Question

Firm A and Firm B have debt-total assets ratios of 65 percent and 45 percent, respectively, and returns on total assets of 5% and 7%, respectively. Which firm has a greater return on equity

Answer 1

Firm A

Explanation:

D = Debt

A= Asset

E = Equity

ROA = Return on assets

ROE = Return on equity

For Firm A:

`(D)/(A)=0.65\\(E)/(A)=1-0.65=0.35\\ROA = 0.05\\ROE=(ROE)/((E)/(A))=(0.05)/(0.35) \\ROE=0.1429=14.29\%`

For Firm B:

`(D)/(A)=0.45\\(E)/(A)=1-0.45=0.55\\ROA = 0.07\\ROE=(ROE)/((E)/(A))=(0.07)/(0.55) \\ROE=0.1273=12.73\%`

Therefore, Firm A has a greater return on equity.