Classnotes 5

Question 1

Return on Equity (ROE):

Answer 1

Focuses on return to shareholders, thus uses only their investment in the denominator

Question 2

ROE Equation

Answer 2

Return on Equity = Net Income / Average Shareholders’ Equity

Question 3

Return on Assets (ROA):

Answer 3

the most popular metric to evaluate the combined results of the organization’s operational and investment activities.
Measures the after-tax rate of return being earned on all of the firms’ assets regardless of the method of financing the assets;
Thus add back interest expense (net of income tax effect)

Question 4

ROA Equation

Answer 4

RoA= Net Income + Interest Expense X (1- Tax Rate) / Average Total Assets

Question 5

Decomposing ROA into Margin and Turnover

Answer 5

=(NI + Interest Expense X (1-Tarate)/ Sales) X (Sales / Average Total Assets)

Question 6

Profit Margin

Answer 6

= NI + Interest Expense X (1-Tax Rate) / Sales

Question 7

Asset Turnover

Answer 7

=Sales / Average Total Assets

Question 8

ROA

Answer 8

=Profit Margin X Asset Turnover