CAPITAL STRUCTURE AND PROFITABILITY OF A FIRM

Presented By :

Muhammad Romaan Qamar

Muhammad Kumail Hassan

Saquib Hassan

Abubakkar Habib

Amir Ali Zaidi

CAPITAL STRUCTURE AND PROFITABILITY

Mix of the long term sources of funds used by the firm.

Prudent capital structure requires answer to the following questions

What should be maturity composition of the firm’s sources of funds???

In what proportion relative to the total should the various forms of permanent financing utilized???

CAPITAL STRUCTURE AND PROFITABILITY The objective of the capital structure is

the source of the funds used by a firm in the way that will increase the company’s common stock price.

Capital structure management is the objective by which firm seeks the mix of funds that will minimize its cost of capital.

IMPORTANCE OF CAPITAL STRUCTURE

Makes economic sense of the firms to strive to minimize the cost of the using financial capital.

Both capital costs and other costs, such as the manufacturing cost share a common characteristic in that it potentially reduces the size of the cash and dividend that could be paid to the common stock holders.

IMPORTANCE OF CAPITAL STRUCTURE Profitability is the primary goal of all

businesses. Without profitability the business will not

survive in the long run. Profitability is measured with income and

expenses. Profitability is measured with an “income

statement” because income statement is measure of income and expenses during a given time period.

CAPITAL STRUCTURE DECISION MAKING:

Have direct impact on firm value and return to stakeholders.

UNLEVELED and LEVELED firms. Financial manager’s responsibility to

raise the money for the investment in real assets.

Issuance of shares or take loans.

LITERATURE REVIEW (LAURANCE BOOTH), Portability across different countries.

(RAGHURAM G. RAJAN), Determinants of Capital structure.

(STEWART), Mix of securities and financing

(ERIK BERGLOF), Problems of financial contracting.

FRAMEWORK

Two ways of thinking about capital structure.

1. Static tradeoff framework

2. Old-fashioned pecking order framework

DATA/TERMINOLOGIES

KSE 100 INDEX EQUITY SHORT-TERM DEBT LONG TERM DEBT PROFITIBILTY

METHODOLOGY

How the proportion of debt and equity affects the profitability ?

FUNCTION:

ROE=f (STD/TL, LTD/TL, SHE/TL, LTD /SHE, U)

ROE: The profitability ratio

STD/TL: Corresponds to short-term debt to total liability

LTD/TL: Shows the ratio of Long-Term Debt to Total Liability

SHE/TL: It is the ratio of Share Holder’s Equity to Total Liability

LTD /SHE: Corresponds to the Long-Term Debt to Share Holder’s Equity

DESCRIPTION OF RATIOS

ROE: Reinvested earnings to generate additional

earnings Company's efficiency Returns on equity that are high and growing

STD/TL: Portion of short-term debt is used in total debt The value of short-term debt that a company

uses

LTD/TL: Value of long-term debt out of total debt Portion of long-term debt is used

SHE/TL: Equity in relation to debt Excess earning available for dividend Greater margin of safety Lower risk

LTD /SHE: Long-term debt compared to its available

capital Identify risk exposure

RESULTS & DISCUSSION

Sectors selected

Averages and standard deviation

Performance of sectors

Proportion analysis

RESULTS & DISCUSSION Fertilizer Sector:

Index Average Standard Deviation

ROE 0.328594 0.221084239

STD/TL 0.771944 0.221882109

LTD/TL 0.228056 0.231732808

SHE/TL 0.941613 2.008654713

LTD /SHE 0.314748 1.076046782

TOBACCO SECTOR

Index Average Standard Deviation

ROE 0.240611 0.252326572

STD/TL 0.950483 0.056866476

LTD/TL 0.049517 0.066776577

SHE/TL 0.644447 1.262782892

LTD /SHE 0.026318 0.11588583

Oil and Gas Marketing:

Index Average Standard Deviation

ROE 0.174301 0.07058567

STD/TL 0.856325 0.133468824

LTD/TL 0.143675 0.122458627

SHE/TL 1.971033 0.901354066

LTD /SHE 0.289004 0.265712772

Oil and Gas Exploration:

Index Average Standard Deviation

ROE 0.283569 0.14484408

STD/TL 0.906538 0.107109764

LTD/TL 0.093462 0.116129665

SHE/TL 1.411654 1.098681229

LTD /SHE 0.180385 0.24426594

Cement SectorIndex Average Standard Deviation

ROE 0.012989 0.798476188

STD/TL 0.569325 0.285958503

LTD/TL 0.43402 0.275472458

SHE/TL 2.034975 5.538369892

LTD /SHE 0.374572 6.614605791

STATISTICAL ANALYSISAMONG THESE VARIABLES

Correlation among variables:

Negative values indicates an inverse relationship which means that two variables move in the opposite direction. Whereas, positive value shows their movement in the same direction.

  STD/TL SHE/TL LTD/TL LTD /SHE ROE

STD/TL 1 -.123 -.746 -.182 .085

SHE/TL -.123 1 .162 .233 -.855

LTD/TL -.746 .162 1 .002 -.096

LTD /SHE -.182 .233 .002 1 -.225

ROE .085 -.855 -.096 -.225 1

Regression: Dependence of one variable, conventionally called

a dependent variable, on one or more other variables called independent variable.

We are using multiple regressions

Fig. Variables Entered/Removed

 Model

 Variables Entered

 Variables Removed

 Method

 1

 LTD/SHE, LTD/TL, SHE/TL, STD/TL

 .

 Enter

Regression (cont...)

R is a multiple correlation coefficient. The co-efficient of multiple determination lies between 0 and 1

R2 shows the variability in the dependent variable due to independent variables

27% accounted as an Error term.

Model R R2 Adjusted R2 Std. Error of the Estimate

1 .857 .735 .729 .27269

ANOVA: The various sources is used for testing the

hypothesis that Capital structure of firms effects its

profitability.

explains the variation in dependent variable due to our chosen independent variables

Model  

Regression 

Residual  

Total

Sum of Squares

dfMean

SquareF Sig.

 51.595

 4

 12.899

 120.430

 .000

 18.636

 174

 .107

   

 70.231

 178

     

CONCLUSION used more portion of short-term debt than long-

term debt. higher the portion of short-term debt in total liability

higher will be the return on equity. ROE has a negative correlation with the long-term

debt. least square method we used proves our

hypothesis that profitability is affected by capital structure.

profitability of a firm is affected 73% by a mix of capital structure and 27% by other factors.

THANKYOU