Firms HL and LL are identical except for their leverage ratios andthe interest r

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Firms HL and LL are identical except for their leverage ratios andthe interest rates they pay on debt. Each has $20 million inassets, $4 million of EBIT, and is in the 40 percentfedral-plus-state tax bracket. Firm HL, however, has a debt ratio(D/A) of 50 percent and pays 12 percent interest on its debt,whereas LL has a 30 percent debt ratio and pays only 10 percentinterest on its debt.

a) Calculate the reate of return on equity (ROE) for each firm.
b) Observing that HL has a higher ROE, LL's treasurer is thinkingof raising the debt ratio from 30 to 60 percent, even though thatwould increase LL's interest rate on all debt to 15 percent.Calculate the new ROE for LL.

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