1. Two operationally similar companies, DW and DS, have identical amounts of assets, operating income (EBIT), tax rates, and business risk, but DW has a much higher debt ratio than DS. Company DS’s return on invested capital (ROIC) exceeds its after-tax cost of debt, (1-T) rd and DW’s return on invested capital (ROIC) exceeds its after-tax cost of debt (1-T) rd. Based on this information, which statement would be accurate?
a) DW’s ROE would be higher if it had no debt
b) DW has a higher times interest earned (TIE) ratio than DS
c) DW has a higher return on equity (ROE) and risk than Company DS
d) DW has a higher return on assets (ROA) than DS
2. If debt financing is used, which of the following will be true?
a) The percentage change in net income will be greater than the percentage change in net operating income.
b) The percentage change in sales will be greater than the percentage change in EBIT, which in turn will be greater than the percentage change in net income.
c) The percentage change in net operating income will be greater than a given percentage change in net income.
d) The percentage change in net operating income will be equal to a given percentage change in net income.