Which of the following statements is CORRECT?
A) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%.Under these conditions, the ROE will decrease.
B) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%.Under these conditions, the ROE will increase.
C) Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%.Without additional information, we cannot tell what will happen to the ROE.
D) The modified DuPont equation provides information about how operations affect the ROE, but the equation does not include the effects of debt on the ROE.
E) Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales.

Question

Quizplus · Accepted Answer

The ROE (Return on Equity) can increase even if the total assets turnover ratio decreases, provided the profit margin increases and the firm leverages more (increases its debt), assuming the cost of debt is not prohibitively high. This is because ROE is influenced by net profit margin, asset turnover, and financial leverage. An increase in profit margin and higher leverage (more debt) can offset the decrease in asset turnover, potentially leading to a higher ROE.

Which of the Following Statements Is CORRECT