A decomposition of ROE for Company A and Company B is as follows:
|
Company A |
Company B |
|||
|
2005 |
2004 |
2005 |
2004 |
|
|
ROE |
26.46% |
18.90% |
26.33% |
18.90% |
|
Tax burden |
0.7 |
0.75 |
0.75 |
0.75 |
|
Interest burden |
0.9 |
0.9 |
0.9 |
0.9 |
|
EBIT margin |
7.00% |
10.00% |
13.00% |
10.00% |
|
Asset turnover |
1.5 |
1.4 |
1.5 |
1.4 |
|
Leverage |
4 |
2 |
2 |
2 |
Which of the following choices best describes reasonable conclusions an analyst might make based on this ROE decomposition?
a. Company A’s ROE is higher than Company B’s in 2005, but the difference between the two companies’ ROE is very small and was mainly the result of Company A’s increase in its financial leverage.
b. Company A’s ROE is higher than Company B’s in 2005, apparently reflecting a strategic shift by Company A to a product mix with higher profit margins.
c. Company A’s ROE is higher than Company B’s in 2005, which suggests that Company A may have purchased new, more efficient equipment.