ASSESSMENT OF CAPITAL STRUCTURE OF HUTCHISON WHAMPOA BASED ON

FUTURE FINANCING NEEDS

BY:-

TANIA ROY – 423

NITIN MEHROTRA – 425

TANMAY MEHTA –527

UTKARSH VASHISHTA – 528

SAHIL VOHRA - 530

WHAT IS CAPITAL STRUCTURE?

The term `capital structure' represents the total long-term investment in a business firm

Includes funds raised through ordinary and preference shares bonds debentures loans from financial institutions

Any earned revenue and capital surpluses are also included in the structure

CAPITAL STRUCTURE CONSTITUTES OF

CAPITAL STRUCTURE

DEBTS

BONDS DEBENTURES

EQUITY

ORDINARY & PREFERENCE

SHARES

RETAINED EARNINGS

CAPITAL STRUCTURE FOR AN ORGANISATION

Optimum capital structure should be planned in a manner that ensures that the market value of its shares is maximum

A number of factors influences the capital structure decision of a company and significant variations among industries and among' different companies

The judgment of the person or group of persons making the capital structure decision plays a crucial role

These factors are complex and qualitative as capital

markets are not perfect and the decisions have to be taken knowing consequent risks

FEATURES OF THE CAPITAL STRUCTURE

Planning is based on the interest of shareholders

To be determined at initial stage

Capital Structure decision is a continIous process

COMPONENTS OF CAPITAL STRUCTURE

THEREOTICAL

Profitability Flexibility Cost of capital Size of the company Marketability Control Cash Flow

ANALYTICAL

EBIT-EPS relationship ROI-ROE relationship Debt ratio Debt-equity ratio Total capitalization

ratio Interest coverage ratio

CASH FLOW

Conservatism related to the assessment of liability of fixed charges

Amount of fixed charges are high when large debt is employed

Debt should be raised only when provision for future cash flow exists

It is risky to employ sources of capital with fixed charges for companies whose cash inflows are unstable or unpredictable

SIZE OF THE COMPANY

Finds it difficult to raise long-term loans, available at a high rate of interest and on inconvenient terms

Restrictive covenants in loans make their capital structure quite inflexible

The management thus cannot run business freely

They have to depend on owned capital and retained earnings for their long-term funds

Greater degree of flexibility in designing its capital structure

It can obtain loans at easy terms and can also issue ordinary shares, preference shares and debentures to the public

Management can run business more freely

Small Companies Large Companies

CAPITAL STRUCTURE DECISIONTHE TARGET

Minimize the cost of capital

Maximize the value of the firm

EBIT-EPS ANALYSIS

How sensitive is EPS to changes in EBIT under different financing alternatives

EPS = [(EBIT – I)(1 - t)] / n

I = interest burdent = tax raten = number of equity shares

Assumptions

Plan A: all debt, no equity shares Plan B: 75% debt, 25% equity shares Plan C: 50% debt, 50% equity shares Plan D: 25% debt, 75% equity shares Plan E: no debt, all equity shares

Interest rate = 9% Tax rate = 14.71%

ALL FIGURES IN HK$ MILLIONS

A B C D E

EBIT 12208.47

12208.47 12208.47 12208.47 12208.47

INTEREST 1098.76

824.07 549.38 274.69 0

EBT 11109.71

11384.4 11659.09 11933.78 12208.47

TAX 1634.23

1674.24 1715.05 1755.45 1795.86

EAT 9475.48

9709.76 9944.04 10178.33 10412.61

NO OF SHARES

4121.1 4140.9 4160.72 4180.53 4200.35

EPS 2.3 2.34 2.39 2.43 2.48

Calculations

DEBT VS EPS

0 0.2 0.4 0.6 0.8 1 1.22.2

2.25

2.3

2.35

2.4

2.45

2.5

Proportion of debt

EPS

HUTCHISON’S CASE

Financing from cash on hand, internal cash generation

Long term projects, large capital requirements

Increased outstanding debts and capital commitments

Alternative source of financing Appropriate mix of debt and equity

ROI-ROE ANALYSIS

Relationship between return on investment and return on equity for different financing options

ROE = [ROI + (ROI – r)D/E](1-t)

r = cost of debtD/E = debt – equity ratiot = tax rate

CALCULATIONS

1. D/E = 0.67

2. D/E = 1

3. D/E = 1.5

ROI 5% 9% 15% 20%

ROE 1.98% 7.67% 16.22% 23.34%

ROI 5% 9% 15% 20%

ROE 0.85% 7.67% 17.9% 26.4%

ROI 5% 9% 15% 20%

ROE -0.85% 7.67% 20.17% 31.1%

ROE VS ROI

5 9 15 20

-5

0

5

10

15

20

25

30

35

D/E=.67D/E=1D/E=1.5

ROI

ROE

COST OF CAPITAL Minimize the cost of capital Depends on expected returns and risk Rate of interest fixed and company legally bound

to pay interest for debt holders Rate of dividends not fixed and company not

legally bound to pay dividends in case of shareholders

Debt – a cheaper source of funds Tax deductibility of interest charge

DEBT VS COST OF CAPITAL

Cost of capital

Debt

CONTROL

Existing management’s desire to continue its control over the company

Risk of loss of control when new shares are issued Use debt to avoid loss of control 49.9% shares owned by Cheung Kong holdings New shares required – a very small percentage of

existing shares Loosing control was not really a problem for the

company

Debt-Equity Ratio Measurement of how much suppliers, lenders, creditors and

obligors have committed to the company versus what the shareholders have committed

Ratios

Provides a general indication of a company's equity-liability relationship

Large, well-established companies can push their liability structure to higher percentages without getting into trouble. 

Current Scenario

Future Scenario

100%D, 0%E

75%D, 25% E

50%D, 50%E

25%D,75%E

0%D,100%E

Total Liabilities(A)

26177 30044.5 29077.63

28110.75

27143.88

26177

Shreholder’s Funds(B)

58839 58839 59805.88

60772.75

61739.25

62706.5

D/E Ratio(A/B)

0.44 0.51 0.48 0.46 0.44 0.41

Calculations

Current D/E Ratio is ideal Even if US$ 500M is raised through entire debt the ratio

remains at 0.51 which is also quite stable

Total Debt Ratio

Compares a company's total debt to its total assets

• A low percentage means that the company is less dependent on leverage

• higher the ratio, the more risk

Calculations

Inference

Current Total Debt Ratio is quite good Higher the debt , Higher is Total Debt Ratio

Current Scenario

Future Scenario

100%D, 0%E

75%D, 25% E

50%D, 50%E

25%D,75%E

0%D,100%E

Total Liabilities (A)

31503 35370.50 34403.63 33436.75 32469.88 31503

Shreholder’s Funds(B)

58839 58839 59805.88 60772.75 61739.63 62706.5

Total Debt Ratio(A/B)

0.54 0.60 0.58 0.55 0.53 0.50

Capitalization Ratio

Measures the debt component of a company's capital structure to support a company's operations and growth

Describe the makeup of a company's permanent or long-term capital

Prudent use of leverage increases the financial resources available for growth and expansion

Highly leveraged company may find its freedom of action restricted by its creditors or have its profitability hurt by high interest costs

Calculations

Inference

Current Capitalization of 0.31 provides a cushion to investors

Even if whole US $500M is raised through debt, the total capitalization will still be stable

Current Scenario

Future Scenario

100%D, 0%E

75%D, 25% E

50%D, 50%E

25%D,75%E

0%D,100%E

Long Term Debt(A)

26174 30041.5 29074.55 28107.5 27140.88 26174

Total Capitalization (B)

85013 88880.5 88880.5 88880.5 88880.5 88880.5

Total Capitalization Ratio(A/B)

0.31 0.34 0.33 0.32 0.30 0.29

Interest Coverage Ratio Determine how easily a company can pay interest

expenses on outstanding debt

The lower the ratio, the more the company is burdened by debt expense

The non-payment of debt principal is a seriously negative condition

A company finding itself in financial/operational difficulties can stay alive for quite some time as long as it is able to service its interest expenses.

Calculations

Current Ratio of 3.98 is quite good. Company can pay its interest obligations easily As Debt borrowed increases, Interest Coverage

decreases

Current Scenario

Future Scenario

100%D, 0%E

75%D, 25% E

50%D, 50%E

25%D,75%E

0%D,100%E

EBIT(A) 11181 12208.47 12208.47 12208.47 12208.47 12208.47

Interest (B)

2808 3906 3632 3357 3082 2808

Interest Coverage Ratio(A/B)

3.98 3.13 3.36 3.63 3.96 4.34

COMPARISONS

EBIT INTEREST COVERAGE

4.825

4.875

4.925

4.975

5.025

5.075

EBIT / Interest Expense

•Suggestion: • Improve EBIT by

optimizing company’s operational costs.

EBITDA INTEREST COVERAGE

3.05

3.15

3.25

3.35

3.45

3.55

3.65

3.75

EBITDA / Interest Expense

•Comparatively better• It can be further improved by reviewing the tangible and intangible assets of the company.

FUNDS FROM OPERATIONS/ TOTAL DEBT(%)

2.5

7.5

12.5

17.5

22.5

27.5

32.5

37.5

Operating Cash Flow / Total Debt

•Funds generated from operations are less related to debts.•Operating cost for this company is high.

•Suggestions:• Need to optimize the

operations by employing Skilled labour, latest technology etc.

FREE OPERATING CASH FLOW/ TOTAL DEBT (%)

5

15

25

35

45

Free Operating Cash Flow = EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net

Working Capital - Capital Expenditure

•Poor performance in terms of Free operating cash flow.

•Suggestion:Company should sell some of its inefficient assets.

OPERATING INCOME/SALES(%)

1

3

5

7

9

11

13

15

17

19

Operating Income / Total Sales (Revenue)

• Is an indicator of profitability of a company

• Hutchison Wampoa is performing better in terms of profitability.

• Operational optimization can further improve the performance.

LONG TERM DEBT/CAPITAL(%)

2.5

7.5

12.5

17.5

22.5

27.5

32.5

Long Term Debt / Long Term debt + Preferred Stock + Common Stock

• Higher value for Hutchison Wampoa indicates that it is relying more on long term debts.

• Suggestion:Short terms debts can be one of the options.

TOTAL DEBT/CAPITALIZATION(%)

2.5

7.5

12.5

17.5

22.5

27.5

32.5

37.5

42.5

47.5

Debt / Debt + Shareholders’ Equity

• This is not a good indication as higher debt value will limit company’s flexibility.

RETURN ON EQUITY(%)

1

3

5

7

9

11

13

15

17

Net Income / Shareholders Equity

• Comparatively better performance as Hutchison Wampoa is giving a higher return on equity.

CONCLUSION

On the basis of the analytical and theoretical criteria we propose a capital structure for the company comprising of 60% debt and 40% equity which will minimize the cost of capital and maximize the value of the firm.

%

EQUITY40%

DEBT60%

MARKETABILITY

Ability of the company to sell or market particular

type of security in a particular period of time which in turn depends

upon -the readiness of the investors to buy that

security

Sometimes market favours debenture issues and at

another time, it may readily accept ordinary

share issues

Company decides whether to raise funds through common shares or debt

based on changing market sentiments

FLOATATION COST

Floatation costs are incurred when the funds are raised

Cost of floating a debt is less than the cost of floating an equity issue, hence companies use debt rather than issuing ordinary shares

If the owner's capital is increased by retaining the earnings, no floatation costs are incurred

THANK YOU