question archive This year Baldwin achieved an ROE of 31
Subject:FinancePrice:2.84 Bought6
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.