Which of the following statements is CORRECT?
A)If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.
B)A firm's use of debt will have no effect on its profit margin on sales.
C)If two firms differ only in their use of debt-i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates-but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.
D)The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable.
E)If two firms differ only in their use of debt-i.e., they have identical assets, sales, operating costs, and tax rates-but one firm has a higher debt ratio, the firm that uses more debt will have a higher profit margin on sales.

Question

Quizplus · Accepted Answer

A firm's use of debt affects its interest expenses, which in turn affect its net income and profit margin. Therefore, if two firms are identical except for their debt ratios, the firm with the higher debt ratio will have lower net income and a lower profit margin. The TIE ratio, on the other hand, does depend entirely on the amount of debt a firm uses, but it is not certain that the firm with the higher debt ratio will have a lower TIE ratio. Additionally, the debt ratio calculation does not generally make an adjustment for leases, so option D is incorrect. Option B is also incorrect as a firm's use of debt could potentially affect its profit margin. Option E is incorrect as it is the opposite of the correct statement.

Which of the Following Statements Is CORRECT