EVALUATION OF CAPITAL STRUCTURE AND PROFITABILITY OF BUSINESS ORGANISATION (A Case Study Of Selected Quoted Companies)
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EVALUATION OF CAPITAL STRUCTURE AND
PROFITABILITY OF BUSINESS ORGANISATION (A Case Study Of Selected Quoted
Companies)
ABSTRACT
Capital
structure is the proportion or each type of capital debt and equity used by a
business organisation. Many organizations employ debt in their capital
structure because of its benefits. One of the benefits is that interest on debt
is tax deductible and reduces tax liability of the organizations concerned.
Furthermore, failure to pay interest commitment can result to financial
backwardness. The financial managers consider so many factors in their capital
structure decisions because of the implications in the use of debt. The factors
are cost of capital, debt capacity cash flow. Etc.
The primary
aim of business organisation is to make maximum profit if possible. The
researcher made a study of selected quoted manufacturing and oil servicing
companies to see how capital structure related to profitability of business
organizations.
Five
companies were selected and their financial statements for four years extracted
and analyzed. The analysis showed that there is a strong relationship between
capital structure and profitability between debt equity ration and
shareholders’ return. It means that the cost of debt in the companies put
together is less than their return on investment. A company having return on
investment greater than cost of debt will have an increasing shareholders’
return.
Table Of
Content
Title Page
Approval
Page
Dedication
Acknowledgement
List Of
Tables Abstract
Chapter One:
1.0
Introduction
1.1
Background Of The Study
1.2
Statement Of The Problem
1.3
Objective Of The Study
1.4
Significance Of The Study
1.5 Scope
And Limitation Of The Study
1.6 Research
Hypothesis
1.7
Definition Of Terms
Reference
Chapter Two:
2.0
Literature Review
2.1 Implication
Of Capital Structure
2.2
Determinants Of Capital Structure
2.3 Feature
Of Appropriate Capital Structure
2.4 Concept
Of Cost Of Capital
2.5 Capital
Structure Theories
2.6
Existence Of Optimum Capital Structure Traditional View
2.7
Criticism Of Traditional View
2.8
Modigliani And Miller Propositions
2.9
Criticisms Of Modigliani And Miller Propositions
2.10 Capital
Structure And Corporate Tax
2.11 Concept
Of Profit And Profitability
Reference
Chapter
Three:
3.0 Research
Design And Methodology
3.1 Research
Design
3.2 Sources
Of Data
3.3
Population And Determination Of Sample Size
3.4 Methods
Of Investigation
Reference
Chapter
Four:
4.0
Presentation, Analysis And Interpretation Of Data
4.1 Analysis
Of Data
4.2 Test Of
Hypothesis
Chapter
Five:
5.0 Summary
Of Finding Conclusion And Recommendation
5.1 Summary
Of Finding
5.2
Conclusion
5.3
Recommendations
Bibliography
Appendices
CHAPTER ONE
1.0
INTRODUCTION
1.1
BACKGROUND OF STUDY
The most
important decision all corporate managers should take into consideration is the
way in which the long-term capital requirements of their companies should be
financial. Capital structure is the permanent financing of a firm represented
primarily by equity and long-term liability without including all short-term
credits. Many factors have to surface in order to determine the capital
structure of a business organisation. These factors are what the financial
managers consider first in order to determine appropriate capital structure
suitable to his firm. Some of the factors are: cost of capital, floation costs,
size of the company, government policies and market condition. The combination
of debt and equity has some implication. The first is that debt-equity ratio,
which is regarded as an indicators of risk. According to Samuel etal (1992:44)
high fixed interest commitment which must be paid by the business organisation
irrespective of whether profits are made or not. Debt capacity which is the
ability of a firm to service its debt payment of interest and principal is
usually measured. On eof the ways of measuring debt capacity is by raising the
ratio of net cash inflow to interest charges.
Pandey
(1998-656) has it that the ratio indicates the number of times the interest
obligation are covered by the next cash inflows generated by the company. The
greater the coverage the lower the risk arising from the debt in the capital
structure. Conversely, the lower the coverage the higher is the risk arising
from the debt in capital structure. And failure of a company to pay its
interests obligation can lead to bankruptcy. Furthermore, left for the business
owners, they will employ more of debt in their capital structure as to increase
profit. All things being equal will accrue to them and they only have to pay
interest to provide of debt capital. Thus less amount of tax is paid by the
company with debt capital.
In
determining whether to employ more of debt and less of equity or more of
equally and less of debt in its capital structure, the financial managers of
the firms concerned should take into account, the profit objectives of that
business. They should consider how the capital structure will affect the
profitability of their business organisation. The profitability of any business
organisation will determine whether it will remain in business or not
especially in the long run. Profitability is normally measured using return on
capital employed return on equity, earning per share, return on assets, net
profit margin and gross profit margin.
1.2
STATEMENT OF PROBLEM
The owners
of a company will not like to loose the control they have in their company by
issuing more shares to the public in order to finance their capital projects.
Instead, they to borrowing, this means using debt instrument like debenture
stock. These owners of the business should not fail to know that whether there
is profit or not that the debentures should be settle their interest. Nobody
can perfectly predict the future, there can be business boom and there can
equally be stump in business.
The problem
then is how can business combine debt and equity financing in order to ensure
profitability?
1.3
OBJECTIVE OF THE STUDY
1. To
critically evaluate the variations in capital structure used by different
companies under study.
2. To see
how the capital structure affects the profitability of the business
organizations concerned.
3. To
identify some of capital structure problems encountered by these companies.
4. To
recommend solutions to these problems.
1.4
SIGNIFICANCE OF THE STUDY
Business
financing is a very important business decision. Corporate financial managers
have to decide whether to employ more of debt or more of equity whichever
measure is adopted has effects. Everybody should bear in mind that the main
objective of every business is to make profit of which this research work will
through its findings achieve the followings:
1. To
convince corporate managers of the relationship between capital structure and
profitability of business organisation and will enable them make appropriate
decision to that effect.
2. It will
help intending investors to plan their capital structure very well from the
statement in order to maximize profit.
3. This will
be of good advantage to future researchers in their research work.
1.5 SCOPE
AND LIMITATION OF THE STUDY
Not minding
that capital structure has many implications on a company such as
profitability, market value of shares and financial distress, this study took
at the relationship between capital structure and profitability of business
organisation. Business organisation studied was manufacturing companies and oil
servicing companies quoted in Nigerian Stock Exchange.
In course of
the research work, the researcher encountered some problems that bring up their
ugly heads. Business organizations should some elements of indifference in
relating to their financial statement. Also, there was problems of dund and
some gate men who refused that the researcher could not meet the financial
managers e.g. Nigerian Bottling Company 9th Mile Corner Enugu.
However, the
researcher was not discouraged by the problems. Through the mercy of God enough
information were collected form general securities, a member of Nigerian Stock
Exchange, Apes a member of Nigerian stock exchange all in Enugu, and University
of Nigeria Enugu Campus Library.
1.6 RESEARCH
HYPOTHESIS
The
following hypothesis have been formulated to guide the study.
(a) Ho:
There is a relationship but not strong between capital structure and
profitability of business organizations as measured be return on equity.
Hi: There is
a strong relationship between capital structure and profitability of business
organizations as measured by return on equity.
(b) Ho:
There is a relationship but no strong between capital structure and
profitability of business organizations as measure by return on investment.
Hi: There is
a strong relationship between capital structure and profitability of business
organisation as measured by return on investment.
1.7
DEFINITION OF TERMS
1. FINANCIAL
LEVERAGE: This is the use of fixed charges source of fund such as debt and
preference capital along with the owner’s equity in the capital structure.
2. DEBENTURE
STOCK: These are loans that companies raise by the issue of stocks to members
of the public. A fixed rate of interest is offered and the rights of the
investors in the event of non-payment of either interest or principal. Mortgage
debenture shows that the deeds of title to property have been deposited with
the trustee in which case the property can be sold to repay the debenture
hoders in the event of the company or defaulting.
3. PREFENCE
STOCK: These are stocks which give the holders the right to stated rate of
dividend, such sums being due for payment out of the company’s profits before
any dividend is paid to the holders of ordinary stock. Preference stock holders
are members of the company but do not usually have voting rights. It is a hybrid
security because it has qualities of debt and equity instrument.
4. DEBT:
Debt is loan borrowed from outsider to finance a business. It is repayable and
receives a return in form of interest charged on the amount of debt
outstanding. The holders of debt instruments are legally creditors of the
borrowing company. Debenture is an example of debt.
5. EQUITY:
It is a permanent investment in a company. Equity investment makes a person a
part owner of the company. This is also a method of long-term financing. It
includes share capital, share premium and reserves.
6.
DIVIDENDS: These are cash payments to shareholders when credited accounts are
published the company may declare dividend and this is under the approval of
the shareholders at the annual general meeting. In a bad year, a company may
wish to pay a larger dividend that total earning allowed. The difference must
be paid from reserves which are accrued profits from previous years.
7. CAPITAL
COMPONENTS: These are items on the left hand side of the balance sheet on the
old method of computation of balance sheet statement. The item viz: various
types of debts, preferred stock, and common equity. According to J. F. Weston
at al (19977:695) any net increase in assets must be financed by an increase in
one or more capital components.
8. EARNINGS
BEFORE INTEREST AND TAX (EBIT): Earning before interest and tax is the earnings
of a business organisation before deduction of interest and tax. In this
research work, it is denoted by EBIT.
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