Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of the following statements is CORRECT?
A) Company HD has a lower total assets turnover than Company LD.
B) Company HD has a lower equity multiplier than Company LD.
C) Company HD has a higher fixed assets turnover than Company LD.
D) Company HD has a higher ROE than Company LD.
E) Company HD has a lower operating income (EBIT) than Company LD.

Question

Quizplus · Accepted Answer

Since both companies have the same ROA and PM, the difference in their return on equity (ROE) must be due to the difference in their leverage ratios. Company HD has the higher debt ratio, which means it has a higher equity multiplier. The equity multiplier is the total assets divided by equity. Since both companies have the same total assets, Company HD must have a lower equity. This means that their ROE will be higher due to financial leverage. Therefore, Company HD has a higher ROE than Company LD.

Companies HD and LD Are Both Profitable, and They Have