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- December 17, 2016 at 9:57 am #363892
F9 December 2015 paper, Section B, Question 1 – a
They ask: (a) Calculate the debt/equity ratio of Gemlo Co based on market values and comment on your findings.
The answer of this qn says: Market value of equity = 15,000,000 x 3·75 = $56,250,000
Market value of each irredeemable loan note = 6/0·07 = $85·71
Market value of irredeemable loan notes = 10,000,000 x 85·71/100 = $8,571,000
Market value of each 7% loan note = (7 x 5·582) + (105 x 0·665) = $39·074 + 69·825 = $108·90
Market value of 7% loan notes = 12,000,000 x 108·90/100 = $13,068,000
Total market value of debt = 8,571,000 + 13,068,000 = $21,639,000
Debt/equity ratio based on market values = 100 x 21,639,000/56,250,000 = 38·5%
This is slightly less than the average debt/equity ratio of companies similar to Gemlo Co and so the company appears to have
a similar financial risk to these companies.MY QUESTION HERE: When calculating market value of each 7% loan note, I can`t understand from where come 105, pls explain for me. Thank you!
December 18, 2016 at 8:19 am #363929The loan notes have a nominal value of $100, and are redeemed at a 5% premium after 7 years. So the amount paid on redemption is $100 + (5% x $100) = $105.
(and the market value is the present value of the interest and the redemption amounts, discounted at 6%).My free lectures will help you with this – the lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
December 18, 2016 at 9:23 am #363937Thank you very much!
December 18, 2016 at 7:59 pm #363973You are welcome 🙂
May 5, 2021 at 4:31 pm #619780AnonymousInactive- Topics: 0
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Hi Sir,
Why we did not include reserves in equity while calculating debt/equity ratio, aren’t Reserves part of Equity ?
May 6, 2021 at 7:04 am #619810Reserves are part of equity and if gearing is every measures on book values (the values in the SOFP) then equity is the share capital plus reserves.
However when using the market values of shares (as we usually do because it is more realistic) then we do not add on the reserves. The reason is that the most obvious reason for the market value being higher is because the company has made profits – the market value effectively includes the reserves.
I do explain this in my free lectures 🙂
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