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Hi Mr.John,
I hope you are alright. My question is that in BPP kit question No 41, Fly 4000, we have been given gearing ratios of Rover Airways as in:
“The gearing ratio for Rover Airways, expressed as total debt to total capital ( debt plus equity) is 60 per cent and as total debt to equity is 150 per cent.”
To calculate CAPM in this question, these ratios have been used to assume value of equity and debt. Debt value has been 1.5 while equity value is 1.
Can you please help me understand that in a situation like this, is equity always assumed to be 100% or 1? Or given the statement above from the question, we have to do some logical workings to show how did we end up calculating equity’s vaue as 1 or 100%. If there are workings can you tell me please what they are?
Although did end up calculating equity value is 1 and I did revise related F9 material but I am still confused how to approach such a situation in exam. I’d really appreciate your help.
Thank you.
It doesn’t matter what figures you use because in the formula it is just the ratio that matters.
I always use 100 for the one we are taking a percent of.
So….for the first bit of the sentence, if total capital is 100 then debt is 60 (60% x 100), and therefore equity is 40 (100 – 60).
In the second bit of the sentence, if equity is 100, then debt is 150 (150% x 100).
In the formula it makes no difference whether you use 60 and 40, or 150 and 100. The ratio between the two is the same. (If you don’t believe me then try both sets of numbers in the formula and you will end up with the same answer 🙂 )
🙂 Thank you Mr. John. That was really helpful. I was just confused how do I assume what total capital or equity can be in an exam question if only debt ratio is given. I re read the question and it said 60 per cent and 150 per cent so like you said, it is 100 for the one we are taking a percent of. Pure common sense. Its dumb things like this that made me fail my exam :(. Yet thank you so much for helping me understand :).
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