Return on Asset (RoA)

Return on Asset (RoA):
Having understood the DuPont Model, understanding the next two ratios should be simple. Re-
turn on Assets (RoA) evaluates the effectiveness of the entity’s ability to use the assets to create
profits. A well managed entity limits investments in non productive assets. Hence RoA indicates
the management’s efficiency at deploying its assets. Needless to say, higher the RoA, the better it
is.
RoA = [Net income + interest*(1-tax rate)] / Total Average Assets
From the Annual Report, we know:
Net income for FY 14 = Rs.367.4 Crs
And we know from the Dupont Model the Total average assets (for FY13 and FY14) = Rs.1955 Crs
So what does interest *(1- tax rate) mean? Well, think about it, the loan taken by the company is
also used to finance the assets which in turn is used to generate profits. So in a sense, the debt
holders (entities who have given loan to the company) are also a part of the company. From this
perspective the interest paid out also belongs to a stake holder of the company. Also, the com-
pany benefits in terms of paying lesser taxes when interest is paid out, this is called a ‘tax shield’.
For these reasons, we need to add interest (by accounting for the tax shield) while calculating the
ROA.
The Interest amount (finance cost) is Rs.1 Crs, accounting for the tax shield it would be
= 7* (1 – 32%)
= 4.76 Crs . Please note, 32% is the average tax rate.
Hence ROA would be –
RoA = [367.4 + 4.76] / 1955
~ 372.16/ 1955
~19.03%