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Hello,
I am confused that the answer provided in the exam kit. Under the “profitability” heading, the content i cropped as follow:
“Another relevant point may be that Merlot’s owned plant is nearing
the end of its useful life (carrying amount is only 22% of its cost) and they seem to be
replacing owned plant with leased plant. Again this does not necessarily give Merlot
an advantage, but the finance cost of the leased assets at only 7.5% is much lower
than the overall ROCE (of either entity) and therefore this does help to improve
Merlot’s ROCE.”My question is how the 7.5% of lease liability lower than overall ROCE affect/ improve Merlot’s ROCE?
Thank you
Hi,
If they are currently generating a ROCE of 10%, say, from its capital employed then by being able to acquire new capital (assets) at a rate cheaper than this (7.5%) then this is going to be beneficial as it is cheaper. The benefit comes from the cheaper finance cost thus increasing profitability.
Hope that helps.
Thanks
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