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1 July, 01:16

Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each has $10 million in invested capital, has $1.5 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 11% interest on its debt, whereas LL has a 30% 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.

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  1. 1 July, 04:08
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    0.1125 or 11.25% for each firm

    Explanation:

    Given that,

    Each has $10 million in invested capital,

    $1.5 million of EBIT

    25% federal-plus-state tax bracket

    ROIC for LL:

    = [EBIT * (1 - tax rate) ] : invested capital

    = [1.5 * (1 - 25%) ] : 10

    = 0.1125 or 11.25%

    ROIC for HL

    = [EBIT * (1 - tax rate) ] : invested capital

    = [1.5 * (1 - 25%) ] : 10

    = 0.1125 or 11.25%

    Therefore, the return on invested capital (ROIC) for each firm is 11.25%
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