ExpertMedium2 marksMultiple Choice
ACCA · Question 02 · Financial Management Environment
Section A
QuantumTech is a highly geared software startup. The central bank of the country where QuantumTech operates has recently announced a policy of quantitative tightening and significant increases in the base interest rate to combat inflation.
What is the most likely immediate impact of this macroeconomic policy on QuantumTech?
Section A
QuantumTech is a highly geared software startup. The central bank of the country where QuantumTech operates has recently announced a policy of quantitative tightening and significant increases in the base interest rate to combat inflation.
What is the most likely immediate impact of this macroeconomic policy on QuantumTech?
Answer options:
A.
A decrease in the cost of equity due to lower inflation expectations.
B.
An increase in the cost of debt and a decrease in interest cover.
C.
An improvement in cash flow due to higher returns on cash deposits.
D.
A reduction in the company's weighted average cost of capital (WACC).
How to approach this question
Analyze the effect of rising interest rates on a company with high levels of debt (highly geared).
Full Answer
B.An increase in the cost of debt and a decrease in interest cover.✓ Correct
Quantitative tightening and rising base rates directly increase the cost of borrowing. For a highly geared company (one with a high proportion of debt), this means interest expenses will rise significantly. This reduces profit before tax, leading to a lower interest cover ratio (PBIT / Interest).
Common mistakes
Failing to connect 'highly geared' with the specific vulnerability to interest rate hikes.
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