The situation
Two distributors have 6% net margin and 1.5× asset turnover. A has a 2× equity multiplier and B has 3×.
Your task
Compute both ROEs and explain the difference.
Reveal step-by-step solution
Set up the problem
Return on assets is 6% × 1.5 = 9% for both.
Work through the numbers
A ROE = 9% × 2 = 18%. B ROE = 9% × 3 = 27%.
Interpret the result
The 9 percentage point gap comes from leverage in the model. Compare borrowing risk before calling B stronger.
What to remember
Use consistent averages for assets and equity and isolate margin, turnover and leverage.