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Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $$33$ million in invested capital, has $$7$ million of EBIT, and is in the $30\%$ federal$-$plus$-$state tax bracket. Both firms are small with average sales of $$25$ million or less during the past $3$ years, so both are exempt from the interest deduction limitation$.$ Firm HL$,$ however, has a debt$-$to$-$capital ratio of $55\%$ and pays $13\mathrm{.}22\%$ interest on its debt, whereas LL has a $25\%$ debt$-$to$-$capital ratio and pays only $7\mathrm{.}5\%$ interest on its debt. Neither firm uses preferred stock in its capital structure.

a$.$ What is the return on invested capital $($ROIC$)$ for firm HL$?$

b$.$ What is the return on invested capital $($ROIC$)$ for firm LL$?$

c$.$ What is the return on equity $($ROE$)$ for firm HL$?$

d$.$ What is the return on equity $($ROE$)$ for firm LL$?$

Worth $10$ points total.

$$

$20$

$21$

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Unequal Lives

Optimal Capital Structure

Financial Leverage Effects

Residual Divide!