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

Question

Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $29 million in invested capital, has $5.8 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 55% and pays 13% interest on its debt, whereas LL has a 20% 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 __________%

Explanation / Answer

Firm HL
Earnings = ($5.6-50%*$28*11% ).6=2.436 million
ROIC for firm HL is =2.436/28=8.70%

Firm LL
Earnings =($5.6-30%*$28*9% ).6=$2.9064 million
ROIC for firm LL is =$2.9064/28=10.38%


ROIC for firm LL is 10.38%
ROIC for firm HL is 8.70%

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