Answer: Leverage

## Explanation Return on Equity (ROE) can be decomposed using the DuPont formula: **ROE = Net Profit Margin × Asset Turnover × Financial Leverage** Where: - **Net Profit Margin** = Net Income / Revenue - **Asset Turnover** = Revenue / Average Total Assets - **Financial Leverage** = Average Total Assets / Average Shareholders' Equity Alternatively, ROE can also be expressed as: **ROE = (Net Income / Sales) × (Sales / Assets) × (Assets / Equity)** From this decomposition: 1. **Leverage** (Assets/Equity) directly multiplies with the other components to determine ROE 2. **Tax rate** affects net profit margin (lower tax rate increases net income, thus increasing ROE) 3. **Days of sales outstanding** affects asset turnover (lower DSO improves asset turnover, thus increasing ROE) **Analysis of each option:** **A. Leverage** - A decrease in leverage (Assets/Equity ratio) would directly reduce ROE, all else being equal. This is because leverage amplifies the return on equity when the return on assets is positive. **B. The tax rate** - A decrease in the tax rate would increase net income, which would increase ROE, not decrease it. **C. Days of sales outstanding** - A decrease in DSO would improve asset turnover (more efficient use of assets), which would increase ROE, not decrease it. Therefore, only a decrease in leverage would result in a lower ROE, making option A the correct answer. **Key Takeaway:** In the DuPont analysis, financial leverage is a multiplier that amplifies ROE when return on assets is positive. Reducing leverage reduces this amplification effect, leading to lower ROE.

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