Question
IBM Corporation has ordinary shares amounting to $8,000,000 and 8% debentures of $3,200,000. Cisco Systems has ordinary shares worth $7,500,000 and 9% debentures of $2,800,000.
IBM Corporation has ordinary shares amounting to $8,000,000 and 8% debentures of $3,200,000. Cisco Systems has ordinary shares worth $7,500,000 and 9% debentures of $2,800,000. Intel Corporation's capital structure includes $7,200,000 in ordinary shares and $2,500,000 in 7% debentures.
In 1992, the return on capital employed for each firm was 19%, and in 1993 it was 8%. The corporation tax rate in both years was 46%, and debenture interest is deductible for tax purposes.
(a) Determine the percentage return on the shareholders' capital for each company for 1992 and 1993. Assume all profits are distributed. (b) Analyze the advantages and risks associated with high financial leverage for these companies.
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