Corporate Profitability: Return on Equity, Return on Investment, Modigliani & Miller Proposition II And Economic Value Added

Abstract

Corporate profitability is a core issue of financial statement analysis and corporate finance. Economic profitability, deriving from positive marginality where revenues exceed costs, is considered in complementary ways. Return on equity (ROE), Return on investment (ROI), Return on sales (ROS) and other ratios are systematically illustrated. This analysis is preparatory to Modigliani & Miller proposition II: as the proportion of debt in the company's capital structure increases, its ROE increases in a linear fashion. An empirical case is provided, starting from a real balance sheet. Economic Value Added represents the value created in excess of the required return of the company's shareholders, i.e. the net profit less the equity cost of the firm's capital.