Suppose two firms with the same amount of assets pay the same interest rate on their debt and earn the same rate of return on their assets,and that ROA is positive.However,one firm has a higher debt ratio.Under these conditions,the firm with the higher debt ratio will also have a higher rate of return on common equity.

Question

Quizplus · Accepted Answer

The firm with the higher debt ratio will have a higher rate of return on common equity due to the leverage effect. This means that the same amount of equity is supporting more assets, leading to potentially higher returns on equity.

Suppose Two Firms with the Same Amount of Assets Pay