How does the rate earned on total assets differ from the rate earned o

QUESTION

How does the rate earned on total assets differ from the rate earned on stockholders equity?
Which ratio is normally higher? Explain.
Why is the rate earned on stockholders equity by a thriving business ordinarily higher than the rate earned on total assets?
Should the rate earned on common stockholders equity normally be higher or lower than the rate earned on total stockholders equity? Explain.
1) ROA = operating profits/Average assets ROE= PAT/Average Equity ROA includes return for both debt issuers and equity shareholders. ROE includes return for only equity shareholders. 2) ROE is normally higher as average equity is much less than average assets. Assets= equity+ liability. This is why companies with high leverage (high liabilites) usually have more ROE. 3) If a business is thriving, the company can use leveraqe to boost sales and profits, while equity value remains the same. On¦

r hand, although operating profits will increase, increased leveage will be reflected in increased asset base. 4) Rate on common shareholder equity is more than rate on total shareholder equity as preferred shares are similar to debt instruments and pay fixed dividends. Thus, preferred shares are low risk and hence have low returns.

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