Asked by Priya Puppala on Jun 05, 2024
Verified
If the interest rate on debt is higher than ROA, a firm will __________ by increasing the use of debt in the capital structure.
A) increase the ROE
B) not change the ROE
C) decrease the ROE
D) change the ROE in an indeterminable manner
ROA
Return on Assets, a financial ratio indicating the profitability of a company relative to its total assets.
Capital Structure
The mix of a company's long-term debt, specific short-term debt, common equity, and preferred equity, which is used to finance its overall operations and growth.
ROE
Return on Equity, measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.
- Assess the effect that leverage has on return on equity (ROE) for firms when faced with varying circumstances.
Verified Answer
CS
Connor SimpsonJun 05, 2024
Final Answer :
C
Explanation :
When the interest rate on debt is higher than the Return on Assets (ROA), using more debt in the capital structure increases the cost of debt relative to the returns generated by the assets. This leads to a decrease in Return on Equity (ROE) because the firm pays more in interest than it earns on its investments, reducing the earnings available to equity holders.
Learning Objectives
- Assess the effect that leverage has on return on equity (ROE) for firms when faced with varying circumstances.