Asked by Rebekah Gonzalez on Apr 25, 2024
Verified
Suppose that Chicken Express, Inc. has an ROA of 7% and pays a 6% coupon on its debt. Chicken Express has a capital structure that is 70% equity and 30% debt. Relative to a firm that is 100% equity-financed, Chicken Express's net profit will be ________, and its ROE will be ________.
A) lower; lower
B) higher; higher
C) higher; lower
D) lower; higher
E) It is impossible to predict.
ROA
Return on Assets, a financial ratio indicating how profitable a company is relative to its total assets, used to assess how efficient a company's management is at using its assets.
Capital Structure
The combination of borrowing (debt) and ownership (equity) capital employed by a firm to finance its activities and expansion.
Equity-Financed
The method of funding a business through the sale of shares, thus raising capital without incurring debt.
- Assess the impact of financial leverage on a company's net profit and Return on Equity (ROE).
Verified Answer
KC
Kasigari Chandrarekha7 days ago
Final Answer :
D
Explanation :
Chicken Express's net profit will be lower because it has to pay interest on its debt, which reduces its net income. However, its ROE will be higher because leveraging (using debt) magnifies the return on equity when the cost of debt is lower than the return on assets (ROA > interest rate on debt).
Learning Objectives
- Assess the impact of financial leverage on a company's net profit and Return on Equity (ROE).