(A) The Bureau Limited is a company that is being incorporated to organise and manage a computer bureau operation. The directors are considering whether to finance the company by equity or equity and loan.

They estimate that the company will require \(£ 5000000\) and that the rate of return on capital employed, calculated on the basis of profit before interest and tax to capital employed, could range from \(10 \%\) to \(20 \%\) as follows:

A return on capital employed of \(20 \%\) if the company is able to obtain a contract with the government for processing monthly statistics, or A return on capital employed of \(15 \%\) if it is able to obtain a contract with a major commercial organisation for routine processing of the weekly payroll, or A return on capital employed of \(10 \%\) if it is only able to obtain a series of small contracts.

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(a) Calculate the earnings per share on the basis of the three possible rates of return on capital employed assuming that:

(i) The company is financed wholly by equity of \(£ 1\) ordinary shares. Assume corporation tax at \(30 \%\).

(ii) The company is financed half by ordinary shares of \(£ 1\) each issued at par and half by \(10 \%\) loan stock. Assume corporation tax at \(30 \%\). ( 5 marks)

(b) Explain how the shareholders of Bureau Limited would be advantaged or disadvantaged by introducing a \(50 \%\) gearing. ( 5 marks)

(B) Three proposals have been suggested to record the effect of gearing when accounts are prepared on an inflation accounting basis. These are:

(i) If current cost adjustments have been made to calculate a current operating profit, a gearing adjustment is allowed to abate the operating adjustments in the gearing proportion to derive a current cost operating profit. *

(ii) In addition to the abatement of the operating adjustments, required in part (i) above, an additional entry is to be made to recognise the proportion of the unrealised revaluation surpluses arising in the year that may be regarded as being financed by borrowing.

(iii) A gearing adjustment may be made to reflect the effect of general price changes on the net borrowings and net monetary assets other than those included in monetary working capital.

Required Discuss whether each of the above three proposals has a logical reason to support it and why there is difficulty in agreeing on a standard treatment to record the effect of gearing.