Sinclair Inc. reports the following information for 2016:

Total Revenue: $650,000
Total Expenses (incl. Interest Expense): $320,000
Total Shareholders’ Equity: $2,250,000
Total Liabilities: $450,000

The Interest Expense is $50,000 and the Income Tax Rate is 40%. What is the company’s Return on Assets (ROA)?

Question

Sinclair Inc. reports the following information for 2016:

Total Revenue: $650,000
Total Expenses (incl. Interest Expense): $320,000
Total Shareholders’ Equity: $2,250,000
Total Liabilities: $450,000

The Interest Expense is $50,000 and the Income Tax Rate is 40%. What is the company’s Return on Assets (ROA)?

BlackTom AI · Accepted Answer

We start by laying out the given figures and what each term means for calculating ROA.
- Total assets = Total liabilities + Shareholders' equity = 450,000 + 2,250,000 = 2,700,000.
- Revenue = 650,000.
- Total expenses (incl. interest) = 320,000, of which interest expense is 50,000. This means operating (before interest) expenses = 320,000 − 50,000 = 270,000.
- EBIT (operating income before interest and taxes) should be Revenue minus operating expenses = 650,000 − 270,000 = 380,000.
- Pre-tax income (Earnings before tax) = EBIT − interest = 380,000 − 50,000 = 330,000.
- Tax at 40% = 0.40 × 330,000 = 132,000.
- Net income = Pre-tax income − tax = 330,000 − 132,000 = 198,000.

Now, consider how ROA is defined and which denominator to use. ROA is commonly calculated as Net Income / Average Total Assets. When beginning-of-period assets aren’t provided, a common simplification is to use ending total assets as a proxy for average assets, yielding ROA ≈ Net Income / Total Assets. Using Net Income of 198,000 and Total Assets of 2,700,000 gives ROA ≈ 198,000 / 2,700,000 ≈ 7.33%. Nevertheless, some problems in textbooks or exams use different variants of ROA, such as EBIT (or operating income) divided by assets, or they may implicitly expect using EBIT in the numerator instead of net income.

Option-by-option analysis:
- Option 12.22%: This value matches if you incorrectly treat EBIT as Revenue minus Total Expenses (including interest), i.e., 650,000 − 320,000 = 330,000, and you divide by assets 2,700,000: 330,000 / 2,700,000 = 12.22%. This is a common pitfall because it uses the wrong numerator for ROA (it uses EBIT after including interest in expenses), conflating EBIT with net operating income. The correct EBIT for ROA purposes should exclude interest, which would be 380,000, giving a different result.
- Option 20.00%: This would imply a numerator of 540,000 if you divide by 2,700,000 (since 540,000 / 2,700,000 = 0.20). There is no straightforward way to get 540,000 net income or EBIT from the given numbers without altering the definitions. This option is not supported by standard ROA calculations from the data provided.
- Option 25.19%: This percentage would require a numerator of about 678,000 when divided by 2,700,000. That figure does not align with any standard interpretation (net income of 198,000; EBIT of 380,000; pre-tax income of 330,000) given the inputs. It appears to be an inconsistent or misapplied calculation.
- Option 13.33%: To reach 13.33% with assets of 2,700,000, the numerator would need to be 360,000 (since 0.1333 × 2,700,000 ≈ 360,000). However, none of the standard ROA variants (net income, EBIT, pre-tax income) produced exactly 360,000 with the provided figures. This suggests this option reflects a mismatch or a different interpretation of ROA that isn’t supported by the usual definitions for this data.

In summary, the core challenge is choosing the correct numerator for ROA. If ROA is defined as Net Income / Total Assets, you’d get 7.33% with the numbers above. If you instead use EBIT (operating income before interest) / Total Assets, you’d get 380,000 / 2,700,000 ≈ 14.07%. The option 12.22% corresponds to a common misstep of using 330,000 as the numerator (i.e., treating EBIT as Revenue minus Total Expenses including interest), which is technically incorrect because interest should be excluded when computing EBIT. The other options do not align with the standard ROA calculations using the provided data.

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