Company’s Introduction
Discuss about the Study Of Capital Structure Of Selected Manufacturing.
With the increasing market competition, business entity aims to optimise their financial position to ensure their survival in the existing market with minimum financial cost (Elmagrhi and etal. 2018). Harvey Norman has been considered for this assignment to analyse the corporate financial structure of an enterprise to beat all its competitors operating in a similar market. Strategies can craft by the firm by analysing its own financial performance to launch new products to grab the attention of the majority of its users. This assignment will include the determination of the weighted average cost of capital of the company to test its capability in comparison with its rivals and also check the calibre of the overall capital structure prepared by the firm. In addition to this, the weighted average cost of capital is also included in the study supported by the calculation of gearing ratios of this entity to know the fluctuating level of an entity. With the help of capital structure theories, the judgment about the corporate structure of the business concern is analyzed in the current project report.
Harvey Norman is a transnational retailer firm of Australia deals in various products such as furniture, beds, electronics items and all consumer household items. This firm is listed under Australian stock exchange to provide the benefits of the market and its volatile nature. This brand distributes its franchisees among all the users in domestic as well as in the international market and enjoys the royalty for giving franchisee to all the businesses all across the globe. As per the market study of Australia for the year 2016, 280 companies from different parts of the earth owned the franchisees of Harvey Norman includes countries like Australia, New Zealand, Europe, South East Asia (Harvey Norman, 2018). Gerry Harvey and In Norman generate an idea for opening the collaboration of both their surnames into Harvey Norman and created a global brand by distributing its franchisees to mark its presence in all across the globe.
The cost of equity of Harvey Norman is 43.40% which is determined by applying CAPM Model (Appendix 1.1)
Risk free rate- 2.78 %( Appendix 1.1)
Risk Premium- 6.97%
Beta- 9.86(Appendix 1.1)
An entity uses dividend growth model and return on equity model to test the capability of an entity in paying dividend out of the earnings of the business (Appendix 2.1)
Findings
Evaluating Dividend 1
Dividend 1 is determined by using the formula Div1 (1+g) (Appendix 2.1)
Dividend Growth rate
Dividend growth rate of Harvey Norman is determined by including interim as well as final dividend by applying the formula (Appendix 2.1)
Cost of Debt = Interest Expense/ Total Debt (Appendix 1.2)
WACC= Cost of equity* Value of equity/ (Debt+equity) + Cost of debt*(1-0.45)*Value of Debt/ (Debt+equity) (Appendix 3.2)
The weighted average cost of capital is a technique used by an entity to know the financial performance of an entity for a particular financial year. This also shows the fluctuations takes places in the entire capital structure of an entity (Broccardo, Tibiletti and Vilpas, 2018). This tool helps in assessing all the components included in a capital structure of an entity by determining the costs of equity and debt used in a business to deal with all the expenditures incurred in a business (Weighted average cost of capital, 2018).
Weighted average cost of Harvey Norman is 10.522% is considered as the higher weighted average cost of capital due to higher costs of equity as compared to overall costs of debt of an entity (Capital asset pricing model, 2018). Cost of equity is 7.80%, and cost of debt is 4.03% that means equity of this company is 3.5% higher than the overall equity held by a firm. An entity is required to decrease the equity component in comparison with the debt component. Debt is the cheapest source of fiancé as against the equity as a source of finance. Raising equity is costly in contrast to issue of debentures and taking a bank loan (Mari and Marra, 2018). Both in bank loan and taking debenture as a source of finance, an entity will require paying interest on the amount taken by the firm from its lenders. But this case is different in equity where the firm will issue equity shares and in exchange of this will give ownership rights to all the equity shareholders as a part of their company by giving voting rights and share in the excess profits earned by the firm in a financial year.
The risk is also associated with the increasing or decreasing proportion of both the equity and debt components in the overall capital structure of an entity. Debt has lower risks as against the equity source of finance as this consists of higher risks in an entity. An entity bears a lot of burden in terms of overall costs associated with the inclusion of equity. The current condition of Harvey Norman is not good as its weighted average cost of capital needs to be improved by decreasing the amount of equity. The current amount of debt is 330 and equity is 2790 that means the equity is 2460 more than the debt that needs to be balanced to decrease the overall costs associated with it.
Gearing ratio is a tool used by an entity to measure the capability of an entity to take the load of the entire debt component held in a business. This ratio tests the gearing effect of the company to analyze the corporate structure of an entity. Debt to equity ratio helps in measuring the financial performance of an entity within a given period (Johan, 2018). This ratio includes two elements such as long-term debt and the equity component. This ratio tells the segmentation of equity in paying off the overall equity held in a business which needs to be payable by the firm within a stipulated time period to overcome all the liabilities incurred in an entity as their motive is to accomplish all the financial goals and the objectives.
Debt to equity= Total Debt/Total equity (Appendix 5)
The debt equity ratio of Harvey Norman is 0.11 as which is better position of an entity as it debt is lesser than the available equity held by an entity.
Debt Ratio= Total Debt/Total asset (Appendix 5)
Debt ratio is 0.07 which shows the lower amount of debt in comparison with the total assets held by Harvey Norman.
Equity Ratio= Total equity/ Total asset (Appendix 5)
Equity ratio shows the utilization of equity in building the total assets of an entity as this ratio is 0.66 which shows that the amount of assets is overpower the overall equity.
TIE= EBIT/Interest Expense (Appendix 5)
It checks the capability of an entity in paying off its interest out of the overall earnings of an entity.
Gearing ratio of Harvey Norman is 0.11 is good as the component of debt is manageable by the firm as the amount of equity is higher than the overall debt by an enterprise. This shows the efficiency of an entity as debt amount is lower, but at the same time, it possesses lower risks in contrast to the equity component held by a business which needs to be decreased.
Capital structure is a framework uses by an entity which includes two important components such as debt and the equity sources of finance to meet the funding requirements of the business (Dewi, Amboningtyas and Paramita, 2018). The operations of an enterprise will get easy by using the stabilizing and balancing capital structure which helps in achieving all its goals and the objectives within a stipulated time period. The proportions of debt and equity used by an individual will help in determining the capability of an entity in paying off all its capital expenditures incurred in an entity and also meeting all the financial uncertainties of an entity.
Every entity aims for adopting an optimal capital structure where there is a balance among both the debt and the equity components which will results in the increasing or decreasing the weighted average cost of capital. Debt and the equity components collectively consider as a total asset of an entity (Siqueira, Guenster, Vanacker and Crucke, 2018). The increasing or decreasing component of debt in a capital structure will directly affect the leverage ratio of the business. The involvements of debt in a capital structure possess lower risks, and on another hand, equity possesses higher risks as in this ownership is diluted.
The capital structure of Harvey Norman has higher risks due to a higher component of equity as compared to the overall long-term debt held by an entity.
It is recommended to Harvey Norman to improve its current capital structure which is fully surrounded by the risk of equity as the equity component is higher than the overall debt component held in a business.
7.1 Comparison to Industry
The increasing amount of equity needs to be decreased by at the same time a source of debt needs to be increased to stabilize the overall position of the capital structure. An entity needs to adopt Net income approach in which the increasing amount of debt will result in the decrease in the costs of debt.
7.2 The Conservative Approach
The narrow approach followed by Harvey Norman as the capital structure of an entity is 10: 90 (Debt: Equity) which require firm to use buy-back share option to increase the component of debt in comparison with the equity.
7.3 The aggressive approach
The debt ratio of Harvey Norman is increasing from one period to another reflects the overall performance of the company in paying off its debt by using the equity. In 2015, the debt-equity ratio of the company is 11.4% which gets increased to 11.8 in 2017 shows the increasing component of equity.
Conclusion
It summarises from the above study that Capital structure of Harvey Norman is not stable as due to the increasing component of equity, it is covered with higher risks which are affecting its overall corporate performance. The gearing ratio of the firm is higher as the firm’s efficient enough to pay off all the debt incurred by an entity. An entity is proposed to use the net income approach to overcome its current situation as it results in the increasing performance of the firm in front of its competitors.
References
Books and journals
Bao, M.X., Billett, M.T., Smith, D.B. & Unlu, E., (2018). Does Incremental Other Comprehensive Income (OCI) Volatility Affect the Cost of Debt, Capital Structure and Credit Ratings?.
Bhardwaj, A., (2018). Financial Leverage and Firm’s Value: A study of capital Structure of Selected Manufacturing Sector Firms.
Broccardo, L., Tibiletti, L. & Vilpas, P., (2018). A Scorecard to Detect Financial Leverage Profitability. International Journal of Business and Management. 13(3). p.244.
Dewi, D. K., Amboningtyas, D. & Paramita, P. D., (2018). THE OPTIMIZE INFLUENCE OF FIRM SIZE, CAPITAL STRUCTURE, AND FINANCIAL RATIO TO COMPANY VALUE IS MODERATED BY DIVIDEND POLICIES ON SECTOR A VARETY OF INDUSTRY COMPANIES LISTED IN INDONESIA STOCK EXCHANGE PERIOD OF 2012-2016. Journal of Management. 4(4).
Elmagrhi, M., & et.al., (2018). Trustee Board Diversity, Governance Mechanisms, Capital Structure and Performance in UK Charities.
Johan, S., (2018). The Relationship Between Economic Value Added, Market Value Added And Return On Cost Of Capital In Measuring Corporate Performance. Jurnal Manajemen Bisnis dan Kewirausahaan. 3(1).
Mari, C. & Marra, M., (2018). Valuing Firms Under Default Risk and Bankruptcy Costs: A WACC-Based Approach. International Journal of Business. 23(2).
Siqueira, A. C. O., Guenster, N., Vanacker, T. & Crucke, S., (2018). A longitudinal comparison of capital structure between young for-profit social and commercial enterprises. Journal of Business Venturing.
Tanha, H., Dempsey, M. & Labeb, M., (2018). Derivatives Usage by Australian Industrial Firms: Pre-, during and post-GFC. Review of Economics & Finance. 11. pp.31-39.
Online
Beta of Harvey Norman, (2018). Available through: < https://www.infrontanalytics.com/fe-en/30032AA/Harvey-Norman-Holdings-Ltd/Beta > [Accessed on 11th May 2018].
Capital asset pricing model, (2018). Available through: < https://www.wallstreetmojo.com/cost-of-equity-capm/> [Accessed on 11th May 2018].
Capital structure theories, (2018). Available through: < https://www.yourarticlelibrary.com/financial-management/capital-structure/top-4-theories-of-capital-structure-with-calculations/65449> [Accessed on 11th May 2018].
Capital structure, (2018). Available through: < https://corporatefinanceinstitute.com/resources/knowledge/finance/capital-structure-overview/> [Accessed on 11th May 2018].
Government bond yields, (2018). Available through: < https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia> [Accessed on 11th May 2018].
Harvey Norman Holdings Ltd, (2018). Available through: < https://financials.morningstar.com/balance-sheet/bs.html?t=HVN®ion=aus&culture=en-US> [Accessed on 11th May 2018].
Harvey Norman, (2018). Available through: < https://www.harveynorman.com.au/ > [Accessed on 11th May 2018].
Market rate of Harvey Norman, (2018). Available through: < https://www.marketwatch.com/investing/stock/hnory> [Accessed on 11th May 2018].
Weighted average cost of capital, (2018). Available through: < https://www.educba.com/wacc/> [Accessed on 11th May 2018].
Harvey Norman stock price, 2018. Available through: < https://www.bloomberg.com/quote/HVN:AU> [Accessed on 14th May 2018].
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