whether or not capital structure affects the profitability of a firm ?

1. Presented By :
Muhammad Romaan Qamar
Muhammad Kumail Hassan
Saquib Hassan
Abubakkar Habib
Amir Ali Zaidi

2. 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???

3. 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.

4. 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.

5. 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.

6. 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.

7. 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.

8. FRAMEWORK
 Two ways of thinking about capital
structure.
1. Static tradeoff framework
2. Old-fashioned pecking order framework

9. DATA/TERMINOLOGIES
 KSE 100 INDEX
 EQUITY
 SHORT-TERM DEBT
 LONG TERM DEBT
 PROFITIBILTY

10. METHODOLOGY
 How the proportion of debt and equity
affects the profitability ?
 FUNCTION:
 ROE=f (STD/TL, LTD/TL, SHE/TL, LTD /SHE, U)

11.  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

12. 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

13. 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

14. RESULTS & DISCUSSION
 Sectors selected
 Averages and standard deviation
 Performance of sectors
 Proportion analysis

15. 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

16. 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

17. 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

18. 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

19. Cement Sector
Index 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

21. 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

22. 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

23. 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

24. 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
df
Mean
Square
F Sig.
51.595 4 12.899 120.430 .000
18.636 174 .107
70.231 178

25. 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.

26. THANKYOU