group8 (1)
TRANSCRIPT
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
BONDS DEBENTURES
EQUITY
ORDINARY & PREFERENCE
SHARES
RETAINED EARNINGS
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
Profitability Flexibility Cost of capital Size of the company Marketability Control Cash Flow
ANALYTICAL
EBIT-EPS relationship ROI-ROE relationship Debt ratio Debt-equity ratio Total capitalization
ratio Interest coverage ratio
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
Finds it difficult to raise long-term loans, available at a high rate of interest and on inconvenient terms
Restrictive covenants in loans make their capital structure quite inflexible
The management thus cannot run business freely
They have to depend on owned capital and retained earnings for their long-term funds
Greater degree of flexibility in designing its capital structure
It can obtain loans at easy terms and can also issue ordinary shares, preference shares and debentures to the public
Management can run business more freely
Small Companies Large Companies
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)] / n
I = 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%
ALL FIGURES IN HK$ MILLIONS
A B C D E
EBIT 12208.47
12208.47 12208.47 12208.47 12208.47
INTEREST 1098.76
824.07 549.38 274.69 0
EBT 11109.71
11384.4 11659.09 11933.78 12208.47
TAX 1634.23
1674.24 1715.05 1755.45 1795.86
EAT 9475.48
9709.76 9944.04 10178.33 10412.61
NO OF SHARES
4121.1 4140.9 4160.72 4180.53 4200.35
EPS 2.3 2.34 2.39 2.43 2.48
Calculations
DEBT VS EPS
0 0.2 0.4 0.6 0.8 1 1.22.2
2.25
2.3
2.35
2.4
2.45
2.5
Proportion of debt
EPS
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
CALCULATIONS
1. D/E = 0.67
2. D/E = 1
3. D/E = 1.5
ROI 5% 9% 15% 20%
ROE 1.98% 7.67% 16.22% 23.34%
ROI 5% 9% 15% 20%
ROE 0.85% 7.67% 17.9% 26.4%
ROI 5% 9% 15% 20%
ROE -0.85% 7.67% 20.17% 31.1%
ROE VS ROI
5 9 15 20
-5
0
5
10
15
20
25
30
35
D/E=.67D/E=1D/E=1.5
ROI
ROE
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
DEBT VS COST OF CAPITAL
Cost of capital
Debt
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
Debt-Equity Ratio Measurement of how much suppliers, lenders, creditors and
obligors have committed to the company versus what the shareholders have committed
Ratios
Provides a general indication of a company's equity-liability relationship
Large, well-established companies can push their liability structure to higher percentages without getting into trouble.
Current Scenario
Future Scenario
100%D, 0%E
75%D, 25% E
50%D, 50%E
25%D,75%E
0%D,100%E
Total Liabilities(A)
26177 30044.5 29077.63
28110.75
27143.88
26177
Shreholder’s Funds(B)
58839 58839 59805.88
60772.75
61739.25
62706.5
D/E Ratio(A/B)
0.44 0.51 0.48 0.46 0.44 0.41
Calculations
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 Ratio
Compares a company's 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
Inference
Current Total Debt Ratio is quite good Higher the debt , Higher is Total Debt Ratio
Current Scenario
Future Scenario
100%D, 0%E
75%D, 25% E
50%D, 50%E
25%D,75%E
0%D,100%E
Total Liabilities (A)
31503 35370.50 34403.63 33436.75 32469.88 31503
Shreholder’s Funds(B)
58839 58839 59805.88 60772.75 61739.63 62706.5
Total Debt Ratio(A/B)
0.54 0.60 0.58 0.55 0.53 0.50
Capitalization Ratio
Measures the debt component of a company's capital structure to support a company's operations and growth
Describe the makeup of a company's permanent or long-term capital
Prudent use of leverage increases the financial resources available for growth and expansion
Highly leveraged company may find its freedom of action restricted by its creditors or have its profitability hurt by high interest costs
Calculations
Inference
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
Current Scenario
Future Scenario
100%D, 0%E
75%D, 25% E
50%D, 50%E
25%D,75%E
0%D,100%E
Long Term Debt(A)
26174 30041.5 29074.55 28107.5 27140.88 26174
Total Capitalization (B)
85013 88880.5 88880.5 88880.5 88880.5 88880.5
Total Capitalization Ratio(A/B)
0.31 0.34 0.33 0.32 0.30 0.29
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 Ratio of 3.98 is quite good. Company can pay its interest obligations easily As Debt borrowed increases, Interest Coverage
decreases
Current Scenario
Future Scenario
100%D, 0%E
75%D, 25% E
50%D, 50%E
25%D,75%E
0%D,100%E
EBIT(A) 11181 12208.47 12208.47 12208.47 12208.47 12208.47
Interest (B)
2808 3906 3632 3357 3082 2808
Interest Coverage Ratio(A/B)
3.98 3.13 3.36 3.63 3.96 4.34
COMPARISONS
EBIT INTEREST COVERAGE
4.825
4.875
4.925
4.975
5.025
5.075
EBIT / Interest Expense
•Suggestion: • Improve EBIT by
optimizing company’s operational costs.
EBITDA INTEREST COVERAGE
3.05
3.15
3.25
3.35
3.45
3.55
3.65
3.75
EBITDA / Interest Expense
•Comparatively better• It can be further improved by reviewing the tangible and intangible assets of the company.
FUNDS FROM OPERATIONS/ TOTAL DEBT(%)
2.5
7.5
12.5
17.5
22.5
27.5
32.5
37.5
Operating Cash Flow / Total Debt
•Funds generated from operations are less related to debts.•Operating cost for this company is high.
•Suggestions:• Need to optimize the
operations by employing Skilled labour, latest technology etc.
FREE OPERATING CASH FLOW/ TOTAL DEBT (%)
5
15
25
35
45
Free Operating Cash Flow = EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net
Working Capital - Capital Expenditure
•Poor performance in terms of Free operating cash flow.
•Suggestion:Company should sell some of its inefficient assets.
OPERATING INCOME/SALES(%)
1
3
5
7
9
11
13
15
17
19
Operating Income / Total Sales (Revenue)
• Is an indicator of profitability of a company
• Hutchison Wampoa is performing better in terms of profitability.
• Operational optimization can further improve the performance.
LONG TERM DEBT/CAPITAL(%)
2.5
7.5
12.5
17.5
22.5
27.5
32.5
Long Term Debt / Long Term debt + Preferred Stock + Common Stock
• Higher value for Hutchison Wampoa indicates that it is relying more on long term debts.
• Suggestion:Short terms debts can be one of the options.
TOTAL DEBT/CAPITALIZATION(%)
2.5
7.5
12.5
17.5
22.5
27.5
32.5
37.5
42.5
47.5
Debt / Debt + Shareholders’ Equity
• This is not a good indication as higher debt value will limit company’s flexibility.
RETURN ON EQUITY(%)
1
3
5
7
9
11
13
15
17
Net Income / Shareholders Equity
• Comparatively better performance as Hutchison Wampoa is giving a higher return on equity.
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.
%
EQUITY40%
DEBT60%
MARKETABILITY
Ability of the company to sell or market particular
type of security in a particular period of time which in turn depends
upon -the readiness of the investors to buy that
security
Sometimes market favours debenture issues and at
another time, it may readily accept ordinary
share issues
Company decides whether to raise funds through common shares or debt
based 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 owner's capital is increased by retaining the earnings, no floatation costs are incurred
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