Recently Old Forge Company reported that it had earned a profit margin of 20% on sales of $10 million. Its net assets totaling $25 million were financed by equal amounts of debt and equity. What return on equity did Old Forge earn?

Question

Quizplus · Accepted Answer

The return on equity (ROE) can be calculated by dividing the net income by the shareholder's equity. Given a profit margin of 20% on sales of $10 million, the net income is $2 million (20% of $10 million). Since the net assets are $25 million, financed equally by debt and equity, the equity is $12.5 million (half of $25 million). Therefore, the ROE is $2 million / $12.5 million = 0.16, or 16%.

Recently Old Forge Company Reported That It Had Earned a Profit