Companies HD and LD have the same total assets, operating income (EBIT), tax rat

Question

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, both companies' basic earning power (BEP) ratios exceed their cost of debt (r). Which of the following statements is CORRECT?
Answer
a. HD should have a higher return on assets (ROA) than LD.
b. HD should have a higher times interest earned (TIE) ratio than LD.
c. 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.
d. Given that BEP > r, HD's stock price must exceed that of LD.
e. Given that BEP > r, LD's stock price must exceed that of HD.

Explanation / Answer

THE CORRECT STATEMENT IS c. 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.

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