Question

an increase in which of the following will increase the return on equity, all else constant ?

1. total asset turnover
2. net income
3. total assets
4. debt-equity ratio

a. 1 only
b. 1 and 2 only
c. 1, 2 and 4 only
d. 1, 2 and 3 only
e. 1, 2, 3, and 4

Answer 1

The Asset Turnover Ratio is an activity ratio and is equal to Revenue/Total Assets.

Asset Turnover Ratio = Revenue/Total Assets.

= (Net Income/ Net profit margin) / Total Assets

All else remaining constant also means that Net Profit margin is constant and hence an increase in this ratio means more net income per unit of asset (composed of fixed Debt/Equity Ratio). As the Net Income Increases,  so does the ROE. So 1 is correct

An increase in Net income directly means increase in ROE. So, 2 is also correct

An increase in total assets may happen by more equity or more debt. Depending upon the situation, the Net Income may increase but it cant be said whether the Return on equity increases or not. In case the Operating margin is less than cost of debt, the ROE decreases, else it increases. So, an increase in assets may not increase ROE . option 3 is not correct

Similarly, an increase in Debt/Equity ratio also means more debt used in the organisation. Depending on the level of Operating margin and its relationship with cost of debt, it may or may not increase ROE.   option 4 is not correct

So b) 1 and 2 only   is the correct answer