Which of the following is most correct? a. When the return on capital employed (

Question

Which of the following is most correct?

a. When the return on capital employed (ROCE) is less than the before tax cost of debt, a company can increase its ROE by trading out equity and into debt.

b. When the return on capital employed (ROCE) is more than the before tax cost of debt, a company can increase its ROE by trading out equity and into debt.

c. When the return on capital employed (ROCE) is less than the after tax cost of debt, a company can increase its ROE by trading out equity and into debt.

d. When the return on capital employed (ROCE) is more than the after tax cost of debt, a company can increase its ROE by trading out equity and into debt.

Answer is not b.

Explanation / Answer

CORRECT ANSWER : d: When the return on capital employed (ROCE) is more than the after tax cost of debt, a company can increase its ROE by trading out equity and into debt.

It is after tax cost of debt which is to be considered while making decision. So if firm has ROCE higher than after tax cost of debt, earnings for shareholders will increase and there by ROE. THis is also known as trading on equity

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