Firms HD and LD Are Identical Except for Their Use

question 41

Multiple Choice

Firms HD and LD are identical except for their use of debt and the interest rates they pay HD has more debt and thus must pay a higher interest rate. Based on the data given below, how much higher or lower will HD's ROE be versus that of LD, i.e., what is ROEHD ? ROELD?
80) $\begin{array}{c}\begin{array}{lr}\underline{\text { Applicable to Both Firms }}\\ \text { Capital } \quad \$ 3,000,000 \\\text { EBIT } \quad \$ 500,000 \\\text { Tax rate } \quad 35 \%\end{array}\begin{array}{lll}\underline{\text { Firm HD's Data }}\\ \mathrm{w}_{\mathrm{d}} \quad\quad\quad\quad 70 \% \\\text { Int. rate } \quad 12 \% \\\\\end{array}\begin{array}{lll}\underline{\text { Firm LD's Data }} \\\mathrm{w}_{\mathrm{d}} \quad\quad\quad\quad 20 \% \\\text { Int. rate } \quad 10 \%\\\\\end{array}\end{array}$

• A) 5.41%
• B) 5.69%
• C) 5.99%
• D) 6.29%
• E) 6.61%

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Definitions:

Fixed Expenses

Costs that do not change with the level of company activity or production volume, such as rent or salaries.

Unit Contribution Margin

The profit per unit sold, calculated by subtracting the variable cost per unit from the selling price per unit.

Break-Even Point

The level of production or sales at which total costs equal total revenue, meaning the business neither earns nor loses money.

Contribution Margin Percentage

The ratio of contribution margin (sales revenue minus variable costs) to total sales revenue, expressed as a percentage.