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9 Accounting, 8th edition I. Contents } . ._ .. ,,.. .. 2012 Rate of
Return on Gammon industry
Formula Stockholders’ Equity Average
Rate of return .. Net mcornea dividends $48,000 _ $0 .. 0 142 £05
on common _ Average cummon $338300 _ ' ' stockholders1 equity stockholders' equity Greg’s return on equity of 0142 is higher than its return on assets of 0.101.
This difference results from borrowing at one rateH-‘say, 8%—-and investing the
money to earn a higher rate, such as the firm’s 14.2% return on equity. This practice
is called trading on the equity, or using leverage. It is directly related to the debt
ratio. The higher the debt ratio, the higher the leverage. Companies that finance
Operations with debt are said to leverage their positions. Duringgood times, leverage increases profitability. But leverage can have a neg—
ative impact on profitability as well. Therefore, leverage is a doubleaodged sword,
increasing profits dureng good times but compounding losses during bad times.
Compare Greg’s Groovy Tunes’ return on equity with the industry average of 0. [05.
Once again, Greg’s Groovy Tunes is performing much better than the average corn-
pany in its industry. A return on equity of 15% to 20% year after year is considered
good in most industries. At 14.2%, Greg’s is doing wail. Earnings per Share of Common Stock Earnings per share ofcommtm stock, or simply earnings per share (EPS), is perhaps
the most widely quoted of all financial statistics. EPS is the only ratio that must appear on the face ofthe income statement. EPS is the amount of net income earned
for each share of the company’s outstanding common stock. Recall that Outstanding nod: =‘Issued stack — Treasury stock.- ¢ I||| Read wpscms.pearsoncmg.com ...
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