Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd.However, Company HD has a higher debt ratio and thus more interest expense than Company LD.Which of the following statements is CORRECT?

Question

Quizplus · Accepted Answer

CCompany HD, having a higher debt ratio, incurs more interest expense, reducing its net income more than Company LD. This leads to a lower Return on Assets (ROA) for Company HD since ROA is calculated based on net income relative to total assets, which are identical for both companies. However, the basic earning power (BEP) being the same for both companies indicates that before considering interest expenses, their operational efficiency is identical, leading to the same ROA before interest expenses are accounted for.

Companies HD and LD Have Identical Tax Rates, Total Assets