Problemfirms hl and ll are identical except for their, Ask an Expert

Accounting

Problem:

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

Task:

Question 1: Calculate the rate of return on equity (ROE) for each firm.

Question 2: Observing that HL has a higher ROE, LL's treasurer is thinking of raising the debt ratio from 30% to 60% even though that would increase LL's interest rate on all debt to 15%. Calculate the new ROE for firm LL.

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Accounting Basics, Accounting

Category:- Accounting Basics
Reference No.:- M91172892

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