Jerry Rice and Grain Stores has $4,030,000 in yearly sales. The firm earns 2.2 percent on each dollar of sales and turns over its assets 4 times per year. It has $140,000 in current liabilities and $343,000 in long-term liabilities. Required:
a. What is its return on stockholders' equity?
b. If the asset base remains the same as computed in part a, but total asset turnover goes up to 4.50, what will be the new return on stockholders' equity?

a. Return on stockholders' equity = 16.90%

b. New return on stockholders' equity = 18.62%

Explanation:

a. What is its return on stockholders' equity?

Assets turnover = Sales / Total assets ……………. (1)

Therefore, we have:

Total assets = Sales / Assets turnover = $4,030,000 / 4 = $1,007,500

Total liabilities = Current liabilities + Long-term liabilities = $140,000 + $343,000 = $483,000

Stockholders' equity = Total assets - Total liabilities = $1,007,500 - $483,000 = $524,500

Net income = Sales * Percentage earns on each dollar sales = $4,030,000 * 2.2% = $88,660

Return on stockholders' equity = Net income / Stockholders' equity = $88,660 / $524,500 = 0.1690, or 16.90%

b. If the asset base remains the same as computed in part a, but total asset turnover goes up to 4.50, what will be the new return on stockholders' equity?

Based on equation (1) in part a above, we can have:

New sales = New total asset turnover * Total assets from part a above = 4.50 * $1,007,500 = $4,533,750

New net income = New sales * Percentage earns on each dollar sales = $4,533,750 * 2.2% = $99,742.50

New stockholders' equity = Stockholders' equity in part a above + (New net income - Net income in part a above) = $524,500 + ($99,742.50 - $88,660) = $535,582.50

New return on stockholders' equity = New net income / New stockholders' equity = $99,742.50 / $535,582.50 = 0.1862, or 18.62%

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