This year Baldwin achieved an ROE of 31.7%. Suppose next year the profit margin (Net Income/Sales) increases. Assuming sales, assets and financial leverage remain the same next year, what effect would you expect this action to have on Baldwin's ROE?

Select : 1

1) Baldwin ROE will remain the same.

2) Baldwin ROE will increase.

3) Baldwin ROE will decrease.

answer is 

Baldwin ROE will increase.

Step-by-step explanation

Return on equity formula = Net income/Equity

As next year profit margin is increased, So net income will increases.

But Assets and financial  leverage remain same, So equity will be unchanged

As Numerator increases, but denominator unchanged, So value of ROE will increased

So answer is 

Baldwin ROE will increase.

Another Method:

ROE as per Duo-pont equation = Profit margin * Asset turnover * Equity Multiplier

Next year Sales and assets will remain same, so Asset turnover will also be the same. (as asset turnover = sales/total assets)

 Financial leverage will remain same, So equity multiplier will remain same (as equity multiplier = (debt+equity) /equity)

Profit margin = Net income/sales

Next year, profit margin will increase, As profit margin will increase but sales remain same, So Net income will increase

As we can observe from Duo-pont equation that if Asset turnover and equity multiplier remain same, but Profit margin increase, Then its opposite site ROE will also increase.