Higher debt utilization ratios will always increase a firm's return on equity given a positive return on assets.

Question

Quizplus · Accepted Answer

The return on equity (ROE) formula is net income divided by shareholders' equity. When a firm has a higher debt utilization ratio, it means they are using more debt to finance their operations instead of equity. This can increase their return on equity because debt is cheaper than equity, and the interest paid on debt is tax-deductible. However, this statement only holds true if the firm has a positive return on assets (ROA). If the ROA is negative, then increasing debt utilization will further decrease the ROE.

Higher Debt Utilization Ratios Will Always Increase a Firm's Return