A. ROE measures the amount of net income returned as a percentage of shareholders equity. ROE is important to measurement because it helps us compare companies to their peers. A dollar amount cannot tell us how profitable particular companies are without ROE. Return on equity measures a company’s profitability by calculating how much profit a company generates with the money shareholders have invested. It is a one of the best measurement for equity valuation purpose.
B. ROE is made up with two parts, one of the part happen to be RNOA (return net operating asset), and non operating return. Non operating return can be anything that is outside of company core operation. It can be non core asset investments, Discounting operation, Interest. ROE uses shareholder’s investments to measure the profitability of the company. RNOA uses the total asset base invested by both creditors and shareholders to measure the effectiveness and profitability of the company. The non-operating portion of ROE determines the amount to which a company uses debt to increase its return on equity. Return on equity will increase if return earned on assets financed by the debt is greater than interest rate on debt.
C. The amount tax paid on an additional dollar of income is the marginal tax rate. Tax shied is s the reduction in income taxes that results from taking an allowable deduction from taxable income. It is very important to fully understand tax shield benefits to a business. For example, because interest on debt is a tax-deductible expense, taking on debt creates a tax shield. Since a tax shield is a way to save cash flows, it increases the value of the business, and it is an important aspect of business valuation. Company must review to assess the right balance of debt, and the benefit it receives from tax shield. It is also saves taxes by having tax-deductible non-operating expenses.