Firms U and L Both Have a Basic Earning Power

question 36

Multiple Choice

Firms U and L both have a basic earning power ratio of 20% and each has the same amount of assets.Firm U is unleveraged,i.e.,it is 100% equity financed,while Firm L is financed with 50% debt and 50% equity.Firm L's debt has a before-tax cost of 8%.Both firms have positive net income.Which of the following statements is CORRECT?

• A) Firm L has a lower ROA than Firm U.
• B) Firm L has a lower ROE than Firm U.
• C) Firm L has the higher times interest earned (TIE) ratio.
• D) Firm L has a higher EBIT than Firm U.
• E) The two companies have the same times interest earned (TIE) ratio.

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Definitions:

Borrower

An individual or entity that receives funds from a lender under the agreement that the funds will be repaid, typically with interest, over a period of time.

Installment Accounts Receivable

Refers to the money owed to a company that will be paid back in regular, periodic payments.

Term Loans

Loans from financial institutions that are repaid over a set period of time with scheduled payments.

Personal Guarantees

A commitment by an individual to repay a debt if the original borrower defaults, often required in business loans.