# Question

Use the following financial data for Greta’s Gadgets, Inc., to determine the impact of using additional debt financing to purchase additional assets. Assume that an additional $1 million of assets is purchased with 100 percent debt financing with a 10 percent annual interest rate.

a. Calculate the current (2012) net profit margin, total asset turnover, assets-to-equity ratio, return on total assets, and return on common equity for Greta’s Gadgets.

b. Now, assuming no other changes, determine the impact of purchasing the $1 million in assets using 100 percent debt financing with a 10 percent annual interest rate. Further assume that the newly purchased assets generate an additional $2 million in sales and that the costs and expenses remain at 90 percent of sales. For purposes of this problem, further assume a tax rate of 40 percent. What is the effect on the ratios calculated in part (a)? Is the purchase of these assets justified on the basis of the return on common equity?

c. Assume that the newly purchased assets in part (b) generate only an extra $500,000 in sales. Is the purchase justified in this case?

d. Which component ratio(s) of the DuPont system is not affected by the change in sales? What does this imply about the use of financial leverage?

a. Calculate the current (2012) net profit margin, total asset turnover, assets-to-equity ratio, return on total assets, and return on common equity for Greta’s Gadgets.

b. Now, assuming no other changes, determine the impact of purchasing the $1 million in assets using 100 percent debt financing with a 10 percent annual interest rate. Further assume that the newly purchased assets generate an additional $2 million in sales and that the costs and expenses remain at 90 percent of sales. For purposes of this problem, further assume a tax rate of 40 percent. What is the effect on the ratios calculated in part (a)? Is the purchase of these assets justified on the basis of the return on common equity?

c. Assume that the newly purchased assets in part (b) generate only an extra $500,000 in sales. Is the purchase justified in this case?

d. Which component ratio(s) of the DuPont system is not affected by the change in sales? What does this imply about the use of financial leverage?

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