Return on equity increases when the expected rate of return from the acquired assets is higher than the interest rate on the debt issued to finance the acquired assets.

Question

Quizplus · Accepted Answer

Return on equity is calculated by dividing net income by average equity. When an acquisition is made using debt financing, the cost of that debt (interest rate) will affect the return on equity. If the expected return from the acquired assets is higher than the interest rate on the debt, then the return on equity will increase. This is because the return on equity is calculated after deducting the interest expense on the debt.

Return on Equity Increases When the Expected Rate of Return