If a firm's return on investment (i.e., earnings after taxes divided by total assets) is 7% and the firm has no preferred stock financing, it is ____.
A) possible that its return on stockholders' equity is 10%
B) possible that its return on stockholders' equity is 5%
C) impossible for its debt-to-equity ratio to be 1.0
D) impossible for its net profit margin to be 7%

Question

Quizplus · Accepted Answer

If a firm's return on investment (i.e. earnings after taxes divided by total assets) is 7%, it is possible that its return on stockholders' equity is 10% because return on equity is calculated as earnings after taxes divided by stockholders' equity. However, it is not possible for return on equity to be 5% because 7% is the minimum return that should be earned by the stockholders to compensate for the opportunity cost of investing elsewhere. It is also possible for the debt-to-equity ratio to be 1.0 and for the net profit margin to be different from 7%.

If a Firm's Return on Investment (I