What does a return on equity (ROE) of 15\% represent?

• A. The company's assets increased by 15\% over the year.
• B. The company generated a net income equal to 15\% of its average shareholders' equity during the period.
• C. The company paid 15\% of its net income as dividends to shareholders.
• D. The company earned a 15\% return on its total assets.

Answer: (B)

Verified step by step guidance

1. Understand the concept of Return on Equity (ROE): ROE measures a company's profitability by showing how much net income is generated as a percentage of shareholders' equity. It is calculated using the formula: $\mathrm{ROE}=\frac{\mathrm{Net}\mathrm{Income}}{\mathrm{Average}}$
2. Analyze the given ROE value: A ROE of 15% means that the company generated net income equal to 15% of its average shareholders' equity during the period. This indicates how effectively the company is using its equity to generate profits.
3. Clarify the incorrect options: The statement 'The company's assets increased by 15% over the year' is unrelated to ROE, as ROE focuses on net income and equity, not asset growth. Similarly, 'The company paid 15% of its net income as dividends to shareholders' pertains to dividend payout ratio, not ROE. Lastly, 'The company earned a 15% return on its total assets' refers to Return on Assets (ROA), not ROE.
4. Relate ROE to financial performance: A higher ROE generally indicates better financial performance, as it shows the company is efficiently generating profits relative to shareholders' equity. However, it is important to compare ROE across similar companies or industries for meaningful insights.
5. Summarize the correct interpretation: The correct answer is that the company generated a net income equal to 15% of its average shareholders' equity during the period. This reflects the company's ability to create value for its shareholders.