FM Case Study - 3

8/2/2019 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.


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


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.


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


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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Documents

FM Case Study - 3