Cost of Capital- The Effect to Firm Value and Profitability Performance in Malaysia

Transcription

1 Cost of Captal- The Effect to Frm Value and Proftablty Performance n Malaysa Nor Ed Azhar Bnt MOHAMAD Norza Bnt Mohd SAAD Fnance & Economcs Department College of Busness Management & Accountng UNITEN, Pahang, Malaysa E-mal: NorEd@unten.edu.my Fnance & Economcs Department College of Busness Management & Accountng UNITEN, Pahang, Malaysa E-mal: Norza@unten.edu.my ABSTRACT KEY WORDS JEL CODES Frm's cost of captal s determned n the captal markets and s closely related to the degree of rsk assocated wth new nvestments, exstng assets, and the frm's captal structure. It s an overall return that a corporaton must earn on ts accessble assets and busness operatons n order to augment or preserve the value of ts current stock. Thus a careful approxmaton of a frm's specfc fnancng and weghted-average cost of captal (WACC) s essental for a good fnancal management. Thus study hghlghts the effect of cost of captal towards frms value and proftablty for a sample of 415 lsted companes n man market Bursa Malaysa for 6 years bass from 2005 to The result of the study shows sgnfcant relatonshps exst between cost of captal wth frm value and proftablty. Weghted-average cost of captal, Tobn Q, Return on Asset and Z-Score D24 1. Introducton The rason d'être of the corporate fnancal management s to maxmze the shareholders value by maxmzng the frm value persuades from effectve and accurate fnancng decsons makng. The frm s source of fnancng ether the external or nternal funds compostons roused the frm s mxture of captal structure s decson. The fnance theory dctate that the used of captal by a frm requred an opportunty cost to the fund s provder as funds are dverted from earnng a return on other nvestment that provded the same rsk level. Snce the fund s provder has a lot of alternatves n the nvestment decsons n the fnancal market, they have to be compensatng wth a sutable return as benchmark for the fund s opportunty cost. Thus n fnance theory ths benchmarks s wdely known as cost of captal and unless a frm can gan n excess of ts cost of captal, t wll not add value to ts nvestors wealth. As accordng to Khadka (2006), the cost of captal sgnfes what a frm has to pay for the captal used to fnance new nvestments. In auxlary, a careful approxmaton of a frm's specfc captal structure and cost of captal s essental n a specfc nvestment decsons whch lead to a dscrepancy between accreton and eroson of shareholder value. In vew of that, the analyss on 353

2 the cost of captal arse a common focus n manageral accountng and fnancal management and s treated essentally n most textbooks on corporate fnance, fnancal management, and other smlar area (.e. Gtman, 1994; and Brgham and Gapensk 1996). However the captal structure puzzle n relatons wth frm value have been a consderable debates from both the fnance managers and academcans for the last 50 years, predomnantly snce the publcaton of the artcles by Franco Modglan and Merton Mller n Hence, ths paper makes an attempt to analyze some dmenson n the vcnty of captal structure from the vewponts of cost of captal and ts nfluence towards frm value and proftablty of publcly traded Malaysan frms over 2005 to 2010 perods. Whch eventually, so far have not been thoroughly explore but these areas tend to nstgate a consderable mpact n the manner the lterature on captal structure from Malaysa perspectve s understood. 2. Lterature Revew Modglan and Mller (1958) suggest that the overall cost of captal of the frms s computed for the market value as the weghted average of the cost of each of the components of captals used by the frms. Also known as Weghted-Average Cost of Captal (WACC), t s wdely used n practce to assess a frm s cost of captal. The Modglan Mller theorem Proposton I often called the captal structure rrelevance prncple (of Franco Modglan, Merton Mller.1958) (MM hereafter) forms the bass for modern thnkng on captal structure theory. The basc theorem states that, under a certan market prce process (the classcal random walk), n the absence of taxes, bankruptcy costs, agency costs, and asymmetrc nformaton, and n an effcent market, advocated that the frm value and weghted average cost of captal (WACC) s unaffected by the fnancal structure of the frm. Modglan and Mller (1963) later modfed ther orgnal MM s model and consdered the tax deductblty of nterest (tax shelds effect) thus demonstrate that the market value of a frm s an ncreasng functon of leverage wth the exstence of corporate tax that allow the deductblty of nterest payments. Later supported by Brgham and Gapensk (1996) whch argue that an optmal captal structure can be attaned f there exst a tax shelterng benefts, provded an ncrease n debt level s equal to the bankruptcy costs. They suggest that managers of the frm should be able to dentfy when the optmal captal structure s attaned and try to mantan t at that level. Ths s the pont at whch the fnancng costs and the cost of captal (WACC) are mnmzed, thereby ncreasng frm value and performance. Tashfeen and Lton (2010) estmate the WACC for twenty four commercal banks that are lsted n the Dhaka Stock Exchange, Bangladesh between January, 2006 and December, Usng correlaton and regresson analyses, they fnd a strong negatve correlaton s emergng between the cost of captal of commercal banks and ther respectve market returns. Ther results also show that for the majorty of the banks that are lsted n Dhaka Stock Exchange the varaton n the returns on stocks can be strongly explaned by the varaton of ther respectve cost of captal by the end of Pástor, Snha, and Swamnathan (2008) argue that the mpled cost of captal, computed usng earnngs forecasts s useful n capturng tme varaton n expected stock returns. Ther study show that cost of captal theoretcally s perfectly correlated wth the condtonal expected stock return under plausble condtons and s helpful n detectng an ntertemporal rsk return relaton, even when earnngs forecasts are poor. Swanson, (2006) examnes the relaton between the nvestor determned cost of captal and the frm s nvestment from return on assets both n total and decomposed nto operatng and fnancal components. Ths study s provde evdence of a sgnfcant postve assocaton between the return on total assets 354

3 and the frm s cost of captal. When total asset returns are decomposed nto operatng and fnancal asset returns, both the operatng and fnancal assets have a postve sgnfcant relaton wth the cost of captal. Hs study also found a sgnfcant leverage nteracton mpact upon relaton of the return on assets and WACC; and from the operatng/fnancal asset mx upon the relaton between WACC and the return on frm assets. Syed Waqar Hussan et al. (2012) found a negatve relatonshp between return on equty on WACC. Ther paper has appled the WACC vs-à-vs rsk premum model, Gorden model, FAMA and French to Cement Industry of Pakstan. The results have quantfed the proportonate mpact of cost of captal on return on equty n Cement ndustry under the assumpton that scale of operaton and manageral effcency n all the frms operatng n ths ndustry remans the same. The trade-off theory of fnancal leverage that frst formulated by Krause and Ltzenberger n 1973 ndcate that the ncrease n debt level wll ncrease the cost of bankruptcy, fnancal dstress and agency, hence decrease the value of the company. As Mller (1977) ndcate that f fnancal dstress costs are ncluded n the valuaton of the frm, then, the probablty of bankruptcy ncreases as the amount of debt ncreases thus wth small ncreases n debt, the WACC decreases and the value of the frm ncreases. The bankruptcy costs and fnancng decson also explore by Warner (1977) and Altman (1984), they proposed that drect and ndrect bankruptcy costs are ncurred when debt fnancng s used, therefore, Bankruptcy costs may be one of the constrants affectng the amount of fnancng decson. 3. Data and Methodology 3.1. Varable and Data selecton Ths study focus on securtes that s lsted n Bursa Malaysa Man market. As at May 2012, a total of 930 of securtes are lsted on Bursa Malaysa and 517 samples had been selected usng stratfed random samplng from 7 dfferent sectors. Due to avalablty of nformaton only 415 numbers of lsted companes are selected for 6 years bass from year 2005 to 2010 wth 2490 total observaton. The data are gathered from Bloomberg and Thompson Data Stream. Ths study utlzed data (ndependent varables) tems of cost of captal as (WACC), leverage (DT), dstress rsk (SCORE) and the control varable are Sze (LnTotal Asset) and Gross Domestc Product (GDP). The key dependent varables for ths research to represent the frm value and proftablty are measures Tobn Q and by Return on Asset (ROA) respectvely. Table 1. The proxes for dependent and explanatory varables Proxes for Dependent and Explanatory Varables Varables Proxes Dependent (Rsk & Return) Return on Asset (ROA) Frm Value (TobnQ) Explanatory Weghted Cost of captal (WACC) Dstress Rsks (SCORE) total debt rato (TDR) lntotal Asset (SIZE) Growth Domestc Product (GDP) 355

4 1. Independents varable (WACC) Adopted from Modglan & Mller (1958, 1963), the cost of captal WACC of a frm after corporate taxes (but before personal taxes) s gven by the formula as below: D E WACC 1 TC x rd x re (1) V V Where: D s the market value of debt Tc s the corporate tax rate V s the market value of the frm r d s the cost of debt E s the market value of equty r e s the cost of equty The market value of the debt (D) s equal to the number of bonds outstandng multpled by the current market prce of the bonds. The total market value of the common stock (E) s equal to the current market prce of one share of stock multpled by the number of shares outstandng. The total market value of the frm (V) wll be found by addng the total market value of bonds and the total market value of common equty. The cost of debt s the yeld to maturty of the current prce of the bonds relatve to the expected future coupon payments and the face value of the bond at maturty. For ths study, the data for WACC were extracted from Bloomberg s database. For the Laverage varables we wll follow Mustafa, Ismal and Mna (2011), usng total debt rato as ths s vewed as a proxy for what s left for shareholders n the case of lqudaton. The formula s as follows. Long Term Debt Current Lablty Totaldebtrato(DR) TDR (2) Total Assets The varable for frm rsk s representng by the probablty of dstress rsk whch s the Z- score value. It was based on the works of Altman (1983) n whch he used the dscrmnate analyss technque to calculate bankruptcy rato. Ths rato whch uses the Z value to represent overall ndex of corporate fscal health, s used mostly by stockholders to determne f the company s a good nvestment. The formula for the rato s: Altman Z-score =0.012X X X X X 5, (3) Where: X 1 = Workng captal/total Assets), X 2 = (Retaned Earnngs/Total Assets), X 3 = (EBIT/Total Assets), X 4 = (market Value of Equty/Book value of Total Labltes), X 5 = (Sales/Total Assets). The range of the Z-value for most corporatons s between -4 and +8. The score was range nto three categores. Low probablty of dstress frms have Z values above 2.99 and was rank as 3, whle those wth hgh probablty of dstress wth Z value below 1.81 was rank as 1. Frm n the mddle are ndetermnate that could go ether way and was rank as

5 2. Dependent varables For the ndependents varable, Tobn Q was used as a proxy for the frm's value from an nvestor's perspectve. The hgher the q value, q > 1.00 ndcatng a better nvestment opportunty (Lang, Stulz & Walklng, 1989) wth hgher growth potental (Branard & Tobn 1968; Tobn, 1969). The model equaton as per below: MarketValueofEquty BookValueofLablty TobnQ (TQ) (4) Total Assets Return on assets (ROA) was used as the proxy for frm proftablty snce t was one of the preemnent measurements for corporate performance. The measurement as per below and the ncreased of ROA ndcate an ndustrous fnancal performance of relatve busness (Sddqu, 2008). Net Proft Returnon Asset ROA Total Assets (5) 3.2. Regresson Model and Equaton Next, two alternate hypotheses had been developed to fnd the sgnfcant assocaton between WACC wth the dependent varable. Hypothess H1: There s an assocaton between costs of captal wth Tobn Q. Hypothess H2: There s an assocaton between costs of captal wth ROA. The relatonshp between the cost of captal and dependent varables was estmated usng the followng regresson equatons: TQ α β1 (WACC 1) β2 (SCORE 1) β3 (DR3 ) β4 (SIZE 4) β5 (GDP 5) ε (6) ROA α β1 (WACC 1) β2 (SCORE 1) β3 (DR3 ) β4 (SIZE 4) β5 (GDP 5) ε (7) Where: = the constant term, = the slope or coeffcent estmates of the explanatory varables, = the standard error of the th company, R OA the return on asset of the th company s of the th year, TQ the market value of the th company s of the th year, WACC the Cost of Captal of the th company s of the th year, SCORE the dstress rsk of the th company s of the th year, TDR the total debt rato of the th company s of the th year, the sze of the th company s of the th year, SIZE GDP the GDP of the th year. 357

6 4. Fndngs ROA TQ WACC SCORE DR SIZE GDP Table 2. Correlatons analyss ROA TQ WACC SCORE DR SIZE GDP **.169 **.510 ** **.146 ** **.303 ** **.065 ** **.160 ** ** ** ** **.303 **.260 ** ** ** ** ** ** **.190 ** ** **.133 ** ** Correlaton s sgnfcant at the 0.01 level (2-taled). The correlatons between the varables are reported n Table I. Results ndcate no multcollnearty problems, as the correlatons are relatvely low. As accordng to Gujarat (1995), multcollnearty problems exst when the correlatons value exceeded The correlatons results for ROA ndcate postve coeffcent wth WACC (+0.169), SCORE (+0.510), Sze (+0.146) and LnGDP (+0.016) all at 1% sgnfcant level but negatve nsgnfcant wth DTR (-0.337). As for TQ, results demonstrate postve coeffcent wth WACC (+0.160), SCORE (+0.303), Sze (+0.190) and LnGDP (+0.065) at 1% level, whlst, postve nsgnfcant coeffcent wth DTR (0.032). Overall the correlatons results ndcates both alternate hypotheses 1, and 2 can be accepted mplyng a sgnfcant correlatons exst between ndependent varables components wth market valuaton. Table 3. Dedependent varable and cost of captal measured by WACC Dependent Varable Eq. 6 TQ Eq. 7 ROA Independent Varable t P t P WACC 7.343*** SCORE *** ***.000 DT *** ***.000 SIZE 7.224*** ***.000 GDP 2.463*** R R Square F-Value *** *** Durbn-Watson

7 To test the effect of ndependent varables on cost of captal, a regresson analyss were performed usng 2490 frm-years observatons and the results s presented n table II. The results for the equaton 1 for frm value (TQ) depcted postve coeffcent and sgnfcant for WACC however postvely nsgnfcant wth ROA. Ths ndcate that any ncrease n TQ can be explaned by an ncreased n WACC however any changes n ROA cannot be explaned by any changes n WACC. We could say that postve market valuaton of the frms can be obtaned by offerng a hgher WACC. The results for ROA s contradct towards study s by Swanson (2006) whch provde evdence of a sgnfcant postve assocaton between the return on total assets and the frm s cost of captal. The regresson results for SCORE ndcate a 1% confdence havng postve assocaton wth TQ and ROA ndcatng any ncrease n TQ and ROA can be explaned by an ncreased n SCORE thus support hypotheses 1 and 2.As for ths study s concerned, the hgher the score, the lower the probablty of dstress frms ndcatng the better the frm fnancal qualty (Altman, 1968) and consequently mproved the value of the frms. As depcted by the results of DT, coeffcent s postve and sgnfcant for the leverage varable at 1% sgnfcant level wth TQ whlst negatvely sgnfcant wth ROA at 1% level. Ths shows that any changes n TQ and ROA can be explaned by the changes n DR. The results mply that an ncrease or decrease of debt level wll have an nfluence n market valuaton and frm proftablty whch support the argument of Modglan and Mller (1963) mplyng that the frm s value rses wth leverage n the presents of corporate taxes. As the results for ROA wth leverage s confrms s corroborate wth Huang and Song (2006) and Chakraborty (2010) whch found negatve relatons between leverage and performance. Results for control varable.e. Sze and GDP n relatons wth the market valuatons n Malaysa s concerned both dsclosed a postve assocaton wth TQ at 1% sgnfcant level. Whereas, for the ROA ndcate 1% confdence level havng a postve sgnfcant assocaton wth Sze however postve nsgnfcant assocaton wth GDP. Gven the postve and sgnfcant approxmaton for frm sze, results exemplfy that larger frms are more proftable wth an enhancement n frm value as compared to smaller frms. Ths study forms an evdence for the lsted companes n Malaysa as an ndcator that larger frm s has the ablty n explotng the economcs of scale by obtanng access captal at lower costs than smaller frms. 5. Conclusons In ths paper we make an emprcal research on the effects of cost of captal usng the weghted-average cost of captal (WACC) approach wth frm value and proftablty from the vewponts of lsted companes n Bursa Malaysa. The study employed two model specfcatons n order to test the postulated hypotheses, usng cost of captal measure of WACC along wth other ndependent varables for 415 lsted companes for the perod of 2005 untl On the bass of fndngs for ths research, t can be conclude that there are sgnfcant relatons between cost of captal wth frm s value and proftablty for lsted companes n Malaysa whch dsclose both postve and negatve assocaton. The regresson results support hypotheses 1 and 2, as depcted by table II, the F statstcs s substantated at the 1% sgnfcant level for Equaton 1, TQ (F= ) and Equaton 2, ROA ( ) mplyng the null hypotheses that the regressons coeffcents are all zeros can be rejected at 1% level of sgnfcant. Though, the R squared (0.190) and (0.292) statstcally shows weak relatonshps for the hypotheses 1 and hypotheses 2 respectvely, however, the estmated regressons s effcent for predctons and hypotheses 1 and hypotheses 2 can be accepted mplyng that there are an assocatons between cost of captal wth frm value and return of lsted 359

8 companes n Malaysa. In conclusons, although the alternate hypotheses are support by the analyss, however the results of present study are n contradcton to some earler studes on the ssues. Nevertheless, we hope that the result can contrbute to the body of knowledge by dentfyng the mportant factors that could nfluence frm s value and return. It was recommended that the study s further mproved wth more sample sze, dfferent varables nternal and external varable whch could provde a strong relatonshp between the varables and help to uncover the better frm s value and return performance n Malaysa perspectves. Thus ths study s left for future to be further explored. References 1. A.Kraus, and R.H. Ltzenberger (1973). "A State-Preference Model of Optmal Fnancal Leverage", Journal of Fnance, September, pp A. Sddqu (2008). Fnancal contracts, rsk and performance of Islamc bankng, Manageral Fnance, Vol. 34 No. 10, pp E.F.Brgham and L.C. Gapensk (1996. Intermedate Fnancal Management, 5th Edton, Illnos: The Dryden Press, Hnsdale. 4. E. I. Altman (1983). Corporate fnancal dstress: A complete gude to predctng, avodng, and dealng wth bankruptcy. New York: John Wley & Sons. 5. E.I. Altman (1984). A Further Emprcal Investgaton of Bankruptcy Costs, Journal of Fnance, September, pp F.Modglan, and M. H. Mller (1958). The Cost of Captal, Corporate Fnance and the Theory of Investment.. Amercan Economc Revew 48(3): F. Modglan, and M. H. Mller (1963). Corporaton Income Taxes and the Cost of Captal: A Correcton, Amercan Economc Revew, 53, H.B Khadka (2006). Leverage and the Cost of Captal: Some Tests Usng Nepalese Data, The Journal of Nepalese Busness Studes, Volume III, No H.Tashfeen and C.Lton (2010). Is The Cost of Captal an Important Determnant of Market Performance of Prvate Commercal Banks n Bangladesh? Proceedngs of ASBBS, ASBBS Annual Conference: Las Vegas, February 2010 Volume 17 Number 1 pg I. Chakraborty (2010). Captal structure n an emergng stock market: The case of Inda, Research n Internatonal Busness and Fnance, Vol. 24, pp J. Tobn (1969). "A General Equlbrum Approach to Monetary Theory." Journal of Money, Credt, and Bankng 1 (1), February: L.H.P Lang, R.M Stulz, and R. A. Walklng, (1989). Manageral performance, Tobn's q and the gans from successful tender offers. Journal of Fnancal Economcs 24, L.J Gtman (1994). Prncples of Manageral Fnance, 7th edton, HarperCollns College Publshers (New York) 14. Ľuboš Pástor, Meenaksh Snha, Bhaskaran Swamnathan (2008). Estmatng the Intertemporal Rsk Return Tradeoff Usng the Impled Cost of Captal, The Journal of Fnance, Volume 63, Issue 6, pages , December M.H,Mller (1977). Debt and taxes, Journal of Fnance, Vol. 32 No. 2, pp M. Mustafa,H.Ismal and B. Mna (2011), Determnants Of Debt Structure: Emprcal Evdence From Malaysa 2nd Internatonal Conference On Busness And Economc Research (2nd Icber 2011) Proceedng. 17. S. Huang, and F. Song (2006). The determnants of captal structure: evdence from Chna, Chna Economc Revew, Vol. 17 No. 1, pp

9 18. Syed Waqar Hussan,, Asmat Ullah, Ghazanfar Al, Za Ul Islam (2012). Impact of Cost of Captal on Corporate Proftablty: A CaseStudy of The Cement Industry, Pakstan, Journal of Rsk and Dversfcaton; ISSN , Issue 4, EuroJournals Publshng, Inc.; dversfcaton.com 19. W. Branard, and J, Tobn (1968). Ptfalls n Fnancal Model Buldng, Amercan Economc Revew, Vol. 58(2), pages Z. Swanson (2006). Does the Weghted Cost of Captal Assocate wth Returns on Operatng and Fnancal Assets wth Investor Antcpaton Or Reacton? [And Do Operatng and Fnancal Assets Have Synergy?], Central States Workshop at Kansas State Unversty. Avalable at SSRN: 361