.2 points Question 19 Companies HD and LD have identical tax rates, total assets
ID: 2681498 • Letter: #
Question
.2 pointsQuestion 19
Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?
Answer Company HD has a higher net income than Company LD.
Company HD has a lower ROA than Company LD.
Company HD has a lower ROE than Company LD.
The two companies have the same ROA.
The two companies have the same ROE.
.2 points
Question 20
Which of the following statements is CORRECT?
Answer If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.
A change in the personal tax rate should not affect firms
Explanation / Answer
Company HD has a lower ROA than Company LD. A change in the personal tax rate should not affect firms’ capital structure decisions. Total risk. The ROA would remain unchanged. The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.
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