CFR-2 CURRENT ASSET FINANCING Safari Adventure Travels and Eco Touring co. had the following balance sheets as at December 31 , 2015 (thousands of dollars):

Safari Adventure

Travels Eco Touring co.

Current assets	$100,000	$ 80,000
Fixed assets (net)	100,000	120,000
Total assets	$200,000	$200,000

Current liabilities	$ 20,000	$ 80,000
Long-term debt	80,000	20,000
Common stock	50,000	50,000
Retained earnings	50,000	50,000
Total liabilities and equity	$200 000	$200 000

Earnings before interest and taxes for both firms are $20 million, and the effective tax rate is 30%.

a. What is the return on equity for each firm if the interest rate on current liabilities is 6% and the rate on long-term debt is 8%?

ANSWER

b. Assume that the short-term rate rises to 14%. While the rate on new long-term debt rises to 10%, the rate on existing long-term debt remains unchanged. What would be the return on equity for Safari Adventure Travels and Eco Touring Co. under these conditions?

ANSWER

c. Which company is in a riskier position? Why?

ANSWER