Question

Companies HD and LD have the same tax rate, sales, total assets, and basic earning power.Both companies have positive net incomes. Both firms finance using only debt and commonequity and total assets equal total invested capital. Company HD has a higher total debt to totalinvested capital ratio and, therefore, a higher interest expense. Which of the following statementsis CORRECT?
A. Company HD has a lower equity multiplier.
B. Company HD has more net income.
C. Company HD pays more in taxes.
D. Company HD has a lower ROE.
E. Company HD has a lower times-interest-earned (TIE) ratio.

Answer 1

Company HD pays more in taxes.

Answer: Option C.

Explanation:

The debt-to-capital ratio is calculated by taking the company's interest-bearing debt, both short- and long-term liabilities and dividing it by the total capital. Total capital is all interest-bearing debt plus shareholders' equity, which may include items such as common stock, preferred stock, and minority interest.

Since the debt to capital ratio of this firm is higher than the other firm, then the firm will have to pay a higher tax compared to the other firm which is given in the question.