A framework for analysing the impact of economic variations on return on equity

Return on Equity (ROE) is usually characterised as the most important profitability ratio from the perspective of equity investors. This paper develops a concise method for analysing how this ratio is affected by changes in various economic variables such as price, quantity, cost and interest on debt. The differential impact of changes in those variables can be elucidated. The paper also explores the relationship between changes in ROE and changes in leverage. The analytical framework is very helpful for entrepreneurs and financial managers in analysing potential projects. Numerical illustrations are provided.