Company A and Company B have the same total assets, operating income (EBIT), tax rate, and business risk. Company A, however, has a much higher debt ratio than Company B. Company A's basic earning power (BEP) exceeds its cost of debt financing (rd). Which of the following statements is most correct?
A) Company A has a higher return on assets (ROA) than Company B.
B) Company A has a higher times interest earned (TIE) ratio than Company B.
C) Company A has a higher return on equity (ROE) than Company B, and its risk, as measured by the standard deviation of ROE, is also higher than Company B's.
D) Statements b and c are correct.
E) All of the statements above are correct.

Question

Quizplus · Accepted Answer

Company A's higher debt ratio increases financial leverage, which can lead to a higher ROE if BEP exceeds rd. However, this also increases the risk, leading to a higher standard deviation of ROE.

Company a and Company B Have the Same Total Assets