13.33 billion.

To find out net Income we need to determine sales of the company, for this we will use asset turnover ratio;

Asset turnover = Sales / Assets

0.5 = Sales / $20 billion

Sales = $10 billion.

Profit margin of Primavera Holdings is 25% so net income will be 25% of Sales which is $2.5 billion.

If the company has 90% payout ratio then $9 billion will be given to shareholders as dividend, its assets will reduce to ($20 - $9) $11 billion and equity will be ($13.33 - $9) $4.33 billion and net income will fall by 3% of $9 billion which is $0.27 billion.

The net income after the dividend will become ($2.5 - $0.27) $2.23 billion

The Return On Equity of the company will be = (Net Income / Equity) * 100

ROE = ( $2.23 / $4.33 ) * 100

ROE = 51.50%

The ROE is between 40% and 60% so this is correct answer.