If net income increases while average shareholders’ equity remains constant, ROE will:

If net income increases while average shareholders’ equity remains constant, ROE will:

• A. ROE decreases
• B. ROE becomes negative
• C. ROE increases
• D. ROE unchanged

Answer: (C)

Return on equity shows how much profit is earned for each dollar of shareholder equity. It’s calculated as net income divided by average shareholders’ equity. If net income rises while average equity stays the same, you’re generating more profit from the same amount of equity, so the ratio increases. For example, with net income of 100 and average equity of 400, ROE is 25%. If net income increases to 120 with the same equity, ROE becomes 30%. So ROE increases.

Return on equity shows how much profit is earned for each dollar of shareholder equity. It’s calculated as net income divided by average shareholders’ equity. If net income rises while average equity stays the same, you’re generating more profit from the same amount of equity, so the ratio increases. For example, with net income of 100 and average equity of 400, ROE is 25%. If net income increases to 120 with the same equity, ROE becomes 30%. So ROE increases.