Chapter 2, Problem 16PROB

Summary Introduction

DB's total assets are $440,000, return on assets is 8%, and its debt ratio is 20%. Calculate the net income and return on equity.

The total asset turnover ratio is the efficiency ratio which is used to measure how much sales is generated by using the firm's total assets.

$\text{Total assets turnover ratio}=\frac{\text{Net sales}}{\text{Total assets}}$

Debt ratio is the percentage of total debts divided by total assets which measures the percentage of liabilities that a firm has in terms of total assets. A higher ratio indicates that the firm is at risk.

$\text{Debt ratio}=\frac{\text{Total debt}}{\text{Total assets}}$

Return on assets is used to measure how profitable a firm is related to the firm's total assets.

$\begin{array}{cc}\text{Return on assets}& =\frac{\text{Net income}}{\text{Total assets}}\hfill \\ & =\frac{\text{Common equity}}{\text{Total assets}}\times \frac{\text{Net income}}{\text{Common equity}}\hfill \\ & =\left(1-\text{Debt ratio}\right)\times ROE\hfill \end{array}$

Return on equity is used to measure the financial performance that owners of the common stock of a company receive on their shareholdings.

$\text{Return on equity}=\frac{\text{Net income}}{\text{Equity}}$