(Computing ratios) Solve for the return on equity with the given income statement and balance sheet (assume all sales are made on credit). Assume that there are 365 days in a year.

Balance Sheet for eBuy Corporation
Balance Sheet
Assets Liabilities and owners equity
Current year Last year
Current year
Current assets Current liabilities

Cash $ 435 Accounts payable $ 789
Accounts receivable 578
Inventory 901 Total $ 789
Total $ 1,914
Long-term debt $ 1,111
Fixed assets
Total liabilities $ 1,900
Net PP&E $ 8,789 Owner's equity $ 8,803
Total Assets $ 10,703 Total liab. and equity $

10,703

Current Year Income Statement
Sales $ 67,500
Cost of goods sold 7,890
Depreciation 333
Earnings before interest and taxes $ 59,277
Interest 652
Earnings before taxes $ 58,625
Taxes 23,450
Net income 35,175

Question

(Computing ratios) Solve for the return on equity with the given income statement and balance sheet (assume all sales are made on credit). Assume that there are 365 days in a year.

Balance Sheet for eBuy Corporation
Balance Sheet
Assets	 	Liabilities and owners equity
Current year	 	Last year
	Current year
Current assets			Current liabilities
			
Cash	$	 435	Accounts payable		$	789
Accounts receivable		578				
Inventory		901	Total		$	789
Total	$	1,914				
			Long-term debt		$	1,111
Fixed assets						
			Total liabilities		$	1,900
Net PP&E	$	8,789	Owner's equity		$	8,803
Total Assets	$	10,703	Total liab. and equity		$

10,703

Current Year Income Statement
Sales	$ 67,500
Cost of goods sold	7,890
Depreciation	333
Earnings before interest and taxes	$ 59,277
Interest	652
Earnings before taxes	$ 58,625
Taxes	23,450
Net income	35,175

BlackTom AI · Accepted Answer

Restating the problem and data: We are asked to compute return on equity (ROE) for eBuy Corporation using the provided income statement and balance sheet, assuming all sales are on credit and using 365 days in a year. The relevant figures from the Balance Sheet show current year equity of 8,803 (Owner's equity) and total assets of 10,703, with liabilities totaling 1,900, so the balance sheet balances as expected. The Income Statement provides Net Income of 35,175.

Key concept to apply: ROE is Profitability relative to shareholders by definition ROE = Net income / Average shareholders' equity. Here, the challenge is the phrase “average equity” since only the current year equity is clearly shown. The common practice in such problems is to assume that last year's equity is equal or nearly equal to this year's equity if last year figures are not provided, or to use the average of the two year-end equity values when both are given. Because the balance sheet snippet includes a line for last year but does not provide a separate last-year equity figure, we infer that last year equity is roughly the same as this year’s equity, yielding a simple average close to 8,803.

Step-by-step analysis of the options (in this case, there is a numeric result to verify):
- Compute average equity: With equity this year = 8,803 and, by interpretation of the missing last-year data, assuming last year’s equity is essentially the same, the average equity ≈ (8,803 + 8,803) / 2 = 8,803. If last year’s equity differed slightly, the result would be close to this value, since the problem appears to be designed with near-equal year-end equity.
- Apply ROE formula: ROE = Net income / Average equity = 35,175 / 8,803.
- Perform the division: 35,175 ÷ 8,803 ≈ 3.9958.
- Convert to a percentage: multiply by 100 to express as a percentage, giving approximately 399.58%.

Why this approach makes sense: Using net income from the income statement provides the return generated for the shareholders, while equity represents the owners’ stake in the company. When there is no explicit data for last year’s equity, using the current year equity (or its closest approximation) to form the average is a standard practical method in introductory financial ratio problems, especially when the problem setup implicitly assumes stability across years.

Potential pitfalls if misapplied: If one tried to use total assets or total liabilities as a proxy for equity, the result would be invalid—ROE specifically needs equity (owners’ residual interest). If one mistakenly used net income before taxes or without dividing by the correct average equity, the ratio would misrepresent profitability relative to shareholder investment. If the average equity was significantly different year over year and the problem provided exact prior-year equity, failing to average the two values would lead to an incorrect ROE.

Summary: The ROE calculation using net income 35,175 and an estimated average equity around 8,803 yields a result near 3.996, which corresponds to about 399.58%.

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