(Review Problems ) 3

Book versus market return on equity. Return on equity (ROE) can be estimated using financial statements (book value) or financial market data (market value). The book value of ROE over an accounting period is earnings after tax divided by owners' equity. The market value of ROE is the return that an investor would have experienced during the same period. It is the difference in share price plus dividend paid during the period divided by the share price at the beginning of the period. Why are the two ratios different? If the market ROE is more relevant to any investor, what is the use of the book ROE?

Review Question 4.

The structure of a firm's profitability. a. If a firm has a return on equity (ROE) of 15 percent, a financial multiplier of 2, and does not pay any tax, what is its return on invested capital before tax? b. If a firm has an ROE of 15 percent, a financial cost effect of 0.9, and a pre-tax ROIC of 10 percent, what is its debt-to-equity ratio (total debt divided by owners' equity)? Assume that the firm does not pay any tax. c. Under what condition(s) can a firm have, at the same time, a negative pre-tax ROIC and a positive ROE?