BEC – Return On Equity after Refinance?

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    Topic
  • #201408
    Mole351
    Participant

    Sorry for not posting in the BEC study group…can’t find where it will let me do so? Anyway – confused on this question from NINJA MCQ.

    Spear Corp. had sales of $2,000,000, a profit margin of 11%, and assets of $2,500,000. Spear decided to reduce its debt ratio to 0.40 from 0.50 by selling new common stock and using the proceeds to repay principal on some outstanding long-term debt. After the refinancing, what is Spear’s return on equity?

    A.

    3.5%

    B.

    5.3%

    C.

    14.7%

    D.

    22.9%

    FAR - 87 (5/15)
    AUD - 93 (8/15)
    REG - 86 (2/16)
    BEC - 87 (5/16)

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  • #772706
    Mole351
    Participant

    Why would the equity amount used be the % of the assets prior to the refinance? doesn't that change with the refi? $1.5M is 60% of the total assets prior to the refi. Are they not ISSUING new CS…only selling new stock? (is there a difference?) answer below:

    Answer is C. Here is the explanation:
    Assets total $2,500,000. The sum of liabilities and equity also equals $2,500,000. The company will have debt equal to 40% of the $2,500,000, or $1,000,000. That leaves equity of $1,500,000. Since the profit is 11% of the $2,000,000 sales, the company has a profit of $220,000. Return on equity is net income divided by equity; profit of $220,000 divided by equity of $1,500,000 gives return on equity of 14.7%.

    FAR - 87 (5/15)
    AUD - 93 (8/15)
    REG - 86 (2/16)
    BEC - 87 (5/16)

    #772707
    ohiostategirlcpa
    Participant

    The refinancing is a distractor. It is irrelevant to solving the problem. Only the final results count, ie the .4 debt ratio.

    F91 A95 R90 B94
    CMA since 2015
    (Gleim books/PDFs, MCQs, SIMS)

    #772708

    Problem tells you Debt it going from .5 to .4 – so that means Equity must be going from .5 to .6 2.5M*.6=1.5M in Equity

    AUD - 75
    BEC - 79
    FAR - 81
    REG - 75
    Happily Finished

    FAR - Aug 2015 (58), Feb 2016 (81)
    u
    BEC - May 2016 (79)
    AUD - Jul 2016
    REG - Aug 2016

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