Suppose that Chicken Express, InC. has an ROA of 7% and pays a 6% coupon on its debt. Chicken Express has a capital structure that is 70% equity and 30% debt. Relative to a firm that is 100% equity-financed, Chicken Express's net profit will be ________, and its ROE will be ________.
A) lower; lower
B) higher; higher
C) higher; lower
D) lower; higher
E) It is impossible to predict.

Question

Quizplus · Accepted Answer

Chicken Express's net profit will be lower because it has to pay interest expense. But as long as Chicken Express's ROA exceeds the cost of its debt, leverage will have a positive impact on its ROE.

Suppose That Chicken Express, InC