FM Case Study - 3
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Transcript of FM Case Study - 3
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Financial Leverage, earnings and
dividend To maximize owners wealth the finance manager needs to pay
attention on investment, financing & dividend decision.
Investment Decision: decisions regarding allocation of limitedresources among different projects.
Financing Decisions: decisions regarding sources from where funds
can be raised for the firm.
Dividend Decisions: decisions regarding what amount out of the
earnings to be distributed as dividend among the shareholders and
what amount to be retained for the firms growth.
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Financial Leverage
concerned with the financial activities involving raising fundsfrom sources for which the firm has to bear a fixed charge.
Includes long term debt like bonds, debentures.
Shows the effect of change in EBIT on EPS. It is calculated as
follows:
= % %
when change in the level of activity
=
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Earnings Per Share
The reward for an investor for making
investment.
It is calculated as follows:
=&
.
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Dividend Per Share
The amount paid as dividend for each share issued.
It is calculated as follows:
=
.
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Bharat Heavy Electricals Ltd. (BHEL)
Company Profile:
Paid-up capital Rs. 2448 million
Turnover of Rs. 66,340 million in 1999-2000 Investment on plan capital programs
Enhancing competitiveness by reducing time
& cost, improving quality & tapping newopportunities in the environment.
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Research Study
Objectives:
Study the methods of raising finance & financial leverage
practice of the company.
Examine the impact of financial leverage on EPS.
Know about the dividend policy of the company.
Assess the inter relationship between DFL, EPS and DPS.
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Research Design and Methodology
Collection of Data:The data have been collected from the annualreports of the company and compiled as per the requirement of the
study.
Period of study:1993-1994 to 1999-2000
Technique of analysis:The data has been converted into relativemeasures such as ratios & percentages rather than absolute one.
For analyzing the degree of association between DFL, EPS & DPS,
Pearsons correlation analysis has been applied.
The t test has been used judge whether the calculated correlation co-
efficient are significant or not.
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Testing of Hypothesis
1. Company uses debt as a cheaper source of
finance than equity.
Year DFL EPS DPS DPR(%) Interest(%) Kd (%) Ke (%) Rate of return oninvestment
1993-94 1.34 5.6 1.5 27 7.9 4.7 3.6 5.7
1994-95 1.28 5.8 1.5 26 9.6 5.8 3.2 6.3
1995-96 1.19 14.3 2 14 12.8 7.7 3.3 14.8
1996-97 1.18 18.9 2.2 12 18.4 11 2.8 16.6
1997-98 1.05 29.4 2.75 9 15.3 9.1 2.6 24.1
1998-99 1.03 22.3 2.77 12 18.6 11.2 2.2 16.7
1999-00 1.02 24.5 3.49 14 9 5.4 2.5 16.6
Result: Debt is not used as a cheaper source of finance by the company.
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2. Company is enable to earn a higher rate of returnon investment than the cost of financing
investment.Year Total Capital
Employed Long termdebt Equity sharecapital1993-94 23941 13839 2448
1994-95 22304 10760 2448
1995-96 23707 8822 2448
1996-97 27888 8640 2448
1997-98 29846 3896 2448
1998-99 32526 1701 2448
1999-00 35985 2407 2448
Year DFL EPS DPS DPR(%) Interest(%) Kd (%) Ke (%) Rate of return oninvestment Cost of capital
1993-94 1.34 5.6 1.5 27 7.9 4.7 3.6 5.7 4.5
1994-95 1.28 5.8 1.5 26 9.6 5.8 3.2 6.3 5.3
1995-96 1.19 14.3 2 14 12.8 7.7 3.3 14.8 6.71996-97 1.18 18.9 2.2 12 18.4 11 2.8 16.6 9.2
1997-98 1.05 29.4 2.75 9 15.3 9.1 2.6 24.1 6.6
1998-99 1.03 22.3 2.77 12 18.6 11.2 2.2 16.7 5.9
1999-00 1.02 24.5 3.49 14 9 5.4 2.5 16.6 3.9
Result: Rate of return on investment is greater than the cost of financing investment.
EAT1369
1409
3502
4632
7195
5446
5994
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3. DFL & EPS are positively correlated.
Year DFL EPS DPS DPR(%) Interest(%)1993-94 1.34 5.6 1.5 27 7.9
1994-95 1.28 5.8 1.5 26 9.6
1995-96 1.19 14.3 2 14 12.8
1996-97 1.18 18.9 2.2 12 18.4
1997-98 1.05 29.4 2.75 9 15.3
1998-99 1.03 22.3 2.77 12 18.6
1999-00 1.02 24.5 3.49 14 9
Result: DFL & EPS are negativelycorrelated.
Correlation between DFL & EPS -0.94
Year Total CapitalEmployed Long termdebt Equity sharecapital Reserves &surplus Net worth EBIT Interest EBT Dividend EAT
1993-94 23941 13839 2448 7654 10102 4269 1096 3173 367 1369
1994-95 22304 10760 2448 9096 11544 4690 1039 3651 367 1409
1995-96 23707 8822 2448 12437 14885 6952 1129 5823 490 3502
1996-97 27888 8640 2448 16800 19248 10235 1591 8644 539 4632
1997-98 29846 3896 2448 23502 25950 10813 596 10217 673 7195
1998-99 32526 1701 2448 28377 30825 9640 317 9323 679 5446
1999-00 35985 2407 2448 31130 33578 8871 217 8654 853 5994
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4. DFL is positively correlated with DPS.
Year DFL EPS DPS DPR(%) Interest(%)1993-94 1.34 5.6 1.5 27 7.9
1994-95 1.28 5.8 1.5 26 9.6
1995-96 1.19 14.3 2 14 12.8
1996-97 1.18 18.9 2.2 12 18.4
1997-98 1.05 29.4 2.75 9 15.3
1998-99 1.03 22.3 2.77 12 18.6
1999-00 1.02 24.5 3.49 14 9
Result: DFL & DPS are negativelycorrelated.
Correlation between DFL & DPS -0.95
Year Total CapitalEmployed Long termdebt Equity sharecapital Reserves &surplus Net worth EBIT Interest EBT Dividend EAT
1993-94 23941 13839 2448 7654 10102 4269 1096 3173 367 1369
1994-95 22304 10760 2448 9096 11544 4690 1039 3651 367 1409
1995-96 23707 8822 2448 12437 14885 6952 1129 5823 490 3502
1996-97 27888 8640 2448 16800 19248 10235 1591 8644 539 4632
1997-98 29846 3896 2448 23502 25950 10813 596 10217 673 7195
1998-99 32526 1701 2448 28377 30825 9640 317 9323 679 5446
1999-00 35985 2407 2448 31130 33578 8871 217 8654 853 5994
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5. EPS is positively correlated with DPS.
Year DFL EPS DPS DPR(%) Interest(%)1993-94 1.34 5.6 1.5 27 7.9
1994-95 1.28 5.8 1.5 26 9.6
1995-96 1.19 14.3 2 14 12.8
1996-97 1.18 18.9 2.2 12 18.4
1997-98 1.05 29.4 2.75 9 15.3
1998-99 1.03 22.3 2.77 12 18.6
1999-00 1.02 24.5 3.49 14 9
Result: EPS & DPS are positivelycorrelated.
Correlation between EPS & DPS 0.89
Year Total CapitalEmployed Long termdebt Equity sharecapital Reserves &surplus Net worth EBIT Interest EBT Dividend EAT
1993-94 23941 13839 2448 7654 10102 4269 1096 3173 367 1369
1994-95 22304 10760 2448 9096 11544 4690 1039 3651 367 1409
1995-96 23707 8822 2448 12437 14885 6952 1129 5823 490 3502
1996-97 27888 8640 2448 16800 19248 10235 1591 8644 539 4632
1997-98 29846 3896 2448 23502 25950 10813 596 10217 673 7195
1998-99 32526 1701 2448 28377 30825 9640 317 9323 679 5446
1999-00 35985 2407 2448 31130 33578 8871 217 8654 853 5994
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