Three companies have the capital structures shown below. Company Ordinary shares 12% debentures A B C 000

Three companies have the capital structures shown below.

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Company Ordinary shares 12% debentures A B C 000 000 000 600 400 50 200 550 600 600 600 The return on capital employed was 20 per cent for each firm in 19X4, and in 19X5 was 10 per cent. Corporation tax in both years was assumed to be 55 per cent, and debenture interest is an allowable expense against corporation tax. (a) Calculate the percentage return on the shareholders' capital for each company for 19X4 and 19X5. Assume that all profits are distributed. (b) Use your answer to explain the merits and the dangers of high gearing. (University of London GCE 'A' level)