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?