Question

Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio. Which of the following statements is CORRECT?
a. Company HD has a higher fixed assets turnover than Company LD.

b. Company HD has a lower equity multiplier than Company LD.

c. Company HD has a lower total assets turnover than Company LD.

d. Company HD has a higher ROE than Company LD.

e. Company HD has a lower operating income (EBIT) than Company LD.

Answer 1

Answer:

The correct option is D

Explanation:

Debt ratio is defined as the ratio of total debt to total asset. which means a company has more liabilities than assets.

So company HD will have a higher ROE because of them having a higher debt ratio.

Answer 2

Answer:

D) Company HD has a higher ROE than Company LD.

Explanation:

This is easier to explain using an example:

                                           HD                               LD

total sales                          $100                            $100

profit margin                       10%                               10%

total assets                         $50                              $50

total liabilities                     $30                              $25

total equity                         $20                              $25

debt ratio                            0.6                               0.5

return on equity            = 10/20 = 50%            = 10/25 = 40%

Since company HD has a higher debt ratio, it means that stockholders' equity is lower compared to company LD. Since ROE measures how much profit is generated by each dollar invested, a lower denominator results in a higher ratio.