Which of these statements are correct:.. finance hw...?

Question

Which of the following statements is correct?

Suppose a firm's total assets turnover ratio falls from 10% to 9%, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will decrease.

Suppose a firm's total assets turnover ratio falls from 10% to 9%, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will increase.

Suppose a firm's total assets turnover ratio falls from 10% to 9%, but at the same time its profit margin rises from 9% to 10%, and its debt increases from 40% of total assets to 60%. Without additional information, we cannot tell what will happen to the ROE.

The modified Du Pont equation provides information about how operations affect the ROE, but the equation does include the effects of debt on the ROE.

Other things held constant, an increase in the debt ratio will result in an increase in the profit margin on sales

Answer 1

The correct answer is;

Under these conditions, the ROE will increase

Du Pont equation is : ROE= Asset Turnover*Profit margin* Asset to equity ratio

So, the initial position was ROE=0.10*0.09* (1/0.6)

The changed situation is ROE= 0.9*0.10* (1/0.4)

By just comparing we can see ROE  is now higher. ROA remains the same (0.09*0.10=0.10*0.09) but Asset to equity has has risen due to lower percentage of equity. So, ROE will increase.

I am correct if Asset turnover means Sales divided by Average Assets.