Question

This year Andrews achieved an ROE of 6.9%. Suppose next year the profit margin (Net Income/Sales)...

This year Andrews achieved an ROE of 6.9%. 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?

Andrews ROE will increase.

Andrews ROE will decrease.

Andrews ROE will remain the same.

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Answer #1

The Answer is “Andrews ROE will decrease.”

The return on equity is the aggregate product of profit margin, asset turnover and equity multiplier. A Decrease in the profit margin [ Net Income / Sales ] will results in decrease in the Return on Equity [ ROE ]

The formula for Return on Equity is

Return on Equity [ ROE [ = Profit Margin x Asset Turnover x Equity Multiplier

= [ Net Income / Sales ] x [ Sales / Total Assets ] x [Total Assets / Equity ]

= [ Net Income / Equity ]

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