Question

Describe each of the following components of the return on equity model and discuss their interrelationship.

1) ROE - Return on Equity

2) ROA - Return on Asset

3) EM - Equity Multiplier

4) ER - Expense Ratio

5) AU - Asset Utilization

Answer 1

Ans.1. Return on Equity: It is a component of the return on equity model. It help the firms to determine that how much income is generated from shareholder's equity.

Formula Used:

Return on Equity: Net Income / Shareholder's equity.

Ans.2.Return on Assets: It is a component of the return on equity model. It helps the firms to determine that how much income is generated from total assets.

Return on Asset = Net Income / Total assets.

Ans.3.Equity Multiplier: Equity multiplier is a component of return on equity model . It helps the firms to determine that how much assets are financed by shareholder's equity.

Equity Multiplier = Total assets / Shareholder's equity.

Ans.4. Expense ratio: Expense ratio is used to determine that how much costs is incurred for managing total assets.

Expense ratio = Total costs / Total assets.

Ans.5.Asset utilization: Asset utilization is defined as how much revenue is generated from total assets of the organisation.

Asset Utilization : Net Sales / Total assets.

Relationship:

All the five components of the return on equity model is interrelated to each other. Every components requires total assets and shareholder's equity. without these, we are not able to calculate all these ratios. This model determines the overall profitability of the business.