A firm has an ROE of -2%, a debt/equity ratio of 1.0, a tax rate of 0%, and an interest rate on debt of 10%.The firm's ROA is
A)2%.
B)4%.
C)6%.
D)8%.

Question

Quizplus · Accepted Answer

ROA (Return on Assets) can be calculated using the relationship between ROE (Return on Equity), interest rate on debt, the tax rate, and the debt/equity ratio. The formula to connect ROE, ROA, and the other variables is: ROE = ROA + [ROA - Interest Rate*(1-Tax Rate)]*(Debt/Equity). Plugging in the values: -0.02 = ROA + [ROA - 0.1*(1-0)]*1. Solving for ROA gives ROA = 0.04 or 4%.

A Firm Has an ROE of -2%, a Debt/equity Ratio