Bigbux and Lottadoe are two very similar businesses in all respects except that Bigbux relies mainly on equity financing, while Lottadoe relies heavily on debt financing. This year both firms have enjoyed strong growth in net income. This is likely to result in a higher return on equity for Bigbux than for Lottadoe.

Question

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Lottadoe, which relies heavily on debt financing, is likely to have a higher return on equity (ROE) than Bigbux, assuming both firms have enjoyed strong growth in net income. This is because leveraging (using debt) can amplify the returns on equity when a company is profitable, despite also increasing the risk.

Bigbux and Lottadoe Are Two Very Similar Businesses in All