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The new CFO thinks that inventories are excessive and could be lowered sufficiently to cau

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cau

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.70, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change?

Sales                                                       $280,000

Net income                                            $21,000

Actual current ratio                                  4.20

Target current ratio                                  2.70

ORIGINAL BALANCE SHEET

Cash $14,000                  Accounts payable $42,000

Receivables $70,000                  Other current liabilities $28,000

Inventories $210,000                  Long-term debt $70,000

Net fixed assets $126,000                  Common equity $280,000

Total assets $420,000                  Total liab. and equity $420,000

NI/Equity = ROE: 7.50%

Inv. at target CR                               $105,000

Reduction in inv & equity $105,000     = inventories and common equity decrease by this amount -(how I can find this number?)

New common equity                    $175,000

New ROE 12.00%

ROE 4.50%

Abhinav 02-Dec-2019

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