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    Question: Austral & Company Has A Debt Ratio of 0.5, A Total Assets Turnover Ratio of 0.25, and A Pro ..

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    Malik Asad

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    Question: Austral & Company has a debt ratio of 0.5, a total


    assets turnover ratio of 0.25, and a pro ...

    Austral & Company has a debt ratio of 0.5, a total assets turnover ratio of 0.25, and a profit margin of 10%.
    The Board of Directors is unhappy with the current return on equity (ROE), and they think it could be
    doubled. This could be accomplished (1) by increasing the profit margin to 12% and (2) by increasing debt
    utilization. Total assets turnover will not change. What new debt ratio, along with the new 12% profit margin,
    would be required to double the ROE?

    Expert Answer

    Anonymous
    answered this

    CURRENT ROE = Pro t margin * Asset turnover * Equity multiplier

                                = 10 * .25 * 2

                                = 5%

    **Let Asset be 1 so debt = 1*.50 = .50 .Equity = total asset - total debt

                                      = 1 -.50 = .50

    Equity multiplier = Asset /equity

                        = 1 /.50

                        = 2

    Now ,Double ROE = 5 * 2 = 10%

    10 = 12 * .25 *Equity multiplier


    10 = 3 * EM

    Equity multiplier = 10 /3 = 3.33

    Let equity be 1 so Total asset = 3.33 . Therefore debt = 3.33 - 1 = 2.33

    Debt ratio = 2.33/3.33

                 = .70

    New debt ratio = .70

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