Y8 Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $23 million in invested capital, has $6.9 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 12% interest on its debt, whereas LL has a 25% debt-to-capital ratio and pays only 10% 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 % 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 % Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital ratio from 25% 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. %
Financial Ratios
A Ratio refers to a figure calculated as a reference to the relationship of two or more numbers and can be expressed as a fraction, proportion, percentage, or the number of times. When the number is determined by taking two accounting numbers derived from the financial statements, it is termed as the accounting ratio.
Return on Equity
The Return on Equity (RoE) is a measure of the profitability of a business concerning the funds by its stockholders/shareholders. ROE is a metric used generally to determine how well the company utilizes its funds provided by the equity shareholders.
Y8
Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $23 million in invested capital, has $6.9 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 12% interest on its debt, whereas LL has a 25% debt-to-capital ratio and pays only 10% interest on its debt. Neither firm uses
- 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 % - 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 % - Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital ratio from 25% 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.
%
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