Question
Three companies have the capital structures shown below. Company A B C Ordinary shares 900 600 150 10% debentures 0 400 450 Total 900 1,000
Three companies have the capital structures shown below.
Company | A | B | C |
Ordinary shares | £900 | £600 | £150 |
10% debentures | £0 | £400 | £450 |
Total | £900 | £1,000 | £600 |
The return on capital employed was 26% for each firm in 2045, and in 2046 was 20%. Corporation tax in both years was assumed to be 30%, and debenture interest is an allowable expense against corporation tax.
Required:
(a) Calculate the percentage return on the shareholders’ capital for each company for 2045 and 2046. Assume that all profits are distributed. (b) Use your answer to explain the merits and dangers of high gearing.
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