ACCA FM · Guided practice (Show me how)
Chapter 13: Capital structure and financial ratios
Financial and operating gearing - the effect on returns
Part 1 - financial gearing. Two companies, U and G, both generate operating profits (before interest) of $100. U is ungeared (no debt); G is geared and pays debt interest of $30 a year. Tax is 30%, and both companies distribute all available earnings as dividends.
| U | G | |
|---|---|---|
| Profits | 100 | 100 |
| Debt interest | - | (30) |
| Profit before tax | 100 | 70 |
| Tax at 30% | (30) | (21) |
| Available for shareholders | 70 | 49 |
Calculate the percentage change in dividends in each company if profits were to fall by (a) 20% and (b) 40%.
Part 2 - operating gearing. Companies A and B both have sales of $100,000 a year and costs of $60,000 a year. A's costs are $50,000 variable and $10,000 fixed; B's are $20,000 variable and $40,000 fixed. Calculate the percentage change in profit in each company from (a) an increase in sales volume of 10% and (b) a reduction in sales volume of 20%.
Part 1 Financial gearing
Prepare G's profit and dividend figures after the specified annual operating profit falls and calculate the dividend changes.
Part 2 Operating gearing
Calculate B's annual operating profit after each specified volume change, A's percentage changes in profit, and B's operating gearing.
Opening this exercise…