Violet Shades and Raindew are two companies that are identical in every respect, except that Violet Shades uses only equity financing while Raindew relies heavily on debt financing. Over the past year, the firms had identical earnings before interest and taxes. If net income for both firms was high:
A) Violet Shades would pay less in taxes than Raindew.
B) Raindew would report a higher return on equity than Violet Shades.
C) Raindew would report a lower return on equity than Violet Shades.
D) Violet Shades would be required to pay no taxes, unlike Raindew.

Question

Quizplus · Accepted Answer

Raindew, with its heavy reliance on debt financing, benefits from the tax shield provided by interest payments, which can lead to a higher return on equity compared to Violet Shades, which uses only equity financing.

Violet Shades and Raindew Are Two Companies That Are Identical