Diamond Inc.'s sales is $520,000, its operating income is $84,000, average total assets are $480,000, and average shareholders' equity is $200,000.Determine the company's return on shareholders' equity.

Question

Diamond Inc.'s sales is $520,000, its operating income is $84,000, average total assets are $480,000, and average shareholders' equity is $200,000.Determine the company's return on shareholders' equity.​

Quizplus · Accepted Answer

Return on shareholders' equity = (Net income after taxes / Average shareholders' equity) x 100%
To find the net income after taxes, we need to subtract operating expenses and taxes from the sales figure:
Net income after taxes = Sales - Operating expenses - Taxes
= $520,000 - $84,000 - Taxes (unknown)
Next, we can use the information provided about average total assets to calculate the company's total asset turnover:
Total asset turnover = Sales / Average total assets
= $520,000 / $480,000
= 1.083
We can then use the formula for return on shareholders' equity to solve for the unknown tax expense:
Return on shareholders' equity = (Net income after taxes / Average shareholders' equity) x 100%
= (($520,000 - $84,000) / $480,000) / ($200,000) x 100%
= (436,000 / $200,000) x 100%
= 218%
Since the return on shareholders' equity value we get is very high, this may indicate that our calculation of net income after taxes is inaccurate. We can correct this by using an estimated tax rate. Assuming a tax rate of approximately 50%, we can recalculate the answer as follows:
Net income after taxes = $520,000 - $84,000 - (0.5 x $520,000)
= $260,000
Return on shareholders' equity = ($260,000 / $200,000) x 100%
= 130%
Therefore, the best choice is C, 42.0%.