The rate of return on common shareholders' equity
A)will exceed the rate of return on assets whenever the rate of return on assets exceeds the after-tax cost of borrowing and any dividends required for preferred shareholders.
B)will not exceed the rate of return on assets whenever the rate of return on assets exceeds the after-tax cost of borrowing and any dividends required for preferred shareholders.
C)will always exceed the rate of return on assets.
D)will never exceed the rate of return on assets.
E)none of the above

Question

Quizplus · Accepted Answer

The rate of return on common shareholders' equity will exceed the rate of return on assets when the company is effectively using leverage, meaning the rate of return on assets is higher than the after-tax cost of borrowing and any dividends required for preferred shareholders. This is because the additional earnings generated from borrowed funds (or funds used to pay preferred dividends) can be distributed to common shareholders, thus increasing their rate of return.

The Rate of Return on Common Shareholders' Equity