Two operationally similar companies, HD and LD, have the same total assets, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also HD's return on invested capital (ROIC) exceeds its after-tax cost of debt, (1-T)rd. Which of the following statements is CORRECT?
A. HD should have a higher times interest earned (TIE) ratio than LD.
B. HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's.
C. Given that ROIC > (1-T) rd, HD's stock price must exceed that of LD.
D. Given that ROIC > (1-T) rd, LD's stock price must exceed that of HD.
E. HD should have a higher return on assets (ROA) than LD.
Answer: B
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