Question

If a firm has a positive tax rate and a positive operating ROA, and the interest rate on debt is the same as the operating ROA, then operating ROA will be_______.

	A.	equal to ROE
	B.	less than ROE
	C.	greater than ROE
	D.	greater than zero, but it is impossible to determine how operating ROA will compare to ROE

Answer 1

Formula for Operating ROA= Earnings before Interest and taxes/ Total assets

ROE= Net Income or PAT / Shareholders' Equity

As per the question, the Interest rate on debt is equal to the Operating ROA which does not take into account interest deduction yet and no taxes have been deducted as well. The Firm has a positive tax rate.

Both interest and tax will be deducted from EBIT to arrive at the PAT which will be used in ROE calculation. Hence, as per ratio changes, the operating ROA will be greater than the ROE of the Firm (the numerator in ROE will be quite lower as compared to the numerator in operating ROA)

hence, ans C) Greater than ROE.

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