If a firm's profit margin increases by 8%, the debt-to-equity ratio increases from 35% to 55% and its asset turnover falls by 20%, the effect on its ROE is ________.
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A. B. C. D.Explanation
ROE = net income/equity = (net income/sales)*(sales/assets)*(assets/equity) = (profit margin)*(asset turnover)*(1+debt/equity) The original assets/equity = 1 +
0.35 = 1.35 and the changed assets/equity = 1.55. Therefore, the change in ROE equals (1+8%)*(1-20%)*1.55/1.35 = 0.992. Thus, ROE falls by 0.8%.