Gearing – Knowsia

FR – L2 – Q56 – Financial Instruments

Account for convertible loan notes in Tafu Ltd's financial statements for the year to 30 September 20X4.

Question

Tafu Ltd issued GH¢10 million of 4% convertible loan notes on 1 October 20X3, on which interest is paid annually in arrears on 30 September. The loan notes are convertible into equity shares of Tafu Ltd on 30 September 20X6 at the rate of 20 shares in Tafu Ltd for every GH¢100 of notes. Alternatively, the notes can be redeemed on that date for cash at par, at the option of the note holder.
If Tafu Ltd had issued straight loan notes, redeemable at par after 3 years, it would have had to pay interest at the rate of 7% in order to persuade investors to subscribe for them.

Required:
(a) Show how the convertible loan notes would be accounted for in the financial statements of Tafu Ltd for the year to 30 September 20X4.

(b) Comment on the validity of the reasons of the directors for choosing to issue convertible loan notes.

Answer

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Tags: Convertible Loan Notes, Financial instruments, Gearing, IAS 32
Level: Level 2

Topic: Financial Reporting Standards and Their Applications

FM – L2 – Q40 – Capital structure

Calculate optimal gearing level and WACC for a company given varying costs of debt, ungeared equity beta, and tax rate.

Question

A company has estimated that its cost of debt capital varies according to the level of gearing, as follows:

Gearing	Cost of debt
20	5.0
30	5.4
40	5.8
50	6.5
60	7.2

Gearing is measured as the market value of the company’s debt as a proportion of the total market value of its equity plus debt.
The rate of tax is 30%. The ungeared equity beta factor for the company is 0.90. The risk-free rate of return is 4% and the return on the market portfolio is 9%.

Required:
Identify the optimal gearing level and WACC.

Answer

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Tags: Capital structure, CAPM, Cost of Equity, Financial Risk, Gearing, Optimal capital structure, Tax shield, Weighted Average Cost of Capital
Level: Level 2

Topic: Capital structure

FM – L2 – Q37 – Capital structure

Calculate the total value of a geared company and its equity value using Modigliani and Miller's theory after issuing debt to repurchase shares.

Question

A company has 4,000,000 equity shares in issue. The shares have a current market value of GH¢10 each. The company is considering whether to issue GH¢15,000,000 of debt finance and use the cash to buy back and cancel some equity shares. The tax rate is 30%.

According to Modigliani and Miller, if the company decided to issue the debt capital and repurchase shares, what would be:

(a) the total value of the geared company, and (3 marks)

(b) the value of equity in the company? (3 marks)

Answer

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Tags: Capital structure, Company valuation, Debt Finance, Equity valuation, Gearing, Modigliani and Miller
Level: Level 2

Topic: Capital structure

FM – FM – L2 – Q35 – Capital structure

Analyze gearing impact on two companies' EPS and financial risk using provided financial data.

Question

The following information is available about Company A and Company B:

	Company A	Company B
Capital structure	GH¢	GH¢
Equity shares of GH¢1	10,000	10,000
Reserves	20,000	90,000
10% debt capital	30,000	—
	60,000	100,000
	100,000	100,000

| Annual profit | | | | Sales | 80,000 | 80,000 |

| Variable costs | 40,000 | 40,000 |

| Contribution | 40,000 | 40,000 |

| Fixed operating costs | 10,000 | 10,000 |

| Profit before interest and tax | 30,000 | 30,000 |

| Interest costs | 3,000 | — | | Profit | 27,000 | 30,000 |

| Tax (20%) | 5,400 | 6,000 |

| Profit after tax (= earnings after interest and tax) | 21,600 | 24,000 |

Required:

(a) Calculate the earnings per share for Company A and Company B.

(b) Calculate the level of profit before interest and tax at which the earnings per share for Company A will be equal to the earnings per share for Company B.

Answer

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Tags: Capital structure, Debt, Earnings per share, Equity, Financial Risk, Gearing, Profit after tax
Level: Level 2

Topic: Capital structure

FM – L2 – Q1 – Sources of finance: equity

Calculate and comment on ratios relevant to investors for SunnyCorp, including EPS, PE ratio, dividend yield, dividend cover, interest yield, and gearing.

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

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Tags: Debentures, Dividend yield, Earnings per share, Equity ratios, Financial Ratios, Gearing, Investor metrics
Level: Level 2

Topic: Dividend policy

Tag (SQ): Gearing

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FR – L2 – Q56 – Financial Instruments

Account for convertible loan notes in Tafu Ltd's financial statements for the year to 30 September 20X4.

FM – L2 – Q40 – Capital structure

Calculate optimal gearing level and WACC for a company given varying costs of debt, ungeared equity beta, and tax rate.

FM – L2 – Q37 – Capital structure

Calculate the total value of a geared company and its equity value using Modigliani and Miller's theory after issuing debt to repurchase shares.

FM – FM – L2 – Q35 – Capital structure

Analyze gearing impact on two companies' EPS and financial risk using provided financial data.

FM – L2 – Q1 – Sources of finance: equity

Calculate and comment on ratios relevant to investors for SunnyCorp, including EPS, PE ratio, dividend yield, dividend cover, interest yield, and gearing.

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FR – L2 – Q56 – Financial Instruments

Account for convertible loan notes in Tafu Ltd's financial statements for the year to 30 September 20X4.

You're reporting an error for "FR – L2 – Q56 – Financial Instruments"

FM – L2 – Q40 – Capital structure

Calculate optimal gearing level and WACC for a company given varying costs of debt, ungeared equity beta, and tax rate.

You're reporting an error for "FM – L2 – Q40 – Capital structure"

FM – L2 – Q37 – Capital structure

Calculate the total value of a geared company and its equity value using Modigliani and Miller's theory after issuing debt to repurchase shares.

You're reporting an error for "FM – L2 – Q37 – Capital structure"

FM – FM – L2 – Q35 – Capital structure

Analyze gearing impact on two companies' EPS and financial risk using provided financial data.

You're reporting an error for "FM – FM – L2 – Q35 – Capital structure"

FM – L2 – Q1 – Sources of finance: equity

Calculate and comment on ratios relevant to investors for SunnyCorp, including EPS, PE ratio, dividend yield, dividend cover, interest yield, and gearing.

You're reporting an error for "FM – L2 – Q1 – Sources of finance: equity"

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