HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, HD uses more debt than LD. Which of the following statements is CORRECT?
A) Without more information, we cannot tell if HD or LD would have a higher or lower net income.
B) HD would have the lower equity multiplier for use in the DuPont equation.
C) HD would have to pay more in income taxes.
D) HD would have the lower net income as shown on the income statement.
E) HD would have the higher operating margin.

Question

Quizplus · Accepted Answer

Since HD uses more debt than LD, it would have a higher interest expense. This would result in a lower net income for HD as compared to LD, all else being equal. Therefore, D is the correct answer. We cannot determine the equity multiplier for HD or LD without more information, and we also cannot determine which company would pay more in income taxes or have a higher operating margin based on the given information.

HD Corp and LD Corp Have Identical Assets, Sales, Interest