Question

A company is evaluating their financial performance and digging into their ratios. The company wants to keep the same Return on Equity (ROE) (as it looks good) but they are faced with the reality that their total asset turnover ratio as well as their net profit margin are declining. What can management do?

A. reduce their revenue while increasing the quality of assets on their balance sheet

B. decrease their leverage (equity multiplier)

C. increase their leverage (equity multiplier)

D. increse their revenue while decreasing the quality of assets on their balance sheet

Answer 1

Answer : C. increase their leverage (equity multiplier)

=> In case the company's total asset turnover ratio as well as the net profit margin are declining, the leverage ie. the equity multiplier, should be increased as it improves the assets quality and quantity, which increases the revenues and the income. Also, increasing the leverage will bring down the equity level which will help in maintaining the same Return on Equity, which is looking good.

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