Question

A firm has an ROE of 6%, a debt/equity ratio of 0.7, a tax rate of 35%, and pays an interest rate of 6% on its debt. What is its operating ROA? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Operating Return on Asstes is the ratio of company's operating income to the Total average assets of the company. The operating income of the company is the earnings that is generated before interest and tax.

In this question, we want to find the operating return on assets and the following informations are given :-

ROE= 6% = 0.06

Debt-equity ratio= 0.7

tax rate = 35%= 0.35

Interest rate= 6%= 0.06

The formula relating ROE and ROA is

ROE = (1-T) x (ROA+(ROA-I) x Debt/Equity)

Where T= Tax rate and I= Interest rate

Deriving from the above equation:

ROA = 0.06 / {( 1 - 0.35) * (1+ 0.7 ) } + (0.7 / 1+0.7) * 0.06

= 0.06/ (0.65* 1.7) + 0.4117* 0.06

= 0.0542 + 0.0247

= 0.0789 = approx ( 0.079)