Question

1). Which of the following are correct formulas for computing the return on equity?

I. ROE = Net income / Total equity

II. ROE = Return on assets × (1 + Debt-equity ratio)

III. ROE = Profit margin × Total asset turnover × Equity multiplier

IV. ROE = Return on assets × (1 + Equity multiplier)

a. I and III only

b. II and IV only

c. I, II, and III only

d. I, III, and IV only

Answer 1

a.ROE=Net income/Equity

b.ROA=Net income/Total assets

1+Debt/equity ratio=(Equity+Debt)/equity

=Total assets/equity

Hence ROE=Return on assets × (1 + Debt-equity ratio)

=(Net income/Total assets)*(Total assets/equity)

=Net income/equity

c.Profit margin=Net income/Sales

Total asset turnover=Sales/Total assets

Equity multiplier=Total assets/Equity

Hence ROE=Profit margin*Total asset turnover*Equity multiplier

d.ROA=Net income/Total assets

1+Equity multiplier=1+(Total assets/equity)

=(Equity+Total assets)/equity

Hence it will not compute ROE

Hence the correct option is:

c. I, II, and III only