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FM Chapter 13 Questions – Capital structure and financial ratios

 

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  1. Greetings dear sir,

    For Q1)
    a) I did not understand why for return on capital – its profit before interest and tax, whereas for return on equity – its profit after interest and tax.

    b) difference between shareholder fund and prior charge capital.

    • If using the market value then we do not include retained earnings. The most obvious reason for the market value being higher than the nominal value is because the business has been making profits. The market value effectively already includes the retained earnings.

      Have you watched my free lectures because I do explain this?

    • The question asks for the gearing to be calculated using book values i.e. the value on the SOFP.

      The total book value (nominal value) appearing on the SOFP is $200M.

      (There are 400 shares and each share has a nominal value of $0.50)

  4. Dear sir,

    I am facing a bit challenge to learn the ratios. Since got exemption in F2& F3 and I am yet to prepare for paper F5. Hence, I couldn’t go through these papers notes.

    Could you please help me with a way to learn the ratios easily.

    Many thanks

  5. Dear Johann,

    In Q4 and Q5, Market Value(MV) of equity is O.Sh only and Book Value(BV) of equity is O.Sh plus Retain Earning.
    what is the difference between MV and BV regarding with equity?

    • The market value is the value of the shares on the stock exchange, and the most obvious reason for the share price being higher than the nominal value is because of the retained earnings. You don’t add retained earnings on to the market value because they are effectively already included.
      I do suggest that you watch my free lectures on this – the lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.

    • You must in future say which question you are referring to.

      The market value of a share already includes retained earnings – it is the main reason for the market value being higher than the nominal value.

    • In future please say which question you are referring to.

      High operational gearing does not reduce the profits at all – it is simply a measure of how much of the operating costs are fixed and how much are variable.
      If sales increase, then the higher the operational gearing the greater the increase in the profits.

      I do suggest that you watch the free lectures on both financial and operational gearing (there is no point in attempting these tests until after you have watched the lectures 🙂 )

      • Hi professor

        Re question 3

        I cannot understand your statement that higher operational gearing is better for higher sales.

        op gearing = cont / pbit so if contribution is 100 and pbit 50 we get an op gearing of 2

        if cont is 100 and pbit 30 we get an op gearing of 3.33 which is higher due to lower pbit. Lower pbit is the result of higher fixed costs assuming vc per unit remain unchanged.

        if we take 10000 units at sp of 5 per unit and vc of 2 per unit we get 30000 contr assuming fc are at 10000 we get an op gearing of 30000/20000 = 1.5

        If sales now increase to 15000 units we get a contr of 15000*3 = 45000 and if fixed costs are 10000 then op gearing will be 45000/35000 = 1.28 which is lower

        Also the lower the operational gearing the lower the business risk due to lower fixed costs and so why should a company prefer to have a high operational gearing and so a high level of business risk?

        What am I missing?

        Thanks in advance for your kind assistance in our queries 🙂

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