Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

14. Financial Statement Analysis

Ratios: Return on Equity (ROE)

Financial Accounting

14. Financial Statement Analysis

Ratios: Return on Equity (ROE)

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Multiple Choice

Given two companies with identical net income but different equity levels, which of the following statements about their Return on Equity (ROE) is correct?

The company with lower equity will have a higher ROE.

ROE is not affected by the amount of equity.

Both companies will have the same ROE.

The company with higher equity will have a higher ROE.

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Verified step by step guidance

Understand the concept of Return on Equity (ROE). ROE is a financial ratio that measures a company's profitability relative to its equity. The formula for ROE is: ROE = (Net Income) / (Shareholder's Equity).

Analyze the relationship between net income and equity in the ROE formula. If two companies have the same net income but different equity levels, the company with lower equity will have a higher ROE because the denominator (equity) is smaller.

Consider the implications of the ROE formula. A smaller equity base amplifies the ROE value for the same net income, while a larger equity base reduces the ROE value.

Evaluate the given options based on the formula and reasoning. The correct statement is: 'The company with lower equity will have a higher ROE.' This is because ROE is inversely proportional to equity when net income is constant.

Reject the other options. 'ROE is not affected by the amount of equity' is incorrect because equity directly impacts the ROE calculation. 'Both companies will have the same ROE' is incorrect because their equity levels differ. 'The company with higher equity will have a higher ROE' is incorrect because higher equity reduces ROE for the same net income.