Section III-Company Policies

Capital structure

Capital structure refers to the long-term asset mix of the firm, i.e. the mix of equity capital and debt capital. It shows the long-term sources of funds for the firm and is one of the major concerns of the finance manager.

And the capital structure of Renata pharmaceuticals is as follows-

Figure 2 CAPITAL STRUCTURE OF RENATA LIMITED

 Dividend policy

Dividend means any distribution of the earnings of the firm to its stockholders that result in a cash inflow to the investors. Dividend can be of many forms; i.e. cash dividend, liquidating dividend, stock dividend etc.

Dividend policy refers to making decisions on whether to pay dividend or to retain earnings and if pay dividend, then the amount and timing of dividend. Since dividend represents a cash flow to the shareholders from the firm, the manager have to pay careful attention to this policy.

Usually profitable and high growth firms pay less dividend as they have to retain earnings for investing in growth opportunities. But contrary to that, Renata limited have been paying quite high rate of dividend although enjoying a high growth. The historical dividend pattern of the firm is as follows-

The dividend pattern of the company can be better understood form the following charts:

Figure 3 CASH AND STOCK DIVIDEND OF RENATA LIMITED (PER SHARE)

Figure 4 TOTAL DIVIDEND PAYMENTS BY RENATA LIMITED (PER SHARE)

Market capitalization

Market capitalization refers to the market value of total outstanding shares of a firm. It is calculated by multiplying share price with number of outstanding shares. Since share price is the indicator of performance of a company, market capitalization is very important in determining the value of the firm.

The historical market capitalization of Renata limited is as follows-

Figure 5 historical market capitalizations

Debt financing & Financial risk

From our study of the firm, we have found that the company has enjoyed significant growth and its profitability is quite good. Since profitable firms use less debt as they have greater internal financing, we expect the firm to use less debt in its capital structure. Again, since growth offsets the tax advantage of debt, this also strengthens the argument for using less debt financing. As a result, we see that the firm stayed UNLEVERED for years 1997-2001 and 2004. And in 2003 and 2002, when the company changed its capital structure from Unlevered to Levered the amount of debts was very small in relation to equity.

However, we have found that the company depends quite heavily on short-term debts for operations. And since debt create financial risk, it is important to identify the level of financial risk of the company as these plays an important role on value of the firm.

Here for determining financial risk level of Renata limited, we are using Altman’s z-score model that provides an index of possibility of bankruptcy. Since Renata is a manufacturing company, the appropriate formula for determining the z-score will be-

Z-score = 3.3*(EBIT/Total assets)+1.2*(Net working capital/Total assets) + 1.0*(Sales/Total assets) +0.6*(Market value of equity/Book value of debt) +1.4*(Accumulated retained earnings/Total assets)

Using this formula, the z-score for Renata limited is determined below-

Decision:

1. if z-score is more than 2.99, it predicts no bankruptcy.
2. if z-score is between 1.23 and 2.99, it states that the firm possesses some possibility of being bankrupt.
3. if z-score is less than 1.23, it predicts a certain bankruptcy.

Our conclusion:  here the z-score of the firm has always been greater than 1.23 and increased over the years and finally have surpassed the 2.99 level. So, we can say that the firm has improved its position and has reduced costs of financial distress over the years.

Renata Limited: Ratio Analysis

Calculation of ratios

Interpretations:

Net profit ratio: the net profit ratio shows the proportion of sales revenue that the company earns as net profit. The more the profit is the better is the company’s profitability and efficiency. Although the pharmaceuticals industry is enjoying a high growth, it also observes a hard competition among companies. As a result, much of the company’s earnings are spent for marketing purposes. Keeping this point in mind, we find the company in quite a profitable position.

1. Return on equity: it shows the percentage of return shareholders gets for each Tk. of earnings. Here the ratio shows that the company is improving its position year by year and the shareholders are expected to get more in the coming years
2. EPS ratio: the EPS ratio states the per share earnings to an investor. The greater the ratio is, the better will be the company’s position. Here we see that the company has increased its EPS ratio from 45.80% in 1998 to 260.8% in 2004. So the firm has maximized its value over the years
3. PE ratio: it shows by how many times price of the shares exceeds earnings per share. The greater the ratio the better the company’s financial position. Due to market changes the ratio of the company dropped to near, 4 during 2002 but the company regained and improved it ratio during 2004.
4. Debt equity ratio: it shows the financial structure of the company Here the company’s ratio shows that the company stayed UNLEVERED for years 1996-2001 and year 2004. And in 2002-2003, the company’s total debt is very small than total equity. So, the company can use its borrowing capacity for further expansion and thus try to maximize firm value.
5. Times interest earned: it shows the company’s ability to meet interest payments. And Renata’s TIE ratio states that the company now generates enough money to cover interest payments and indicates the firm’s ability to bear more debt.
6. Return on assets (ROA): it shows how much the investor of the company is earning as return from investing on firm’s assets. This ratio is of particular interest to stakeholders in determining value of the firm. And the company’s ROA is fair in relation to the industry.
7. Assets turnover ratio: this states whether the company is earning enough to justify its assets. And from the ratio of Renata limited, we conclude that the company is earning enough to justify their assets.
8. Sponsor shareholding ratio; it shows the proportion of shares held by the sponsor. This is used to indicate the controlling position of the sponsors. If this ratio is more than needed to control the firm, it provides an indication of less agency costs. Here, the ratio for Renata limited is 51%, which indicates that the sponsors are controlling the firm activities, which in turn, asserts less agency costs to the company.

Firm value

According to the pie model, firm’s value = value of shares + value of debt + tax + cost of financial distress.

Using this model, the value of Renata limited is determined below-

Firm value components

Figure 6 COMPONENTS OF VALUE OF RENATA LIMITED

Here b₁ = -98.4223 implies that, for 1 % change in debt equity ratio, PE ratio will change inversely by 98.4223%.

b₂ = -1.4534 implies that for 1% change in TIE ratio, P E ratio will change inversely by 1.4534%

b₃ = 33.3676 implies that for 1% change in AT ratio, P E ratio will change by 33.3676%

The F statistic for regression of P-E ratio on D-E ratio, TIE ratio and AT ratio is 2.519987. And the significance of F statistic is 0.233897, which is more than 5% significance level. Therefore, the results from regression model are statistically not significant. Therefore, we can conclude that the P-E ratio of Renata limited is not significantly influenced by D-E ratio, TIE ratio and AT ratio. And since P-E ratio reflects the value of the firm we can say that the value of Renata limited is not significantly influenced by the capital structure decision of the firm.

Findings:

From the above calculations, we have the following findings-

i. The capital structure decision of Renata limited has no significant impact on its profitability.

ii. Return on assets is significantly influenced by capital structure decisions. So, capital structure decisions are important to its stakeholders in determining value of the firm in terms of returns on assets.

iii. Capital structure decision has significant impact on return on equity. So, from the viewpoint of equity holders, capital structure decision affects firm value

iv. The price earnings ratio is not significantly affected by capital structure decisions. So, capital structure decisions have very little or insignificant influence on firm value, from the market perspective.

Our over view

In current business world, it is important to decide about  a firm’s capital structure and dividend policy in order  to achieve the goal of finance. And in case of making financial decisions, we must consider the possible impacts of these decisions on firm value.

Here we have tried to determine several financial aspects of Renata limited. We have also tried to focus on the impacts of financial decisions on firm value. As we have seen from our studies, the firm’s future prospect is quite bright as it enjoys good profitability and a high growth. Its market capitalization is growing @ 59.24% with an acceleration rate of 28.45%. besides, as it is a high growth profitable firm, we found that the firm uses very low level of debt occasionally. Again, due to efficient management of the company, its cost of financial distress is also less. Finally, through several analysis, we have found that the value of the firm is affected by its capital structure decision from the perspective of stakeholders but its profitability is not affected by such decisions.

So, we can say that  the capital structure decision of Renata limited has a significant impact on the value of the firm.

Bibliography

1. Ross, Westerfield, And Jaffe. “Corporate Finance”, 7^th Edition,, P-845-846.
2. Gitman, “Managerial Finance”.
3. Weygandt, Kieso, Kimmel, “Accounting Principles”, 6^th Edition, P-779.
4. Arens & Loebbecke, “Auditing: An Integrated Approach”,7^th Edition, P-198-202.

Glossary

• Business capital: business capital refers the amount of capital that a firm uses to conduct business. Usually it consists of paid up capital, net working capital, retained earnings, mid & short term loans and paid up preferred capital.
• Capital structure: the long-term assets mix of a firm, i.e. the mix of equity and debt capital.
• Dividend: any type of earnings distribution to shareholders that result in additional cash flow to shareholders.
• Market capitalization: total market price of outstanding shares
• Unlevered firm: firm that uses no debt capital.
• Levered firm: firm that uses debt in it’s capital structure
• Financial risk: risk of becoming unable to meet debt obligations.
• Costs of financial distress: risk of having financial distress due to debt financing
• Net profit ratio: net profit / turnover
• ROA : turnover/ total assets
• ROE: turnover / total equity
• EPS: earnings to shareholders / number of outstanding share
• PE ratio: price per share / earnings per share