If a company's ROA is 10% and it has a 50/50 debt-to-equity ratio, what can you expect the ROE to be?

To determine the expected Return on Equity (ROE) when a company's Return on Assets (ROA) is 10% and there is a 50/50 debt-to-equity ratio, it is crucial to understand the relationship between ROA, ROE, and leverage.

ROA is calculated as net income divided by total assets, while ROE is net income divided by shareholders’ equity. In a scenario where the debt-to-equity ratio is 50/50, it indicates that the company is using equal amounts of debt and equity financing.

In this case, the company's assets are financed with both debt and equity. Given the 50/50 ratio, the average total assets are double that of the equity portion. Thus, when calculating ROE, leveraging the higher ROA due to the use of debt provides a magnifying effect on the returns to equity holders.

The formula relating these components is as follows:

ROE = ROA * (1 + Debt/Equity)

Since the debt-to-equity ratio is 1 (indicating equal parts debt and equity), the formula simplifies to:

ROE = ROA * (1 + 1) = ROA * 2

Substituting the given ROA of