Analysts and investors often use return on equity (ROE) to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the companys ROE numbers look good.

If a firm takes steps that increase its expected future ROE, its stock price will increase.

Based on your understanding of the uses and limitations of ROE, which of the following projects will a manager likely choose if his or her bonus is solely based on the ROE of the next project?

Project X, with 35% ROE and a large investment, generating high expected cash flows

Project Y, with 40% ROE and a small investment, generating low expected cash flows

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the companys performance. If you wanted to conduct a trend analysis, you would:

Analyze the firms financial ratios over time

Compare the firms financial ratios with other firms in the industry for a particular year

You decide also to conduct a qualitative analysis based on the factors summarized by the American Association of Individual Investors (AAII). According to your understanding, a company with one key product is considered to be risky than companies with a wide range of products.

The American Association of Individual Investors (AAII) has identified several qualitative factors that should also be considered when evaluating a companys likely future financial performance. Consider the scenario and indicate how you would expect the described event or situation to affect the described business organization.

Northern Services Inc.

The family who founded and operates Northern Services Inc. is headed by a strong-willed and very astute octogenarian. The company has no succession plan for replacing him in the event of his injury, death, or incapacitation.

How would you expect this situation to affect the assessment of Northerns financial condition and performance?

The absence of a succession plan for Northerns leader and driving force can place the organization in serious jeopardy. A firms financial condition and performance are the result of decisions made by the firms leadership and staff.

Although nonquantitative factors may be relevant to a companys financial evaluation in general terms, the details of this specific situation are not relevant to the firms financial condition or performance.

Because the company is family owned, succession planning should not be an issue, and the family can pull together to run the organization when the leader dies. This should ensure that the companys expected future