Three companies have the capital structures shown below. Company A B C Ordinary shares 750 550 150
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Question:
Three companies have the capital structures shown below.
Company | A | B | C |
Ordinary shares | £750 | £550 | £150 |
12% debentures | £0 | £350 | £500 |
Total | £750 | £900 | £650 |
The return on capital employed was 33% for each firm in 2099, and in 2100 was 27%. 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 2099 and 2100. Assume that all profits are distributed. (b) Use your answer to explain the merits and dangers of high gearing.
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