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Financial Management - Assignment 1

Name: Roll number: Course:

Pratap Kulhari 50 EPGDIB – VSAT Batch 7

Topic:

Capital structure and its effect on corporate performance

Reference Articles: 1. The impact of capital structure on profitability with special reference to it industry in India 2. Impact of debt structure on profitability in textile industry of Pakistan 3. The effect of financial leverage on corporate performance of some selected companies in Nigeria

Abstract of Findings:

The general findings are that while financial leverage offers tax advantages and cheaper source of finance, the profitability has a significant negative relationship with debt ratio.

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If the firm falls on hard times and if it’s operating income is insufficient to cover interest charges. 2 . The article refers to various prior studies on the topic. and increase in the use of debt fund in CS tends to reduce the net profit of the it firms listed in Bombay Stock Exchange in India. The impact of capital structure on profitability with special reference to it industry in India The journal article is aimed to find out “The impact of capital structure on profitability with special reference to it industry in India”.e. At the same time. The study concludes that overall there has been a strong one-to-one relationship between CS variables and Profitability variables (ROA and ROCE). The study results show that there is no significant relationship between selected CS variables and ROA of low income IT firms. the firm may be forced into bankruptcy. then stockholders will have to make up the short fall. rising interest rates overwhelm the tax advantages of debt. the authors have used the data from 102 IT sector companies listed on the stock exchange. The study has divided the sample data based on two parameters i. medium and large firms. and the CS has a significant influence on Profitability. Income Groups (Low. The data were collected from CMIE (Centre for Monitoring Indian Economy) Prowess Package.e. Standard Deviation. But too much debt can keep the company wipeout shareholders in the process. Good times may be just around the corner. In their study.1. and thus higher the interest rate will be. Medium and Large). and increase in use of debt fund in CS tends to minimize the net profit of the it firms listed in Bombay Stock Exchange in India. The higher the debt ratio. Medium and High) and Size of Total Assets (Small. the issue of external equity is seen as being the most expensive and also dangerous in terms of potential loss of control of the enterprise by the original owner-managers. while there is an inverse relationship between these variables for the medium and high income group firms. and Ratios has been used. In terms of preferred order of financing. Statistics such as Mean. there is a clear inverse relationship between CS and ROA variables for all the three groups of firms under Asset size category i. Return on Assets (ROA) and Return on Capital Employed (ROCE) and the CS has significant influence on Profitability. The study proves that there has been a strong one-to-one relationship between CS (Capital Structure) variables and Profitability variables. small. One of the interesting facts covered in the study is the possible bankruptcy risk while using extra debt. and if they can’t. the greater the risk. Also.

Further it is also suggested that the companies with huge sales should not go for the short term debts. the article points out to some of the important findings related to the subject.e. usually the net income i. In order to do so. As the latter have negative relationship with the profitability. Return on equity reveals the percentage earnings of the funds of a shareholder. the companies having small sales should go for the short term debts viz-a-viz long term debts. However.e. in Millions of rupees in their sample). stating the result in percentage (however. in Billions of rupees in their sample) and has no impact on the companies which have low sales (i. One such finding indicates that an increase in the long-term debt position is linked with a decrease in profitability. However. then debt and finally external equity.2. net profit after interest and tax is used for ROE calculation). Impact of debt structure on profitability in textile industry of Pakistan The journal article is aimed to find out “Impact of debt structure on profitability in textile industry of Pakistan”. The article refers to Modigliani and Miller (1958) which states that any firms’ market value and its cost of capital were free of its capital structure in the perfect market conditions. According to them. any organization and industry would first prefer using internal available funds. 3 . as short term debts have less potential for profit for them.e. Through references to various studies. profitability is calculated by frequently used ratio by many researchers i. it can be seen from the results that the debt levels affect the profitability of the firm only when the sales are high (i. The authors of the study have also defined the key variables used in their study. As per the pecking order theory. It is calculated by dividing the net profit before interest and taxes by the shareholders’ equity. the basic assumptions behind this study never hold true in the real markets. From the their research. return on equity (ROE). according to the authors. the authors have used the data from 17 companies from the industry.e.

The effect of financial leverage on corporate performance of some selected companies in Nigeria The journal article is aimed to find out “What is the effect of introduction of fixed. Earnings per share depend on indirect effects of leverage changes and less on direct effects. However. the higher the return on equity (ROE). Also. The article concludes that leverage changes (debt/ equity ratio) have substantial effect on corporate performance especially when the “net assets per share (NAPS)” is used as an indicator of corporate performance in Nigeria over the period covered by the study. It is done by examining the impact of leverage on the earnings per share and net assets per share of corporate firms in Nigeria. Net Assets per Share will fall if the company obtains debt at a cost higher than the rate of return on the company’s assets. Few of the prior studies referred in the article state that debt magnifies the earnings available to shareholders. the equity beta of the firm. It is therefore enough to note that financial leverage increases the firm’s (financial) risk and hence. The degree of financial leverage is defined as the change in a company’s profit after tax due to changes in its EBIT.interestbearing funds (debts) on the return to the firm’s shareholders”. The article also explains the concept of financial leverage and its various effects on the company’s performance. The implication of this is that Earnings per Share and of course. this assertion will only be valid if the return on assets (ROA) is higher than the cost of debt.3. Financial leverage increases the potential reward to shareholders. but it also increases the potential for financial distress and business failures. the finding revealed that the leverage effect on earnings per share indirectly affect the net assets per share of firms as the bulk of the effects on the net assets per share was received from earnings per share of the firms. 4 . In this case the more the debt.

php/css/article/view/j. Goher Fatima.1923669720120801. Mehboob Ahmad International Journal of Economics and Research. Candasamy Gavoury Volume 9 • Number 4 • Winter 2011 .css.si/zalozba/ISSN/1581-6311/9_371-392.net/index. vol.700 5 . pp.ijeronline. 8. 1. 85-91 http://cscanada.pdf Impact of debt structure on profitability in textile industry of Pakistan By: Wali ur Rehman.REFERENCES: The impact of capital structure on profitability with special reference to it industry in India By: Ramachandran Azhagaiah.Managing Global Transitions http://www. Dr. v3i2.p df The effect of financial leverage on corporate performance of some selected companies in Nigeria By: Akinmulegun Sunday Ojo Canadian Social Science.com/documents/volumes/Vol%203%20issue%202/ijer20120301MA(5). 2012. 61-70 http://www. 2012. no.fm-kp.