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Accounting Ch 3 - • Return on equity(ROE is the(net...

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Chapter 3: Fundamental Interpretations Made from Financial Statement Data Rate of return is a percentage calculated by dividing the amount of return on an investment for a period of time by the average amount invested for the period. Primary measure of profitability. Interest = Principal X Rate X Time (Interest is the income or expense from investing or borrowing money, principal is the amount invested or borrowed, rate is the interest rate per year as a percentage, time is the length of time the funds are invested or borrowed, in years) Return on investment (ROI) is the (net income)/(average total assets) where the denominator is found by averaging the assets reported at the beginning and end of the year. DuPont model is an expansion of the calculation to [margin] X [turnover] or [(net income)/sales] X [(Sales)/(Average total assets)] **Average ROI is between 8% and 12%
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Unformatted text preview: • Return on equity (ROE) is the (net income)/(Average owners’ equity) **Average ROE is between 10% and 15% • Liquidity refers to a firm’s ability to meet its current financial obligations, measure in three ways: • Working capital = Current assets – current liabilities • Current ratio = current assets / current liabilities • Acid-test ratio = (Cash + Accounts receivable) / (current liabilities) **No inventories included • Adequate liquidity: Current ratio of 2.0, Acid-test ratio of 1.0 • Some companies do not declare or pay any dividends during some years because many stockholders also wish to avoid tax consequences of current dividends, and stockholders of highly profitable firms are not inclined to place strong dividend pressures on the board of directors because the firm does a better job managing their investment then they could do themselves...
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