ACCA Financial Management (F9) Certification Practice Exam

How is Financial Gearing calculated using market values?

1. Market value of debt / (Market value of equity + Market value of debt)

2. Market value of prior charge capital / (Market value of equity + Market value of prior charge capital)

3. Market value of assets / Total liabilities

4. Market value of equity / Total capital employed

The correct answer is: Market value of prior charge capital / (Market value of equity + Market value of prior charge capital)

Financial gearing, often referred to as financial leverage, measures the proportion of a company's capital structure that is financed by debt. It effectively indicates how much of a company's operations and investments are funded through borrowed funds compared to equity financing. The correct calculation uses the market value of prior charge capital in the numerator, along with the market value of equity and prior charge capital combined in the denominator. This is because prior charge capital typically includes all forms of debt that have a fixed charge on the assets of the company – like debentures or preference shares that come before ordinary equity holders in claims on assets. By dividing the market value of prior charge capital by the total of market value of equity and market value of prior charge capital, this calculation provides a clear picture of the company's leverage position. A higher ratio suggests that the company relies more on debt relative to equity, which could indicate higher risk, especially in times of financial distress. While other options presented may reference various financial aspects, they don't effectively capture the specific structure and intention behind measuring financial gearing in the context of prior charge capital and its relation to the total capital structure.