Three companies have the capital structures shown below.

The return on capital employed was 20 per cent for each firm in 2004, and in 2005 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 2004 and 2005. Assume that all profits are distributed.

(b) Use your answer to explain the merits and the dangers of high gearing.

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Company A B C 000 000 000 Ordinary shares 600 400 50 12% debentures 200 550 600 600 600