Earnings before interest and taxes for both firms are 30

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Vanderheiden Press Inc. and the Herrenhouse Publishing Company had the following balance sheets as of December 31, 2002 (thousands of dollars):


Vanderheiden Press

Herrenhouse Publishing

Current assets

$100,000

$ 80,000

Fixed assets (net)

100,000

120,000

Total assets

$200,000

$200,000

Current liabilities

$ 20,000

$ 80,000

Long-term debt

80,000

20,000

Common stock

50,000

50,000

Retained earnings

50,000

50,000

Total liabilities and equity

$200,000

$200,000

Earnings before interest and taxes for both firms are $30 million, and the effective federal-plusstate tax rate is 40 percent.

a. What is the return on equity for each firm if the interest rate on current liabilities is 10 percent and the rate on long-term debt is 13 percent?

b. Assume that the short-term rate rises to 20 percent. While the rate on new long-term debt rises to 16 percent, the rate on existing long-term debt remains unchanged. What would be the return on equity for Vanderheiden Press and Herrenhouse Publishing under these conditions?

c. Which company is in a riskier position? Why?

Reference no: EM13572896

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