You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?
A) Its total assets turnover must be above the industry average.
B) Its return on assets must equal the industry average.
C) Its TIE ratio must be below the industry average.
D) Its total assets turnover must be below the industry average.
E) Its total assets turnover must equal the industry average.

Question

Quizplus · Accepted Answer

Since ROE is above the industry average, it means that the firm is generating higher return on shareholder's equity. This suggests that the firm is potentially using its assets more efficiently than the industry average to generate profits. However, the profit margin and debt ratio being below the industry average indicates that the firm is either operating in a low margin industry or it is aggressive in its use of debt financing.

To have a high ROE, the firm must either have a high net profit margin, be highly leveraged, or have a high total assets turnover. Since profit margin is below the industry average, it leaves leverage and total assets turnover as possibilities. However, since the debt ratio is also below the industry average, it suggests that the firm is not highly leveraged. Hence, the only possibility left for the high ROE is that the firm's total assets turnover must be above the industry average.

You Observe That a Firm's ROE Is Above the Industry