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I alam studying F5 & F9, and always seem to do the gearing different from the answer, F9 tutor stated to do it Debt/Debt + Equity, new tutor said no, do Debt/Equity, is there a rule? Or does it really matter so long as you state how you have calculated it?
F5 Tutor did not like Debt/Debt + Equity, preferred Debt/Equity – quite strongly?Just did Q43 BPP R&R under both debt/equity and debt/debt+equity and there is a big difference……
Under debt/equity Gearing under book value is 94% and mv = 66.38%
Under debt/debt+equity book value is 48.5% and mv is 39.9%
therefore the difference between book value and market value is greater under debt/equity than under debt/debt+equity –
so confused ………. is there a rule when to use which?- Topics: 0
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for me i think debt/debt+equity is mostly used when we are finding the gearing for the company as a whole … mostly help in getting the Beta factor of a company and in getting the company’s cost of capital
While debt /equity is use to for the share holders to know how much debt is covered by equity …..
hope my contribution counts
The important thing is to compare like with like.
The second debt/debt+equity essentially gives you the portion of assets financed by debt.
The earlier is the equation that would normally be used in equity research and corporate finance in business as the gearing ratio.
Just make sure that what you are calculating is the same method as what you are comparing it to if sector averages are given or if you are looking at a historical sequence. Also be able to describe the relationship between gearing (financial risk) and operating leverage (business risk).
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Some times the question will guide which formula to use
There are various definitions of gearing and of equity and loan capital. A simple definition of gearing is:
Gearing = Loan Capital/Equity.
Thus, if loan capital is £100K and equity is £200K gearing will be:
£100K/£200K
= 0.5The important point is to demonstrate that you understand what gearing is – for example – a company that has low gearing is one that has a lot of equity to external debt.
You are right to be concerned as to how you should express this because different people express gearing in different ways and you need to ensure when comparing accounts that you are comparing ‘apples with apples’. You tutor should indicate which method the ACCA examiner prefers – if any.
Hope this helps
Clive Marsh, Author, Mastering Financial Management, Financial Times Prentice Hall
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