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Answer on Economics of Enterprise Question for Lamarcus Streeter

Question #5967

Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt. However, company HD has a higher debt ratio. Which of the following statements is CORRECT?

a. Given this information, LD must have the higher ROE.
b. Company LD has a higher basic earning power ratio (BEP).
c. Company HD has a higher basic earning power ratio (BEP).
d. If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company HD will have the higher ROE.
e. If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company HD will have the higher ROE.

Expert's answer

b. Company LD has a higher basic earning power ratio (BEP).
As HDs debt ratio is higher, it has more debts or less assets, than LD, that's why LD
has a higher basic earning power ratio (BEP).

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