1. Two firms HL and LL are identical except for their leverage ratios and interest rates on debt. Each has $20 million in assets, earned $4 million before interest and taxes in 2008 and has a 40 percent tax rate. Firm HL, however has a leverage ratio (D/TA) of 50 percent and pays 12 percent interest in its debt, whereas LL has a 30 percent leverage ratio and pays only 10 percent interest on its debt.

1. Calculate the rate of return on equity (net income/equity) for each firm.
2. Observing that HL has a higher rate of return on equity, LLs treasurer decides to raise the leverage ratio from 30 to 60 percent, which will increase LLs interest rate on all debt to 15 percent. Calculate the new rate of return on equity for LL.