1) BigDebt firm and SmallDebt firm are identical except for their level of debt and the...

1) BigDebt firm and SmallDebt firm are identical except for their level of debt and the interest rates they pay on debt-BigDebt has more debt and pays a higher interest on that debt. Based on the data given below, what is the difference between two firms' ROEs?

Applicable to Both Firms

Assets = $400
EBIT = $100
Tax Rate = 35%

Firm BigDebt’s Data
Debt Ratio       =          45%
Interest Rate    =          12.5%

Firm SmallDebt’s Data
Debt Ratio       =          25%
Interest Rate    =          9.0%

options:

	3.18%
	22.9%
	29.7%
	4.25%
	3.21%

Solutions

Expert Solution

We can calculate the diiference between the ROE's of both firms as follows

Formulas used in the excel sheet are

So, the Difference between the ROEs of Big Debt Firm and Small Debt firm comes out to be 3.18%. So, the correct answer is option (a).

Hope I was able to solve your concern. If you are satisfied hit a thumbs up !!

jeff jeffy answered 1 year ago

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