Question

Which of the following statements is CORRECT?a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant. b. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE. c. All else equal, increasing the debt ratio will increase the ROA. d. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.

Answer 1

(d). A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in it's capital structure.

Step-by-step explanation:

Financial leverage refers to the composition of debt in a company's capital structure.

Equity multiplier is used as a measure of financial leverage. It is given by the following formula

Equity Multiplier =
`(Total\ Assets)/(Total\ Equity)`

It represents what portion of a company's capital is financed by equity.

Financial Leverage on the other hand conveys the proportion of debt in the capital structure.

Financial Leverage =
`(Debt)/(Equity)`

Debt refers to total debt whereas Equity refers to total shareholders funds.

It is noteworthy that debt is a tax deductible expense unlike equity.

A high equity multiplier could arise when total equity is less in proportion to total assets. This further indicates that company has employed more of debt which means the firm employs financial leverage.

This means a firm with financial leverage i.e with debt in it's financial structure will have a higher equity multiplier than an otherwise identical firm that has no debt in it's capital structure.