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In bpp, it says that, surplus assets should be sold so that the cash is released & could be invested in more productive ways or alternatively could be used to repay liabilities, either way, it will enhance ROCE.
I dont understand how ROCE could be increased by repaying liabilities, I mean if we pay long term debt by that cash, it will reduce capital emloyed thus increasing ROCE, but we cannot repay long term debt before maturity, so we’ll only be able to pay short term liabilities, using the cash received by disposal of asset. How will a reduction in current liability lead to an increase in ROCE?
Fixed assets 5m
current assets 1m
current liabilities 0.75m
Profit 2m
Roce 38%
Sold a surplus asset of 0.1m & repaying 0.1m to suppliers, thus reducing current liabilities to 0.65m, Roce would still be 38%?I will answer your question, although in future if you want me to answer you must ask in the Ask the Tutor Forum (this forum is for students to help each other 🙂 )
Obviously selling surplus assets and investing in more productive ways will increase profitability and therefore increase the ROCE.
With regard to using the cash to pay off liabilities, they are not talking about paying off current liabilities, but reducing long-term debt. You are correct in saying that it is usually not possible to repay long-term debt before maturity (although it does depends on the terms of the debt – sometimes there are provisions to rely early, albeit probably at a premium). However, financial management is all about long-term planning. If long-term debt is coming up to maturity, then it would clearly make sense to use cash from the sale of surplus asset to repay it, rather than take on more debt in order to repay the existing debt.
I do suggest that you watch our free lectures. Our free lectures are a complete course for Paper F9 and cover everything needed to be able to pass the exam well.
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