Question 15

The company's return on equity will increase.

By significantly increasing its use of debt while maintaining a constant net profit margin and total asset turnover, the company will improve its return on equity. This occurs because leveraging debt allows the company to generate higher returns on the equity invested.

A) It will equal the company's use of equity.

This option is incorrect because return on equity (ROE) does not simply equate to the company's use of equity. While equity is a component of the calculation, ROE is influenced by net income and total equity, and increasing debt alters this relationship, leading to a different outcome.

B) It will remain unchanged.

This choice is incorrect as well. If the company increases its debt, the effects of leverage will impact the return on equity. Since the net profit margin and total asset turnover are held constant, the use of debt will enhance the return on equity, resulting in a change rather than a static outcome.

C) It will decrease.

This option is incorrect because increasing debt typically does not decrease return on equity when profit margins and asset turnover remain constant. Instead, it enables the company to amplify its returns, assuming the additional debt is managed effectively and used for profitable investments.

D) It will increase.

This is the correct answer. By increasing debt, the company can enhance its return on equity due to the leverage effect. Since net profit margin and total asset turnover are held constant, the additional debt allows for a greater return on the equity invested, thereby increasing ROE.

Conclusion

In summary, the correct answer is that the company's return on equity will increase due to the leverage effect of using more debt while maintaining constant profitability metrics. The other options fail to recognize the impact of debt on equity returns, misinterpreting the relationship between leverage and profitability.