2. Company A and Company B had the following balance sheets as of December 31, 20N5 (thousands of dollars)
Current assets
Fixed assets (net)
Total assets
Short-term liabilities
Long-term liabilities
Common stock
Retained earnings
Total liabilities and
equity
Company A
200 000
130 000
330 000
40 000
70 000
50 000
50 000
Company B
140 000
90 000
230 000
70 000
20 000
70 000
50 000
210 000
210 000
Earnings before interest and taxes for both firms are $40 million, and the effective federal plus-state tax
rate is 20%
a
What is the return on equity and return on total assets for each firm if the interest rate on short
term liabilities is 9% and the rate on long-term liabilities is 15%?
b. Assume that the short-term rate rises until 15% and the rate on long-term debt remains
unchanged. What would be the returns on equity for both companies under these conditions?
c. Which company is in a riskier position? Why?