Page 29 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Objectives

Example 5

Blunderbuss Co is a listed company with 1 million $1 shares in issue and long
term bank borrowings of $5 million. The bank interest rate in the most recent
year was 8%, but this is expected to change to 10% for the whole of next year.

The company made an operating profit of $1.84 million last year.

What will be the change in the interest cover of Blunderbuss Co next
year, on the assumption that operating profits will stay constant?

A 25% increase

B 20% decrease

C 25% decrease

D 20% increase

Solution

The answer is (B).

Interest cover is (operating profit/interest payable)

Last year = $1.84m/($5m × 8%) = 4.60

Next year = $1.84m/($5m × 10%) = 3.68

i.e. a decrease of 20%

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