Question

Total assets = $500,000, total asset turnover = 1.40, total debt ratio = 0.30, return on assets = 8.60%. What is the return on equity?

	A.	Below 6.55%
	B.	Between 6.55% and 8.05%
	C.	Between 8.05% and 9.55%
	D.	Between 9.55% and 11.05%
	E.	Between 11.05% and 12.55%
	F.	Between 12.55% and 14.05%
	G.	Between 14.05% and 15.55%
	H.	Above 15.55%

Answer 1

Return on equity = Net income / Shareholders equity

i) Calculation of shareholders equity

a) Total debt ratio = Total liabilities / Total assets

Here, Total debt ratio = 0.30

Total assets = $500,000

Now put the values into formula,

0.30 = Total liabilities / $500,000

Total liabilities = $500,000 * 0.30

Total liabilities = $150,000

b) Shareholders equity = Total assets - Total liabilities

Shareholders equity = $500,000 - $150,000

Shareholders equity = $350,000

ii) Calculation of net income :

Return on assets = Net income / Total assets

Here, Return on assets = 8.60% or 0.0860

Total assets = $500,000

Now put the values into formula,

0.0860 = Net income / $500,000

Net income = $500,000 * 0.0860

Net income = $43,000

Now,

Return on equity = $43,000 / $350,000

Return on equity = 0.1229 or 12.29%

Answer : E) Between 11.05% and 12.55%

Note : Total assets turnover ratio is not useful for the purpose of calculation of return on equity and hence it is ignored.