Question

Calculate the Return on Equity (ROE) for Neerja International, for the year 2020 – 2021 from the details given below:

	Details	Amount (₹)
i.	Investments	10,00,000
ii.	12% Loan from State Bank of India	2,00,000
iii.	8% Debentures	2,00,000
iv.	Fixed  expenses per month
	– Salary	1,50,000
	– Rent	50,000
	– Electricity & Utilities	10,000
v.	Depreciation	35,000
vi.	Tax Rate	30%

Monthly Sales revenue was ₹ 10,00,000 and Cost of goods sold was ₹ 4,00,000.

Answer 1

The following procedures must be followed in order to determine Neerja International's Return on Equity (ROE) for 2020–2021: 

1. Determine the cost of goods sold (COGS) and yearly income.

Annual Sales Revenue = Monthly Sales Revenue × 12.

Annual Sales Revenue = ₹ 10,00,000 × 12 = ₹ 1,20,00,000

Annual COGS = Monthly COGS × 12

Annual COGS = ₹ 4,00,000 × 12 = ₹ 48,00,000

2. Calculate the annual gross profit:

Gross Profit = Annual Sales Revenue − Annual COGS

Gross Profit = ₹ 1,20,00,000 − ₹ 48,00,000 = ₹ 72,00,000

3. Calculate the annual fixed expenses:

Annual Fixed Expense = Salary + Rent + Electricity & Utilities × 12

Annual Fixed Expenses = (₹ 1,50,000 + ₹ 50,000 + ₹ 10,000) × 12 = ₹ 2,10,000 × 12 = ₹ 25,20,000

4. Calculate the annual interest expenses:

Interest on Loan from SBI = 12% × ₹ 2,00,000 = ₹ 24,000

Interest on Debentures = 8% × ₹ 2,00,000 = ₹ 16,000 

5. Calculate the earnings before tax (EBT):

EBT = Gross Profit − Annual Fixed Expenses - Depreciation − Total Interest Expense

EBT = ₹ 72,00,000 − ₹ 25,20,000 − ₹ 35,000 − ₹ 40,000 = ₹ 46,05,000

6. Calculate the tax amount:

tax = EBT × Tax Rate

Tax = ₹ 46,05,000 x 30% = ₹ 13,81,500

7. Calculate the net income (Net Profit):

Net Profit = EBT − Tax

Net Profit = ₹ 46,05,000 − ₹ 13,81,500 = ₹ 32,23,500

8. Calculate the equity

Given the Investments − ₹ 10,00,000, this is considered as the equity (assuming no other equity investment).

9. Calculate the Return on Equity (ROE):

ROE = `"Net profit"/"Equity" xx 100`

ROE = `(32,23,500)/(10,00,000)xx 100`

= 322.35%