Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $25 million in assets, $5 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 13% interest on its debt, whereas LL has a 40% debt ratio and pays only 10% interest on its debt.
Calculate the rate of return on equity (ROE) for each firm. Round your answers to two decimal places.
a. ROE for firm LL is %
b. ROE for firm HL is %
Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt ratio from 40% 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.