Firms HL and LL are identical except for their financial leverage ratios and the interest rates...

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Finance

Firms HL and LL are identical except for their financialleverage ratios and the interest rates they pay on debt. Each has$28 million in invested capital, has $5.6 million of EBIT, and isin the 40% federal-plus-state tax bracket. Firm HL, however, has adebt-to-capital ratio of 50% and pays 11% interest on its debt,whereas LL has a 20% debt-to-capital ratio and pays only 8%interest on its debt. Neither firm uses preferred stock in itscapital structure.
Calculate the return on invested capital (ROIC) for each firm.Round your answers to two decimal places.
ROIC for firm LL is
ROIC for firm HL is
Calculate the rate of return on equity (ROE) for each firm.Round your answers to two decimal places.
ROE for firm LL is
ROE for firm HL is
Observing that HL has a higher ROE, LL's treasurer is thinkingof raising the debt-to-capital ratio from 20% to 60% even thoughthat would increase LL's interest rate on all debt to 15%.Calculate the new ROE for LL. Round your answer to two decimalplaces.

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3.6 Ratings (268 Votes)

Please see the table below All financials are in mn Please see the column titled Linkage That will help you understand how each row has been calculated Final answers are highlighted in yellow colored cells See Answer

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Firms HL and LL are identical except for their financialleverage ratios and the interest rates they pay on debt. Each has$28 million in invested capital, has $5.6 million of EBIT, and isin the 40% federal-plus-state tax bracket. Firm HL, however, has adebt-to-capital ratio of 50% and pays 11% interest on its debt,whereas LL has a 20% debt-to-capital ratio and pays only 8%interest on its debt. Neither firm uses preferred stock in itscapital structure.Calculate the return on invested capital (ROIC) for each firm.Round your answers to two decimal places.ROIC for firm LL isROIC for firm HL isCalculate the rate of return on equity (ROE) for each firm.Round your answers to two decimal places.ROE for firm LL isROE for firm HL isObserving that HL has a higher ROE, LL's treasurer is thinkingof raising the debt-to-capital ratio from 20% to 60% even thoughthat would increase LL's interest rate on all debt to 15%.Calculate the new ROE for LL. Round your answer to two decimalplaces.