Question: Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $20 million in assets,

Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $20 million in assets, has $4 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL, however, has a debt ratio (D/A) of 50% and pays 12% interest on its debt, whereas LL has a 30% debt ratio and pays only 10% interest on its debt.

a. Calculate the rate of return on equity (ROE) for each firm.

b. Observing that HL has a higher ROE, LL’s treasurer is thinking of raising the debt ratio from 30% to 60% even though that would increase LL’s interest rate on all debt to 15%. Calculate the new ROE for LL.

Step by Step Solution

★★★★★

3.29 Rating (173 Votes )

There are 3 Steps involved in it

1 Expert Approved Answer

Step: 1 Unlock

a LLDTA 30 EBIT 4000000 Interest 6000000 010 600000 EBT 3400000 Tax 40 1360000 Net income 2040... View full answer

Question Has Been Solved by an Expert!

Get step-by-step solutions from verified subject matter experts

Step: 2 Unlock

Step: 3 Unlock

Document Format (1 attachment)

43-B-C-F-C-S (75).docx

120 KBs Word File

Students Have Also Explored These Related Corporate Finance Questions!

The firms HL and LL are identical except for their debt-to-total-assets ratios and interest rates on debt. Each has $20 million in assets, earned $4 million before interest and taxes, and has a 40...

Firms HD and LD are identical except for their level of debt and the interest rates they pay on debt-HD has more debt and pays a higher interest rate on that debt. Based on the data given below, what...

Firm AB and Firm YZ are identical except for their debt-to-total-assets ratios (D/TAs) and interest rates on debt. Each has $200,000 in assets, $40,000 EBIT, and a 40 percent marginal tax rate. Firm...

Lahore School of Economics Financial Management II Capital Structure and Leverage - 2 Chapter 14 Assignment 16 Examples 1. Harley Motors has $10 million in assets, which were financed with $2 million...

14-3: Determining the Optimal Capital Structure Problem 14-4 Unlevered beta 1. Harley Motors has $12 million in assets, which were financed with $7.2 million of debt and $4.8 million in equity....

1 4 - 4 UNLEVERED BETA Harley Motors has $ 1 0 million in assets, which were financed with $ 2 million of debt and $ 8 million in equity. Harley's beta is currently 1 . 2 , and its tax rate is 4 0 %...

Financial leverage effects Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $25 million in invested capital, has $5 million of EBIT,...

Firms HL and LL are identical except for their leverage ratios and the Interest rates they pay on debt. Each has $20 million in assets, $4 million of EBIT, and has a 40% Income tax rate. Firm HL,...

Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $20 million in assets, $4 million of EBIT, and is in the 40 percent fedral-plus-state...

A firm generates 12 cents in net income per dollar of sales and needs $1.40 in assets to generate a dollar of sales. calculate the firms return on assets?

A company manufactures motors. It buys the coil (a component used in the motor) from a vendor at a price of $12 per unit. Assume there are 300 business days in a year and the company assembles 45...

Which one of the following statements is true? Multiple Choice Most mutual funds are managed funds. How long the present fund manager has been managing the fund is irrelevant. You should ignore fees...

If and are integers, then is an integer. The converse, contrapositive and negation of the above statement are:

We will consider two frames of reference moving with respect to each other. Let the stationary frame of reference be associated with the Sun and another star, 10 light years away from the Sun. Let...

5 pnts Which of the followings is the correct choice of "k" for which all solutions of the differential equation remain finite as t 00. y" + (3k 1)y+ (2k 1)ky = 0 A)O B)20 C) D) 0 E) 12

6 pnts Consider the following differential equation 1 (t2 kt)y" Vt ly + In t - 64|y = (t 1) subject to y(5) = 1; y'(5) = 4 Find the certain value of "k" so that the largest possible interval over...

During the financial crisis, many executives pay was stifled, reduced, or even withheld. Among the hardest hitthe U.S. auto industry. Shareholder groups, union leaders, political officials, and the...

Can a firm generate a 25 percent return on assets and still be technically insolvent (unable to pay its bills)? Explain.

The traditional definitions of collection period and inventory turnover are criticized because in both cases balance sheet figures that are a result of approximately the last month of sales are...

Which financial ratios would you be most likely to consult if you were the following? Why? a. A banker considering the financing of seasonal inventory b. A wealthy equity investor c. The manager of a...

Question 78 of 83\ Using the same information from before, please calculate the WACC of Correct Inc. assuming a risk free rate of 2.5% , a company Beta of 1.2 and a market risk premium of 6% .\ 9.7%...

What is a way to validate transactions and achieve a distributed consensus? Blockchain distributed, computing proof of work or proof of Stake

Use your ti calculator to write down commands for b A hypotheses test, some information from one sample, and a standard error from a randomization distribution are provided. avalgib noming s...