Page 1 of 5 Mark Scheme S llabus Paper

AS and A Level Examinations·June 2002 9706 4

Que9tiOD 1 Olta:r pie

(a) (i) interest cover: 1000/ 2so·= 4 times (2.)

(ii) dividend cover: 750 ·J W / 3 = 1.8 times (2)

(iii) earnings per share: 63 000 000/400 Qoo = $1.57f( {i '1 .f-$- )
(iv) price earnings ratio: 30 / i.f = 19 {'£)

(v) dividend yield : 8(.I75) x 10 S'>3 0 = 2.9% (I)

(vi) gearing: (debentures = $250k x 100/ 12.s = $2 OOOk) llJ

2 000 000 • I 500 000/ 4 ooo ooo .900 ooo + 3 500 000 X 100 = 41.7o/o )
mativoly

ooo ooo • 1 soo ooo / 4 000 000 • 900 000 = 71.4°.k. t=;)z.

(ii) (i) Interest cover shows how many times interest payments are covered by
operating profit!J)It is an indication of the risk that future profits may be
insufficient to cover interest payments. (l )Tue risk that interest payments
might tum a small profit into a loss;(I) that future dividends might be at
risk. 0)
(ii) Dividend cover shows how many times the onlinary dividend is covered by
profit available for the dividend. O)A low cover might indicate that future
dividends are at risk if profitability declines.(l)Dividend cover may reflect
the directors' dividend policy (1"'J.. high cover usually indicates a
conservative policy.(\)

(iii) Eantlngs per share shows how much profit after tax and preference
dividends is attributable to each ordinary share.Q)All profits after tax
and preference dividends belong to the ordinary shareholders(.!) It is a
more informative measure of ordinary shareholders' fortunes than
dividend cover. (})Investors usually regard EPS as a convenient measu
re of the success of a company. (I)

(iv) Price earnings ratio relates the market price of a share to the earnings
per share.(1) It may be regarded as the nu mber of ye·earnings that
investors are prepared to pay for in the purchase price of a company's
shares. LI) Tue higher the PER, the greater the confidence of investors
in the ability of the company to maintain the EPS. (I)

(v) Dividend yield expresses the dividend as a percentage of the market

price of a share. (\ )'his is should be of more interest to investors than
dividend expressed as a percentage of the nominal value of each share,
or the
nu mber of cents per share. (I )

(vi) Gearing is calculated as futed """' capite.l/ pl"' med <»•capital where fU::ed cost
capital)il\,cludes long term loans (usually debentures) and preference
share capitaIUmd equity includes ordinary share capital plus all
reserves.. Q)
OR if the alternative answer is given to (a)(vi): l'Wod -=-.capitel/ «1.wty
Gearing is expressed as a percentage. (1)
Calculated in this way, 50 o/o is regarded as neutral gearing, > SOo/o is
 Page 2 of 5 Mark Scheme S llabus Paper
AS and A evel Examinations ·June 2002 9706 4

considered as high and < 50% as low. (1)

Alternatively, gearing is sometimes calculated as m.,.; _,capital / <quity.
Calculated in this way 100% is 'neutral', > 100% is 'high' and < lOOo/o is
1ow'. (I)
Highly geared companies may pose greater risk to ordinary shareholders
because tixed cost capital must be rewarded in priority to holders of
,.,_
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'equity'. ( !) The risk is that profits may decrease.(1) (i"'- .
,."""""--\2 "M.&..)
(b) (i) Interest cover has fallen by 27%(!) It is still satisfactory but if it
falls too far the shareholders' dividends may be at risk. (I)
Dividend cover has fi:lllen from 2.5 x to 1.BX(l)lf profits 8re not at least
maintained, the shareholders' dividends could be at risk. (I)
Price earnings ratio has declined from 22 to 19£.DThis seems to indicate

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that investors are less confident that the company will maintain its

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present profitability in future. (J )
Gearing has increased by 5%(1) It is still low but shows that the _ 0 :\
proportion of loan capital has increased.(!) k:i. 1'Pf ou.JIA.. ......... r Q.)) 8
(ii) Other evidence: ((_ 'O c...C. (1)
(i;..t. In_vestigate prior years (before 2001) to ascertain trends. (1 )
0 t-- e...... lWA9' • fil....ebeck inter-firm comparisons if possible (I)
1'\..ICIY O '"Qp\J.11..
u.r i.l. -\0 See directors' repoi\J>for recommended dividends, (J) overview
of f-.._, · company's performances (I)xisitions(!)future trading etc{
I) t:r1'" l -h-
c:.,.....,"""'j See the auditors' report for any qualifications arising from audit: (1)
opinions as to company's 'going concern' st.atus,(1)dependence
upon continuation of bank loans/overdrafts or provision of additional

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finance. [I)

QUESTION
(i) 2 Joloss pie
{a)
Balance Sheet immediately after capital reduction on 1 May 2002
(r) ll ) $'000s $'000s
'AlnWlrle flXed assets ( bs"o - I S-o) 500 ( l)tt:"" "-' ik"OL&\-
Current assets (t) l Ce rf'upt-e.J
Stock (Jt.-1 2) 22 )) ·
Dobton($612.. l b <1) 64 c
Bank J §.
92
Creditors: amounts falling due
within one year 42 50 .t!
- ' 55cflV/' Otal;I"\- 1o..-..":.._,,_ _
Ordinary shares of $0.55 . l?.9.rr "" "_.S...
( .....,
. f'+-..la..-f"Vf\ -:.C.•
--- (I) r-..at. o"' I
'4!1 '°J -
(ii) The net asset value of Joloss pie's shares before capital reduction was
1000 - 4f>O J 1000 -= $0.55. (1)
The capital reduction merely recognises the reality of the situation.( j \
Reduction in the nominal value of each share does not entail any tuMer loss
to the shareholders. (I)
The shareholders will stand to receive dividends equal to $0.25 per share as
soon as the company realises the profits forecast by the directors. (J)
If the shareholders had rejected the scheme, they would have had to wait for
over three years before the expected profits would have eliminated the debit
balance on the P & L account to enable dividends to be paid. fl)

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(Other points may be acceptable) ( !-'\ •
""'-'-· 5;)