Return on equity and quick ration: a company has sales of $200,000,
Return on equity and quick ration: A company has sales of $200,000, a net income of $15,000 and the following balance sheet:
Cash $10,000 Accounts payable $ 30,000
Receivables $50,000 other current liabilities$ 20,000
Inventories $150,000 Long term debt $ 50,000
Net fixed assets$90,000 Common equity $200,000
———— ————
Total assets $300,000 Total liabilities & equity$300,000
The new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average of 2.5x, without affecting either sales or net income. If inventories are sold off and not replaced thus reducing the current ratio to 2.5x, if the funds generated are used to reduce common equity (stock can be repurchased at book value), and if no other changes occur, by how much will the ROE change? What will be the firm’s new quick ratio?
