ABC Company and XYZ Company are identical, with the only difference in their capital structures. ABC Company has a debt to equity ratio of 1:1, whereas XYZ Company has a debt to equity ratio of 1:4. The interest rate to be paid on the debt taken by each of the company is 8%. There are no taxes and capital markets are perfect.

(a.) Suppose that you own 2% of the stocks of ABC Company and the company has net operating income of Rs.360,000. The return on assets of the company is 18%. What is your return in rupees? What is the rate of return on the equity of the company?

(b.) What is the rate of return on the equity of XYZ Company? Compare ABC Company and XYZ Companys return on equity. Explain the difference in returns, if any.