ROCE will exceed ROA whenever ROA exceeds the after-tax cost of borrowing plus any dividends required for preferred shareholders.Which of the following is/are true?
A)The bond holders earn a higher return, but they undertook more risk in their investment.
B)The preferred shareholders earn a lower return, but they undertook more risk than the common shareholders in their investment.
C)The common shareholders earn a higher return, but they undertook more risk in their investment.
D)Using lower-cost borrowed funds and then earning a rate of return on those funds higher than their cost increases the return to the common shareholders.
E)Choices c and d.

Question

Quizplus · Accepted Answer

ROCE (Return on Capital Employed) is a measure of the profitability of a company's total capital investments, while ROA (Return on Assets) is a measure of how efficiently a company utilizes its assets to generate income. Whenever the ROA exceeds the after-tax cost of borrowing plus any dividends required for preferred shareholders, the company can earn a higher return using borrowed funds than the cost of that borrowing. This increases the return to common shareholders while they undertake more risk in their investment. Hence, choice C is true. Additionally, using lower-cost borrowed funds and then earning a rate of return on those funds higher than their cost increases the return to the common shareholders. Hence, choice D is also true. Therefore, the correct answer is choice E.

ROCE Will Exceed ROA Whenever ROA Exceeds the After-Tax Cost