Question
Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $14 million in
Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $14 million in invested capital, has $2.1 million of EBIT, and is in the 25% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 60% and pays 12% interest on its debt, whereas LL has a 35% debt-to-capital ratio and pays only 8% interest on its debt. Neither firm uses preferred stock in its capital structure.
Calculate the return on invested capital (ROIC) for each firm. Round your answers to two decimal places.
ROIC for firm LL: %
ROIC for firm HL: %
Calculate the rate of return on equity (ROE) for each firm. Round your answers to two decimal places.
ROE for firm LL: %
ROE for firm HL: %
Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital ratio from 35% to 60% even though that would increase LL's interest rate on all debt to 15%. Calculate the new ROE for LL. Round your answer to two decimal places.
%
Step by Step Solution
There are 3 Steps involved in it
Step: 1
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-text-image.webp)
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Step: 3
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started