What is primarily responsible for the potential distortion among the ROA of different firms when net income is used in the numerator of ROA?
A) Firms have different dividend payout ratios.
B) Some firms use fully depreciated assets.
C) Financial leverage varies among firms.
D) Unprofitable firms will not have tax liability.

Question

Quizplus · Accepted Answer

Financial leverage, or the amount of debt a firm uses to finance its operations, varies among firms and can significantly impact the ROA calculation. A firm with high financial leverage will have a higher ROA than a firm with low financial leverage, even if their net incomes are the same. This is because the firm with high financial leverage has a lower denominator (total assets), which results in a higher ROA ratio. Alternatively, a firm with low financial leverage will have a lower ROA than a firm with high financial leverage, even if their net incomes are the same, because the firm has a higher denominator (total assets). Thus, financial leverage can distort the ROA calculation when comparing firms with different levels of debt. Choices (A), (B) and (D) are not primarily responsible for the potential distortion among the ROA.

What Is Primarily Responsible for the Potential Distortion Among the ROA