Firms HD and LD Are Identical Except for Their Level

question 69

Multiple Choice

Firms HD and LD are identical except for their level of debt and the interest rates they pay on debt--HD has more debt and pays a higher interest rate on that debt.Based on the data given below, what is the difference between the two firms' ROEs?
$$\begin{array} { | c | c | c | } \hline & \text { Firm HD } & \text { Firm LD } \\\hline \text { Assets } & 200 & 200 \\\hline \text { Debt } & 100 & 60 \\\hline \text { Equity } & 100 & 140 \\\hline & & \\\hline \text { EBIT } & 40 & 40 \\\hline \text { Interest } & 12 & 6 \\\hline \text { EBT } & 28 & 34 \\\hline \text { Taxes } & 7 & 8.5 \\\hline \text { Net income } & 21 & 25.5 \\\hline \text { ROE } & 21.00 \% & 18.21 \% \\\hline\end{array}$$

• A)2.18%
• B)2.29%
• C)2.41%
• D)2.54%
• E)2.66%

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Definitions:

Price Floor

A government-imposed minimum price for goods or services, intended to prevent prices from falling below a certain level.

Market-clearing Price

The price at which the quantity demanded by buyers equals the quantity supplied by sellers, eliminating any surplus or shortage in the market.

Surplus

The condition in which the quantity of a good or service supplied exceeds the quantity demanded at the current price.

Foreign Currency

Currency used in a country other than one's own, involved in international trade, investments, and travel.