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Hi,
Could you please help me out with this question? I am confused as to why the interest cover is reduced when the finance costs are reduced? Also if the finance cost is lower than roce why would that have a detrimental affect for shareholder profit?
Yogi Question 396
“Yogi appears to have used the other 4 million from the disposal proceeds to pay down half the 10% loan notes. This has reduced the finance costs and interest cover but as the finance cost at 10% is much lower than the 2005 roce of 21.8% it will have a detrimental effect on overall profit available to shareholders”
Thanks!
Hi,
Yo would need to calculate the interest cover to get the full picture but I’d answer the questions by saying that the reduction in interest costs is likely to lead to an improvement in interest cover. It could be that the reduction in profitability however offsets the reduced finance costs, leading to a worsening interest cover.
ROCE looks at what profit is being generated from the capital that is employed (debt and equity). If the debt holders are taking a 10% return then the company is not generating the 21.8% required overall and hence it will worsen the profit available to the shareholders. The amounts for the debt holders are fixed, hence any variability in returns is borne by the shareholders.
Thanks
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