Question

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 $3 million of EBIT, and is in the 25% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 55% and pays 12% interest on its debt, whereas LL has a 30% debt-to-capital ratio and pays only 8% 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.

Answer 1

11.25%; 11.25%

Step-by-step explanation:

Given that,

Invested capital of each company = $20 million

EBIT = $3 million

Federal-plus-state tax bracket = 25%

ROIC for LL:

= EBIT × (1 - Tax rate) ÷ Invested capital

= [$3 × (1 - 25%)] ÷ $20

= 0.1125 × 100

= 11.25%

ROIC for HL:

= EBIT × (1 - Tax rate) ÷ Invested capital

= [$3 × (1 - 25%)] ÷ $20

= 0.1125 × 100

= 11.25%