Question

A firm has an ROE of 5%, a debt/equity ratio of 0.5, a tax rate of 35%, and pays an interest rate of 7% on its debt. What is its operating ROA? (Do not round intermediate calculations. Round your answer to 2 decimal places.) % ROA

Answer 1

ROE= [1-Tax]*[ROA+ (ROA-Interest rate)*D/E]

Here, D/E refers to the debt/equity ratio
ROE refers to return on equity
ROA refers to return on assets

Return on equity= [1-35%]*[ROA+ (ROA-7%)*0.5]
5%= [1-35%]*[ROA+ (ROA-7%)*0.5]

5%= (1-35%)*(ROA+ .5ROA-0.035)
5%/(1-35%)=(1.5ROA-0.035)
0.076923077+0.035=1.5ROA
0.111923077=1.5ROA
ROA=0.111923077/1.5
=0.074615385 or 7.46% (Rounded to two decimal places)