Question

A company reports the following:

Net income $ 125,000

Preferred dividends 5,000

Average stockholders’ equity 1,000,000

Average common stockholders’ equity 800,000

Determine (a) the return on stockholders’ equity and (b) the return on common stockholders’ equity. Round percentages to one decimal place.

Answer 1

The following formulae can be used to calculate the return on equity (ROE) and the return on common stockholders' equity (ROCE):

(a) Return on Stockholders' Equity = Net Income / Average Stockholders' Equity (b) Return on Common Stockholders' Equity = Net Income - Preferred Dividends / Average Common Stockholders' Equity

Given: Net income: $125,000 Preferred dividends: $5,000 Average stockholders' equity: $1,000,000 Average common stockholders' equity: $800,000

(a) Return on Stockholders' Equity: Return on Stockholders' Equity = Net Income / Average Stockholders' Equity = $125,000 / $1,000,000 = 0.125

To express the ROE as a percentage, we multiply it by 100:

Return on Stockholders' Equity (ROE) = 0.125 * 100 = 12.5%

Therefore, the return on stockholders' equity is 12.5% (rounded to one decimal place).

(b) Return on Common Stockholders' Equity: Return on Common Stockholders' Equity = (Net Income - Preferred Dividends) / Average Common Stockholders' Equity = ($125,000 - $5,000) / $800,000 = $120,000 / $800,000 = 0.15

To express the ROCE as a percentage, we multiply it by 100:

Return on Common Stockholders' Equity (ROCE) = 0.15 * 100 = 15%

Therefore, the return on common stockholders' equity is 15% (rounded to one decimal place).

 

Therefore, the return on stockholders' equity is 12.5% (rounded to one decimal place).

Therefore, the return on common stockholders' equity is 15% (rounded to one decimal place).