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SSC Audit Tax Finance P-II QUESTION #6185
Question 1
Based on the Du Pont Identity, if a firm increases its Debt-Equity ratio while maintaining a constant Profit Margin and Total Asset Turnover, what occurs to the ROE?
  • ROE decreases due to higher interest expense.
  • ROE remains constant as it only depends on operating efficiency.
  • ROE increases because the Equity Multiplier rises.✔️
  • ROE becomes equal to the ROA.
Correct Answer Explanation
$ROE = \text{Profit Margin} \times \text{Total Asset Turnover} \times \text{Equity Multiplier}$. Increasing debt increases the multiplier, thus raising ROE [cite: 45, 46, 48].