The return on equity (ROE) is the profit a company earns specifically with shareholders' equity. For investors, the internal rate of return (IRR) is the rate of return an investment is expected to generate. For companies, IRR is the rate of return a particular project is expected to generate once completed.
ROE is a profitability measure of how well a company generates profits through its normal business operations. The formula for ROE is net income divided by shareholders' equity, and is expressed in a percentage. ROE is the rate at which investors can reasonably expect the company to grow their investment dollars. A company can use the ROE to assess if its top executives or management teams are doing an adequate job of investing and reinvesting shareholders' capital.
ROE Formula Components
You can find all the information you need to calculate ROE on a company’s income statement and balance sheet. The net income component of the ROE formula is income before any dividends are paid to common shareholder’s and after dividends are paid to preferred shareholders. You can find this information on the company’s income statement. You can find shareholders' equity on the balance sheet.
The IRR is an estimate of the rate of return of a project and can be different than the actual or real rate of return a project generates once completed. Company’s often use the IRR to compare the profitability of two or more projects it is considering undertaking. The purpose of calculating the IRR is to determine if the rate of return of a project is greater than its cost of capital.
IRR Calculation Components
IRR calculations involves discounting multiple future cash flows to their net present value (NPV), which is why companies often use a computer program to perform the calculations. The discount rate a company uses to discount future cash flows to its NPV varies. Companies may choose to plug in different rates and find the discount rate by trial and error. Other methods include using the weighted average cost of capital (WACC). The WACC is the cost of debt and equity financing the company uses to pay for the project or the rate of return on government securities, such as a Treasury bill.
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