Question

What is ROE, and what are we trying to measure with it? How do you calculate and interpret ROE? What are the various “pieces” of performance that ROE can reflect? Why is it important to realize that there are different ways to try to increase ROE? What are ROA and Financial Leverage, and why do we need to distinguish between them when thinking about ROE? You should be able to do basic adjustments to ROE to remove preferred stock and/or non-controlling interests

Answer 1

1. What is ROE, and what are we trying to measure with it?

Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity.

Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

2.How do you calculate and interpret ROE?

Return on equity may also be calculated by dividing net income by average shareholders' equity. Average shareholders' equity is calculated by adding the shareholders' equity at the beginning of a period to the shareholders' equity at period's end and dividing the result by two.

3.What are the various “pieces” of performance that ROE can reflect?

ROE calculation to include three of its component parts. These parts include the company’s profit margin , its asset turnover, and its equity multiplier. Accordingly, this expanded DuPont formula for ROE is as follows:

4.Why is it important to realize that there are different ways to try to increase ROE?

1. Use more financial leverage

2. Increase profit margins

3. Improve asset turnover

4. Distribute idle cash

5. Lower taxes

5.What are ROA and Financial Leverage, and why do we need to distinguish between them when thinking about ROE?

Return on assets (ROA) is a financial ratio that shows the percentage of profit a company earns in relation to its overall resources. It is commonly defined as net income divided by total assets. Net income is derived from the income statement of the company and is the profit after taxes.

Financial leverage refers to the use of debt to acquire additional assets. Financial leverage is also known as trading on equity. Below are two examples to illustrate the use of financial leverage, or simply leverage

The Difference Is All About Liabilities. The big factor that separates ROE and ROA isfinancial leverage, or debt. ... By taking on debt, a company increases its assets, thanks to the cash that comes in. But since equity equals assets minus total debt, a company decreases its equity by increasing debt