Answer:
A. ROIC for firm LL 12%
ROIC for firm HL 12%
B. ROE for firm LL 13.5%
ROE for firm HL 18.6%
C. New ROE for firm LL 16.5%
Explanation:
A. Calculation to determine the return on invested capital (ROIC) for each firm
Using this formula
ROIC=EBIT(1-T)/Total Invested Capital
Let plug in the formula
ROIC=$5 million(1-.40)/$25 million
ROIC=$5 million*.60/$25 million
ROIC=$3 million/$25 million
ROIC=0.12*100
ROIC=12% for both firms
Therefore the return on invested capital (ROIC) for each firm is:
ROIC for firm LL is 12%
ROIC for firm HL is 12%
B. Calculation to determine the rate of return on equity (ROE) for each firm.
Calculation for ROE for firm LL
First step is to calculate the Debt
Debt=$25 million*20%
Debt=$5 million
Second step is to calculate the Debt Interest
Debt Interest=$5 million*10%
Debt Interest=$500,000
Third step is to calculate the EBIT of firm LL
EBIT of firm LL=$5 million- $500,000
EBIT of firm LL=$4,500,000
Fourth step is to calculate Tax owed
Tax owed =$4,500,000*40%
Tax owed =$1,800,000
Fifth step is to calculate the Net income of firm LL
Net income of firm LL=$4,500,000-$1,800,000
Net income of firm LL=$2,700,000
Sixth step is to calculate the Equity for firm LL
Equity for firm LL=$25million-$5 million
Equity for firm LL=$20 million
Now let calculate the ROE using this formula
ROE=Net income /Equity
Let plug in the formula
ROE=$2,700,000/$20 million*100
ROE=13.5%
Calculation for ROE for firm HL
First step is to calculate the Debt
Debt=$25 million*55%
Debt=$13,750,000
Second step is to calculate the EBIT of firm HL
EBIT of firm HL=$5 million-[(55%*$25 million)*11%]
EBIT of firm HL=$5 million-($13,750,000*11%)
EBIT of firm HL=$5 million-$1,512,500
EBIT of firm HL=$3,487,500
Third step is to calculate the Tax owed
Tax owed =$3,487,500*40%
Tax owed =$1,395,000
Fourth step is to calculate the Net income of firm HL
Net income of firm HL=$3,487,500-$1,395,000
Net income of firm HL=$2,092,500
Fifth step is to calculate the Equity for firm HL
Equity for firm HL=$25million- $13,750,000
Equity for firm HL=$11,250,000
Now let calculate the ROE using this formula
ROE=Net income /Equity
ROE=$2,092,500/$11,250,000*100
ROE=18.6%
Therefore the rate of return on equity (ROE) for each firm is:
ROE for firm LL is 13.5%
ROE for firm HL is 18.6%
C. Calculation to determine the new ROE for LL
First step is to calculate the debt
Debt=$25 million*60%
Debt=$15 million
Second step is to calculate the Debt Interest
Debt Interest=$15 million*15%
Debt Interest=$2,250,000
Third step is to calculate the EBIT of firm LL
EBIT of firm LL=$5 million- $2,250,000
EBIT of firm LL=$2,750,000
Fourth step is to calculate the Tax owed
Tax owed =$2,750,000*40%
Tax owed =$1,100,000
Fifth step is to calculate the Net income of firm LL
Net income of firm LL=$2,750,000-$1,100,000
Net income of firm LL=$1,650,000
Sixth step is to calculate the Equity for firm LL
Equity for firm LL=$25million-$15 million
Equity for firm LL=$10 million
Now let calculate the New ROE using this formula
ROE=Net income /Equity
Let Plug in the formula
ROE=$1,650,000/$10 million*100
ROE=16.5%
Therefore the new ROE for LL is 16.5%
