Increasing the operating income by optimizing its operational costs.
Comparatively better, and the company should look forward towards improving it.
Funds generated from operations are less.
Poor performance in terms of Free operating cash flow.Suggestion:Company should not plan for expansion for its near future.
SuggestionEmphasis should be more on Short term debt and equity
Comparatively better performance
ASSESSMENT OF CAPITAL STRUCTURE OF HUTCHISON WHAMPOA BASED ON FUTURE FINANCING NEEDS BY:- TANIA ROY – 423 NITIN MEHROTRA – 425 TANMAY MEHTA –527 UTKARSH VASHISHTA – 528 SAHIL VOHRA - 530
WHAT IS CAPITAL STRUCTURE? The term `capital structure represents the total long-term investment in a business firm Includes funds raised through ordinary and preference shares bonds debentures loans from financial institutions Any earned revenue and capital surpluses are also included in the structure
CAPITAL STRUCTURE CONSTITUTES OF CAPITAL STRUCTURE DEBTS EQUITY ORDINARY & RETAINED BONDS DEBENTURES PREFERENCE EARNINGS SHARES
CAPITAL STRUCTURE FOR AN ORGANISATION Optimum capital structure should be planned in a manner that ensures that the market value of its shares is maximum A number of factors influences the capital structure decision of a company and significant variations among industries and among different companies The judgment of the person or group of persons making the capital structure decision plays a crucial role These factors are complex and qualitative as capital markets are not perfect and the decisions have to be taken knowing consequent risks
FEATURES OF THE CAPITAL STRUCTURE Planning is based on the interest of shareholders To be determined at initial stage Capital Structure decision is a continIous process
COMPONENTS OF CAPITAL STRUCTURE THEREOTICAL ANALYTICAL Profitability Flexibility EBIT-EPS relationship ROI-ROE relationship Cost of capital Debt ratio Size of the company Debt-equity ratio Marketability Total capitalization ratio Control Interest coverage ratio Cash Flow
CASH FLOW Conservatism related to the assessment of liability of fixed charges Amount of fixed charges are high when large debt is employed Debt should be raised only when provision for future cash flow exists It is risky to employ sources of capital with fixed charges for companies whose cash inflows are unstable or unpredictable
SIZE OF THE COMPANY Small Companies Large Companies Finds it difficult to raise long- Greater degree of term loans, available at a flexibility in designing its high rate of interest and on inconvenient terms capital structure Restrictive covenants in It can obtain loans at easy loans make their capital terms and can also issue structure quite inflexible ordinary shares, The management thus preference shares and cannot run business freely debentures to the public They have to depend on Management can run owned capital and retained earnings for their long-term business more freely funds
CAPITAL STRUCTURE DECISIONTHE TARGET Minimize the cost of capital Maximize the value of the firm
EBIT-EPS ANALYSIS How sensitive is EPS to changes in EBIT under different financing alternatives EPS = [(EBIT – I)(1 - t)] / nI = interest burdent = tax raten = number of equity shares
Assumptions Plan A: all debt, no equity shares Plan B: 75% debt, 25% equity shares Plan C: 50% debt, 50% equity shares Plan D: 25% debt, 75% equity shares Plan E: no debt, all equity shares Interest rate = 9% Tax rate = 14.71%
Calculations A B C D EEBIT 12208.4 12208.47 12208.47 12208.47 12208.47 7INTEREST 1098.76 824.07 549.38 274.69 0EBT 11109.7 11384.4 11659.09 11933.78 12208.47 1TAX 1634.23 1674.24 1715.05 1755.45 1795.86EAT 9475.48 9709.76 9944.04 10178.33 10412.61 NO OF 4121.1 4140.9ALL FIGURES IN HK$ MILLIONS 4160.72 4180.53 4200.35 SHARESEPS 2.3 2.34 2.39 2.43 2.48
DEBT VS EPS Proportion of debt 2.52.482.462.442.42 2.4 EPS2.382.362.342.32 2.32.28 0 0.2 0.4 0.6 0.8 1 1.2
HUTCHISON’S CASE Financing from cash on hand, internal cash generation Long term projects, large capital requirements Increased outstanding debts and capital commitments Alternative source of financing Appropriate mix of debt and equity
ROI-ROE ANALYSIS Relationship between return on investment and return on equity for different financing options ROE = [ROI + (ROI – r)D/E](1-t)r = cost of debtD/E = debt – equity ratiot = tax rate
ROE VS ROIROE35302520 D/E=.6715 D/E=1 D/E=1.51050 5 9 15 20-5 ROI
COST OF CAPITAL Minimize the cost of capital Depends on expected returns and risk Rate of interest fixed and company legally bound to pay interest for debt holders Rate of dividends not fixed and company not legally bound to pay dividends in case of shareholders Debt – a cheaper source of funds Tax deductibility of interest charge
CONTROL Existing management’s desire to continue its control over the company Risk of loss of control when new shares are issued Use debt to avoid loss of control 49.9% shares owned by Cheung Kong holdings New shares required – a very small percentage of existing shares Loosing control was not really a problem for the company
RatiosDebt-Equity Ratio Measurement of how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committedProvides a general indication of a companys equity-liability relationshipLarge, well-established companies can push their liability structure tohigher percentages without getting into trouble.
Calculations Current Future Scenario Scenario 100%D, 0 75%D, 50%D, 25%D, 0%D, %E 25% E 50%E 75%E 100%E Total 26177 30044.5 29077.63 28110.75 27143.88 26177 Liabilities( A) Shreholde 58839 58839 59805.88 60772.75 61739.25 62706.5 r’s Funds(B) D/E 0.44 0.51 0.48 0.46 0.44 0.41 Ratio(A/B) Current D/E Ratio is ideal Even if US$ 500M is raised through entire debt the ratio remains at 0.51 which is also quite stable
Total Debt RatioCompares a companys total debt to its total assets • A low percentage means that the company is less dependent on leverage • higher the ratio, the more risk
Calculations Current Future Scenario Scenario 100%D, 0% 75%D, 50%D, 25%D, 0%D, E 25% E 50%E 75%E 100%ETotal 31503 35370.50 34403.63 33436.75 32469.88 31503Liabilities(A)Shreholder’ 58839 58839 59805.88 60772.75 61739.63 62706.5s Funds(B)Inference0.54Total Debt 0.60 0.58 0.55 0.53 0.50Ratio(A/B) Current Total Debt Ratio is quite good Higher the debt , Higher is Total Debt Ratio
Capitalization Ratio Measures the debt component of a companys capital structure to support a companys operations and growthDescribe the makeup of a companys permanent or long-termcapitalPrudent use of leverage increases the financial resources availablefor growth and expansionHighly leveraged company may find its freedom of action restrictedby its creditors or have its profitability hurt by high interest costs
Calculations Current Future Scenario Scenario 100%D, 75%D, 50%D, 25%D, 0%D, 0%E 25% E 50%E 75%E 100%ELong Term 26174 30041.5 29074.55 28107.5 27140.88 26174Debt(A)Total 85013 88880.5 88880.5 88880.5 88880.5 88880.5Capitalization (B)Total 0.31 0.34 0.33 0.32 0.30 0.29CapitalizatiInferenceonRatio(A/B) Current Capitalization of 0.31 provides a cushion to investors Even if whole US $500M is raised through debt, the total capitalization will still be stable
Interest Coverage Ratio Determine how easily a company can pay interest expenses on outstanding debt The lower the ratio, the more the company is burdened by debt expense The non-payment of debt principal is a seriously negative condition A company finding itself in financial/operational difficulties can stay alive for quite some time as long as it is able to service its interest expenses.
Calculations Current Future Scenario Scenario 100%D, 75%D, 50%D, 25%D, 0%D, 0%E 25% E 50%E 75%E 100%EEBIT(A) 11181 12208.47 12208.47 12208.47 12208.47 12208.47Interest (B) 2808 3906 3632 3357 3082 2808Interest 3.98 3.13 3.36 3.63 3.96 4.34CoverageRatio(A/B) Current Ratio of 3.98 is quite good. Company can pay its interest obligations easily As Debt borrowed increases, Interest Coverage decreases
EBITDA INTEREST COVERAGE EBITDA / Interest Expense 3.8 3.7•Comparatively better 3.6• It can be further improved 3.5 3.4by reviewing the tangible and 3.3intangible assets of the 3.2company. 3.1 3 1995 Hutchison 3.7 Whampoa Industry 3.25 avg
FUNDS FROM OPERATIONS/ TOTAL DEBT(%) Operating Cash Flow / Total Debt•Funds generated from 40operations are less related to 35debts. 30•Operating cost for this 25company is high. 20 15 10•Suggestions: 5 •Need to optimize the 0 operations by employing 1995 Skilled labour, latest Hutchison 14.8 Whampoa technology etc. Industry 36.3 avg
FREE OPERATING CASH FLOW/ TOTAL DEBT(%) Free Operating Cash Flow = EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure 50 45•Poor performance in terms 40 35of Free operating cash flow. 30 25 20•Suggestion: 15 10Company should sell some 5 0of its inefficient assets. 1995 Hutchison 7.3 Whampoa Industry 46.2 avg
OPERATING INCOME/SALES(%) Operating Income / Total Sales (Revenue) 20• Is an indicator of 18profitability of a company 16 14 12• Hutchison Wampoa is 10performing better in 8terms of profitability. 6 4 2• Operational optimization 0can further improve the 1995performance. Hutchison 17.8 Whampoa Industry 11.43 Avg
LONG TERM DEBT/CAPITAL(%) Long Term Debt / Long Term debt + Preferred Stock + Common Stock• Higher value for 35Hutchison Wampoa 30indicates that it is 25 20relying more on long 15term debts. 10 5• Suggestion: 0 1995Short terms debts Hutchisoncan be one of the 28.9 Whampoaoptions. Industry 22.35 avg
TOTAL DEBT/CAPITALIZATION(%) Debt / Debt + Shareholders’ Equity 50• This is not a good 45 40indication as higher debt 35value will limit company’s 30 25flexibility. 20 15 10 5 0 1995 Hutchison 44.8 Whampoa Industry 31.05 avg
RETURN ON EQUITY(%) Net Income / Shareholders Equity• Comparatively better 18performance as 16Hutchison Wampoa is 14giving a higher return 12 10on equity. 8 6 4 2 0 1995 Hutchison 16.5 Wampoa Industry 10.75 avg
CONCLUSION On the basis of the analytical and theoretical criteria we propose a capital structure for the company comprising of 60% debt and 40% equity which will minimize the cost of capital and maximize the value of the firm. % EQUITY 40% DEBT 60%
MARKETABILITY Ability of the company to sell or market particular type of security in a particular period of timewhich in turn depends upon -the readiness of the investors to buy that securitySometimes market favours debenture issues and atanother time, it may readily accept ordinary share issuesCompany decides whether to raise funds through common shares or debtbased on changing market sentiments
FLOATATION COST Floatation costs are incurred when the funds are raised Cost of floating a debt is less than the cost of floating an equity issue, hence companies use debt rather than issuing ordinary shares If the owners capital is increased by retaining the earnings, no floatation costs are incurred