Return on Equity in Presence of Large Treasury Stock Balance NJ Simpson Inc. reported the following equity accounts in its 2017 balance sheet. Stock prices for the past three year-ends of 2017, 2016, and 2015 are: $244.80, $196.96, and $136.34, respectively.

Shareholders’ Equity ($ millions, expect par and shares) 2017 2016 2015 Common stock — par value $1 per share (authorized 70,000,000 shares;

issued 40,000,000 shares) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40 $ 40 $ 40 Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,2401,2401,240 Accumulated other comprehensive income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 (96) (220)

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,419 1,340 1,209 Stockholders’ equity before treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,807 2,524 2,269 Less: common stock held in treasury, at cost (15,360,000, 10,336,000, and 980,000 shares, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(2,776)

(1,844)

(114)

Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 680 2,155 Equity attributable to noncontrolling interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6) (6) (6)

Equity attributable to company shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25 $ 674 $2,149 The income statement for NJ Simpson Inc. reports the following.

$ millions 2017 2016 2015 Earnings attributable to company shareholders . . . . . . . . . . . . . . . . . . . . . . . . . $405 $301 $217 Consolidated net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409 303 218

a. Compute return on equity for 2017 and 2016, under the following assumptions.

• Traditional definition of equity.

• With adding back treasury stock to equity.

• Using market value of equity instead of book value.

b. Which of these metrics do we believe best measures the company’s return for the past two years?

Explain.