Question

Question 11.

Companies Heidee and Leaudy have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company Heidee has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT? Rationalize your selection.

a. Company Heidee has more net income.

b. Company Heidee pays less in taxes.

c. Company Heidee has a lower equity multiplier.

d. Company Heidee has a higher ROA.

e. Company Heidee has a higher times interest earned (TIE) ratio.

Answer 1

EXAMPLE WITH COMPANY X and Y

X=Haidee, Y=Leaudy

		Company X	Company Y
A	Debt Ratio	0.6	0.3
B	Total Asset	1000	1000
C=A*B	Total Liabilities	600	300
D=B-C	Total Equity	400	700
E	Interest Rate	10%	10%
F=C*E	Interest Expense	60	30
G	Sales	1000	1000
H	Earning Before Interest and taxes	150	150
I=H-F	Before Tax Income	90	120
J	Tax Rate	30%	30%
K=I*J	Tax expense	27	36
L=I-K	NET INCOME	63	84

.a Company Haidee(X) does not have more net income. It has lower Net Income

.b Company Haidee (X) Pays less in taxes . True, because it has higher interest expense

.c Equity Multiplier =Total Assets/Total Shareholders Equity

Equity Multiplier of Haidee(X) =1000/400=2.5

Equity Multiplier of Leaudy(Y) =1000/700=1.43

Company Haidee does not have lower equity multiplier. It has higher equity multiplier

d.ROA(Return on assets)=Net Income/Total Assets

ROA of Haidee(X)=63/1000=0.063

ROA of Leaudy (Y)=84/1000=0.084

Company Haidee does not have higher ROA. It has a lower ROA

e.Times Interest Earned Ratio(TIE)=Earning before Interest and taxes/Interest expense

TIE of Haidee (X)=150/60=2.5

TIE of Leaudy=150/30=5

Company Haidee does not have higher TIE. It has lower Times Interest Earned Ratio

b. Company Heidee pays less in taxes.