Free ROE and IRR Essay Sample

Return on equity (ROE)

This is used to measure the return rate of shareholders equity. It is thus very essential in showing how efficient is a company at using each share holders' equity to generate profit for it. In other words, it is the result of assets minus liabilities. A company that uses investment funds to grow its earnings effectively is thus a well operating company. A company that has ROEs between 15% and 20% is a desirable company and anybody would want to invest in it. The ROE is gotten by dividing the net income after tax by the shareholders' equity and it is expressed as a percentage. Companies in the same industry can thus be compared by return on equity making one to make a choice as to where they want to invest.

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There is no immediate benefit that is yielded by a high ROE. This is because earnings per share determines the stock price thus making one to pay much in a higher ROE company than in a lower one. However, at a high ROE rate of a company earnings reinvested results in many benefits. These benefits are also brought by dividends on common shares or a combination of both. It is thus used as profitability metric where it compares the profit the company has made with the total shareholder's equity in the balance sheet of the same company. It thus means a company with a high return on equity is able to internally generate cash. Many investors will thus choose to invest in a company where the value is high since they are sure of the probability that their money will generate more profit for them as well as for the company.

Internal rate of return (IRR)

This is another metric that is used to measure how profitable the investments of a company are. It is simply called the rate of return (ROR). The rate of return is termed internal since no environmental factors are incorporated in it during the calculations. Cost of investment's net present value is the same as the benefits of the investments' net present value at the interest rate.

It finds its use in the evaluation of whether an investment is desirable. If the value is high then it means that many will desire to invest or undertake the project. It is advisable that a value that is higher that capitals' cost will make an individual want to invest in such a company. Investors to see how much return they are likely to make by comparing the money they are going to use and the returns thus use it. 

It is thus used to indicate the efficiency of an investment or a project in a company, and how the investment is likely to yield as well as its quality. Therefore, an investment where the value of IRR is greater than the cost of capital has a lot of value and quality to the company since it means that the company is profitable. It is a tool that is used to make decisions as to whether to invest or not and it does not rate projects that are mutually exclusive. 

Toyota and ford motors are companies from the same industry and their calculated returns on equity for the year 2009 are as follows.

Ford motors

Net income after tax=2,717,000

Share holders equity =7,820,000

Return on equity = Net income after tax/ Share holders equity



=35% (Yahoo, 2011).  

Toyota Company

Net income after tax=4,424,000

Share holders equity =101,865,000

Return on equity = Net income after tax/ Share holders equity





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