Last year's return on equity was 30%.This year the ROE has decreased to 20% even though the firm's earnings equaled last year's earnings.The firm has no preferred stock.What caused the decrease?
A)equity decreased by 10%.
B)equity decreased by 50%.
C)equity increased by 10%.
D)equity increased by 50%.

Question

Quizplus · Accepted Answer

The decrease in ROE from 30% to 20% with unchanged earnings indicates that the equity base increased, diluting the return per unit of equity. A 50% increase in equity would mathematically result in such a change, as it would spread the same amount of earnings over a larger equity base, thus reducing the ROE.

Last Year's Return on Equity Was 30