In: Finance
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% |
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).
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