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Return on Equity

29 April, 2015 - 16:39

Return on Equity is an important financial ratio used to compare companies. It is also commonly used as a target for executive compensation. For example, a CEO might have to earn a 15% ROE for the year in order to get his bonus. Targets like these are designed to help shareholders by giving management an incentive to perform better.

ROE is defined as Net Income divided by Shareholder's Equity. However, there are other ways to calculate it. One common way is by using Return on Assets (ROA = Net Income/Assets), which may be easier to calculate, and the debt to equity ratio, in addition to information about tax and interest rates.

ROE = (1 - T)\left[ROA + (ROA - I)\frac{D}{E}\right]