What does a return on assets (ROA) of 12.5\% represent?

• A. The company earns a 12.5\% return on its equity investments.
• B. The company generates \$0.125 in net income for every \$1 of average total assets.
• C. The company pays 12.5\% of its assets as dividends to shareholders.
• D. The company has 12.5\% of its assets financed by debt.

Answer: (B)

Verified step by step guidance

1. Understand the concept of Return on Assets (ROA): ROA is a financial ratio that measures how efficiently a company uses its average total assets to generate net income. It is expressed as a percentage and calculated using the formula: ROA = (Net Income / Average Total Assets) × 100.
2. Analyze the given ROA value: A ROA of 12.5% means that for every \$1 of average total assets, the company generates \$0.125 in net income. This indicates the company's efficiency in utilizing its assets to produce profit.
3. Eliminate incorrect interpretations: The statement 'The company earns a 12.5% return on its equity investments' is incorrect because ROA focuses on total assets, not equity investments. Similarly, 'The company pays 12.5% of its assets as dividends to shareholders' is unrelated to ROA, as dividends are not part of the ROA calculation. Lastly, 'The company has 12.5% of its assets financed by debt' is also incorrect, as ROA does not measure financing structure.
4. Identify the correct interpretation: The correct interpretation is 'The company generates \$0.125 in net income for every \$1 of average total assets,' as this directly aligns with the definition and calculation of ROA.
5. Conclude the explanation: ROA is a key profitability metric that helps stakeholders understand how effectively a company is using its assets to generate earnings. A higher ROA indicates better asset utilization and profitability.