Q1A) which of the following is most correct? When the return on capital employed
ID: 2721392 • Letter: Q
Question
Q1A) which of the following is most correct?
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.
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.
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.
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.
-None of the above
Question 2B) A firm that employs a relatively large proportion of debt in its capital structure will have a relatively ____ degree of financial leverage.
-LOW
high
insignificant
constant
Question 1C)
A DFL (degree of financial leverage) of 3.0 indicates that a 27% increase in EPS is the result of a ____ increase in EBIT.(hint: the EBIT moves __% causing a magnified increase 3 times that in EPS.)
-81%
3%
9%
6%
Question 1D)Financial leverage increases a firm's ROE and EPS under which of the following circumstances?ROCE= Return on Capital Employed
ROCE = cost of debt
ROCE> after tax cost of debt
ROCE>pre tax cost of debt
ROCE = cost of equity
Explanation / Answer
Q1A) The following statement is most correct of all.
When the ROCE is more than the before tax cost of debt, a company can increase its ROE by trading out equity and into debt.
The reason for the above statement being correct is that, when debt is used to finance investments, it produces a magnifies the after tax income for the shareholders.
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