# Rate of return

Laurel company has assets of $2 million and long-term, 10% debt of $1,200,000. Hardy Company has assets of $2 million and no long-term debt. The annual operating income (before interest) of both companies is $400,000. Ignore taxes.

1. Compute the rate of return on

a. assets

b. stockholder equity.

2. Evaluate the relative merits of each base for appraising operating management.

https://brainmass.com/business/bond-valuation/rate-of-return-345758

#### Solution Preview

1a. Return on Assets = (Net Income + Interest X (1-tax rate)/Total Assets

If we ignore taxes, then Net Income + Interest = Operating Income

Return on Assets = Operating Income/Assets

Since both companies have the same assets of $2 million and operating income of $400,000

Return on Assets for both = 400,000/2,000,000 = 20%

b. Return on Equity = Net Income/Total Equity

Laurel Company

Operating Income = 400,000

Interest = 1,200,000 X 10% = 120,000

Net Income = 280,000

Total Assets = 2,000,000 (Debt + Equity)

Debt financing = 1,200,000

Equity financing = ...

#### Solution Summary

The solution explains the calculation of rate of return on assets and equity and the relative merits of each base