Two Operationally Similar Companies, HD and LD, Have the Same

Two operationally similar 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 HD's basic earning power (BEP) exceeds its cost of debt (rd) .Which of the following statements is CORRECT?

A) HD should have a higher times interest earned (TIE) ratio than LD.
B) 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.
C) Given that BEP > rd, HD's stock price must exceed that of LD.
D) Given that BEP > rd, LD's stock price must exceed that of HD.
E) HD should have a higher return on assets (ROA) than LD.

Correct Answer:

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