Question

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 return on invested capital (ROIC) exceeds its after-tax cost of debt, (1-T) r d. Which of the following statements is CORRECT?
a)Company HD has a higher return on assets (ROA) than Company LD.b)Company HD has a higher times interest earned (TIE) ratio than Company LD.c)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.d)The two companies have the same ROE.e)Company HD's ROE would be higher if it had no debt.

Answer 1

Answer:

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.

Explanation:

Answer 2

Answer:

c)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.

Explanation:

Indebtedness rate is a term used to describe the indebtedness that a company contracted through paying expenses for employees and with production in general (however, a company can increase the indebtedness rate in other ways), leaving the company with negative revenues.

The return on invested capital, on the other hand, refers to the profitability that the money invested in the production of the product or service provided.

In relation to the question above, we can see that even if the HD company has a higher debt rate than the LD company, the return on capital invested by the HD company manages to exceed the cost of its debts. The conclusion that can be drawn from this is that HD must have a higher return on equity (ROE) than LD, but its risk, measured by the standard deviation of ROE, must also be greater than LD