## Overall Return Ratios and Market / Investor Ratios

These ratios evaluate returns from the owners' perspective and link accounting performance to market valuation.

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### A. Return Ratios

#### 1. Return on Capital Employed (ROCE) / Return on Investment (ROI)

Version	Formula
Pre-tax ROCE	EBIT / Capital Employed
Post-tax ROCE	EBIT(1−t) / Capital Employed = (EAT + Interest) / Capital Employed

Capital Employed = Equity + Long-term Debt
Pre-tax ROCE is generally preferred for inter-firm comparisons (neutralises different tax positions).
Significance: Overall profitability on total long-term funds employed.

#### 2. Return on Net Worth (RONW) / Return on Equity (ROE)

Version	Formula
Pre-tax RONW	EBT / Net Worth
Post-tax RONW	EAT / Net Worth

Post-tax ROE is generally preferred (reflects what actually accrues to owners).
Net Worth = All Shareholders' Funds (Equity + Preference + Reserves − Misc. Expenditure)

#### 3. Return on Assets (ROA)

Version	Formula
Pre-tax ROA	EBT / Average Total Assets
Post-tax ROA	(EAT + Interest) / Average Total Assets

Average Total Assets = (Opening + Closing) / 2

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### B. Du Pont Analysis

ROI = Net Profit Margin × Capital Turnover Ratio

= (Net Profit / Sales) × (Sales / Capital Employed) = Net Profit / Capital Employed

This decomposition reveals whether a firm's ROI is driven by margin efficiency or asset utilisation (or both). Two firms can achieve the same ROI through entirely different strategies.

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### C. Market / Investor Ratios

#### 4. Earnings Per Share (EPS)

Formula: = Residual Earnings / Number of Equity Shares

Residual Earnings = EAT − Preference Dividend
No. of Shares = Equity Capital / Face Value per Share

#### 5. Dividend Per Share (DPS)

Formula: = Total Equity Dividend / Number of Equity Shares

#### 6. Price-Earnings (P/E) Ratio

Formula: = Market Price per Share (MPS) / EPS

Reflects the market's growth expectations. Higher P/E = market pays more per rupee of current earnings.

#### 7. Dividend Yield

Formula: = DPS / MPS × 100

True cash return to an investor based on current market price (not face value).

#### 8. Book Value per Share

Formula: = Equity Shareholders' Funds (ESHF) / Number of Equity Shares

ESHF = Equity Share Capital + Reserves (Preference capital excluded)

#### 9. Market Value to Book Value Ratio

Formula: = MPS / Book Value per Share

Higher ratio → market values the firm at a premium over its accounting net assets.

#### 10. Tobin's Q Ratio

Formula: = Market Value of Equity and Liabilities / Estimated Replacement Cost of Assets

Q > 1 → Market believes assets generate returns exceeding their replacement cost.
Q < 1 → Acquiring assets through M&A may be cheaper than building them.

Worked example

### Example 1

Example 1 – Du Pont Analysis (from Question 33)

Given: Net Operating Profit (Return) = ₹80,000; Sales = ₹3,00,000; Capital Employed = ₹2,25,000

Capital Turnover Ratio = Sales / Capital Employed = 3,00,000 / 2,25,000 = 1.33 times

Net Operating Profit Ratio = Return / Sales = 80,000 / 3,00,000 = 26.67%

ROI (Du Pont) = Profit Margin × Asset Turnover = 26.67% × 1.33 = 35.56%

Verification: ROI = 80,000 / 2,25,000 = 35.56% ✓

Du Pont insight: A retailer with 5% margin and 7× turnover earns the same 35% ROI as a manufacturer with 26.67% margin and 1.33× turnover. The analysis reveals which lever the firm pulls — critical for strategic decisions.

### Example 2

Example 2 – EPS, P/E Ratio and Dividend Yield (from Question 15)

Given: Equity Shares: 80,000 shares of ₹10 each; 9% Preference Shares = ₹3,00,000; EAT = ₹2,70,000; Equity Dividend = 20%; MPS = ₹40

Preference Dividend = 9% × 3,00,000 = ₹27,000

EPS = (EAT − Preference Dividend) / No. of Equity Shares

= (2,70,000 − 27,000) / 80,000 = 2,43,000 / 80,000 = ₹3.04 per share

Equity DPS = 20% × ₹10 (face value) = ₹2.00 per share

P/E Ratio = MPS / EPS = 40 / 3.04 = 13.16 times

Dividend Yield = DPS / MPS × 100 = 2.00 / 40 × 100 = 5.00%

Dividend Cover for Equity = EPS / DPS = 3.04 / 2.00 = 1.52 times

Preference Dividend Cover = EAT / Preference Dividend = 2,70,000 / 27,000 = 10.00 times

### Example 3

Example 3 – ROCE vs RONW: Leverage Effect (from Question 8, FLOW Ltd.)

Given (₹ lakhs): EBIT = 2.99; Capital Employed = 11.00; EAT = 1.26; Net Worth = 7.50

Pre-tax ROCE = EBIT / Capital Employed = 2.99 / 11.00 = 27.18%

Post-tax RONW = EAT / Net Worth = 1.26 / 7.50 = 16.80%

Why is RONW lower than ROCE here? Tax reduces earnings, and the Net Worth base includes preference capital which dilutes the equity return. Always compare ratios on the same basis (pre-tax with pre-tax, post-tax with post-tax) across firms.

⚠️ Common exam mistakes

Using face value of shares as Market Price per Share — always use the Stock Exchange quoted (market) price for P/E, Dividend Yield, and Market to Book Value.
Including Preference Share Capital in Equity Shareholders' Funds (ESHF) when computing Book Value per Share — ESHF is only equity capital plus reserves.
Forgetting to deduct Preference Dividend from EAT before computing EPS — the full EAT does not belong to equity holders if preference dividends are outstanding.
Confusing ROCE (uses EBIT in numerator) with RONW / ROE (uses EAT or EBT) — mixing numerators gives a meaningless result.
In Du Pont analysis, using the same 'Sales' figure in both ratios is correct — but students sometimes use Capital Employed in both, losing the decomposition.
Computing Earning Yield as EPS / Face Value instead of EPS / Market Price — Earning Yield = 1 / P/E Ratio, both based on market price.

Reference:

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