CMA Part 2 Q&A – How to Calculate ROA (Return on Assets Formula)

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Student Question

“Hi Nathan,

Can you please illustrate further how the ROA [Return on Assets] was calculated in this question?”

– Jason

MCQ – Return on Assets

Anderson Cable wishes to calculate their return on assets (ROA). You know that the return on equity (ROE) is 12% and that the debt ratio is 40%. What is the ROA?

A. 4.8%
B. 12%
C. 7.2% (correct)
D. 20%

Correct answer: (C) 7.2%

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Return on equity (ROA) formula= Net Income/Ave. Equity

Debt Ratio = Total Debt/Total Assets

To calculate the return on assets (ROA), we have to use both formulae:

ROA = ROE x (1 – Debt Ratio)

ROA = 12% x (1-40%)

ROA = 12% x 60%

ROA = 7.20%

How did we arrive at the formula?

First, we have to state the formula of ROA which is:

ROA = Net Income/Total Assets

Second, we have to extract the juice out of the given formula:

Net Income/Total Assets = Net Income/Equity x (1 – Debt Ratio)

Net Income/Total Assets = Net Income/Equity x (100% – Total Debt/Total Assets) -> In this case, the equity ratio is the remaining portion of the 100%.
*Remember the accounting equation: Assets = Liabilities + Equity

Net Income/Total Assets = Net Income/Equity x Equity/Total Assets -> Therefore the equation can be restated as:
Assets (100%) = Liabilities (40%) + Equity (60%)

Net Income/Total Assets = Net Income/Equity x Equity/Assets

Net Income/Total Assets = Net Income/Total Assets

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Until our next lesson,

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