Which of the following statements is CORRECT? Group of answer choices 1) The use of debt...

Which of the following statements is CORRECT? Group of answer choices 1) The use of debt financing will tend to lower the basic earning power ratio, other things held constant. 2) A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. 3) If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE. 4) The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm's ability to pay current interest is affected by taxes. 5) Other things held constant, increasing the total debt to total capital ratio will increase the ROA.

Expert Solution

Answer:

Correct answer is:

2) A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.

Explanation:

Equity multiplier = Total assets / Total shareholder equity

So, a firm that employs financial leverage will have a lower denominator and hence higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.

Hence option 2 is correct.

Basic earning power ratio = Earnings before interest and taxes (EBIT) by total assets

So the use of debt financing will not impact the basic earning power ratio. Hence statement 1 is incorrect.

If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the lower expected ROE since it will have less leverage effect.

Hence option 3 is incorrect.

The numerator used in the TIE ratio is earnings before interest and taxes (EBIT). Hence option 4 is incorrect.

jeff jeffy answered 3 months ago

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