Companies HD and LD have identical amounts of assets, operating income (EBIT), tax rates, and business risk. Company HD, however, has a much higher debt ratio than LD. Company HD's basic earning power ratio (BEP) exceeds its cost of debt (rd). Which of the following statements is CORRECT?
A) Company HD has a higher return on assets (ROA) than Company LD.
B) Company HD has a higher times interest earned (TIE) ratio than
Company LD.
C) Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also
Higher than LD's.
D) The two companies have the same ROE.
E) Company HD's ROE would be higher if it had no debt.

Question

Quizplus · Accepted Answer

Since Company HD has a higher debt ratio and its BEP exceeds its cost of debt, it benefits from financial leverage, leading to a higher ROE compared to Company LD. However, this also increases the risk, as measured by the standard deviation of ROE.

Companies HD and LD Have Identical Amounts of Assets, Operating