Question

Companies HD and LD have identical tax rates, total assets, and return on invested capital (ROIC), and their ROIC exceeds their after-tax cost of debt, (1-T) r d. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is correct?
A) company hd has a lower roa than company ld.
B) company hd has a lower roe than company ld.
C) the two companies have the same roa.
D) the two companies have the same roe.
E) company hd has a higher net income than company ld.

Answer 1

Answer: A) company hd has a lower ROA than company ld.

Explanation:

Company HD has more debt than Company LD which is why they have a higher interest expense. Interest expense is deducted from revenue to reach net profit so Company HD will have a lower profit than Company LD.

Return on Assets is calculated by dividing Net Income by Total assets. With Company HD having a lower net income, it will also have a lower ROA as a result seeing as the numerator will be lower than that of company LD.