Question

Companies HD and LD are both profitable, and they have the same total assets (TA), total invested capital, sales (S), return on assets (ROA), and profit margin (PM). Both firms finance using only debt and common equity. However, Company HD has the higher total debt to total capital 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 turn-over 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:

Option D is correct.

Explanation:

Both company will have same Equity multiplier as total assets and equity are same of both companies. So Option A and B is incorrect.

Option C is also incorrect because there is no difference between the sales and total assets of both companies.

Option D is correct because the return on equity of the company LD is higher as the Net profit which is profit after interest and tax is higher than the profit after interest and tax of the company HD.

ROE = PAIT / Equity

Option E is wrong because when we say ROA is same this means that the operating income is same.

ROA = Operating profit / Total assets

Remember that the operating profit is earnings before interest and tax.