Page 19 - SCS May 2018 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

EXERCISE 3

Long term funding
Couchweb HomeVideo
2018 2017 2018 2017
Capital employed:
Share capital & premium 1,830.0 1,580.0 1,321.2 1,321.2
Retained earnings 1,813.3 1,426.7 1,450.6 1,141.4
Total equity 3,643.3 3,006.7 2,771.8 2,462.6

Long term
debt 5,321.0 4,470.0 5,130.0 2,629.4

Total long term capital 8,964.3 7,476.7 7,901.8 5,092.0

Gearing: (debt/debt+equity) 59.36% 59.79% 64.92% 51.64%

Operating profit 1,084.2 893.2 700.9 834.7
Finance costs 184.0 170.0 177.4 100.0

Interest cover: 5.9 5.3 4.0 8.3

Interest rate on debt: 3.5% 3.8% 3.5% 3.8%

Commentary:

Couchweb has raised a further M$851m of debt finance during the year but has also raised
M$250m of additional equity finance. This, together with the increase in total equity funding
provided by the retained earnings for the year, has resulted in the gearing level remaining
virtually unchanged.

The fact that the company raised both equity and debt in the same year (a somewhat unusual
thing to do) may indicate that it had reached the limit of its debt capacity or may mean that it
considers its current level of gearing to be optimal. Since the interest cover (which has increased
slightly from 5.3 to 5.9) is well within normally acceptable limits, the latter is more likely to be the
case.

As has already been noted (exercise 1), HomeVideo has raised a further M$2.5b of debt during
the year taking its gearing level from 51.64% to 64.92%. This has also reduced the interest cover
from 8.3 to 4.0. (The fact that HomeVideo could do this would again suggest that Couchweb has
not reached the limit of its debt capacity.) Despite the lack of tangible assets to act as security it
seems that these apparently high levels of gearing are quite acceptable in this industry.

(It should be noted that these figures are using book values for equity. Had we been able to use
market values – which is what the equity investors are likely to do – we could have discovered
much lower gearing levels, but this would not change the interest cover which is what the debt
investors are likely to focus on.)

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