Vanderheiden Press Inc. and the Herrenhouse Publishing Company had the following balance sheets as of December 31, 2007 (thousands of dollars):

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

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

b. Assume that the short-term rate rises to 20%. While the rate on new long-term debt rises to 16%, 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?

Transcribed Image Text:

Vanderheiden Press Herrenhouse Publishing $ 80,000 120,000 $200,000 $ 80,000 Current assets $100,000 Fixed assets (net) 100,000 $200,000 $ 20,000 Total assets Current liabilities 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 Vanderheiden Press Herrenhouse Publishing $ 80,000 120,000 $200,000 $ 80,000 Current assets $100,000 Fixed assets (net) 100,000 $200,000 $ 20,000 Total assets Current liabilities 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

Answer rating: 100% (QA)

Step 1 a The income statement for both the firm... View the full answer