Companies HD and LD have the same total assets,sales,operating costs,and tax rates,and they pay the same interest rate on their debt.Both firms finance using only debt and common equity,and total assets equal total invested capital.However,company HD has a higher total debt to total capital ratio.Which of the following statements is CORRECT?
A) Given this information,LD must have the higher ROE.
B) Company LD has a higher basic earning power ratio (BEP).
C) Company HD has a higher basic earning power ratio (BEP).
D) If the interest rate the companies pay on their debt is more than their basic earning power (BEP),then Company HD will have the higher ROE.
E) If the interest rate the companies pay on their debt is less than their basic earning power (BEP),then Company HD will have the higher ROE.

Question

Quizplus · Accepted Answer

The companies have the same EBIT and assets,hence the same BEP ratio.If the interest rate is less than the BEP,then using more debt will raise the ROE.Therefore,statement e is correct.The others are all incorrect.

Companies HD and LD Have the Same Total Assets,sales,operating Costs,and