Firms U and L each have the same amount of assets,investor-supplied capital,and both have a return on investors' capital (ROIC)of 12%.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 an after-tax cost of 8%.Both firms have positive net income and a 35% tax rate.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

EFirm L, which is leveraged, pays interest on its debt, reducing its net income relative to its total assets compared to Firm U, which has no debt. This results in a lower Return on Assets (ROA) for Firm L. Additionally, the use of debt in Firm L's capital structure can lead to a higher Earnings Before Interest and Taxes (EBIT) due to the tax shield effect of the interest expense, assuming both firms generate the same operating income before interest and taxes.

Firms U and L Each Have the Same Amount of Assets,investor-Supplied