Question

Two operationally similar companies, HD and LD, have the same total assets, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also HD'sreturn on invested capital (ROIC)exceeds its after-tax cost of debt, (1-T)rd. Which of the following statements is CORRECT?
a. HD should have a higher times interest earned (TIE) ratio than LD.
b. HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's.
c. Given that ROIC > (1-T) rd, HD's stock price must exceed that of LD.
d. Given that ROIC > (1-T) rd, LD's stock price must exceed that of HD.
e. HD should have a higher return on assets (ROA) than LD.

Answer

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