Firms HL and LL are identical except for their financial leverage ratios and the interest rates they pay on debt. Each h
Posted: Tue Apr 26, 2022 10:46 am
Firms HL and LL are identical except for their financial
leverage ratios and the interest rates they pay on debt. Each has
$22 million in invested capital, has $3.3 million of EBIT, and is
in the 25% federal-plus-state tax bracket. Both firms are small
with average sales of $25 million or less during the past 3 years,
so both are exempt from the interest deduction limitation. Firm HL,
however, has a debt-to-capital ratio of 60% and pays 11% interest
on its debt, whereas LL has a 20% debt-to-capital ratio and pays
only 9% interest on its debt. Neither firm uses preferred stock in
its capital structure.
leverage ratios and the interest rates they pay on debt. Each has
$22 million in invested capital, has $3.3 million of EBIT, and is
in the 25% federal-plus-state tax bracket. Both firms are small
with average sales of $25 million or less during the past 3 years,
so both are exempt from the interest deduction limitation. Firm HL,
however, has a debt-to-capital ratio of 60% and pays 11% interest
on its debt, whereas LL has a 20% debt-to-capital ratio and pays
only 9% interest on its debt. Neither firm uses preferred stock in
its capital structure.