Under what situation will return on equity be higher than return on investment?a. When assets exceed liabilities.b. When the debt to equity ratio is greater than 1.0.c. When net income is higher than it was in the previous year.d. When a company earns more on borrowed money than the interest it must pay.

Question
Asked Apr 25, 2019
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Under what situation will return on equity be higher than return on investment?

a. When assets exceed liabilities.

b. When the debt to equity ratio is greater than 1.0.

c. When net income is higher than it was in the previous year.

d. When a company earns more on borrowed money than the interest it must pay.

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Expert Answer

Step 1

(a) When assets exceed liabilities:

Suppose assets is $ 70,000 and liabilities is $ 50,000 and net income is $ 15,000

ROE = Net Income / Stockholder equity = $15,000 / ($70,000 - $50,000) = 0.75

ROI = Net income / Total Investment = $ 15,000 / $ 70,000 = 0.2143

In this situation, ROE is greater than ROI.

(b) When the debt to equity ratio is greater than 1.0:

Suppose equity is $ 30,000 and debt is $ 50,000 and net income is $ 15,000

Debt/Equity ratio = $50,000 / $ 30,000 = 1.67 (Greater than 1)

Total Investment = Equity + Debt = $ 30,000 + $ 50,000 = $ 80,000

ROE = $15,000 / $ 30,000 = 0.50

ROI = $ 15,000 / $ 80,000 = 0.1875

In this situation, ROE is greater than ROI.

(c) When net income is higher than it was in the previous year.

Not relevant because we are calculating ROI & ROE on the current year net income.

(d)  When a company earns more on borrowed money than the interest it must pay.

Not relevant because we are calculating ROI & ROE on the current year net income which is coming after deduction of inte...

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