Monday, June 25, 2012

Return on Equity ROE Problem


Solve the following accounting problem related to return on equity:

A manufacturing company has a profit margin of 3% and an equity multiple of 2.0.

For the current year, the manufacturing company has sales of $100 million and it has total assets of $50 Million. What is the company's Return on Equity (ROE)? Use the following accounting information and accounting ratios to solve the problem. 


Answer to Accounting ROE Problem:

Formula for Return on Equity (ROE) is : Return on Equity   = Net Income / Shareholder’s Equity

Total Assets  =  $50 million

Net Profit After Tax = Missing
Total Shareholders’ Equity- Missing

To compute return on equity for this company, it is essential to find out shareholder’s equity and total net profit:

Profit Margin Equation =  Net Income/ Sales   =   Net income / Sales
                                    .03       =          Net Income / 100 Million
Net Income                             =          .03 X 100 Million       = $3 Million

Furthermore, the company has an Equity Multiplier of 2 which means it has $2 of dollar aginst every $1 of equity in common stock.


Calculate Equity Ratio for the Company:

Equity Ratio   = 1 / Equity Multiplier                      =          1 / 2     = 0.50  =          50%


Calculate Stockholder equity      =          $50 Million X 0.50     =          $25 Million


Calculate Return on Equity (ROE)                    =          Net Income / Shareholder’s Equity

                                                =          $3 Million / $25 Million
                                                =          0.12     =          12%

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