This year Erie achieved an ROE of 23.9%. Suppose the Board of Directors of Erie mandates that management take measures to increase financial Leverage (Assets/Equity) next year from 2.6 to 3.2. Assuming Sales, Profits, and Assets remain the same next year, what effect would you expect this new Leverage policy will have on Erie ROE? (Hint - use the DuPont formula) "a. Erie s ROE will decrease. b. Erie s ROE will increase. c. Erie s ROE will remain the same. d. Erie s equity will decrease and the stock price will increase

Question

George Jarvis

Business

26 June, 03:20

This year Erie achieved an ROE of 23.9%. Suppose the Board of Directors of Erie mandates that management take measures to increase financial Leverage (Assets/Equity) next year from 2.6 to 3.2. Assuming Sales, Profits, and Assets remain the same next year, what effect would you expect this new Leverage policy will have on Erie ROE? (Hint - use the DuPont formula) "a. Erie s ROE will decrease. b. Erie s ROE will increase. c. Erie s ROE will remain the same. d. Erie s equity will decrease and the stock price will increase

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Answers (1)

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Bentley Rowland · Answer 1

c. Erie s ROE will remain the same

Explanation:

As the return on asset is calcualte using the asset figure it will not change with a financial leverage measurement.

As the financial leverage acts in the composition of other side of the accounting (assets = liabilitis + equity) it will change the return on equity, the debt ratio and other metric related to this side but, not the return on assets.