John Jones is considering purchasing shares in one of two companies and has extracted the following information from the balance sheet of each company.

Required:

(a) Define the term 'gearing' stating clearly what is meant by a low gearing ratio.

(b) Calculate the gearing factor for each company.

(c) Explain to John Jones the significance of gearing to an ordinary shareholder in each of the companies above.

(d) Assuming for each company a trading profit of \(£ 200,000\) before interest and an ordinary dividend of 15 per cent complete the profit and loss appropriation account for a year for each company. You should ignore taxation.

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Authorised share capital 1 ordinary shares 8% 1 preference shares Company A Plc 000 Company B Plc 000 600 1,000 400 Issued share capital 1 ordinary shares 300 800 8% 1 preference shares 200 Reserves Share premium Retained earnings 300 400 400 200 Loan capital 10% debentures (19X0) 200 12% debentures (19X6) 400