HI. Got a few MCQ I’m struggling to get my head around. Any help would be appreciated. October 2012 Q9 Which of the following best summarises the relevance of the income (interest) cover ratio? The answer is A Provides shareholders with an insight into the short term risks associated with their loans but is relatively unimportant to lenders. I thought the interest cover was important for lenders to consider when assessing if a company can meet its debt interest? Which of the following best describes the cost of providing finance from retained earning? Answer is C. Retained earnings are equally expensive as equity share capital. Don’t get this. Was under the impression they were less expensive. Thanks
Hi The income (interest) cover MCQ is something of a strange (and difficult) one! I think you're correct that the interest cover is important for lenders to consider when assessing if a company can meet its debt interest. If one of the 4 available options was that it was important to both shareholders and lenders (in assessing the riskiness of their loans), that would be the one I would have chosen Sadly, that isn't any of A-D, so we need to find the best of the 4 that are actually available! Both C and D mention 'short-term risks' and it could be argued that income cover doesn't cover short-term risks (? maybe the liquidity ratios cover the short-term). That leaves A and B, with A being the better of the 2? For the costs of retained earnings and share capital one, we're considering the cost/return given the risks being taken. Retained earnings are part of the equity (the other part is new share issues). So, both retained earnings / new share issues can be considered 'money from shareholders' and need to earn an adequate return for shareholders. (In practice, using retained earnings may avoid some issuing costs associated with new share issues, so the transaction/implementation costs may be lower, even though the underlying cost/return on the capital is the same). Hope these help a little! Lynn
