- 8 Marks
FM – L2 – Q1 – Sources of finance: equity
Question
The following figures have been extracted from the annual accounts of SunnyCorp:
| Item | Amount |
|---|---|
| Issued share capital | 1,000,000 ordinary shares of ZAR 1 each, fully paid |
| Issued debt capital | ZAR 250,000 10% debentures |
| Reserves | |
| Capital (share premium reserve) | ZAR 200,000 |
| Accumulated profits | |
| Profit and distributions | |
| Profit for the year | ZAR 600,000 (before interest and tax) |
| Ordinary dividend payments | ZAR 0.20 per share |
The current market price of SunnyCorp’s equity shares is ZAR 3.20 each. Its debentures are priced at ZAR 90 per cent. The company’s rate of corporation tax (income tax) is 30%.
Required:
Calculate the ratios that are likely to be of interest to an investor or potential investor in SunnyCorp.
Comment on each:
(8 marks for calculations, 8 marks for comments)
Answer
Earnings per Share (EPS)
| Description | GH¢ |
|---|---|
| Profit before interest and tax | 600,000 |
| Interest (10% × GH¢250,000) | 25,000 |
| Profit before tax | 575,000 |
| Tax (30%) | 172,500 |
| Profit available to equity (earnings) | 402,500 |
| Number of equity shares | 1,000,000 |
| EPS (GH¢) | 0.4025 |
Comment: This is a measure of the profit per equity share.
Price-Earnings (P/E) Ratio
P/E ratio = GH¢3.20 / GH¢0.4025 = 7.95 times
Comment: The P/E ratio indicates how much investors are willing to pay per unit of earnings, reflecting confidence in future growth. A ratio of 7.95 suggests moderate growth expectations.
Dividend Yield
Dividend yield = (GH¢0.20 / GH¢3.20) × 100 = 6.25%
Comment: This shows the return from dividends relative to the share price. A 6.25% yield is attractive for income-focused investors.
Dividend Cover
Dividend cover = GH¢0.4025 / GH¢0.20 = 2.01 times
Comment: This shows that approximately 50% of the earnings for the year have been paid out as dividends and the remainder reinvested in the company. A cover of 2.01 indicates a balanced approach between dividend payments and retained earnings.
Interest Yield on Debentures
Interest yield on debentures = (GH¢10 / GH¢90) × 100 = 11.1%
Comment: This measures the return on debentures relative to their market price. An 11.1% yield is relatively high, indicating attractive returns for debenture holders but also reflecting some risk.
Gearing
Based on market values = [GH¢250,000 × (90/100)] / (1,000,000 × GH¢3.20) × 100 = 7.03%
Based on book values = GH¢225,000 / GH¢2,000,000 × 100 = 12.5%
Comment: Gearing measures the proportion of debt to equity. A market value gearing of 7.03% is low, indicating low financial risk, while the book value gearing of 12.5% is slightly higher but still conservative.
- Tags: Debentures, Dividend yield, Earnings per share, Equity ratios, Financial Ratios, Gearing, Investor metrics
- Level: Level 2
- Topic: Dividend policy
- Uploader: Samuel Duah