Page 19 - CIMA SCS Workbook August 2018 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

Commentary on long term funding

Debt finance

Gearing (statement of financial position)

Gearing has reduced significantly year on year. From the cash flow statement (pre-seen page 20)
we can see that FNG has been repaying B$ 5.674 million of debt each year for the last couple of
years.
Interestingly the statement of financial position shows the same amount as part of current
liabilities too, showing that another B$ 5.674 million is due to be repaid in the next year. There
seems to be a very consistent repayment schedule for this long term debt.

Given that the outstanding balance is now under B$ 10 million, it may be that the intention is to
reduce debt to zero over the next couple of years.

Interest cover

The alarming drop in profitability (discussed in Exercise 1) has contributed to a significant fall in
interest cover.

FNG’s repayment of debt meant that its finance costs fell by 23% year on year (from B$ 2,023,700
to B$ 1,560,500), but because of the fall in profitability interest cover still fell from 4.0 times to
1.9 times.

The directors might hope that paying off more and more of the debt each year will help to stop
this falling too much further. However, unless the decline in profitability can be slowed, there
could be a real problem affording the interest payments in the very near future.

Conclusion on debt finance

FNG’s interest rates seem to be quite high compared to the market interest rates around the
world at the moment, and this might well be linked to the fact that FNG’s performance has
declined markedly over the last few years. It appears that the company’s credit rating has
worsened over the last year – interest rates were higher in 2018 than in 2017.

With this in mind, it is understandable that the directors seem to be happy to reduce the amount
of outstanding debt.

However, the company’s profitability is unlikely to improve without significant investment in new
projects. In order to fund investment, it might be necessary to increase the amount of debt
finance, bearing in mind that FNG’s current gearing is actually quite low and that debt finance is a
very cheap, tax-efficient source of finance.

The cash flow statement (pre-seen page 20) shows that FNG is generating cash despite its drop in
profitability. This cash, coupled with debt finance raised from an understanding lender, might
form the basis for a new investment that could improve the prospects of FNG significantly.

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