Reference no: EM131294100

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 amore useful measure of the return on assets of a firm.