A firm increases its debt-to-equity ratio from 1.5 to 1.75. The increase is beneficial to shareholders...

Question

Question

A firm increases its debt-to-equity ratio from 1.5 to 1.75.

The increase is beneficial to shareholders if ROA is positive

The increase is detrimental to shareholders if ROA is negative

Has no effect on return on equity or shareholders

Which are true?

business finance

Answer 1

Answer #1

ROE = Net Income / Equity

= Net Income / Sales x Sales / Assets x Assets / Equity

= Net Income Margin x Asset Turnover x Financial Leverage

= ROA x Financial Leverage

ROA = Net Profit / Total Assets

If ROA > 1, increase in debt to equity ratio from 1.5 to 1.75, will increase financial leverage (from 2.5 to 2.75) and hence, ROE will improve.

Hence, the first statement is correct.

Answer 2

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