1. Company A and Company B have the same tax rate, the same total assets, and the same basic earning power. Both companies have a basic earning power that exceeds their before-tax costs of debt, rd. However, Company A has a higher debt ratio. Which of the following statements is correct?
a. Company A has a higher net income than Company B.
b. Company B has a lower ROA than Company A.
c. Company A has a higher ROE than Company B.
d. Company B has a lower WACC than Company A.
2. Which statement is False?
a. Adding debt will increase the firm’s ROE as long as the cost of debt is less than their Basic Earning Power.
b. The level of debt does NOT affect the business risk of a firm.
c. If a company increases its level of debt, then its Net Income will increase
d. According to the tradeoff model of capital structure, the costs of debt and equity will both rise as the level of debt increases.