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Ratios: Return on Equity (ROE) quiz #1 Flashcards

Ratios: Return on Equity (ROE) quiz #1
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  • What is the formula for calculating Return on Equity (ROE)?
    ROE is calculated as net income divided by average common equity, where average common equity is (beginning balance + ending balance) / 2.
  • Why is it important to exclude preferred stock equity when calculating ROE?
    Preferred stock equity is excluded because ROE measures the return earned by common shareholders, and preferred shareholders have priority in receiving dividends.
  • How do you calculate average common equity for the ROE formula?
    Average common equity is calculated as (beginning common equity + ending common equity) divided by 2.
  • What does a high ROE indicate to investors?
    A high ROE indicates that the company is efficiently generating net income from its common equity, which is attractive to investors seeking strong returns.
  • How can a company's use of debt affect its ROE?
    A company with higher debt (leverage) can have a higher ROE because net income is spread over a smaller amount of equity, but this also increases financial risk.
  • What does a negative ROE signify, and what is its primary cause?
    A negative ROE signifies a net loss for the period, which is a red flag for investors, and is primarily caused by negative net income.
  • Why is ROE typically expressed as a percentage?
    ROE is expressed as a percentage to show the return generated for each dollar of common equity, making it easier to compare across companies and periods.
  • How does ROE help investors assess a company's performance?
    ROE helps investors assess how effectively a company uses its common equity to generate profits, indicating management's efficiency and the potential return on their investment.
  • If a company has a beginning common equity of $100,000, an ending common equity of $120,000, and net income of $22,000, what is its ROE?
    Average common equity is ($100,000 + $120,000) / 2 = $110,000. ROE = $22,000 / $110,000 = 20%.
  • What is the formula for calculating Return on Equity (ROE)?
    ROE is calculated as net income divided by average common equity, where average common equity is (beginning balance + ending balance) / 2.