In Year 1 Traction Bikes had gearing of 28.6%. This means that the firm had low gearing. In Year 2 gearing had declined further to 15%. Traction Bikes’ combination of low gearing and high profitability means that lenders are likely to be willing to lend further finance to the business if needed. Similarly, investors are likely to be interested in purchasing ordinary shares in such a highly profitable business.
1. Based on the income statements and statements of financial position, calculate the debt/equity ratio for Traction Bikes Ltd in Year 3.
2. What comments would you make to Sandra Roche on Traction Bikes’ gearing in Year 3?
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Case Study Trouble at Toshiba
Toshiba Corporation is a large international company producing a huge range of electrical goods. For many years it was regarded as a consistently profitable company and its shares were in high demand by investors keen to get a share of the profits. That is, until it emerged that over a six-year period the company
had been exaggerating profits in its accounts by approximately €1 billion. The revelation caused the value of Toshiba’s shares to drop by 25%. It infuriated shareholders and led to the sacking of the senior managers responsible. It also led to record fines being imposed on the company.
Discussion
Give one reason why Toshiba’s shareholders would be angry at being provided with inaccurate financial accounts.
