Chapter: 1

Introduction

Capital Structure decision ensures the longer sustainability of the firm. A rational mix of debt
and equity is must to consider in the preparation of capital structure. This is because too much
debt will weaken the long term solvency while too much issuance of share capital would mess
the controlling power of the firm. As capital structure decision means for the liquidity of the
firm, the smooth performance of a firm greatly depends on the management of capital structure.
This report aims at analyzing the impact of capital structure on the performance of BSRM. To
analyze the impact of capital structure on the performance capital structure decisions trend and
Performance of BSRM is analyzed thoroughly. On the basis of analysis there would be some
problem and recommendation in the report.

Company Brief

BSRM is a leading steel manufacturing company in Bangladesh which was established in 1952.
BSRM has a glorious history of being a partner of several successful constructions such as
“Hateerjhil Development project”, “Shah Amanat Bridge”, “Meghna Bridge “and several other
remarkable buildings and factories. By the association of skilled management and employee
team every year BSRM is heading towards successive achievement of its mission and vision.
The vision of the company is to hold the leading position in market by producing best quality
product to achieve customer satisfaction and becoming a reliable partner to the stakeholders. It
creates its values through trust, customer satisfaction, Reliability and through social
responsibility which in turn result in the sustainable growth for the company.

Statement of the problem

Certainly BSRM maintains its leading position for the years being by its own strategies and by
own management policies. Throughout the years several fluctuations in performance and capital
structure is observed from year’s data analysis. Performance fluctuation may be the outcome of
change in political, economical, social or other business influencing exterminators. This research
paper aims at major problem of understanding the impact of capital structure on company
performance.

1
Objective of the study

Principal objective of the study is to comprehend the impact of capital structure on Performance
of BSRM. To support this objective several other specific objectives are set as follows:

 To understand Optimal Capital Structure

 To know the factors affecting capital structure decision
 To identify problems associated with performance and capital structure of BSRM.
 To recommend how to improve both the performance and capital structure of
BSRM.

Limitations and Scope of the study

This paper has done a lot in carrying preliminary objective and finding the factors affecting the
capital structure on Performance of BSRM, yet there are much works to be done. The
performance fluctuation is not only the subject to capital structure decision. This report is not
flawless at all. This paper acknowledges the limitation of this study.

The main limitation of this report is the non availability of primary data. There were almost no
primary data to analyze the market position of the various products. There were some primary
data which were self reported and couldn’t investigate independently. Another limitation is that
there is not enough prior academic research on the topic that could direct the report to find
solution to the major and minor problem. This problem restricted the report to get an overview of
the company in the eye of other researchers.

Such limitations give scope for further research on the facts that have affect on the performance
of BSRM. These facts are beyond the scope of this research. Research can be done on the
financial policy, Management policy, Changing Business and social environment of BSRM.
Such research will enrich knowledge on this topic.

2
Methodology of the study

The research is concluded on impact of capital structure on Performance of BSRM on the basis
of secondary data. There was also shortage of secondary data also as such leading companies do
not uncover data about their company policy. To analyze impact of capital structure on
Performance of the ratio of financial data are applied and several theories on capital structure is
applied. Secondary sources data includes Finance texts, article, journal, consolidated financial
data of BSRM and other online data sources.

3
 Chapter 02: Theoretical Review
Nature of Capital Structure

Capital Structure is the mix of long term debt and equity of a firm. Usually capital structure
refers to debt to equity ratio. Planned and well designed capital structure guides towards long
term solvency of a firm and smooth business operation greatly depends on capital structure of a
firm. Capital Structure itself also signals the riskiness since highly levered capital structure poses
high risk.

Theories of Capital Structure

Smooth performance of activities to achieve objectives and Profitability of a firm is significantly

resolute by as how capital structure of an organization is designed. Several theories on capital
structure have been developed on several times. Major theories on capital structures are -

 Net Income Approach

 Net Operating Income Approach
 Traditional Theory
 Modigliani and Miller Theory
 The trade off Theory.
 The Pecking order theory.
 Signaling Theory.

Net Income theory

David Durand suggested “Net Income Theory” on 1952.This theory assumes that cost of capital
and leverage determines the value of firm. If leverage is increased in capital structure cost of
capital will go down and value of firm will get increased and if leverage is decreased the cost of
capital will be mounted up and value of firm in turn will be decreased. The theory assumes that
there would be no tax and cost of equity capital is higher than cost of debt.

Net operating income theory

Net Operating Theory is also suggested by Durand. This theory depicts that any change in
leverage will not cause any change in the value of the firm. According to the NOI theory overall

4
cost of capital and EBIT would be fixed. The value of the firm will be derived by dividing the
EBIT by overall cost of capital. Therefore value of the firm will only be affected by cost of
equity.

Traditional theory

Traditional theory suggests that the value of the firm would be highest and overall cost of capital
would be lowest at the optimum point. Therefore leverage should be utilized in capital structure
up to a certain limit where cost of capital would be lowest and value of the firm would be in
highest scale.

Modigliani and Miller Theory

It is popularly known as MM theory which is explained in two specific propositions. 1st

proposition is explained for a tax free situation where it depicts that a firms value will not be
changed whatever the mix of leverage and equity is applied in capital structure. 2nd Proposition
describes a tax situation where firm’s value is affected by the use of leverage since the use of
leverage enjoys a tax shield.

Trade off Theory

Trade off theory is based on assumption that benefit from tax shield may get offset by disaster
occurred by the risk aroused by the excessive use of debt in the capital structure. Therefore the
theory suggests that firms with enough taxable income to shield ought to have high target ratios,
the unprofitable firms with risky intangible asset go for equity financing.

Pecking Order theory

In Pecking order theory is no existence of predetermined mix of debt and equity. Rather there
exist two alternatives namely internal and external funds. Pecking order explains why profitable
firms generally borrow less-not because they have low target ratios but because they do not
require external fund.

Signaling Theory

5
The theory suggests that the use of stock is a negative signal and use of debt is a positive or at
least neutral signal. Therefore companies try to maintain a reserve borrowing capacity and this
means using less debt in normal situations.

Optimal Capital Structure

Optimal Capital structure refers to a structure that maximizes the value of firm and minimizes
the cost of capital. Optimal Capital structure varies from firm to firm. Optimal Capital structure
of a firm may be considered as surplus or deficit capital to other firms. Theoretically, debt
financing offers lowest cost of capital for its tax deductibility but on the other hand it raises the
riskiness of the firm. Therefore, to set up a financing mix or capital Structure a firm has to take
into consideration the financial objectives a firm wants to achieve.

Determinants of capital structure.

In practical numerous factors or indicators affect capital structure formation of an entity. Factors
influencing the capital structure formation are briefly presented in the following table:

Factors Influence

Corporate Tax Since debt payment is tax deductible higher tax rate makes use of
debt more attractive.

Flexibility The lower the use of debt ensures higher flexibility in structure.

Riskiness The riskier the business the less debt would be utilized in capital
structure.

Conservatism Conservative policies influence the finance mix of an organization.

Conservative policies will resist the use of debt.

Control The Intense to lose the control frequently hinders the issuance of new
equity.

Growth Rate At the time of growth, companies frequently use debt.

6
Operating Leverage Negative relation exists between operating leverage and debt in
capital structure.

Cash Flow Stability Cash flow stability may lead a firm to exploit leverage benefit to
some extent.

Lenders Attitude Restrictions or other covenant affects a firm to choose debt in finance
mix.

7
 Chapter 03: Industry Analysis

SWOT Analysis of BSRM

The internal and external analysis is an important part of strategic analysis or modeling of any
company. The SWOT analysis of BSRM will elaborate the strength & weakness of, and
opportunities & threats for BSRM steel, Bangladesh. The strength and weakness of BSRM will
be part of the internal analysis, and opportunities and threats will be part of the external analysis.
These are used to explain and analyze its capabilities, strategies, and competitive advantages.

STRENGTH

BSRM is the leader of the market and holds 12 % of the market share. It has been providing
quality production consistently for the past years. So has been grown to a reputed company and
also achieved great competitive skills. Now, it’s able to face strong competition. It has strong
distribution channel all over the country. It has appointed 300 dealers. Also, they have sales
depot in different districts of Bangladesh.

WEAKNESS

BSRM had taken a huge amount of loan from different banks, so, most of the profit goes to the
interest payment. Bangladesh has long-term power crisis, and its increasing day by day. As the
company is a heavy industry, thus it needs a huge supply of electricity. The demand remains
unfulfilled most of the time and company cannot reach to its ideal production.

OPPORTUNITIES

The market share of BSRM is 12% or more. And so, there is potentiality that they may capture
more market share in near future. They are increasing the production from 375,000 Metric Tons
to 500,000 Metric tons. Along with the increasing production, they can start exporting steel
abroad. As a market leader, their main goals are to providing a safe and quality product. If they
do that, they will be able to capture more market in future and dominate.

THREATS

In recent days, some new companies have started their steel production. Among them, Abul
Khayer Steel is a reputed one and promised to keep good quality. They are planning to produce
800,000 Metric Tons of steel per year. Moreover, each of the big steel producers of Bangladesh
wishes to enhance their production capabilities. If they reach their target production capacity,
they will capture more market shares. So competition will also increase in the home country.
Also, the power crisis in the manufacturing sector’s increasing gradually, and thus declining
production.

8
 Chapter 04: Trend of Capital Structure of BSRM
Capital structure trend planned by the company paves the way to analyze the impact of capital
structure on performance. To understand the trend of capital structure managed by BSRM
following table is prepared from the consolidated statements of the company.

Capital Structure

FY Weight of Weight of Cost of debt Cost of equity WACC

debt
Equity

2018 0.03 0.97 29.74% 10%* 10.59%

2017 0.03 0.97 34.40% 10% 10.73%

2016 0.09 0.97 13.63% 15% 15.78%

An optimal capital structure is that maximizes shareholders’ value, maximizing the value of the
firm and minimizing the WACC.

WACC= Weighted Average Cost of Capital

WACC=D/VL*RB* (1-Tc) + E/VL *RE

RE = Ro+ D/E (1-Tc) (Ro-Rd)

Capital structure trend of three consecutive years of 2016, 2017 and 2018 replicates the proper
capital structure planning of BSRM. Since the cost of debt is much higher than cost of equity the
company uses very little portion of debt in its financing planning. From the table mentioned
above it is found that the cost of debt counts for 14% to 35% of the borrowed amount. At the
same time dividend payment counts for 10% to 15% of the financed amount. While there is a
larger imbalance in the cost of debt and equity the financial decision makers of the company can
still manage the weighted average cost of capital to hold on 10% to 15%.

Giant figures of cost of debt on the table exist because of higher rate of interest payment in short
term loans. Since BSRM had to incur a vast amount of working capitals during these years the

9
company had to finance this vast amount through short term financing. This in turn generated
such bulk figures of cost of debts.

Impact of capital Structure on performance of BSRM

1. Gross profit margin:

Gross profit margin indicates that the sign of good management as it implies that the cost
of production of the firm is relatively low. The following results show that the
management is efficient as the margin increases in each year.

Ratio 2018 2017 2016

Gross profit margin 12.30% 11.27% 8.55%

2. Net profit margin:

Net profit margin would ensure the adequate return to the owner. So the return to the
owner decreases in 2018 as the net profit of the firm decreases in 2018.

Ratio 2018 2017 2016

Net profit margin 3.91% 4.33% 3.39%

3. Return on assets (ROA):

Return on assets is the ratio of annual net income to average total assets of a business
during a financial year. It measures efficiency of the business in using its assets to
generate net income. So the efficiency decreases in 2018.

10
Ratio 2018 2017 2016

Return on assets 1.30% 1.60% 3.05%

(ROA)

4. Return on equity (ROE):

The amount of net income returned as a percentage of shareholder equity. Return on

equity measures a corporation's profitability by revealing how much profit a company
generates with the money shareholders have invested. The shareholders profit decreases
in 2018 than 2017 & 2016.

Ratio 2018 2017 2016

Return on equity 5.1% 6.24% 11.46%

(ROE)

Impact of capital structure on profitability

The gross profit margin and net profit margin of the three consecutive years presents an upward
trend in profit earning by the company. During these three years BSRM also faced a down turn
in the dividend payment and an increasing rate of the interest payment. Therefore, wiser mix of
debt and equity in capital structure contributes to the higher profit margin for the company. This
positive increase of profit margin occurred due to lower tax payment rate during those years.
Since the tax payment rate was lower the company had got very little benefit to shield tax by
debt.

On the contrary Return on equity was not satisfactory during these three years. From 2016 to
2018 ROE was in range from 12% to 5% while the cost of equity surrounds to 15% to 6%.

11
Measurement of Financial Leverage.

1. Current ratio:

Current ratio measures the short term solvency of a firm. The following results show that
the solvency increases in 2018 than the previous year.

Ratio (times) 2018 2017 2016

Current ratio .99 0.90 0.93

2. Quick ratio:

Quick ratio measures the firms’ ability to honor short term liabilities. The firms’ ability
decreases in 2017 but it increases in 2018.

Ratio (times) 2018 2017 2016

Quick ratio 0.56 0.39 0.53

3. Debt to equity:

It measure of a company's financial leverage calculated by dividing its total liabilities by

stockholders' equity. It indicates what proportion of equity and debt the company is using
to finance its assets.

Ratio 2018 2017 2016

Debt to equity 3.31 2.88 5.20

12
 4. Equity to total assets:

A ratio used to help determine how much shareholders would receive in the event of a
company-wide liquidation. It represents the amount of assets on which shareholders have
a residual claim. The following results indicate that the shareholder receive less than
2017 in 2018.

Ratio 2018 2017 2016

Equity to total assets 0.23 0.26 0.16

5. Debt to total assets:

-A low ratio of debt to total assets is also always desirables. The firm is unable to ensure
its total debt to total assets ratio in 2018 than other years.

Ratio 2018 2017 2016

Debt to total assets 0.77 0.74 0.84

Impact of capital structure on Financial Leverage

Since BSRM is mostly financed by equity the long term stronger solvent position of the
company is expected. But the ratio of the current solvency depicts that the short term solvency of
the firm is not much satisfactory. The major reason behind the unexpected short term solvency is
that the firm uses a great amount of short term debt. Excessive use of short term loan breeds the
debt portion 3 to 5 times higher than assets. At the same time the receipt of shareholders on
liquidation becomes lower because of much short term loan use.

13
Measurement of EPS Trends.

From the financial statements of BSRM following table is prepared to present the trend of EPS.
To prepare the table summarized data of years 2015 to 2018.

Year 2015 2016 2017 2018

EPS 2.42 1.17 1.25 1.18

Using the summarized data of table following trend line is presented to analyze the trend of EPS
gained by the company during these four years –

EPS
3
2.5
2
1.5
EPS
1
0.5
0
1 2 3 4

EPS measurement is a yardstick to measure the successiveness of capital structure a firm applies.
Positive EPS maintained by BSRM for the last four years depicts that the company’s finance mix
was a successive catalyst to gain attractive EPS. On the other hand the trend of EPS during these
years was on decreasing turn. At the beginning year the EPS was 2.5 which faced continuous
decrease on following years.

14
 Chapter: 05 PESTEL Analysis

PESTEL analysis:

Pestal analyses is a widely used tool to analyze the Political, Economic, Socio-cultural,
Technological, Environmental and legal situations which can provide great and new
opportunities to the company as well as these factors can also threat the company, to be
dangerous in future.
Pestal analysis is very important and informative. It is used for the purpose of identifying
business opportunities and advance threat warning. Moreover, it also helps to the extent to which
change is useful for the company and also guide the direction for the change. In addition, it also
helps to avoid activities and actions that will be harmful for the company in future, including
projects and strategies.

Political:

The political scenario matters greatly as there can be some civil unrest in certain markets or due
to inflation the sales of the product can fall. Most importantly, cross border situations are starkly
different therefore BSRM has to stay in line with all those policies and changes so that they can
adapt to all those changes accordingly. Besides that billion developing-country rod market was
witnessing in-creased penetration by Bangladeshi companies. In most market, Non-Bangladeshi
companies tended to be smaller and therefore fewer strong brands so therefore it was huge
opportunity for BSRM.

Economical:

In BSRM favor, the economic downturn that started in 1998 resulted in increased sales of its
rods mainly as people were being laid off from jobs, corporate which are potential customer of
BSRM Product.

Economic trends influence Tonka’s organizational development. The PESTEL analysis

determines the effects of economic situations or changes on business. Economic factors that
BSRM should consider while conducting PESTEL analysis are –

 Economic growth rate

 Unemployment rate

 Inflation rate
15
  Interest rates

Social:

Social factors greatly impact BSRM. Society’s culture and way of doing things impact the
culture of an organization in an environment. BSRM has to keep in line with those culture in
order to understand their market and how they can cash upon the opportunity.

Technological:

With the advent of the new age in technology, companies have completely integrated themselves
with all the recent changes that have taken place. To mention a recent trend that has greatly
picked up and something that almost every business is turning toward is Social Media. The social
media explosion has allowed for increasingly interactive engagement with the consumers with
real time results so Corporation has to stay ahead of all the developments that take place with
keeping in view how the youth of today utilizes technology for their benefit and how can
Corporation reach them in order to keep on increasing brand recall and brand engagement.
BSRM can also exploit the opportunities to other things.

Environmental:

Environmental factors can affect BSRM, but not immensely alter its trade and profit generation
as these factors affect agri-businesses much more directly.

16
 Chapter 06: Factors affecting capital structure of BSRM
Adequacy or Inadequacy of the capital structure of BSRM is set by several factors for years.
These factors are analyzed and determined through the observation of financial statements of
years 2016 to 2018. Determinants found in analysis are summarized through the following heads:

Corporate Tax: Tax payment by BSRM was seen very minimal throughout the years. While tax
payment was not very larger that’s why BSRM didn’t need much long term debt in finance mix
to get the tax shield.

Interest Payment: Interest payment during the three years was higher than cost of equity.
Higher cost of debt drove the choice of decision maker to apply equity finance more than debt
financing. Since higher cost of capital would deteriorate the profitability of the firm, therefore
the financing decision makers preferred equity financing in the long term capital mix.

Control: It was observed from the last three year financial data that there was a consistent
amount share capital during those years. The reason behind a consistent equity capital implies
the intension of the existing shareholders to lose the control of the company to other parties
hinders the issuance of new share capital.

Working Capital Need: To operate the vast business operations BSRM required a gigantic
figure for working capitals. To meet the need of huge working capital BSRM borrowed a large
bulk of short term loan during the years of 2016 to 2017. This application of short term loan in
wider range causes the company to pay quite a larger bulk of interest payment than other
expenses.

17
 Chapter 07: Problems of BSRM found in analysis
1. Last three year’s EPS was positive but no improvement was occurred in turning the trend
to make an upward trend in EPS.
2. Excessive use of short term loan made interest expenses of BSRM a massive figure every
year.
3. Need of larger amount of capital work in process is another major problem for business
operation of BSRM.
4. Financial statements of BSRM for last three years shows that the company depreciates
too much on fixed assets which lessen the profit occurred from operation.
5. The Gross profit of the firm increases in 2018 than 2017 and 2016.but is not satisfactory
level. The profit increases only a little bit than other year.
6. The cost of sales is so much higher comparing to the sales. The cost of sales may reduce
by ensuring efficient management system.
7. In fact, the overall profitability of the firm decreases because the net profit of the firm
decreases in each year. From 2016 to 2018 the net profit decreases. As a result, the
profitability ratio also decreases.
8. From 2016 to 2018, the current ratio increases each year. It means that the firm has more
investment in current assets than fixed assets. It is also another reason for decreasing
profitability.
9. The portion of equity of the firm is not enough comparing to the total assets. It is the
major reason to decrease its net profit.
10. The firm has more short term borrowing than the average. For huge amount of short term
borrowing, the firm has to pay huge amount of interest.
11. The Inventory of the firm consumes huge amount of investment. So the firm cannot
invest this amount in other sources. As a result, the profitability decreases. This amount
can be reduced by efficient management.

18
 Chapter 08: Recommendation and Conclusion
Recommendation

BSRM should increase the long term loan which will limit the excessive interest payment during
the years. By issuing long term commercial papers it can introduce a new era of long term source
of finance. Analysis of past financial data shows that the company has need of more issuance of
preferred and common share capital to strengthen the solvency base. The management concern
of BSRM has to pay more attention to wipe out the flaws exist on the way of improving ratio of
performance.

CONCLUSION

From the analysis of BSRM it can be summarized that the company follows traditional theory.
Therefore BSRM should use leverage up to a certain level where cost of capital is lowest and
value of firm is higher. Long term loan inclusion in capital structure would improve the solvency
base of the company and lessen the interest charge for BSRM. Impact of capital structure can be
better understood by the EPS position of the company. Year’s data of BSRM shows that it had
several positive EPS every year. But there was a down turn in EPS trend during past years.
Therefore attempts should be taken to improve the EPS trend for BSRM.

19
 REFERENCE
 BSRM, (2018), vision and values. [online] Available at http://www.bsrm.com/, Accessed
on 26th June, 2018.
 BSRM, (2018), Consolidated Statements. [online] available at
http://www.bsrm.com/financialinfo.php Accessed on 29th June, 201.
 Boundless, Capital structure overview and theory, [Online] available
athttps://www.boundless.com/finance/textbooks/boundless-finance-textbook/capital-
structure-13/introducing-capital-structure-104/capital-structure-overview-and-theory-
446-3785/ , Accessed on 1st July, 2018.
 Net MBA, Financial Ratios, [online] available at
file:///C:/Users/SoftPc/Desktop/Capital%20structure/Financial%20Ratios.htm, Accessed
on 5th July, 2018.
 William H. lough, 2010, Business Finance

 CIMA, financial Information in decision making [online] available from

www.cimaglobal.com (accessed: 24th July, 2018)

 ROSS, WESTERFIELD, JORDAN(2003),Fundamentals corporate finance,standard

publication, TaTa McGraw-Hill.

 BRIGHAM & HOUSTOM, (2007-2008),Fundamentals of financial management,tenth

edition, Thomson publication.

 LAWRENCE J. GITMAN (2009-20100, managerial finance, twelfth Edition, Pearson

Pentice Hall publication.

 Richard A. Brealey, Stewart C. Myers and Franklin Allen, 2007, Principles of corporate
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 Michel Schoolser, 2002, Business Finance: Applications, Models and cases, FT/Prentice
Hall.

20
 Appendix

Name Formula 2018 2017 2016

of
ratio

1 Gross (Gross 1274989521 1115867080 966714330

( )×100 ( )×100 ( )×100
profit Profit/Net 10263937825 9898974934 11302986831

margi sales)×100
n

2 Net (Net 404943766 429026819 382783747

( )×100 ( )×100 ( )×100
profit Profit/Net 10263937825 9898974934 11302986831

margi sales)×100
n

3 Retur (Net Profit 404943766 429026819 382783747

( )( )( )
n on after (34211348938+28155426318)/2 (26674582620+26806583326)/2 (22682510549+24125358757)/2

assets tax/Average ×100 ×100 ×100

(ROA Total
) Assets)×100

4 Retur (Net 404943766 429026819 382783747

( )×100 ( )×100 ( )×100
n on Profit/Total 7936824419 6878273660 3658768659

equity Equity)×100
(ROE
):

5 Curre (current 24082127514 16634161292 15921132839

Assets/Curren ( ) ( ) ( )
nt 24440045974 18452333369 17073489483
ratio t Liability)

6 Quick (Current 13642157244 7105125437 8996497530

ratio Assets – ( ) ( ) ( )
24440045974 18452333369 17073489483
Inventory)/Cu
rrent Liability

21
7 Debt (Total 26274524519 19796308960 19023741890
Debt/Total ( ) ( ) ( )
to 7936824419 6878273660 3658768659
equity Equity)

8 Equit ( Total 7936824419 6878273660 3658768659

Equity/Total ( ) ( ) ( )
y to 34211348938 26674582620 22682510549
total assets)
assets

9 Debt (Total Debt/ 26274524519 19796308960 19023741890

Total assets) ( ) ( ) ( )
to 34211348938 26674582620 22682510549
total
assets

Note 1: Long term loan and share capital is included in measuring capital structure trend. short
term loan is excluded from finance mix considering the short term loan as working capital.

22