Chapter 19 Financial Statement Analysis 489
77. Which of the financial statements recognizes only transactions in which cash changes hands?
78. Suppose that Charlie's Cycles, Inc. has a ROA of 7% and pays a 6% coupon on its debt. Charlie's has a capital structure that is 70% equity and 30% debt. Relative to a firm that is 100% equity-financed, Charlie'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. Answer: D Difficulty: Difficult Rationale: Charlie's Net Profit will be lower because it has to pay interest expense. But as long as Charlie's ROA exceeds the cost of its debt, leverage will have a positive impact on its ROE.