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    Question

    A pension fund-sponsored company used debt to repurchase

    equity, leveraging its balance sheet. RBC (Return on Equity) jumped from 12% to 18%. However, ECB (Economic Profit) remained unchanged. What does this imply?
    A Value created via financial leverage Correct Answer Incorrect Answer
    B Equity holders benefited at cost of economic value Correct Answer Incorrect Answer
    C Actual profitability improved Correct Answer Incorrect Answer
    D Both RBC and ECB reflect better performance Correct Answer Incorrect Answer
    E RBC is irrelevant Correct Answer Incorrect Answer

    Solution

    Rising ROE due to higher leverage reflects financial engineering, not necessarily improved economic profit. Since Economic Profit remains flat, the increased ROE is due to value transfer to equity holders via debt, not higher business profitability.

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