returnonequitymeasuresthequalityofbotholderprojects
thathavebeenonthebooksforasubstantialperiodandnew
projectsfrom morerecent periods.Sinceolderinvestments
represent asignificant portionof theearnings,theaverage
returns maynotshift substantiallyforlarger firms thatare
facinga declinein returns on newinvestments because of
eithermarketsaturationorcompetition.Inotherwords,poor
returns on new projects will have a lagged effect on the
measuredreturns.Invaluation,itisthereturnsthatfirmsare
making on their newer investments that convey the most
informationaboutthequalityofafirm’sprojects.Tomeasure
thesereturns,wecouldcomputeamarginalreturnonequity
bydividingthechangeinnetincomeinthemostrecentyear
by the change in book value of equity in the prior year:
Forexample,GoldmanSachsreportedareturnonequityof
18.49%in2005,based onnetincome of$4,972millionin
2005 andbookvalueofequityof$26,888millionattheend
of 2004:
The marginal return on equity for Goldman in 2005 is
computedusingthechangeinnetincomeandbookvalueof
equity:
Changeinnetincomefrom 2004 to 2005 =4,972−4,553=
$419 million