Would taking on more debt increase, decrease, or leave the same, a firm’s ROE? 4 minutes.
taking on more debt reduce the ROE! why do you need 4 minutes for it?
I would think it would decrease it, because interest expense is taken out of net income. Unless, however, the more debt, brings more assets, which brings more sales…
I have my doubts about this, but in Stalla it says it increases ROE for this reason: ROE = NI/Sales * Sales/ Assets * Assets/Equity Assets/Equit is financial leverage. So, if you increase debt, assets go up (Remember that assets = Debt+equit), hence Assets/Equit goes up. But I don’t buy that…can you see why?
Would go with increase. As financial leverage is up, and assuming additional assets purchased with the debt could increase EBIT at a greater percentage increase than the increase in interest burden.
Yes, RIGWDL3. With some assumptions, yes, but the way they stated it sounded like it is an identity. Clearly from the ROE equation, assets cancel out.
Dreary Wrote: ------------------------------------------------------- > I have my doubts about this, but in Stalla it says > it increases ROE for this reason: > > ROE = NI/Sales * Sales/ Assets * Assets/Equity > > Assets/Equit is financial leverage. So, if you > increase debt, assets go up (Remember that assets > = Debt+equit), hence Assets/Equit goes up. But I > don’t buy that…can you see why? Dreary, Stalla is correct
Dreary Wrote: ------------------------------------------------------- > Yes, RIGWDL3. > > With some assumptions, yes, but the way they > stated it sounded like it is an identity. > Clearly from the ROE equation, assets cancel out. Not sure what you mean. Assets will increase by the amount of the debt taken on. The equity portion of financial leverage ratio will not (besides perhaps the incremental RE piece). I don’t necessarily agree that in all cases, more debt = higher ROE, however isn’t this the take private LBO model?
well we could go the 3- or 5-way decomposition but let’s just leave it with the basic identity ROE = NI/Equity ROE = NI/[Assets-Liabilities] liabilities up, ratio up this is probably an ultra simplified view
it makes no business sense to say taking on more debt increases the ROE. now you have less money for equity holders because you have to service your debt, how the HELL can this increase ROE?
But if Sales is canceled out of the equation and Assets are cancelled out, you’re left with NI/Equity. Doesn’t it depend on the effect that more debt has with net income?!?!?
okay equity is become smaller, but roe is getting better.
supersharpshooter Wrote: ------------------------------------------------------- > well we could go the 3- or 5-way decomposition but > let’s just leave it with the basic identity > > ROE = NI/Equity > ROE = NI/ > > liabilities up, ratio up > > this is probably an ultra simplified view Great example!!!
pepp Wrote: ------------------------------------------------------- > it makes no business sense to say taking on more > debt increases the ROE. > > now you have less money for equity holders because > you have to service your debt, how the HELL can > this increase ROE? With your debt you purchase assets that produce more income than the additional interest burden.
> ROE = NI/[Assets-Liabilities] If liabilities go up, assets also go up (isn’t assets = Liabilities + Equity)???
Dreary Wrote: ------------------------------------------------------- > > ROE = NI/ > > If liabilities go up, assets also go up (isn’t > assets = Liabilities + Equity)??? It’s just moving the components around. A = L + E; therefore, A-L = E. ROE = NI/Equity, so ROE = NI/(Assets-Liabilities).
soxboys, read it again.
Isn’t this just a case of financial leverage? So I’ve got a house where I put down 50% down on a 100K house and the price goes up to 110K (not in this market though) in a year then you sell. You’ve made 20% or 10K on your 50K of equity. You take the same house and put down 10% and the price goes up to 110K (not in this market though) in a year and then you sell. You’ve made 100% or 10K on your 10K of equity. Is it more complicated than this?
Leverage increases ROE at first, but eventually the interest expense will overtake the benefit of leverage if it gets too high. NI will decrease as a result of the extra int expense. That’s why its a balance of how much debt you should have.
The argument so far is here: supersharpshooter wrote: > ROE = NI/Equity > ROE = NI/[Assets-Liabilities] > liabilities up, ratio up To which I replied: If liabilities go up, assets also go up (ROE here does not change), so it is not true to conclude that ROE goes up from this equation. Now get back to analyzing.