Two operationally similar 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 (r_d).Which of the following statements is CORRECT? A) Company HD has a higher times interest earned (TIE) ratio than Company LD. B) 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. C) The two companies have the same ROE. D) Company HD's ROE would be higher if it had no debt. E) Company HD has a higher return on assets (ROA) than Company LD.

Question

Quizplus · Accepted Answer

Company HD has a higher basic earning power (BEP) ratio than Company LD, meaning that it generates more EBIT per dollar of assets. Since the two companies have the same business risk, it can be inferred that Company HD's higher debt ratio results in a higher return on equity (ROE) due to the financial leverage effect. However, this also implies that the risk of HD's equity is higher, as measured by the standard deviation of ROE. Therefore, statement B is correct, while statements A, C, D, and E are all incorrect.

Two Operationally Similar Companies,HD and LD,have Identical Amounts of Assets,operating