ExpertMedium1 markMultiple Choice
CPA · Question 15 · Area 2: Financial Statement Analysis
Using DuPont Analysis, a company's Return on Equity (ROE) increased from 15% to 18% year-over-year. The analysis shows:<br/>- Net Profit Margin decreased.<br/>- Asset Turnover remained constant.<br/>- Financial Leverage increased significantly.<br/><br/>What is the most likely interpretation of this performance?
Using DuPont Analysis, a company's Return on Equity (ROE) increased from 15% to 18% year-over-year. The analysis shows:<br/>- Net Profit Margin decreased.<br/>- Asset Turnover remained constant.<br/>- Financial Leverage increased significantly.<br/><br/>What is the most likely interpretation of this performance?
Answer options:
A.
Operational efficiency has improved.
B.
The higher ROE is driven by increased financial risk rather than operational improvement.
C.
The company is generating more sales per dollar of assets.
D.
The increase in ROE is sustainable and indicates high earnings quality.
How to approach this question
Decompose ROE: Profit Margin (Profitability) * Asset Turnover (Efficiency) * Equity Multiplier (Leverage). Analyze which component moved.
Full Answer
B.The higher ROE is driven by increased financial risk rather than operational improvement.✓ Correct
The increase in ROE is entirely attributable to the increase in the Equity Multiplier (Financial Leverage). While this boosts returns to shareholders, it comes with increased financial risk (solvency risk).
Common mistakes
Assuming higher ROE is always 'good' without checking the driver.
Practice the full CPA BAR Practice Exam
50 questions · hints · full answers · grading
More questions from this exam
Q01TechGlobal Inc. is evaluating the performance of its European division using Economic Value Added...HardQ02A manufacturing company is analyzing its production process to identify bottlenecks. The process ...MediumQ03Management is using the COSO Enterprise Risk Management (ERM) framework to address a newly identi...MediumQ04RetailCo is evaluating two strategic initiatives using a Balanced Scorecard approach. <br/>Initia...MediumQ05A company is deciding between two mutually exclusive projects. <br/>Project X: NPV = $50,000, IRR...Medium