Question

Firm A and Firm B have debt-total asset ratios of 35 percent and 25 percent, respectively, and returns on total assets of 9 percent and 13 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.)

Answer 1

Total Assets = Debt + Equity

Computation of Return on Equity for Firm A.

Debt / total assets = 0.35

[Total Assets - Equity] / Total Assets = 0.35

Total Assets - Equity = 0.35 Total Assets

Equity = 0.65 Total Assets

Given that Net income / total assets =0.09

Net Income / (Equity / 0.65) = 0.09

Net income / Equity = 0.1385 or 13.85%

Return on Equity = Net income / Equity

So, Return On Equity for Firm A = 13.85%.

Computation of Return on Equity for Firm B.

Debt / total assets = 0.25

[Total Assets - Equity] / Total Assets = 0.25

Total Assets - Equity = 0.25 Total Assets

Equity = 0.75 Total Assets

Given that Net income / total assets =0.13

Net Income / (Equity / 0.75) = 0.13

Net income / Equity = 0.17333 or 17.33%

Return on Equity = Net income / Equity

So, Return On Equity for Firm B = 17.33%