If the interest rate on debt is lower than ROA, then a firm will __________ by increasing the use of debt in the capital structure.
A)increase the ROE
B)not change the ROE
C)decrease the ROE
D)change the ROE in an indeterminable manner If ROA is higher than the interest rate, then ROE will increase by an amount that depends on the debt to equity ratio.

Question

Quizplus · Accepted Answer

When the interest rate on debt is lower than ROA, adding more debt to the capital structure will increase the return on equity (ROE). This is because the cost of debt is lower than the return on assets, and leveraging the company with debt allows for a higher return on equity. Therefore, the best choice is A: increase the ROE.

If the Interest Rate on Debt Is Lower Than ROA