FINANCIAL LEVERAGE EFFECTS Firms HL and LL are identical except for their financial leverage ratios and the
Question:
FINANCIAL LEVERAGE EFFECTS
Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $26 million in invested capital, has $5.2 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 55% and pays 13% interest on its debt, whereas LL has a 25% debt-to-capital ratio and pays only 9% 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 is_____%
ROIC for firm HL is______%
2.) 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_______%
3.) Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital ratio from 25% 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.
_________%