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Dear Sir,
I posted a question on how to calculate the cost of capital a day or so ago but it seems to have disappeared. I have watched your lecture, read BPP books and found the standard calculation for cost of capital to be current assets+non current assets+investments-current liabilities.
However in a BPP question the correct answer for the best definition of ROCE is ‘Profit before interest and tax/ (ordinary shareholders funds + non current liabilities) x 100. I am unclear as to why the capital employed in this calculation includes non current liabilities.
Also, in another question the capital employed for the ROCE calculation has been calculated as 75,000 without explaining the components that make up this number using the following data:
Non current assets 60,000
Current assets (all receivables) 35,000
Ordinary share capital 15,000
Reserves 30,000
Long term liabilities (5% bank loan) 30,000
Current liabilities 20,000Using the standard forumula from the book I thought this would be 60,000+35,000+15,000-20,000 = 90,000.
Please advise – thank you.
Don’t use the phrase ‘cost of capital’ because this means something else that is not examinable until Paper F9.
The return on capital employed is the profit before interest and tax as a % of the long-term capital used in the business.
The long-term capital is shareholders funds plus long-term borrowings (i.e. non current liabilities). (This is the total long-term money that the business is using the earn the profits for them)With regard to the capital employed in your question, it is calculated as follows:
Share capital 15,000
Reserves 30,000
Long-term liabilities 30,000Total 75,000
(Which is also always equal to non-current assets + current assets – current liabilities.)
Thank you for the response. I am still unsure why current assets are included in this calculation of long term capital, and if they are why the 35,000 (current assets) is not included in the capital employed above. Thanks
No no!
The capital employed is the long term finance used by the company, which is shareholders funds plus the long-term debt finance (i.e. non-current liabilities).
They can get that money in lots of ways – they could get it all from shareholders, or they could get part from shareholders and part from long-term borrowing.(Because Statements of financial position must always balance, this will always be equal to the non-current assets plus the net current assets (current assets less current liabilities). It is these that are being used to generate the profit for the business.)
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