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Hey Chris- another analysis question! BPP CIMA F2 question bank.
thanks in advance.
19.7 SL’s return on capital employed (measured as profit before interest and tax for the year as compared to capital employed at the end of the year) has deteriorated as compared to the previous year.
Which of the following choices are possible reasons for this decline?
A -In accordance with IAS 16 the company revalued its properties which resulted in a significant increase in the carrying value as compared to three years ago.
A- Will cause a decline
B Towards the end of the current year SL made major investments in plant and machinery financed by borrowing.
B- Will cause a decline
C SL converted $1million 10% loan notes into $1million share capital.
Why will C not cause a decline? if SL converts 1million loan notes to share capital.. wont our equity increase? and isn’t the calculation for ROCE= PBIT/CAPITAL EMPLOYED (Equity +interest bearing borrowing) our equity will increase because we have more SC and. the solution says otherwise? it says this will have no effect on equity or PBIT.
D SL issued $1million 10% loan notes to redeem $1 million redeemable preference shares at par.
Why will D also not cause a decline or increase. the solution says it will have no effect on equity or PBIT.
thanks ABI
😉Hi,
You certainly know your stuff from what you’re saying above but as we find with a few of the questions it’s the little bits here and there that catch us out.
You’re correct in C in that the share capital (equity) will increase if we convert the loan notes to shares but don’t forget that as the equity increases the liability (debt) will decrease by the same amounts. The capital employed therefore stays the same and so there is no decline in ROCE, it would most likely stay the same, dependent on PBIT.
It is similar in D. The debt increases on the issue of loan notes but the debt will also decrease as we’re redeeming redeemable prefs (debt) by the same amount. The increase and decrease therefore cancel out.
Don’t be too put off by any of the ratios questions you’ve attempted and not got correct as they are some of the more difficult ratio calculations in the book.
Thanks
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