Question

Firm A and Firm B have debt–total asset ratios of 44 percent and 34 percent and returns on total assets of 8 percent and 14 percent, respectively.

  

What is the return on equity for Firm A and Firm B? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

    

	Firm A	Firm B
Return on equity	%	%

Answer 1

First we need to Total Equity and then Net Income to know ROE.

We know, Total Assets will be same as Total Capital and Total Capital = Total Debt + Total Equity.

We assume Total capital = Total Assets = 100

For Firm A:

Debt to Total Assets = 44

Total Equity = Total Assets - Total Debt

= ( 100 - 44 ) %

= 56 %

Return On Total Assets = 8 %

Hence , Net Income = 8

Return on Equity = Net Income / Total Equity

= ( 8 / 56 )

= 0.1428

= 14.28 %

For Firm B:

Debt to Total Assets = 34

Total Equity = Total Assets - Total Debt

= ( 100 - 34 ) %

= 66 %

Return On Total Assets = 14 %

Hence , Net Income = 14

Return on Equity = Net Income / Total Equity

= ( 14 / 66 )

= 0.2121

= 21.21 %