When a company's ROE is greater than its ROA for a given time-period, it could be that

Question

BlackTom AI · Accepted Answer

When evaluating why a company’s ROE might exceed its ROA in a given period, the role of leverage comes into play. 
Option 1: 'the company has no debt' — If a firm had no debt, ROE and ROA would be driven by the same asset returns (ROE would equal ROA, after accounting for any equity structure). The statement implying no debt would not explain why ROE exceeds ROA, so this option is inconsistent with the observed spread between ROE and ROA. 
Option 2: 'the level of debt has no impact on the ROA' — ROA is net income divided by total assets, and debt affects net income via interest expense (which in turn can affect the equity base and ROE). If debt level truly had no impact on ROA, there would be no mechanism to create a gap where ROE is higher than ROA; in practice, debt financing can influence ROE through interest tax shields and the financial leverage effect. Thus, this option misstates the relationship between leverage and ROA/ROE. 
Option 3: 'the company could borrow at an after-tax rate that was less than the rate earned by investing in assets.' — This option describes the classic leverage effect: if the after-tax cost of debt is lower than the return on assets, using debt increases net income attributable to equity, boosting ROE relative to ROA. This is a plausible and valid explanation for ROE exceeding ROA. 
Option 4: 'the company could borrow at an after-tax rate that was higher than the rate earned by investing in assets' — If the after-tax cost of debt were higher than the return on assets, debt would hurt profitability and reduce ROE relative to ROA, or at least not explain ROE being higher than ROA. Therefore, this option does not account for the observed relationship and is inconsistent with the scenario. 
In summary, the reasoning hinges on the comparison between the after-tax cost of debt and the asset return. A favorable spread (after-tax debt rate < asset return) supports ROE > ROA, while a unfavorable spread would not.

When a company's ROE is greater than its ROA for a given time-period, it could be that Single choice

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Using borrowed funds to generate additional profits for shareholders is referred to as:

Which one of the following statements concerning financial leverage is correct?

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