Primavera Holdings has a profit margin of 25%,an asset turnover of 0.5 and financial leverage (assets to equity)of 1.5.Primavera has $20 billion in assets,of which half is in cash and marketable securities.Assume that Primavera earns a 3 percent after-tax return on cash and securities.What would Primavera's return on equity be if it paid out 90% of its cash and marketable securities as a dividend to shareholders?
A) Negative
B) Between 0% and 20%
C) Between 20% and 40%
D) between 40% and 60%
E) Greater than 60%

Question

Quizplus · Accepted Answer

First we need to calculate Primavera's ROA (Return on Assets) using the formula:

ROA = Net Income / Total Assets

We are given that Primavera's profit margin is 25% and its asset turnover is 0.5, so we can calculate its net income as follows:

Net Income = Profit Margin x Sales
Sales = Asset Turnover x Total Assets

Substituting the given values, we get:

Sales = 0.5 x $20 billion = $10 billion
Net Income = 0.25 x $10 billion = $2.5 billion

Now we can calculate ROA:

ROA = $2.5 billion / $20 billion = 12.5%

Next, we need to calculate Primavera's ROE (Return on Equity) using the formula:

ROE = ROA x Financial Leverage

We are given that Primavera's financial leverage (assets to equity) is 1.5, so we can calculate its equity as follows:

Equity = Total Assets / Financial Leverage
Equity = $20 billion / 1.5 = $13.33 billion

Now we can calculate ROE:

ROE = ROA x Financial Leverage
ROE = 12.5% x 1.5 = 18.75%

Finally, we need to adjust the ROE for the cash and marketable securities payout. We are told that Primavera pays out 90% of its cash and securities as a dividend to shareholders, so we need to subtract this amount from the equity before calculating ROE:

Equity After Payout = Equity - (Cash and Marketable Securities x 0.9)
Equity After Payout = $13.33 billion - ($10 billion x 0.9)
Equity After Payout = $2.33 billion

Now we can calculate the adjusted ROE:

Adjusted ROE = Net Income / Equity After Payout
Adjusted ROE = $2.5 billion / $2.33 billion = 107.28%

Therefore, the answer is D) between 40% and 60%.

Primavera Holdings Has a Profit Margin of 25%,an Asset Turnover