Question

Companies HD and LD have the same total assets, total investor-supplied capital, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also, both companies' returns on investors' capital (ROIC) exceed their after-tax costs of debt, rd(1 – T). Which of the following statements is CORRECT?a. Given that ROIC > rd(1 – T), LD's stock price must exceed that of HD. b. HD should have a higher times interest earned (TIE) ratio than LD. c. Given that ROIC > rd(1 – T), HD's stock price must exceed that of LD. d. HD should have a higher return on assets (ROA) than LD. e. HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's.

Answer 1

Answer:

e. HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's

Explanation:

As these companies only differ in the debt ratio with LD having a lower one means that HD has lower equity, therefore, a higher return on its equity. But it also the standard deviation of the return is higher because is more sensible to the changes in the net incomes.