Return on Shareholders' Equity is increased if a firm can maintain its return on assets but increase its leverage.

Question

Quizplus · Accepted Answer

Return on Shareholders' Equity (ROE) is calculated by dividing net income by shareholders' equity. If a firm can maintain its return on assets (ROA) but increase its leverage, it can effectively increase the amount of debt financing in its capital structure, which can lower the firm's cost of capital and increase its return on equity. This is because debt financing is generally less expensive than equity financing due to the tax-deductibility of interest expenses. However, increasing leverage also increases the risk of financial distress or bankruptcy, which must be carefully managed.

Return on Shareholders' Equity Is Increased If a Firm Can