Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $14 million in invested capital, has $2.1 million ofEBIT, and is in the 25% 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 theinterest deduction limitation. Firm HL, however, has a debt-to-capital ratio of 45% and pays 11% interest on its debt, whereas LL has a 35% debt-to-capital ratio and paysonly 10% 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:ROIC for firm HL:%%b. Calculate the return on equity (ROE) for each firm. Round your answers to two decimal places.ROE for firm LL:ROE for firm HL:%%c. Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital ratio from 35% to 60% even though that would increase LL's interest rate onall debt to 15%. Calculate the new ROE for LL. Round your answer to two decimal places.%

### Original Calculations for ROIC and ROE for Both Firms **Given Data for Both Firms:** - Invested…

Answered: Firms HL and LL are identical except…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all-equity financed with $500,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $250,000 and the interest rate on its debt is 8 percent. Both firms expect EBIT to be $51,000. Ignore taxes. a. Richard owns $25,000 worth of XYZ's stock. What rate of return is he expecting? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. Suppose Richard invests in ABC Co. and uses homemade leverage to match his cash flow in part (a). Calculate his total cash flow and rate of return. (Enter your return answer as a percent. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) c. What is the cost of equity for ABC and XYZ? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) d. What is the WACC for ABC and…
Suppose that Tap Dance, Incorporated's capital structure features 60 percent equity, 40 percent debt, and that its before-tax cost of debt is 7 percent, while its cost of equity is 12 percent. The appropriate weighted average tax rate is 21 percent and TapDance estimates it cannot make any use of the interest tax shield in the foreseeable future. What will be TapDance's WACC? Note: Round your answer to 2 decimal places.
a. Richard owns $33,000 worth of XYZ's stock. What rate of return is he expecting? Rate of return b. Calculate the cash flows and rate of return by investing in ABC, and using homemade leverage, how Richard could generate exactly the same? Total cash flow Rate of return ABC XYZ % c. What is the cost of equity for ABC? What is it for XYZ? Cost of equity ABC XYZ $ d. What is the WACC for ABC? For XYZ? WACC %
McConn Manufacturing is currently all-equity financed, has an EBIT of $2 million, and has a corporate tax rate of 21 percent. Natalie, the company’s founder, is the lone shareholder. All earnings are paid out as dividends to Natalie. If the firm were to convert $4 million of equity into debt, the cost would be 10 percent and Natalie would hold all the debt. Assume Natalie pays personal taxes on interest income at a rate of 37 percent but pays taxes on dividends at a rate of 20 percent. Calculate the total cash flow to Natalie after she pays personal taxes if the firm is unlevered and if it is levered
F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but it would like to add some debt to take advantage of the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: Market Debt-to Equity Ratio (D/S) 0.00 0.1111 0.2500 0.4286 0.6667 Market Equity-to- Value Ratio (ws) 1.0 0.90 6.0% 6.4 0.80 7.0 8.2 0.70 0.60 10.0 F. Pierce uses the CAPM to estimate its cost of common equity, rs, and at the time of the analaysis the risk-free rate is 6%, the market risk premium is 8%, and the company's tax rate is 25%. F. Pierce estimates that its beta now (which is "unlevered" because it currently has no debt) is 0.7. Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure? Do not round intermediate calculations. Round your answers to two…
Barclay Corp is operating in a country K where the corporate tax is 40%, personal income tax on bond investment is 25% while the personal tax on stock is 29%. Assume the firm’s earnings before interest and taxes is $5,400,000 and cost of equity with zero debt is 9%. (Please Show Work) If Barclay current has $12 million total market value of debt financing, what would be the market value of the company of Barclay Corp in this country K?(Please Show Work) What is the proportion of debt (wd) and equity (ws) financing for Barclay Corp with financial leverage? (Please Show Work)
MM with Corporate Taxes Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 5% bonds outstanding. Assume: (1) All of the MM assumptions are met. (2) Both firms are subject to a 25% federal-plus-state corporate tax rate. (3) EBIT is $4 million. (4) The unlevered cost of equity is 12%. a. What value would MM now estimate for each firm? (Hint: Use Proposition 1.) Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answers to two decimal places. Company U: $ Company L: $ million million b. What is rs for Firm U? Round your answer to one decimal place. % What is rs for Firm L? Do not round intermediate calculations. Round your answer to one decimal place. % c. Find SL, and then show that SL + DV₁ results in the same value as obtained in Part a. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round…
Dark Creek Corporation's CEO is selecting between two mutually exclusive projects. The company is obligated to make a $3,700 payment to bondholders at the end of the year. To minimize agency cost, the firm's bondholders decide to use a bond covenant to stipulate that the bondholders can demand an additional payment if the company chooses to take on the high-volatility project. How much additional payment to bondholders would make stockholders indifferent between the two projects? Cash flows pertaining to the two projects are shown in the table below. Economy Probability Low-Volatility Project Payoff High-Volatility Project Payoff $2,900 $4,000 4,800 Bad 40 Good .60 6,300 O $1366.67 O $1166.67 O $1300.00 O $1233,33
AAA Corporation and BBB Corporation are identical in every way except their capital structures. AAA Corporation, an all-equity firm, has 40million shares of stock outstanding, currently worth $15 per share. BBB Corporation uses leverage in its capital structure. The market value of BBB’s debt is $100million and its cost of debt is 6.7 percent. Each firm is expected to have earnings before interest of $200 million in perpetuity. Assume that every investor can borrow at 6.7 percent per year. Corporate tax rate is 35%. (SHOW YOUR WORK) 1). What is the value of AAA Corporation? 2). What is the value of BBB Corporation? 3). What is the market value of BBB Corporation’s equity? 4). What would be the BBB’s cost of equity (Rs)? 5). What would be BBB’s weighted average cost of capital (WACC)?
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