Firms U and L each have the same amount of assets, and both have a basic earning power ratio of 20%. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L's debt has a before-tax cost of 8%. Both firms have positive net income. Which of the following statements is CORRECT?
A) The two companies have the same times interest earned (TIE) ratio.
B) Firm L has a lower ROA than Firm U.
C) Firm L has a lower ROE than Firm U.
D) Firm L has the higher times interest earned (TIE) ratio.
E) Firm L has a higher EBIT than Firm U.

Question

Quizplus · Accepted Answer

Firm L has a lower ROA than Firm U because the interest expense on its debt reduces its net income, while both firms have the same amount of assets.

Firms U and L Each Have the Same Amount of Assets