ACCA Applied Knowledge · Financial Accounting · Ratios
Company X has equity of $500,000 and debt of $250,000, with PBIT of $100,000 and finance costs of $25,000. It issues $250,000 of new 10% loan notes at the start of the next year and uses the cash to buy an asset, earning no extra profit immediately. Ignoring any other changes, what are the new gearing (debt/equity) and interest cover?
Gearing rises to 100.0% and interest cover falls to 2.0 times. Debt doubles to $500,000 against equity of $500,000, and finance costs rise to $50,000. Dividing unchanged PBIT of $100,000 by $50,000 gives 2.0 times.
- A100.0% and 2.0 timesCorrect
- B50.0% and 4.0 times
- C100.0% and 4.0 times
- D75.0% and 2.0 times
Explanation
New debt = 250,000 + 250,000 = 500,000; gearing = 500/500 = 100%. Finance costs = 25,000 + 25,000 = 50,000; cover = 100,000 / 50,000 = 2.0 times. Keeping cover at 4.0 times forgets the extra interest.
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