Produce more useful measure of return on assets of firm

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Reference no: EM131882987

Unlevering the return on assets

When calculating a firm’s return on total assets (“ROA”) ratio, some investment professionals modify the ROA ratio by adding back the interest expense paid by a firm to its creditors, on a net-of-taxes basis, as follows:

Net income + i.(1-tax rate)]

Return on assets = ----------------------------------------

Total assets

Where i is the actual interest expense paid by a firm and the tax rate is a firm’s “effective tax rate” (income tax expense divided by pre-tax net income). Adjusting net income for the interest expense paid by a firm is called “unlevering net income” because the adjustment yields a measure of net income as if the firm were all equity financed (with no debt financing).

Discuss when and why unlevering ROA might produce a more useful measure of the return on assets of a firm.

Reference no: EM131882987

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