Which of the following is a criticism of a policy of maximizing the firm's return on equity (ROE)?
A) ROE is based on after-tax earnings, not cash flows.
B) ROE does not consider risk.
C) ROE ignores the size of the initial investment as well as future cash flows.
D) All of the above are criticisms of ROE as a goal.

Question

Quizplus · Accepted Answer

All of the above options are valid criticisms of a policy of maximizing the firm's ROE.

A) ROE is based only on after-tax earnings, which may not fully reflect the firm's cash flows, especially in cases where the firm has large non-cash expenses such as depreciation.

B) ROE does not consider the risk involved in the firm's operations. A higher ROE may imply higher profitability, but it may also indicate that the firm is taking on more risk, which could lead to financial distress or bankruptcy in the future.

C) ROE ignores the size of the initial investment as well as future cash flows, which are important drivers of value creation. Maximizing ROE may lead the firm to overlook investments in projects with positive net present value or long-term growth potential.

Which of the Following Is a Criticism of a Policy