Answer:
Firms HD has higher ROE than firm LD.
In details, LD's ROE = 15.79%; HD's ROE = 18.20%. So the difference between LD's ROE and HD's ROE is (2.41%) with LD has lower ratio.
Explanation:
*For firm HD:
Value of debt = 200 * 50% = 100; Value of equity = 200 - 100 = 100.
Interest expenses = 100 * 12% = $12 => EBT = 40 -12 = $28
Net income = EBT*(1 - tax rate) = 28 * (1-35%) = $18.2
ROE = net income / equity = 18.2 / 100 = 18.2%
.
*For firm LD:
Value of debt = 200 * 30% = 60; Value of equity = 200 - 60 = 140.
Interest expenses = 60 * 10% = $6 => EBT = 40 -6 = $34
Net income = EBT*(1 - tax rate) = 34 * (1-35%) = $22.1
ROE = net income / equity = 22.1 / 140 = 15.79%
