Flashcards on ROI and ROE in Strategic Management
ROI and ROE in Strategic Management: Explained for Students
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Corporate Financial Performance Metrics
15 cards
Card 1
Question: What two main scenarios determine how asset turnover (and thus performance metrics) change in the long run?
Answer: 1) Company strategy that does not require investing in new assets — changes come from revenue (price × quantity) affecting asset turnover. 2) Strategy
Card 2
Question: When a company's strategy does not imply investing in new assets, what must be analyzed to understand changes in revenue?
Answer: Potential changes in prices and potential changes in units sold (quantity); these are driven by the company’s competitive position and industry life-c
Card 3
Question: How can historic asset turnover be used when forecasting required asset volumes?
Answer: If historic asset turnover is considered efficient, it can be used as a forecasting tool for required asset volumes — but this may not apply if there
Card 4
Question: Write the relationship that links Return on Equity (ROE), Return on Investment (ROI), financial leverage, cost of debt (i), and debt ratio.
Answer: ROE = ROI + (ROI − i) × Debt ratio (equivalently ROE = ROI + Financial leverage)
Card 5
Question: How is ROI decomposed in terms of margin and asset efficiency?
Answer: ROI = Profit margin × Asset turnover (measuring return on total investments or assets before financing effects).
Card 6
Question: What does the cost of debt (i) represent?
Answer: The average interest the company pays on its debt — the effective 'price' of debt financing.
Card 7
Question: What does the debt ratio represent in the context of financial leverage?
Answer: The proportion of a company's assets financed through debt rather than equity (i.e., quantity of debt relative to assets).
Card 8
Question: If ROI > i, what is the effect of increasing debt on ROE and what is the suggestion for debt policy?
Answer: Positive financial leverage: increasing the debt proportion raises ROE. Suggestion: increase debt proportion; recommended debt ratio levels cited are
Card 9
Question: If ROI < i, what is the effect of increasing debt on ROE and what is the suggested policy?
Answer: Negative financial leverage: increasing debt lowers ROE. Suggestion: minimize the debt proportion as much as possible.
Card 10
Question: What factors determine the effectiveness of a company’s financing structure?
Answer: 1) Evolution of economic profitability from business operations. 2) Financial leverage and debt strategy. High debt can be beneficial only if financia