Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $28 million in invested capital, has $5.6 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 50% and pays 11% interest on its debt, whereas LL has a 30% debt-to-capital ratio and pays only 9% interest on its debt. Neither firm uses preferred stock in its capital structure.
a.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 %
b.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 %
c.Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital 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. Round your answer to two decimal places.