Firms U and L Both Have a Basic Earning Power

question 15

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:

Automatic Thinking

The process of making quick, instinctive judgments and responses without conscientious deliberation, often based on learned behaviors or biases.

Mindful Thinking

Involves maintaining a moment-by-moment awareness of our thoughts, feelings, bodily sensations, and surrounding environment with openness and non-judgment.

Corporate Hierarchy

Corporate hierarchy refers to the structured ranking of positions within a company, determining the flow of decision-making and authority.

Visibility

The degree to which an individual's activities, accomplishments, or status are known and acknowledged by others, particularly in a professional context.