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 $20 million in invested capital, $4 million of EBIT, and is in teh 40% federal-plus-state tax bracket. Firm HL, however has a debt-to-capital taio of 50% and pays 12% interest on its debt, whereas LL has a 30% debt to capital ratio and pays only 10% interst on its debt. Neither firm uses preferred stock in its capital structure.
a. Calculate the return on invested capital for each firm.
b. Calculate teh return on equity for each firm.
c. Observing that HL has a higher ROE, LL's treasurer is thinking if raising the debt-to-capital ratio from 30% to 60% even though that would increase LL's interes rate on all debt to 15%. CAlculate the new ROE for LL.