THE EFFECT OF CAPITAL STRUCTURE ON CORPORATE PERFORMANCES (A CASE STUDY OF SELECTED COMPANIES IN

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ABSTRACT

This study 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 Ughelli, Delta 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 this 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.

The recommendations for the study among others were:

That company 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.

The researcher then concludes that:

The inability of many companies to adopt optimal capital structure has been increasing their cost of capital.
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 profitability.
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.

CHAPTER ONE

Background to the Study – – – – – – 1

Statement of the problem – – – – – – 4

Purpose of the study – – – – – – – 6

Research hypothesis – – – – – – – 6

Significance of the study – – – – – – 8

Scope and limitations – – – – – – 9

Definition of terms – – – – – – – 10

References – – – – – – – – 12

CHAPTER TWO

Literature Review – – – – – – – 12

Introduction – – – – – – – – 13

The concept of capital structure – – – – 13

Security valuation – – – – – – – 22

Review of previous studies – – – – – 23

Theoretical foundation – – – – – – 35

The Net Income Approach – – – – – – 40

The Net Operating Income Approach – – – – 41

The Modigliani-Miller Hypothesis (1958) – – – 43

The Traditional Approach – – – – – – 47

References – – – – – – – – 50

CHAPTER THREE

Research Design and Methodology – – – – 51

Sources of data – – – – – – – 51

Primary data – – – – – – – – 52

Questionnaire Method – – – – – – 52

Interview Method – – – – – – – 55

Secondary data – – – – – – – – 56

Population size – – – – – – – – 57

Data treatment and analysis – – – – – 58

References – – – – – – – – 59

CHAPTER FOUR

Data Presentation and Analysis – – – – 60

Questionnaires analysis and presentation – – – 60

Data analysis and presentation – – – – – 80

Test and prove of hypothesis – – – – – 81

CHAPTER FIVE

Summary, Recommendation and Conclusion – 91

Summary of findings – – – – – – – 91

Recommendations – – – – – – – 92

Conclusion – – – – – – – – 93

Definitions of terms – – – – – – – 94

Bibliography – – – – – – – – 96

Appendix – – – – – – – – – 99

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

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 corporation 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”.

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.

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,

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