Page 27 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Objectives

Required:

(a) Calculate the operating profit margin and the asset turnover.

(b) Calculate Return on Capital Employed and Return on Equity, and
compare the financial performance of the company under the two
funding methods.

(c) What is the impact on the company's performance of financing by
debt rather than equity?

Solution

(a) Asset turnover = 100m/20m = 5.0 times

Operating profit margin = 5m/100m × 100 = 5%

(b) Return on capital employed

(with equity finance) = 5m/20m × 100 = 25%

(with debt finance) = 5m/20m × 100 = 25%

Return on equity

(with equity finance) = 3.5m/20m × 100 = 17.5%

(with debt finance) = 2.8m/10m × 100 = 28%

The financial performance of the two funding options is exactly the same
for ROCE. This should not be a surprise given that ROCE is an indication
of performance before financing, or underlying performance.

(c) When considering the ROE we see that the geared option achieves a
higher return than the equity option. This is because the debt (10%) is
costing less than the return on capital (25%). The excess return on that
part funded by debt passes to the shareholders enhancing their return.
The only differences between ROCE and ROE will be due to taxation and
gearing.

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