Companies A and B each have the same level of total assets, the same tax rate, and the same earnings before interest and taxes (EBIT). Company A, however, has a higher debt ratio. Which of the following statements is most correct?
A) Company A has a lower return on assets (ROA).
B) Company A has a lower basic earning power (BEP).
C) Company A has a lower times interest earned (TIE) ratio.
D) Answers a and c are correct.
E) All of the answers above are correct.

Question

Quizplus · Accepted Answer

Company A has a higher debt ratio, which means it has more financial leverage. This higher financial leverage will lead to higher interest expenses, which can lower the company's profitability. Therefore, Company A would have a lower return on assets (ROA) than Company B. Moreover, since the interest expenses are higher for Company A, it will have a lower times interest earned (TIE) ratio than Company B. On the other hand, the basic earning power (BEP) is not affected by the capital structure, so it should be the same for both companies. Therefore, only answers a and c are correct.

Companies a and B Each Have the Same Level of Total