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…

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter17: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 7P

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Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $20 million in invested capital, has $4 million of EBIT, 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 the interest deduction limitation. Firm HL, however, has a debt-to-capital ratio of 50% and pays 12% interest on its debt, whereas LL has 30% debt-to-capital ratio and pays only 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. B) Calculate the return on equity (ROE) for each firm. C) Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital ratio from 30% to 60% even though that would increase LL's interest rate on all debt to 15%. Calculate the new ROE for LL.
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 $3.45 million of EBIT, 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 the interest deduction limitation. Firm HL, however, has a debt-to-capital ratio of 55% and pays 12% interest on its debt, whereas LL has a 25% debt-to-capital ratio and pays only 9% 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: %ROIC for firm HL: % Calculate the return on equity (ROE) for each firm. Round your answers to two decimal places.ROE for firm LL: %ROE for firm HL: % Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt-to-capital…
Firms HL and LL are identical except for their financialleverage ratios and the interest rates they pay on debt. Each has $20 million in investedcapital, has $4 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL,however, has a debt-to-capital ratio of 50% and pays 12% interest on its debt, whereas LLhas a 30% debt-to-capital ratio and pays only 10% interest on its debt. Neither firm usespreferred stock in its capital structure.a. Calculate the return on invested capital (ROIC) for each firm.b. Calculate the return on equity (ROE) for each firm. c. Observing that HL has a higher ROE, LL’s treasurer is thinking of raising the debt-to-capital ratio from 30% to 60% even though that would increase LL’s interest rate on all debt to 15%. Calculate the new ROE for LL.
Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $26 million in invested capital, has $3.9 million of EBIT, and is in the 25% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 50% 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: %ROIC for firm HL: % Calculate the rate of return on equity (ROE) for each firm. Round your answers to two decimal places.ROE for firm LL: %ROE for firm HL: % 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…
Consider two firms, Go Debt corporation and No Debt corporation. Both firms are expected to have earnings before interest and taxes of $100,000 during the coming year. In addition, Go Debt is expected to incur $40,000 in interest expenses as a result of its borrowings whereas No Debt will incur no interest expense because it does not use debt financing. Both firms are in the 21 percent tax bracket. Calculate the earnings after tax for both firms. Compare the difference in after-tax earnings to the difference in interest expense. Can you reconcile that difference?
Companies U and L are identical in every respect except that U is unlevered while L has $20 million of 8% 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 $3 million. (4) The unlevered cost of equity is 12%. What is the WACC for Firm U? % What is the WACC for Firm L? %
Three companies that subcontract with automobile manufacturers have the fol- lowing debt and equity capital amounts and D-E mixes. Assume all equity capital is in the form of stock. Assume the annual revenue is $15 million for each corporation and that, after debt service is considered, the net incomes are $14.4, $13.4, and $10.0 million, respectively. Compute the return on stock for each company, and comment on the return relative to the D-E mixes.
Firm AB and Firm YZ are identical except for their debt-to-total-assets ratios (D/Tas) and interest rates on debt. Each has $200,000 in assets, $40,000 EBIT, and a 40% marginal tax rate. Firm AB has a D/TA ratio of 40% and pays 7.5% interest on its debt, whereas YZ has a 60% D/TA ratio and pays 10% interest on debt. Each firm has 5,000 shares of common stock outstanding. Calculate each firm's EPS and Return on Equity.
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ruz Corporation has $100 billion of debt outstanding. An otherwise identical firm has no debt and has a market value of $500 billion. Under the Miller model, what is Cruz’s value if the federal-plus-state corporate tax rate is 28%, the effective personal tax rate on stock is 17%, and the personal tax rate on debt is 29%?
Wilmore Company Limited is a levered entity with percentage of debt out of total capital being 40%. If the interest rate on a bank loan is 10%, the tax rate is 20%, and the cost of equity is as computed in (a), what will be the after tax cost of debt?
The Shrieves Corporation has $10,000 that it plans to invest in marketablesecurities. It is choosing among AT&T bonds, which yield 7.5%, state of Florida muni bonds, which yield 5% (but are not taxable), and AT&T preferredstock, with a dividend yield of 6%. The corporate tax rate is 35%, and 70% ofthe dividends received are tax exempt. Find the after-tax rates of return on allthree securities.

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