- This topic has 1 reply, 2 voices, and was last updated 14 years ago by
.
- Posts
Hi Tutor, would you pls clarify for me whether preference dividend should be included in the calculation of interest cover and interest gearing or not? In the examples on Kaplan book, they are included. However in some year’s exam question, they are excluded from the calculation. so i’m confused now. Thank you very much!
- Topics: 1
- Replies: 87
- ☆☆
The final answer here depends upon the ASSUMPTION you make at the outset – i.e. are you going to treat preference dividends as debt or equity…. most people treat as debt.
So here comes the confusion, most exam questions in F9 don’t include preference dividends so students and exam questions just ignore them in their definitions of operational gearing and Interest cover.
But say preference div, were “an issue” in a particular exam question scenario then wouldn’t it make more sense to treat the Pref. Div’s as debt and include them in your operational gearing and interest cover calulations.
Strictly speaking, you would treat the pref divs as debt in order to better understand the company’s Systematic Business Risk (in this case the variability (risk) of the operating cash flows).
Remember we use the Capital Gearing Ratio (D;E) to better understand the company’s Systematic Financial Risk (i.e the way in which the company is financed (D:E)).
Hope this helps. Peter Newman
- You must be logged in to reply to this topic.