Question

This year Andrews achieved an ROE of 15.3%. Suppose next year the profit margin (Net Income/Sales) decreases. Assuming sales, assets and financial leverage remain the same next year, what effect would you expect this action to have on Andrews's ROE?

Select: 1

	Andrews ROE will remain the same.
	Andrews ROE will decrease.
	Andrews ROE will increase.

Answer 1

Ans is B Andrews ROE will decrease

Explanation: Roe or return on equity is a ratio that measures the reward to equity holders, as per Dupont analysis, it is divided in three ratios:

ROE = Profit Margin x Asset Turnover x Equity multiplier

Effect on ROE is analyzed by change in all three ratios, if any of the three ratio is increases or decreases it directly affects the ROE, since in this case only profit margin is decreased and other things like sales, assets and financial leverage remains the same, its ROE will decrease.

We can analyze directly also, since ROE = Net income/Average stockholders equity, since Profit margin is decreased but sales is same, i.e net income is decreased, and if net income is decreased, ROE will also decrease.