FINANCIAL LEVERAGE EFFECTS: Firms HL and LL are identical except for their financial leverage ratios and...

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FINANCIAL LEVERAGE EFFECTS: Firms HL and LL are identical exceptfor their financial leverage ratios and the interest rates they payon debt. Each has $20 million in invested capital, has $4 millionof EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL,however, has a debt-to-capital ratio of 50% and pays 12% intereston the debt, whereas LL has a 30% debt-to-capital ratio and paysonly 10% interest on its debt. Neither firm uses preferred stock inits capital structure.
a. Calculate the return on invested capital (ROIC) for eachfirm.
b. Calculate the return on equity (ROE) for each firm.
c. Observing that HL has a higher ROE. LL’s treasurer isthinking of raising the debt-to-capital ratio from 30% to 60% eventhough that would increase LL’s interest rate on all debt to 15%Calculate the new ROE for LL.

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FINANCIAL LEVERAGE EFFECTS: Firms HL and LL are identical exceptfor their financial leverage ratios and the interest rates they payon debt. Each has $20 million in invested capital, has $4 millionof EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL,however, has a debt-to-capital ratio of 50% and pays 12% intereston the debt, whereas LL has a 30% debt-to-capital ratio and paysonly 10% interest on its debt. Neither firm uses preferred stock inits capital structure.a. Calculate the return on invested capital (ROIC) for eachfirm.b. Calculate the return on equity (ROE) for each firm.c. Observing that HL has a higher ROE. LL’s treasurer isthinking of raising the debt-to-capital ratio from 30% to 60% eventhough that would increase LL’s interest rate on all debt to 15%Calculate the new ROE for LL.