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:

Laffer Curve

A theoretical representation showing the relationship between tax rates and government revenue, positing that there is an optimum tax rate that maximizes revenue.

Laffer Curve

A theoretical representation of the relationship between tax rates and tax revenue, suggesting there is an optimal tax rate that maximizes revenue.

Tax Revenue

The financial proceeds that are secured by governments through the imposition of taxes.

Deadweight Loss

The loss of economic efficiency that occurs when the equilibrium outcome is not achievable or not achieved in a market.