Comment on the degree of risk and gearing of the company. Quote two financial indicators with figures and trends, and give a comment.
About this question
Question 3.3 of Accounting Grade 12 Paper 1, NSC Preparatory Examination (Eastern Cape DoE, September 2025). It tests the Term 1 ATP topic Analysis and Interpretation.
- TermTerm 1
- ATP topicAnalysis and Interpretation
- PaperPaper 1
- Marks6 marks: 2 points, 3 marks each
The risk and gearing of the company are shown by two indicators:
- Debt-equity ratio: it improved from \(0{,}5 : 1\) to \(0{,}27 : 1\), so the company relies less on loans and the financial risk is low.
- Return on capital employed: it rose from \(16\%\) to \(20{,}2\%\) (up 4,2 percentage points) and is above the \(13\%\) interest on loans, so the company is positively geared and borrowing is paying off.
More Questions On Analysis and Interpretation
The return on shareholders' equity rose from \(12{,}9\%\) to \(19{,}1\%\) (up 6,2 percentage points). This is well above the \(7{,}5\%\) interest shareholders could earn on an alternative investment, so their money is working better in the company.
The three reasons why the directors prefer an additional loan are:
- The debt-equity ratio of \(0{,}27 : 1\) is low, so the company can still borrow safely.
- A loan does not dilute the current shareholders' interest or voting power, because no new shares are issued.
- The return on capital employed (\(20{,}2\%\)) is higher than the interest rate on loans (\(13\%\)), so the borrowed money earns more than it costs. Also, the loan and interest stop once repaid, while dividends on shares continue indefinitely.
Dividend pay-out rate = DPS / EPS x 100
2024: \(89 \div 101 \times 100 = 88{,}1\%\)
2025: \(60 \div 112 \times 100 = 53{,}6\%\)
The pay-out fell from \(88{,}1\%\) to \(53{,}6\%\).
The two effects of the change in dividend policy are:
- More profit is retained: the pay-out fell from \(88{,}1\%\) to \(53{,}6\%\), so funds are kept for future expansion of the company.
- Shareholders should benefit later, because the retained funds will be used to grow the business, and cash flow is protected because less cash leaves as dividends.
The market price rose from 425 cents to 885 cents (up 460 cents) and is now above the net asset value of 675 cents (by 210 cents). Investors are willing to pay more than the shares are worth on paper, which shows confidence in the company and demand for its shares.