How to Use Production Indexes to Predict Return on Equity

by Ryan Menezes, studioD

A production index describes the production during a period relative to a previous period's production level. On a macro level, such an index tracks aggregate production over several industries in terms of real money, which discounts inflation. On a micro level, if an index measures your company's changing output, you can use it to calculate the firm's changing net income. This value relates to the annual return on equity, which is the ratio between this income and the investors' equity.

Multiply the net income for the company's initial period by the estimated production index. For example, if the company takes in an initial income of $200,000, and a production index of 1.15 predicts its output change between that year and the next, multiply $200,000 by 1.15, giving $230,000.

Add the additional equity that shareholders contribute over the course of the year to the initial equity level. For example, if investors had contributed $500,000 in equity by the reference year and they then invested a further $200,000, add the two figures, giving $700,000.

Divide the net income from Step 1 by the shareholders' assets from Step 2. With this example, divide $230,000 by $700,000, giving 0.329, or 32.9 percent. This is the company's predicted return on equity.

About the Author

Ryan Menezes is a professional writer and blogger. He has a Bachelor of Science in journalism from Boston University and has written for the American Civil Liberties Union, the marketing firm InSegment and the project management service Assembla. He is also a member of Mensa and the American Parliamentary Debate Association.

Photo Credits

  • Images