If the interest rate on debt is higher than ROA, a firm will __________ by increasing the use of debt in the capital structure.
A) increase the ROE
B) not change the ROE
C) decrease the ROE
D) change the ROE in an indeterminable manner

Question

Quizplus · Accepted Answer

When the interest rate on debt is higher than the Return on Assets (ROA), using more debt in the capital structure increases the cost of debt relative to the returns generated by the assets. This leads to a decrease in Return on Equity (ROE) because the firm pays more in interest than it earns on its investments, reducing the earnings available to equity holders.

If the Interest Rate on Debt Is Higher Than ROA