Meera, the finance manager of Platinum Ltd., a firm dealing in a telecommunication equipment chooses a capital structure which was highly geared.
(i) What do you understand by a highly geared capital structure?
(ii) What are the implications of choosing such a structure?
Meera, the finance manager of Platinum Ltd., a firm dealing in a telecommunication equipment chooses a capital structure which was highly geared.
(i) What do you understand by a highly geared capital structure?
(ii) What are the implications of choosing such a structure?
(i) Highly geared capital structure means that Platinum Ltd. has large amount of debt compared to equity. It further means that Meera is dealing with large sum of money borrowed by Platinum Ltd.
(ii) Meera will need to check on the Interest Coverage Ratio (ICR) which is EBIT/Interest expenses and Debt Service Coverage Ratio (DSCR) which is Net Operating Income/Total debts services. If ICR is low then the company is not generating enough revenues to cover interest expense and vice-versa. If DSCR is less than 1 then it means negative cash flow and company's inability to pay off debt in the short-run and vice-versa. Meera will also need to check on ROI which is calculated by dividing net income (after interest and taxes) by total liabilities. If net incomes are more than total liabilities then Platinum Ltd.'s highly geared capital structure should not be an issue. Accordingly, ICR and DSCR should be higher.
(i) Highly geared capital structure means that Platinum Ltd. has large amount of debt compared to equity. It further means that Meera is dealing with large sum of money borrowed by Platinum Ltd.
(ii) Meera will need to check on the Interest Coverage Ratio (ICR) which is EBIT/Interest expenses and Debt Service Coverage Ratio (DSCR) which is Net Operating Income/Total debts services. If ICR is low then the company is not generating enough revenues to cover interest expense and vice-versa. If DSCR is less than 1 then it means negative cash flow and company's inability to pay off debt in the short-run and vice-versa. Meera will also need to check on ROI which is calculated by dividing net income (after interest and taxes) by total liabilities. If net incomes are more than total liabilities then Platinum Ltd.'s highly geared capital structure should not be an issue. Accordingly, ICR and DSCR should be higher.
