Question

A firm has a debt-to-total assets ratio of 60%,$300,000 in debt, and a net income of $50,000. Calculate return on equity.

a)40%
b)20%
c)25%
d)There is not enough information to calculate return on equity.

Answer 1

To compute the return on equity, we find the total assets using the debt-to-total assets ratio and the given debt amount, then subtract debt from total assets to determine equity, and finally divide net income by equity which yields a 25% ROE.

Step-by-step explanation:

To calculate the return on equity (ROE) for a firm with a debt-to-total assets ratio of 60%, $300,000 in debt, and a net income of $50,000, we first need to determine the firm's total assets and equity. The debt ratio signifies that 60% of the firm's assets are financed through debt, which means that the remaining 40% are financed through equity.

Using the debt amount provided, we can find the total assets and then calculate equity:
Total Assets = Debt / Debt Ratio = $300,000 / 0.60 = $500,000
Equity = Total Assets - Debt = $500,000 - $300,000 = $200,000

Now we can calculate the ROE using the net income and the equity:
ROE = Net Income / Equity = $50,000 / $200,000 = 0.25 or 25% Therefore, the correct answer to the student's question is:
c) 25%