If a company increases its debt ratio, but leaves its operating income (EBIT) an
ID: 2617993 • Letter: I
Question
If a company increases its debt ratio, but leaves its operating income (EBIT) and total assets unchanged, which of the following is most likely to occur:
The company's tax liability will fall.
The company's net income will rise.
The company's basic earning power will fall.
Answers a and b are correct.
None of the answers above is correct.
a.The company's tax liability will fall.
b.The company's net income will rise.
c.The company's basic earning power will fall.
d.Answers a and b are correct.
e.None of the answers above is correct.
Explanation / Answer
CORRECT ANSWER : A : THE COMPANY'S TAX LIABILITY WILL FALL
IF TOTAL ASSETS ARE SAME THEN COMPANY HAS NOT MADE ANY NEW INVESTMENTS, THAT MEANS, NET INCOME WILL NOT RISE, SO THAT OPTION IS WRONG.
BASIC EARNING POWER = EBIT/TOTAL ASSETS*100
IF EBIT AND TOTAL ASSETS ARE SAME, THEN BASIC EARNING POWER WILL NOT CHANGE, SO THAT OPTION IS ALSO WRONG.
SO IF DEBT INCREASE, IT WILL RAISE TOTAL INTEREST PAYMENTS, SO THE EBT WILL COME DOWN & SO TAX WILL COME DOWN
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