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Frank and Goyal [ 11 ] have divided this to two parts i. The research methodology used was a causal research, employing quantitative analysis of secondary data. I have tried to show the causeand- effect relationship between debt and value of a firm, by ratio analysis.
Ratio analysis over comes the problem of comparing the performance of companies with different sizes. For the purpose of the paper, to show that debt affects the value of a firm, a sample of hundred companies was taken randomly from nearly all companies of Pakistan listed at Karachi Stock Exchange KSE with the unit of analysis being a company listed at KSE. Secondary financial data of these listed companies was obtained from State Bank of Pakistan and Karachi Stock Exchange on yearly basis for six years [ 12 - 16 ].
Correlation and regression analysis was carried out, with capital structure being the independent variable and the firm value as a dependent variable, to show that whether the proposed relationship exists or not. ROE shows the return that the investors receive for their capital contribution to the firm. The investors are likely to invest as long as they receive good return.
ROA measures the firm profit relative to its investment in assets and is an indication of whether the assets are under or over utilized. It is thus an indicator of operating performance. EPS is derived when net profit is expressed on per share basis and provides a measure of what the market will pay for a share based on perception of future earnings of the firm [ 17 - 22 ]. There exists positive relationship between financial leverage and value of a firm.
To draw conclusions easily in relation to the hypothesis already stated i. Debt affects the value of a firm; the results are presented in tabular form. The results show that a significant relationship exists between leverage and firm value in the market. Also the results on a whole point out a positive relationship between leverage and value of a firm. Although the correlation among variables is weak but the overall results appear to be significant. The confidence level estimates a range in which the population mean is expected to fall.
The sign of the parameter estimates show the direction of the relationship whether positive or negative. Positive sign shows direct relationship and the negative shows inverse one. Based on p-values the null hypothesis is either rejected or accepted. P-values are to be compared with the significance level, if p-value is less than significance level the null hypothesis is to be rejected otherwise accepted.
Tables 1 and 2. For each one unit decrease in debt to equity earnings per share shows an increase of 0.
The result is non-significant since t-stat is less than acceptable level and p-value is higher than 0. For each one unit increase in debt to equity returns on assets shows an increase of 0. The result is significant since t-stat is greater than acceptable level and p-value is lower than 0. For each one unit increase in debt to equity returns on equity shows an increase of 0.
The result is significant since t-stat is greater than acceptable level and p-value is less than 0.
For each one unit increase in debt to equity total assets shows an increase of units. The result is non-significant since t-stat is less than acceptable level with a higher p-value. For each one unit increase in debt to equity fixed assets shows an increase of units. For each one unit increase in debt to equity current assets shows an increase of units. The results as a whole shows that financial leverage is positively related to the value of a firm, any increase in leverage will increase the value of firm.
The results are in line with previous researches conducted on this topic showing a positive relationship. The complexity in results is arisen because of the ratios used as proxies for the firm value.
The coefficients of assets are higher because actual figures are compared with a ratio; such a comparison when used yields inaccurate results. Arguments exist both for and against increased level of financial leverage.
But the combination of debt and equity to be used depends upon the firm specific needs and its operating conditions. According to Jiming negative relation exists for high and low growth companies where as positive one is more likely for mid-growth companies. Hence in data in this case might be taken from mid-growth companies. Because of different kinds of arguments Myers, an expert on the subject matter, stressed that there exists no universally acceptable theory of capital structure and further that there exists no solid reason to prefer one against the others.
The managers should recognize this range and also the shareholders should focus on this range so as to avoid agency problems. Present study ha certain limitations. Firstly mainly because of time limitations it was not possible to gather and arrange all the relevant data to be included in a sample. Secondly, the data used is only for six years and hundred companies; any company having its data not directly available is not included in the sample. Moreover the sample just represent a specific time period. This might cause a sample bias. Thirdly, the market price per share is not included instead its proxies are taken for firm value.
The firm value can best be presented by its share prices. Fifthly, ratios are used instead of actual figures. Future research should consider a number of factors. Sample should be chosen at care by including only those firms for which at least 10 years of worth data is available. Moreover by allowing equal chances for all the firms to be included in the sample can yield somewhat different results. Instead of relying on proxies efforts can be made for obtaining actual data for all the variables involved. Over and above the effects of interest, paid for the use of money, on firm value should be clearly addressed.
If all this is to be made based on actual data and on a sample which is true representative, then there exist chances that the variables of interest will show a negative relationship. By combining such a study with that of De Wet a range for optimal capital structure could be identified. The purpose of the paper was to show whether there exist a relationship between leverage and value of a firm or not. The results showed a positive relationship between leverage and value of a firm, on the basis of which we reject the null hypothesis.
Debt positively affects the value of a firm mainly because of the tax shield. The studies conducted in countries where there are no taxes, like Saudi Arabia, the debt has nothing to do with the value of a firm. In countries where taxes are there, the results of the study appears to be positive.
Home Publications Conferences Register Contact. Mr B said that then he would pay the same as the valuation he has calculated; however, Mr A will only receive the money after payment of debt. Let us do a basic equity value example of comparing two companies on the basis of equity market value and finding the larger one. Here are the details of Company A and Company B —. In this case, we have been given both the numbers of outstanding shares and the market price of shares.
We note that market value of equity of Company A is more than equity market value of Company B. Please have a look at the table below.
From Wikipedia, the free encyclopedia. October 31, Accepted Date: On the basis of the sum of all the present value of future operating cash flows, one can decide on whether to take over a firm or not. Another sound approach towards computing the value of a firm is to determine the present value of its future operating free cash flows. The debt bias can be made less intense by making the interest payments not to be tax deductible or by introducing tax deductibility for equity returns [ 1 ]. The result is significant since t-stat is greater than acceptable level and p-value is lower than 0. But Stulz has shown that debt payments reduce the availability of funds for investment.
In the final analysis, it can be said that equity market value is the best method if an owner of a business wants to know how much he would get by selling his business. This has been a guide to what is Equity value, its formulas along with practical examples. Here we also look at the market value of equity calculation of top companies. You may also look at the following articles to learn more about valuations —. Your email address will not be published. By continuing above step, you agree to our Terms of Use and Privacy Policy. Download Colgate's Financial Model.