IMPACT OF CAPITAL STRUCTURE ON PERFORMANCE OF COMPANIES IN NIGERIA
examined the effect of capital structure on corporate performance with
reference to selected companies in Onitsha, Questionnaires and interviews were
used to collect information from the selected companies in Onitsha, Anambra
State. Analysis and observations were
made which gave rise to the validity of the conclusion at the end of the
analysis, the major finding were:
That these is a relationship
between capital structure and cost of capital.
That capital structure have
significant effect on corporate performance (in terms of profitability)
That there is a high cost of
capital which hinders the companies borrowing ability.
recommendations for the study among others were:
That companies should
increase their efficiency in use of debt capital.
That since cost of borrowing
is so high, if a firm should be able to service fixed charges associated with
senior securities and leasing, it can borrow.
That for improved
performance mostly on profitability, the optimum combination of fund from varying
sources which is superior to any alternative combination is necessary.
researchers then concludes that:
The inability of many
companies to adopt optimal capital structure has been increasing their cost of
Due to increase in the cost
of capital for may firms, they were unable to borrow in order to meet up their
capital investment hence the decrease in their performance mostly on
The optimal capital
structure is one in which the marginal real cost (the sum of both explicit and
the implicit costs) of each available method of financing is the same.
Table of content
Statement of the problem
Purpose of the study
Significance of the study
Scope and limitations
Definition of terms
The concept of capital structure
Review of previous studies
design and methodology
Sources of data
Scope and limitations
Data treatment and analysis
presentation and analysis
Questionnaires analysis and presentation
Data analysis and presentation
Test and prove of hypothesis
recommendation and conclusion
Summary of findings
Definitions of terms
1.1 GENERAL INTRODUCTION
A Corporation, Private or Public need capital to
enable it achieves its objectives.
Capital structure implies the nature and proportion of elements, which
go to make up the capital invested in a business corporations that are in need
of funds exchange their financial instruments for the money provided by the
intermediaries or direct from savers.
This money the corporations convert to tangible assets as building,
land, plant and machinery, motor vehicles etc.
Basically, a corporation uses three main sources of long term and
permanent financing viz: common stock, preferred stock and debt financing
(bond). It is the combination of these
finances to particular firm that is termed capital structure.
There is need for reasonable balance of different
types of securities comprising the capital structure of a firm otherwise the
firm will deplete its financing ability or finance at sub optimal cost. In achieving this, the cost of capital is
important for it has a major impact on the investment decision and the
financing structure of the firm of which affect the riskiness and size of the
firm. Specifically, the issue has been
on whether or not financial leverage effects the firm’s cost of capital, its
value and profitability, hence its corporate performance.
Two major schools of thought (the Traditionalist and
Modigliani Miller) extreme views on the
issues in question have been among those involved in the arguments. According to Modigliani and Miller, in their
proposition which states that “the market value of any firm is independent of
its capital structure and is obtained by discounting its expected return at a
rate appropriate to its risk class”1 in their proposition 2 however, it
states that the cost of equity is equal to the cost of capital of an unlevered
firm plus the after-tax difference between the cost of an unlevered firm and
the cost of debt weighted by the leverage ratio2. Their long standing and unresolved opposite
views have become so controversial that it has led many into concluding that
the literature is marked by serious confusion and contradictions. This particular notion is manifested in the
words of LINTER “the decision rule which have been proposed for determining the
optimal capital structure and reliance on different sources of financing are
mutually in-consistent, in the sense that they have led to often substantially
different decision under given sets of circumstance”3.
We are concerned with whether the way in which
investment proposals are financed matters; and if it does matter, what is the
optimal capital structure. If we finance
with one mix of securities rather than another is the value of the firm
affected? This study will be guide by the definition, which sees capital
structure as the interrelationships among long term dept, preference share and
net worth (ordinary share capital plus reserves and surplus).
Finally, this study will ask some staff or selected
companies in Onitsha, Anambra State how effective and they think their capital
structure have been and what has been the effects on the corporate performance.
This concern on how company or companies can raise
the capital they need for their operations.
These ways can be broadly classified into internal and external sources.
A. INTERNAL SOURCE OF CAPITAL
An existing business can raise its capital asset by
withholding some part of the revenue it has generated. Such internally generated capital can take
one of several forms.
i. Depreciation Capital
Depreciation capital can be created that means
keeping some of the earnings aside as provision for capital consumption during
the process of production. This amount
can rightly be regarded as a cost item since it compensation for the part of
the fixed equipment that is being lost during use.
The inability to make allowance for this
depreciation has led to the failure of businesses after take off. Once a damaged key component of the capital
equipment cannot be replaced, the production process is stopped.
ii. Ploughing Back Profit
Some part of the profit made by the businesses is
kept back in the business instead of sharing it out as dividend or personal
income to the owners. Such ploughed back
funds are alternatively called retained earnings or undistributed corporate
profits in the case of corporate bodies.
When this is done, it means that the operation of the business can be
expanded without involving it in any debt.
The risk of liquidating the enterprise is reduced.
B. EXTERNAL SOURCES OF CAPITAL
Funds are raised from external bodies and can be
done in one of several ways again. These
bodies may not have any ownership relationship with the business before. Alternatively, those that were part owners
may add more to their original combination.
Examples of such external sources are discussed below.
i. Bonds and Debentures
Bonds like debenture and mortgages can be sold to
those external agencies that care to buy.
Interest on those bunds are calculated as cost for the purpose of
taxation. Therefore before profits can
be declared for tax to be imposed, the amount of interest paid must have been
These bond holders lay claim on the assets of the
business first before the shareholders in case of liquidation.
ii. Issuance and Sale of Preferred
This class of shares can be sold to new persons that
were never part of the previous ownership.
Such shares might as well be bought more by previous part owners who
merely wish to increase their shareholding.
Holders of preferred stocks are paid dividends before the common stock
holders. But they cannot be served until
the creditors have been settled.
iii. Issuance of New Common Stocks
New shares of common stocks or ordinary shares or
equity shares can be declared and sold to either existing shareholders or new
ones. This is the last group to benefit
from the earnings of the business.
iv. Direct Loans
Direct Loans can be syndicated from various types of
financial institutions or individual moneylenders. They earn interest on the amount lent out and
do not qualify to have a share of the profit.
These creditors can force the business to
liquidation when the loans cannot be settled as agreed. A court of law will declare the business are
new exposed to public auction in an attempt to settle the debts owed.
v. Grants and Aids
Governments and non-governmental organizations can
asset businesses with nominal or real capital in support of the production
efforts. This source of capital is the
only one that does not involve the firms concerned in direct costs. The donor agency bears the full cost of such
assistance. It is not a debt on the
1.2 STATEMENT OF THE PROBLEM
The use of debt as part of the capital of a business
could either help or worsen the situation of a firm depending on how well the
debt was used. Generally, long-term
borrowing is required for purchase of new fixed assets or expansion of
production capacity. Equally, a firm may
use its retained earnings, which is shareholders money or raise more money
within the organization through the issue of new shares. If loan credit is more
than equity capital (owner’s fund) it is wrong and risky because this will
increase the probability of bankruptcy.
On the other hand, corporations need to borrow for its expansion and
growth. But as usual, the choice of capital
structure of a firm in the financing of capital projects determines to a large
extent the value, profitability and risk of a firm to its shareholders.
Therefore, the study wants to seek answers to the
If a firm is financed with one mix of securities rather than another,
is the value of the firm affected?
Does it matter, the way in which investment proposals are financed?
Does capital structure have any
effect on corporate performance?
What is the optimal capital structure for a firm?
How may corporation establish proper capital mix?
1.3 PURPOSE OF THE STUDY
The researcher want to find out what happens to the total valuation of
the firm and to its cost of capital which the ratio of debt to equity, or
degree of leverge is varied.
To determine whether companies in Onitsha have been adopting adequate
To identify problems affecting or that have been hindering companies
from adopting an adequate capital structure and suggest possible solutions.
1.4 RESEARCH HYPOTHESIS
In evaluating this research work, we postulate the
following hypothesis in determining the effect of capital structure on
corporate performance. The hypothesis
are formulated in both:
Null Hypothesis (H0) and Alternative Hypothesis (H1)
1. H0: Capital structure does not have significant effect on
H1: Capital structure has significant
effect on corporate performance.
2. H0: Equity financing does not increase the
value of the firm more than
financing increase the value of the firm more than debt financing.
3. H0: A corporation should not avoid the use
of debt as part of its
H1: A Corporation should avoid the use of
debt as part of its capital.
4. H0: Weighted average cost of capital is
not an aid to determine proper
H1: Weighted average cost of capital is an
aid to determining proper
1.5 SIGNIFICANCE OF THE STUDY
It is important to point out that on completion of
this work by the researcher, it would be of immense significance to the
RESEARCHERS: Other researchers on the same or similar
topic would find this work helpful as it will form a base of review of related
literature and also a stepping-shine for future researchers.
ECONOMY: This work will help to
improve the national output and thereby national income. This is because of improvement in the
efficiency and effectiveness of the operations as well as the over all success
of companies, which will be achieved through adequate utilization and
management of capital structure as prescribed by the researcher.
standard of corporations will be increased as a result of the knowledge
acquired from this research work.
MANAGEMENT: This efficiency of the
management would be recognized as a result of their knowledge on how adequate
capital mix could be achieved.
SHAREHOLDERS: The wealth of the
shareholders will be maximized due to efficiency of management.
1.6 SCOPE AND LIMITATION
The study will be based on “effect of capital
structure on corporate performance”. The
researcher will restrict his work to selected companies in Onitsha Anambra
Any other reference to materials, place, items,
activities, periods is just for purpose of clarity and vivid under standing of
the topic and not within the scope.
The following constraints faced the researcher and
limited his efforts in elaborating the research work.
FINANCE: The researcher is a full
time student and has been discouraged from traveling to or visiting all the
companies in Onitsha to collect data for her study due to lack of fund. She has therefore chosen very few companies
because of proximity and ease of contact to the management.
TIME: This project work has just
few weeks time.
LIMIT: It would have been desired
for a longer time to exhaust the topic and extend the coverage but it was not
possible. A minimum of six months could
have been appreciated.
OF ACADEMIC WORK: The
researcher have been hindered by pressure of academic work from achieving the
extensive research this work should have deserved.
1.7 DEFINITION OF TERMS
Corporation: A corporation is an
association of persons or a group of persons set up by law and authorized to
act as individual person which is invested with perpetual succession.
structure: Capital structure implies the nature and proportion of element, which
go to make up the capital invested in a business.
of Capital: This is the rate of return that must be achieved from an investment to
satisfy the investors required rate of return.
Financing: Is the act of issuance of
distribution of and purchase of liability and equity claims issued for the
purpose of generating revenue producing assets.
Leverage: This is a measure of the proportion of debt capital present in the
capital structure of the firm.
Risk: This is variability of a
Stock: Is the cushion on which debt is acquired by a corporation and has no
Stock: Is a hybrid security that has
preference over common stock with respect to dividend and sharing in assets.
Debt: Payment which must be, but
has not yet been paid to somebody.
John C. Odike (2001); Managerial Economic 1st Edition.
Modigliani and Miller, (1968); The cost of capital corporation finance
and theory of investment, Arch or and D’ Ambosio p. 425.
Linter J. (1963); The cost of capital and optimal financing of
corporation growth journal of finance. Vol. xviii No. 2.