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							1,240	1,240	1,240
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							$403	$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.

Round answers to one decimal place (ex: 0.2345 = 23.5%)

ROE computation			2017	2016
Traditional			Answer %	Answer %
No treasury stock			Answer %	Answer %
Market value of equity			Answer %	Answer %

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

Select which statement is correct.

Traditional ROE is inflated by the small equity balance in the denominator. This version does not truly measure the companys performance.

ROE with no treasury stock is inflated by the small equity balance in the demoniator as it assumes the company could sell the treasury stock and add the cash to assets.

ROE using market value potentially overstates current period performance because the ratio includes the companys high stock price, which by definition impounds future earnings.

All of these statements are correct.