Question

2. Georgia Electric reported the following income statement and balance sheet for the previous year: The company’s interest cost is 10 percent, so the company’s interest expense each year is 10 percent of its total debt. While the company’s financial performance is quite strong, its CFO (Chief Financial Officer) is always looking for ways to improve. The CFO has noticed that the company’s inventory turnover ratio is considerably weaker than the industry average, which is 6.0. As an exercise, the CFO asks what would the company’s ROE have been last year if the following had occurred: • The company maintained the same sales, but was able to reduce inventories enough to achieve the industry average inventory turnover ratio. • The cash that was generated from the reduction in inventories was used to reduce part of the company’s outstanding debt. So, the company’s total debt would have been $4 million less the freed-up cash from the improvement in inventory policy. The company’s interest expense would have been 10 percent of new total debt. • Assume equity does not change. (The company pays all net income as dividends.) Under this scenario, what would have been the company’s ROE last year?​

Answer 1

Answer:

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