Question

As the CEO of a company, you are interested in raising the ROE (return on equity) of your firm. Explain what you would do considering the components of the ROE as covered in this course

Answer 1

As per the Du Pont identity,

ROE = Profit margin*Total asset turnover*Equity multiplier

The CEO must first try to raise the Profit margin. This will result in higher ROE. Total assets turnover refers to the ratio of Sales to total assets. Hence higher the efficiency of generating sales with the help of assets, higher will be this ratio and vice versa. Equity multiplier refers to the ratio of Total assets to equity. Lower the amount of equity in the business higher will be this ratio and hence higher will be the ROE. Hence the CEO can try to raise this ratio in order to raise the ROE.