What’s the logic of adding interest expense in the Return on Total Capital ROTC = (Net Income + interest expense)/(Average Total Capital)?

rotc includes debt, so that’s why you add back the interest expense that was used to service the debt

on the same note, note that average total capital includes only interest bearing debt + stockholders equity (as of this year, I believe).

I asked this same question in my prep for level I. Here is a link for the answers I received. I post this because Super I answered. He is known for being the FSA expert here. http://www.analystforum.com/phorums/read.php?11,531711,531711#msg-531711 Hope this helps.

very helpful, thanks mwv9.

I believe that interest bearing debt + stockholders equity is the definition of total invested capital. One of the end-chapter comprehensive questions in the CFA textbook equates total capital to average total assets.Go figure…

Very helpful link, mwvt9. So, ROTC represents combined return for debt issuers and equity holders. That’s why the numerator contains net income and interest expense, and denominator contains equity and interest-bearing debt. Then Return on Total Equity represents combined return for common and preferred equity holders. Return on Total Equity = Net Income/Average Total Equity. Here average total equity consists of common and preferred equity. Then Return on Common Equity represents return available for common equity holders only. Return on Common Equity = (Net Income - preferred dividents)/Average Common Equity. Is that a decent summary of what Super I talked about?

good job with that link

maratikus Wrote: ------------------------------------------------------- > Very helpful link, mwvt9. > > So, ROTC represents combined return for debt > issuers and equity holders. That’s why the > numerator contains net income and interest > expense, and denominator contains equity and > interest-bearing debt. > > Then Return on Total Equity represents combined > return for common and preferred equity holders. > Return on Total Equity = Net Income/Average Total > Equity. Here average total equity consists of > common and preferred equity. > > Then Return on Common Equity represents return > available for common equity holders only. Return > on Common Equity = (Net Income - preferred > dividents)/Average Common Equity. > > Is that a decent summary of what Super I talked > about? Looks good to me.