HD Corp and LD Corp have identical assets, sales, interest rates paid on their d

Question

HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. However, HD uses more debt than LD. Which of the following statements is correct?
a) Without more information, we cannot tell if HD or LD would have a higher or lower net income.
b) HD would have lower equity multiplier for use in the DuPoint equation.
c) HD would have to pay more in income taxes.
d) HD would have the lower net income as show on the income statement.
e) HD would have the higher operating margin.

Explanation / Answer

the right option is (d) HD would have the lower net income as show on the income statement

Net Income = EBIT - Interest - Taxes

Here HD uses more debt than LD. Thus HD would have the lower net income comparatively on LD suppose you consider option (a) the above given information is sufficient to find out the Net income of both HD and LD corporations. consider option (b), Equity Multiplier = [Total Assets / Total Equity], HD uses more debt than LD. Basing on the Accounting Equation (Total Assets = Total Debt + Total Equity) HD use a high equity multiplier in duepoint equation consider option (c) Interest on Debt is tax free Hence, the right option is (d) HD would have the lower net income as show on the income statement

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