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 should be chosen if they have the same risk and cost of capital?

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

B) Project X, with 35% ROE and a large investment, generating high 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:

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

B) Analyze the firms financial ratios over time

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 each scenario and indicate how you would expect the described event or situation to affect the described business organization.

Western Amalgamated Corp.

The family who founded and operates Western Amalgamated Corp. 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 Westerns financial condition and performance?

A) The absence of a succession plan for Westerns 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.

B) 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.

C) 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 performance is maintained.