You are considering adding a new product to your firm's existing product line. It should cause a 15 percent increase in your total margin (i.e., new TM = old TM x 1.15), but it will also require a 50 percent increase in total assets (i.e., new TA = old TA x 1.5). You expect to finance this asset growth entirely by debt. If the following ratios were computed before the change, what will be the new return on equity if the new product is added and sales remain constant?

H35 2 PROBLEM 10 3 You are considering adding a new product to your firm's existing product line. It should cause a 4-15 percent increase in your total margin (i.e., new TM-old TM x 1.15), but it will also require 5 a 50 percent increase in total assets (i.e., new TA -old TAx 1.5). You expect to finance this asset 6gowth entirely by debt. If the following ratios were computed before the change, what will be 7 the new return on equity if the new product is added and sales remain constant? 9 Ratios before new product 10 Total margin 11 Total assets turnover 12 Equity multiplier 13 14 ANSWER 10% 15 New total margin: (0.10(1.15)-0.115 15 New total margin: (0.10)(1.15)= 0.115 16 New total asset turnover: 2.0/1.5 1.33 17 New return on assets: (0.115)(1.33) 0.153 18 New equity multiplier: 2.0(1.5)-3.0 19 Return on equity: (0.153)(3.0)-0.46-46% 20 21 Spreadsheet solution: Total margin Total assets turnover Equity multiplier Increase in total margin Increase in total assets 23 24 25 26 27 28 29 30 31 32 Yew total margin New total assets turnover New return on assets New equity multiplier Return on equity 0.0% 0.00 0.00% 0.0 0.0% 34 35 36 37 38 39 40 42 43 45