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?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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