Question

‘Sunshine Fabrics Ltd.' earned a net profit of Rs. 50,000 last year. The shareholders' equity is Rs. 2,50,000 and the company took a loan of Rs. 2,50,000. Interest on loan @ 10% per annum is Rs. 25,000.

Calculate Return on Equity (ROE) and Return on Investment (ROI) for 'Sunshine Fabrics Ltd.'

Hint:

Keep these definitions clear for your exams:

• ROE: Uses net profit divided strictly by Equity.
• ROI: Uses net profit before interest divided by Total Capital Employed (Equity + Debt).

These metrics help investors evaluate both shareholder returns and overall business efficiency.

Answer 1

Step 1: Extracting and Organizing the Financial Parameters:
Net Profit after Interest (NP) &= Rs. 50,000
Shareholders' Equity (Equity) &= Rs. 2,50,000
Debt Long-Term Loan (Debt) &= Rs. 2,50,000
Interest on Loan (Interest) &= Rs. 25,000 (10% of 2,50,000)

Step 2: Calculating Return on Equity (ROE):
ROE measures the profitability of a business relative to the funds invested by its shareholders: Return on Equity (ROE) = \frac{Net Profit after Interest and Tax}{Total Shareholders' Equity} \times 100 Substitute our values: ROE &= \frac{50,000}{2,50,000} \times 100
ROE &= 0.20 \times 100 = 20%

Step 3: Calculating Return on Investment (ROI):
ROI measures the overall operational efficiency of the business relative to its total capital invested (Capital Employed): Total Capital Employed = Shareholders' Equity + Long-Term Loans Total Capital Employed = 2,50,000 + 2,50,000 = Rs. 5,00,000 To calculate ROI, we use Net Profit Before Interest and Tax (NPBIT) to reflect operational returns before financing costs: NPBIT = Net Profit after Interest + Interest on Loan NPBIT = 50,000 + 25,000 = Rs. 75,000 Now, calculate the ROI: Return on Investment (ROI) &= \frac{NPBIT}{Total Capital Employed} \times 100
ROI &= \frac{75,000}{5,00,000} \times 100
ROI &= 0.15 \times 100 = 15%