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1 July, 18:42

Firm A and Firm B have the same total assets, ROA and profit margin. However, Frim B has a higher debt ratio and interest expense then Firm A. Which of the following statements is correct? A.) Firm B must have a higher ROE than first A. B.) Firm B must have a higher capital intensity ratio then Firm A. C.) Firm B must have a higher fixed asset turnover than Firm A. D.) Firm B must have a lower ACP than Firm A.

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  1. 1 July, 19:06
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    A.) Firm B must have a higher ROE than first A.

    Explanation:

    Debt ratio is defined as percentage of a company's assets that is made up of debt and so it is calculated as a ratio of debt to assets of a company.

    Interest expense is the amount that is paid to service a loan.

    This implies that company B has higher loan portfolio than Company A.

    Considering the accounting formula

    Equity = Asset - Debt

    So an increase in debt will result in a decrease in equity.

    Return on equity = Net income/Equity

    It follows that as debt increases and equity reduces, the ROE will increase since a shrink in the ROE denominator (Equity) will lead to an increase in the ratio.
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