How is Return on Equity (ROE) calculated?

Return on Equity (ROE) is a key financial metric used to measure a company's profitability relative to the equity that shareholders have invested in the company. The formula for calculating ROE is Net Income divided by Shareholder's Equity. This ratio provides insight into how effectively a company is generating profits from its equity financing.

By using shareholder's equity in the denominator, ROE reflects the return that shareholders can expect on their investment. A higher ROE generally indicates that the company is efficient in utilizing its equity base to produce profits, which can be attractive to investors.

The other options do not accurately represent the relationship that ROE is intended to measure. For instance, dividing net income by total assets measures return on assets (ROA), which assesses how effectively a company uses all its assets to generate earnings, not just equity. Similarly, dividing net income by market capitalization provides a measure of profitability relative to market value rather than the actual investments shareholders have made. Lastly, dividing net income by debt obligations does not relate to equity at all and thus does not serve the purpose of calculating ROE.