Question

This year Andrews achieved an ROE of 18.4%. Suppose next year the profit margin (Net Income/Sales)...

This year Andrews achieved an ROE of 18.4%. 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 decrease.
Andrews ROE will increase.
Andrews ROE will remain the same.
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Answer #1

Return on equity is amount of net income returned as a percentage of shareholder equity . Since it is mentioned that leverage amount will not change next year and leverage is ratio of debt vs equity , we presume quantum of equity remains unchanged.

It is mentioned that next year profit margin reduces .

Therefore , we have a scenario of profit margin reducing with equity amount remaining unchanged. Therefore , ROE which is equal to Net profit / Equity will also decrease .

ANDREWS ROE WILL DECREASE
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