Return_on_common_equity_ratio = IBT - (Preferred dividends / (1 - tax_rate))
                                            Common_equity
ITB = Income_before_taxes

Leverage_ratios (computed separately for each source of capital other than common equity, e.g., short-term debt, long-term debt, deferred taxes, preferred stock)

Leverage_ratio = (RTA * Amount_of_Source) - Cost_attributable_to_source
                                                       Common_equity

Example (assume the following):
Common equity = 8,210
RTA (return on assets) = 0.18
Current liabilities = 1,600
Interest applicable to current debt = 10
Long-term debt = 2,200
Interest expense = 200
Deferred taxes = 800
Preferred stock = 1,000
Preferred dividends  = 70
Income before taxes (IBT) = 2,300
Tax rate 40%

Leverage_ratio for current liabilities = [(0.18)(1,600)] - (10)     =    0.034
                                                                    8,210

Leverage_ratio for long-term debt = [(0.18)(2,200)] - (200 - 10)     =    0.025
                                                                    8,210

Leverage_ratio for deferred taxes = [(0.18)(800)] - (0)     =    0.018
                                                                    8,210

Leverage_ratio for preferred stock = [(0.18)(1000)] - (70 / (1- (0.40))     =    0.008
                                                                          8,210

The sum of the net returns above (0.034 + 0.025 + 0.018 + 0.008)  plus RTA of 0.18 equals 0.27 rounded
This will equal 'Return on common equity' calculated as
Return on common equity' = (2,300) - (70 / (1 - (0.40)) = 0.27 rounded
                                                           8,210

 

Book_value_per_common_share = Common_equity
                              Common_shares

Return_on_Investment =     Operating Profit
                       Net_assets - Net_liabilities

 

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Copyright: Williams & Partner, 2004