Which one of these statements correctly applies to an unlevered firm that pays no taxes?
A) The return on equity exceeds the WACC.
B) The return on assets equals the return on equity and also equals WACC.
C) The return on assets equals the return on equity and exceeds WACC.
D) The return on equity equals WACC and exceeds the return on assets.

Question

Quizplus · Accepted Answer

An unlevered firm has no debt, hence no interest expense. Therefore, the cost of equity equals the weighted average cost of capital (WACC). In a firm with no taxes, the return on assets (ROA) equals the return on equity (ROE) since the firm doesn't have any debt. Thus, the correct statement about an unlevered firm that pays no taxes is that the ROA equals the ROE, which also equals the WACC.

Which One of These Statements Correctly Applies to an Unlevered