Star Chemical Inc. (SCI) reported the following year-end data: Depreciation expense $25 million Net income $35 million Dividends $10 million Total assets $250 million Shareholders equity $195 million Effective tax rate 35 percent SCI also reported that it changed from an accelerated depreciation method to straight line depreciation. The change resulted in a decrease in depreciation expense of $5 million. Management felt that the change would not have a material effect on financial performance measures. What are the return on assets (ROA) and return on equity (ROE) measures under the old depreciation methods? A) ROA is 13.30% and ROE is 17.21%. B) ROA is 13.50% and ROE is 17.66%. C) ROA is 13.67% and ROE is 17.21%. D) ROA is 12.96% and ROE is 16.71%.
D… Asset = 250-5 = 245 NI = 35 - .65*5 = 31.75 ROA = 31.75/245 = 12.96
D also…
good question. i make so many errors not being clear in my working out. its not that i did not know how to do it, just not beiing clear.
because of increase of depreciation, NI goes down by 3.25. I guess DTL gets reduced by 1.75 -> there should be reduction of assets by 5. what should be reduction of equity: 5 or 3.25?
I have been trying to work that out to. It is hard to tell. Do they still pay 10 mill in dividends even with the reduction in NI? If they do then I would have calculated Equity as: 195-5-(35-31.75)=186.75 ROE= 31.75/186.75=17% which is wrong (and equity has to be higher since ROE is lower in answer D If you account for the DTL it ROE: 195-5+1.75-(35-31.75)=188.5 ROE= 31.75/188.5= 16.8% which is closer. The other thing that is bothering me about this question is the use of the effective tax rate vs the marginal.
Bcos NI feeds into Retained Earnings - which goes into the Equity component -> it should be 3.25. I think what both Mumu and kabhii have done is use the ROA # which was unique in this case, to determine D as the answer. CP
Depreciation expense descreases. If you expense less than the assets should grow. So why isn’t the asset value 250 + 5 = 255 and do you deduct the 5mn?
I too got confused by this initially. Then realized - the 250 mn. is after the Straight Line Depreciation has been taken. So if the Accel. method had been used before, the Depreciation expense would have been 5 mn. lower. CP
^We need to use the accelerated depreciation method as opposed to the straight line method and therefore will result in a higher dep expense. Higher Dep. expense will lower net PPE (Assets). 250-5=245
> SCI also reported that it changed from an > accelerated depreciation method to straight line > depreciation. The change resulted in a decrease in > depreciation expense of $5 million. > What are > the return on assets (ROA) and return on equity > (ROE) measures under the old depreciation > methods? under old method depreciation was higher -> assets are lower
mcpass Wrote: ------------------------------------------------------- > Depreciation expense descreases. If you expense > less than the assets should grow. So why isn’t the > asset value 250 + 5 = 255 and do you deduct the > 5mn? mcpass – the financial info up top is AFTER the depreciation expense. they are asking for ROA/ROE before the change, meaning before they decreased depreciation. so you have to pretend depreciation was $5mm higher, so you would decrease assets by 5mm to figure out the “old” ratios
I need a drink
maratikus Wrote: ------------------------------------------------------- > because of increase of depreciation, NI goes down > by 3.25. I guess DTL gets reduced by 1.75 -> > there should be reduction of assets by 5. what > should be reduction of equity: 5 or 3.25? I believe 5.
Okay make it 5 drinks then.
dinesh…post the damn answer please!!
Second that ^
Come on Dinesh…get with it! haha…
Guys it’s D. We have such winners here!
Can you show the explanation for ROE?