Calculating The Rate Of Return On Equity 547153

Financial Leverage effects. Firms HL and LL are identical except for their leverage ratios and the interest rates they pay on debt. Each has $20 million in assests, has $4 million of EBIT, and is in the 40% federal-plus-state-tax bracket. Firm HL, however, has a debt ratio and pays only 10% interest on its debt.

A. Calculate the rate of return on equity(ROE) for each firm.

B. 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% . Calcuate the new ROE for LL.