Question
Three companies have the capital structures shown below. Company A B C Ordinary shares 850 550 100 12% debentures 0 450 500 Total 850 1,000
Three companies have the capital structures shown below.
Company | A | B | C |
Ordinary shares | £850 | £550 | £100 |
12% debentures | £0 | £450 | £500 |
Total | £850 | £1,000 | £600 |
The return on capital employed was 29% for each firm in 2043, and in 2044 was 23%. Corporation tax in both years was assumed to be 35%, and debenture interest is an allowable expense against corporation tax.
Required:
(a) Calculate the percentage return on the shareholders’ capital for each company for 2043 and 2044. Assume that all profits are distributed. (b) Use your answer to explain the merits and dangers of high gearing.
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