FINANCIAL LEVERAGE EFFECTS Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $13 million in invested capital, has $3.25 million of EBIT, and is in the 40% federal-plus-state tax bracket. Firm HL, however, has a debt-to-capital ratio of 60% and pays 11% interest on its debt, whereas LL has a 35% debt-to-capital ratio and pays only 10% interest on its debt. Neither firm uses preferred stock in its capital structure.
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a] and b]
ROIC = EBIT * (1 - tax rate) / invested capital
c] and d]
ROE = (EBIT - interest expense) * (1 - tax rate) / equity
e]
New ROE = 24.00%
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