Question
Three companies have the capital structures shown below. Company A B C Ordinary shares 800 550 200 8% debentures 0 300 450 Total 800 850
Three companies have the capital structures shown below.
Company | A | B | C |
Ordinary shares | £800 | £550 | £200 |
8% debentures | £0 | £300 | £450 |
Total | £800 | £850 | £650 |
The return on capital employed was 24% for each firm in 2063, and in 2064 was 16%. Corporation tax in both years was assumed to be 20%, and debenture interest is an allowable expense against corporation tax.
Required:
(a) Calculate the percentage return on the shareholders’ capital for each company for 2063 and 2064. Assume that all profits are distributed. (b) Use your answer to explain the merits and dangers of high gearing.
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