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I have a question regarding example 2 of Chapter 13 ‘Capital Structure and Finance Costs’.
In part a) the debt is divided by the total of share capital + reserves + debentures.
However in part b) the debt is only divided by the total of share capital + debentures.
What happened with reserves?
Are they supposed to be in part b) as well, or should they be removed from part a)?Your help will be much appreciated.
In part (a) the gearing is calculated using balance sheet values, and on the balance sheet the total owing to shareholders is the share capital plus the reserves.
However in part (b) the gearing is calculated using market values. One of the main reasons that the market value of the shares will be more than the nominal value (the share capital) is because of the retained earnings (the reserves) and so the market value already takes account of the reserves and so you do not add them again.
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