Page 356 - FM Integrated WorkBook STUDENT 2018-19

Chapter 18

Question 3

Financial gearing

Two firms have the same cost structures but different financial gearing levels:

Double Co Dare Co
$m $m
Sales 10.0 10.0
Variable costs (4.0) (4.0)
Fixed costs (2.0) (2.0)
–––– ––––
EBIT 4.0 4.0
Interest (2.0) 0.0
–––– ––––
PBT 2.0 4.0
–––– ––––

Calculate the impact on each of a 10% increase and of a 10% decrease in sales

10% increase in sales 10% decrease in sales
Double Co Dare Co Double Co Dare Co
$m $m $m $m
Sales 11.0 11.0 9.0 9.0
Variable costs (4.4) (4.4) (3.6) (3.6)
Fixed costs (2.0) (2.0) (2.0) (2.0)
–––– –––– –––– ––––
EBIT 4.6 4.6 3.4 3.4
Interest (2.0) 0.0 (2.0) 0.0
–––– –––– –––– ––––
PBT 2.6 4.6 1.4 3.4
–––– –––– –––– ––––
PBT % change +30% +15% –30% –15%

The higher the financial gearing, the higher the volatility (risk) of profits

Illustrations and further practice

Now try TYU questions 2 and 3 from Chapter 18.

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