Financial leverage effects Firms HL and LL are identical except for their financ

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 $22 million in invested capital, has $4.4 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 60% and pays 11% interest on its debt, whereas LL has a 20% debt-to-capital ratio and pays only 8% interest on its debt. Neither firm uses preferred stock in its capital structure. 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 ________%

Explanation / Answer

HL LL D/TA 60% 20% Debt 13200000 4400000 Equity 8800000 17600000 Interest rate 11% 8% EBIT 4400000 4400000 Intrest 1452000 352000 EBT 2948000 4048000 Tax(40%) 1179200 1619200 Net income 1768800 2428800 Return on invested capital(net imcome/equity capital 20.1% 13.8%

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