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ROE and IRR

We know that when expanding and investing in projects overseas as Acme plans to, it is essential to understand such things as return on equity (ROE) and internal rate of return (IRR). Using Internet sources gather information on ROE and IRR. Provide 1/2 page explanation for each of these terms and the advantages and disadvantages of using them when selecting projects to invest in overseas.

Select two companies from the same industry. Using the annual report information available on the company's website compute the ROE for each company.

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ROE ( Return on Equity):

The formula for calculating Return on Equity is:
Net Profit/ Shareholder's equity

Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet. A business that has a high return on equity is more likely to be one that is capable of generating cash internally. For the most part, the higher a company's return on equity compared to its industry, the better. This should be obvious to even the less-than-astute investor If you owned a business that had a net worth [shareholder's equity] of $100 million dollars and it made $5 million in profit, it would be earning 5% on your equity [$5 / $100 = .05, or 5%]. The higher you can get the "return" on your equity, in this case 5%, the better.

Return on equity is particularly important because it can help you cut through the garbage spieled out by most CEO's in their annual reports about, "achieving record earnings". Warren Buffett pointed out years ago that achieving higher earnings each year is an easy task. Why? Each year, a successful company generates profits. If management did nothing more than retain those earnings and stick them a simple passbook savings account yielding 4% annually, they would be able to report "record earnings" because of the interest they earned. Were the shareholders better off? Not at all; they would have enjoyed heftier returns had the earnings been paid out. This makes obvious that investors cannot look at rising per-share earnings each year as a sign of success. The return on equity figure takes into account the retained earnings from previous years, and tells investors how effectively their capital is being reinvested. Thus, it serves as a ...

Solution Summary

Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet.

$2.19