The business is a computer sales and repair store. There has been an increase in customer demand with more people working from home, but there have also been rising costs due to COVID19. The actual dollar figure for profit is fairly similar between the current and prior year, however the business did issue more share capital.

Is the change in the ratio a an improvement or deterioration/decline in the financial situation of the business? Or neither?

Return on equity

Previous year Current year
13.5% 10.4%

Question

The business is a computer sales and repair store. There has been an increase in customer demand with more people working from home, but there have also been rising costs due to COVID19. The actual dollar figure for profit is fairly similar between the current and prior year, however the business did issue more share capital.

Is the change in the ratio a an improvement or deterioration/decline in the financial situation of the business? Or neither?

Return on equity

Previous year	Current year
13.5%	10.4%

BlackTom AI · Accepted Answer

Return on equity fell from 13.5% to 10.4%, so the returns delivered to shareholders have declined.

1) Relevant knowledge points and concepts
- Return on equity (ROE) = Net Income / Shareholders’ Equity. It measures how efficiently a business uses equity to generate profits.
- If net income is unchanged but equity rises (for example, because the company issued share capital), ROE will fall.
- A lower ROE indicates a deterioration in the return on shareholders’ funds (less profitable use of equity).

2) Step-by-step reasoning
- The scenario states actual profit (net income) is “fairly similar” year-on-year while the business issued more share capital (equity increased). That directly affects ROE because the numerator (net income) is roughly constant while the denominator (equity) grows.
- Compute the change in ROE: previous 13.5% → current 10.4%. The drop is 13.5% − 10.4% = 3.1 percentage points.

3) Calculations and intermediate steps
- Absolute change: 3.1 percentage points.
- Relative decline = 3.1 / 13.5 ≈ 0.2296 → about a 22.96% reduction in ROE.
- If we illustrate with numbers (assume Net Income = $10,000 for clarity):
  - Equity_prev = 10,000 / 0.135 ≈ $74,074.07
  - Equity_curr = 10,000 / 0.104 ≈ $96,153.85
  - Equity increased by ≈ $22,079.78, which is ≈ 29.8% increase in equity, causing ROE to fall.

4) Why the correct answer is correct
- ROE decreased substantially because equity increased while profit stayed roughly the same. That means shareholders are getting a lower percentage return on their invested capital in the current year—an objective deterioration in financial performance from an equity-return perspective.

5) Why the other options are incorrect
- “Financial situation is improving”: incorrect because ROE declined, so returns to equity holders have worsened.
- “Neutral - neither bad or good”: incorrect because a ~23% relative fall in ROE (3.1 percentage points) is material; although issuing equity can strengthen the balance sheet, it reduces ROE when profit does not rise proportionally.

6) Conclusion
- The change represents a deterioration/decline in the financial situation relative to shareholder returns. This matches the provided answer: Financial situation is declining.

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