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Hello,
In this question proposal 3 the company sells assets for $27 million (with a book value of $25 million) and uses the money to pay down debt. The after tax return on investment is 15%. To calculate the lost profits due to the sale ACCA do the sum $25 million x 15%. Shouldn’t this be $27 million x 15%? Is the assumption that the 15% has been calculated on historic (slightly wrong) asset values and therefore the slightly wrong asset value should be used to calculate likely future profitability?
Also, in the ACCA answers, the profit from the sale of the asset is $2million before tax and $1.6 million after tax (I agree). But in the main table in the answers the “Profit on sale of non-current assets is $2million” and no adjustment for tax is made before the bottom line “Adjusted profit after tax” – did they forget to subtract the $0.4 million tax?
Thanks,
Stu
As is so often the case in P4, a lot depends on assumptions and provided you make your workings clear (so that the marker can see what assumptions you have made) then you will get the marks even though you will often get a different answer.
With regard to the return on investment, there is a logic to what you have and it would be accepted. However ROI is more usually calculated on balance sheet figures and therefore I think what the examiner has done is actually better.
With regard to the profit on sale, I certainly agree with you (and the examiner has said in his note that you could have brought in the after-tax profit which would then change all the figures.
You would get full marks either way.
Dear Sir
I have another query regarding this particular Question.
Under Proposal 1: I did not understand the split between Share Capital and Retained Earnings where it was calculated as $20m*40c/320c where $2.5m goes to share capital and 17.5m to Retained Earnings.I did not understand how the R.E 320c came from. and the basis for the split
Thanks
Salim
The share price is $3.20 and so when they buy back the shares they pay $3.20 per share.
So…….they buy back 20M/3.20 shares.
However on the balance sheet, the share capital only falls by the nominal value of the shares redeemed, which is 0.40.
That gives a reduction in share capital of 20M/3.20 x 0.40.
Hope that makes sense 🙂
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Dear John,
the reduction in retarined earnings of 17.5m, would the double entry for this be from a reserve account in the balance sheet?
also the interest calculation 20m * 6%…what’s the 1-0.2 for? sorry its a stupid question.
Please could you,let me know how this works.
many thanks,
devi steven
Yes – from a reserve account.
The 1-0.2 is to account for the tax saving on interest of 20% – the net cost to the company of extra interest is only 80% (or 0.8).
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Dear John,
many thanks,
Devi
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i am sorry if this sound stupid, but where you get $320000 in proposal 1? tq
It is not me, it is the examiner 🙂
I assume that you mean the extra interest of 320,000?
If so, then the answer does explain – it is an extra 0.25% on 160M x 0.8 (because of tax relief on the interest of 20%)
Hey John
For the same question, why have they reduced the retained earnings by 17.5?
Thanks
I assume that you are referring to Proposal 1 (although you have not said so in your question!!).
They are repaying 20M to shareholders and so the total owing on the SOFP to shareholders (i.e. share capital plus reserves) must reduce by 20M.
The nominal value of the shares repaid is 2.5M and so share capital reduces by 2.5M and so the remaining 17.%M must reduce the reserves (i.e. here, retained earnings).
This part is really financial accounts rather than financial management.
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