Page 21 - CIMA SCS Workbook November 2018 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

Commentary on long term funding

Debt finance

Gearing (statement of financial position)

Novak has paid back some of its borrowings during the last year, and its overall gearing level has
reduced.

In contrast, PosterRend has increased its borrowings and its gearing has increased.

Both companies now have approximately the same amount of debt finance (C$ 32,000 million for
Novak and C$ 30,000 million for PosterRend). However, PosterRend’s gearing ratio is significantly
smaller than Novak’s, because the book value of its equity is greater. Admittedly, it would be
preferable to measure gearing using market values, but without knowing the number of shares in
each company, that isn’t possible here.

Interest cover and interest rates

In both companies, interest cover has fallen year on year. However, this isn’t a big problem,
because it is still very high in both cases.

Interest rates in both companies are low and fairly stable. This shows that both companies have
good credit ratings.

Both companies could easily afford to take on more debt finance (and more interest
commitments).

Equity finance

Both companies are listed companies – graphs of their share prices are shown on page 24 of the
pre-seen.

Unfortunately, we aren’t told how many shares each company has in issue, so it is impossible to
calculate ratios like dividend yield and price-earnings ratio that would help us to assess the
shareholders’ view of the company’s performance.

However, we can calculate dividend cover and the results are very interesting – it is only 1.1 times
for Novak and 1.5 times for PosterRend.

For Novak this means that the dividends paid out in 2017 were only slightly smaller than the
bottom line profits generated (89% of profit paid out). The directors have elected to pay out the
vast majority of the profit as a dividend, rather than retain funds for future investment. If Novak’s
profits were to fall again next year, the level of dividend pay-out might not be sustainable.

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