ACCA F9 lectures ACCA F9 notes
ACCA F9 Capital Structure and Financial Ratios 鈥撀燜inancial Gearing
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Hello sir,
I’m so confused about this MCQ
My answers are A & D
The actual answers are B & D
Which TWO of the following are most likely to result in a company鈥檚 financial gearing being high?
A Low taxable profits
B High tax rates
C Inexpensive share issue costs
D Intangible assets being a low proportion of total asset
The explanation for B is that high聽 tax聽 rates聽 mean聽 that聽 there聽 is聽 a聽 larger聽 tax聽 shield聽 on聽 interest聽 payments聽 on聽 debt聽 finance,聽making聽 debt聽 more聽 attractive. I can’t understand what’s actually they are saying!
For me A is much more accurate, as gearing rises interest increases and results in low taxable profits
Please Explain!
In future you must ask this kind of question in the Ask the Tutor Forum and not as a comment on a lecture.
Debt interest is allowable for tax and so make debt borrowing cheaper than equity borrowing (because dividends are not allowable for tax).
This is all explained in later lectures on the cost of finance.
I have no idea why you have come to this page anyway. Paper F9 is now called Paper FM and you should be using the lectures linked from the main Paper FM page!!
Hi again 馃檪
In the financial gearing ratio formula the preference share capital have been included in the numerator which makes them a debt by default . My question is that are the preference shares considered a debt to the company ?? Guide please …
For these purposes, preference shares are traded as though they are long-term debt owing by the company. The reason is that just as there is fixed interest payable on long-term debt borrowing, there is a fixed dividend payable on preference shares. It is the fixed payment (whether interest or dividend) that creates the extra risk.
thankyou 馃檪
You are welcome 馃檪
Hi John
In your lecture you say that the examiner will be clear whether he wants you to use book or market values.
Will the examiner say ” calculate total gearing using book values (or market values)? or will it just depend what information is he given you. For example if he gives you a SOFP and the market values, are you to assume that you use the market values because he has given them?
Hope that question makes sense.
Many thanks
You always will use market values unless he specifically tells you to use book values.
OK, THANK YOU.
You are welcome 馃檪
On page 75 the Ordinary share capital is 60 000 and reserves are 140 000.
When calculating gearing ratio why did you use 140 000 for equity?
I don’t know which notes you are using, but it is not page 75! The example is on page 71 and share capital is 10,000 and reserves are 130,000. So the total book value (when using book values for gearing) is 140,000.
on the video the lecturer has been concluded that Book Value is better than Market Value in calculating gearing which the Market Value will overestimate the Equity part on Gearing Equation but on BPP Kit on one of the questions said that why Market Value WACC is better than Book Value WACC? and the answer on part of the answer of this question is the book value made understmate of equity and therefore understmate WACC So, it has been concluded that Book Value is better >>>> What do you think of those two opposite ideas ?
I have not concluded that at all in the lecture!!!
We always calculate the WACC using market values (unless specifically told to do otherwise which is rare).
Nowhere in any of the lectures do I suggest that using book values is better than using market values.
Hi John,
Is there a lecture where you discuss financial and operating gearing in detail? The lecture before this is convertible debt..or am I missing something?
I thought there was, but it doesn’t seem to be here 馃檨
I will try and find it or otherwise re-record it.
Hello John
Is there a recording available about financial and operating gearing in detail
Sorry – not yet. Just what is in the lecture notes.
Hi John,
I’m struggling to get the concept that why Market values are preferred over book values in the calculation. Suppose, a company issues a share for $1 & even if the MV of the share is $10, its just the price at which share is being traded on stock market, the value that company got for the issue of share is $1.
Same goes with the bond, if company issued a bond at $100 & has to redeem it at $100, if the bond is being traded at 95, it does not reduce the company’s gearing?
I cannot really get the point of calculating gearing using market values.
Four things. Firstly, the total borrowed from shareholders is not simply the share capital – it is the share capital plus reserves, and the most obvious reason for the market value of the shares being higher than the nominal value is because of the reserves that have been earned.
Secondly, if new bonds were to be issued to replace the existing bonds, then they would have to be issued at the current market value.
Thirdly, if (hypothetically) all lenders (shareholders and bond holders) were to be repaid today, they would want to be repaid at current market values.
Finally, the total value of a business is never going to be the book value in the Statement of financial position – it is the total market value (and that is financed partly by equity and partly by debt).
The reserves belong to shareholders & the reason for the market value of shares being higher are the reserves (earnings) of the company, but then practically, why it is that the total market value of a company’s shares is not equal to, in fact it could be much different from, the share capital + all the reserves of the company?
Secondly, what are the reasons for the market value of a bond being different from its original value & is it that the market value is higher than par value due to future interest & why the market value could be lower than par (particularly if the bond is to be redeemed at par) ?
This is all explained in the lectures on the valuation of securities.
With regard to shares, the market value depends on the shareholders expectations of future dividends and their required rate of return.
With regard to bonds, the future receipts are fixed but again their required return will change (depending very much on whatever general interest rates are).
Again, do watch the free lectures on the valuation of securities where all this is explained.
Is there a lecture on Business valuation methods? If yes, would you please tell me which one?
And great lecture as usual.. 馃檪
Yes there is. You should really watch them in order, but there are a few chapters on the valuation of securities. (The value of a business is the value of the shares in the business)
Hi John,
Could you please include a link to the lecture that you keep referring to in the lecture above and wherein you discuss financial and operating gearing from scratch?
Arun.
Hi John. I tried one of these questions and it said gearing based on prior charge capital. I’m a bit unclear as to what that means. Could you explain it.
Prior charge capital is non-current liabilities + preference shares.
Thanks…I feel ready for tomorrow now…just kidding.
Hi Sir
From the lecture, there are two ways of looking at gearing, the market value and balance sheet value. Which of this shows the real gearing of the company
Market values, because the book values in the Statement of financial position (especially that of equity) do not generally provide a true measure of the values in the business.
Hi John,
Excellent lecture as per usual! I just have one question on Example 2 part (b): when calculating the Equity at market value, how come you don’t include Reserves? I’m a bit rusty on F3 馃檪
Ah I just played it back and realised it’s already included! My mistake
hello,john thank you very much for your lecture. but i m little bit confused about calculating gearing in a market value…why u did not add reserve in equity …please let me clear it.. thank you
One of the main reasons why the market value of equity is more than the original capital is because the business has been making profits and is therefore ‘bigger’.
So the market value effectively already includes the reserves.
Example 2 share capital 10000
So total shares 10000/10c =1000
1000*2.20
is this correct?
please explain me
No – it is not correct.
If share capital is $10,000 and they are $0.10 shares, then there are 10000/0.10 = 100,000 shares.
If the market value is $2.20 per share, then the total market value is 100,000 x $2.20 = $220,000
Pls let me knw hw to download this video
Lectures cannot be downloaded – they can only be watched online.
It is the only way that we can keep this website free of charge.
Master John, as far as I’m concerned, the figure of equity thas is used for the calculation of the financial leverage includes retained earnings as well. In example 2 of course, the BS couldn’t balance if there were retained earnings as well, so I guess Lavetal doesn’t have any.
However, if there were retained earnings as well, should we include these in the “equity” figure?
Hi Sir John 馃檪
Can u pls tell whether we take reserves like retained earnings or revaluation reserve as equity in the calculations?
Thanks
There are two ways of looking at gearing depending on what information is available.
The best way would be to use the market values of debt and of equity – if you have these then reserves are not relevant (because the market value is already taking these into account).
If you do not have market values then it means we have to use balance sheet values. In this case you take the total shareholders funds (share capital plus all reserves).
Perfect explanation Mr John, I wanted to ask about this point, I never knew that the MV takes into account the reserves, nice thing to learn.
the videos are very slow
They are working perfectly fine. I just wish the people here would stop complaining for one second about the free service they are getting.
ABSOLUTELY…..
Same question i had , but if you listen to this with full focus you will realize that john has indeed made operational gearing concept clear but has stated that he will not be doing numbers on it as perhaps there is no fixed way of doing so.
Operational gearing , btw, is a measure of variable costs to fixed costs.Hope this helps a little.
Where is the discussion bit for financial gearing and operating gearing.I recon it’s supposed to be at the beginning of this lecture, which might have been cut off. If that is not available, pls make that available with the old lectures to cover it a bit.
I have the same question… where is the discussion on financial and operational gearing..? thank you
There is a little bit from about 15 minutes onwards. I will record a bit more when I have the time, but if you look at the example in the course notes then it should make sense without a lecture.
Most probably, its your internet connection. It works fine because these lectures are around 30MB only
can any tell me wat happens to video
lecture all videos gettin to much time to download ..! ..its took me wait so long almost 1 hour to watch this video ..! :(:( olders videos are fine with me ..! any solutions ??