Lewis Mutswatiwa

8/15/2019 Lewis Mutswatiwa...

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CHINHOYI UNIVERSITY OF TECHNOLOGY

School of Entrepreneurship and Business Sciences Department of

Accounting and Finance

EFFECT OF CAPITAL STRUCTURE ON FINANCIAL

PERFORMANCE OF RETAIL FIRMS LISTED ON

ZIMBABWE STOCK EXCHANGE

BY

LEWIS MUTSWATIWA

C1213393G

A research project submitted to Chinhoyi University of

Technology, School of Entrepreneurship and Business Sciences,

Department of Accounting and Finance in partial fulfilment of

the requirements of the award of Bachelor of Science Honours

degree Accountancy

Chinhoyi, Zimbabwe

2015


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RELEASE FORM

Name of student LEWIS MUTSWATIWA

Title of the research project Effect of capital structure on financial performance of

retail firms listed on the Zimbabwe Stock Exchange

Programme for which the

Project was presented Bsc Hons in Accountancy (BSCAC)

Year granted 2016

Permission is hereby granted to the Chinhoyi University of Technology Library to produce

single copies of this project and to lend or sell such copies for private, scholarly, or scientific

research purposes only. The author reserves other publication rights and neither the project

nor extensive contracts from it may be printed or otherwise reproduced without the author`s

permission.

Permanent address 1072 Samoyo Cresent Cherutombo Marondera

Student`s signature …………………………………

Date ………………………………….


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DECLARATION

I Lewis Mutswatiwa do hereby declare that this research project is the result of my own work

except to the extent indicated in the acknowledgements, references and by comments

included in the body of the report, and that it has not been submitted in part or in full for any

other degree to any other university.

………………………………………

Lewis Mutswatiwa

………………………………………

Date


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APPROVAL FORM

The undersigned certify that they have read and recommended to the Department of

Accounting Science and Finance, School of Business Sciences & Management, Chinhoyi

University of Technology, for acceptance; a project titled, “Effect of capital structure on

financial performance of retail firms listed on Zimbabwe Stock Exchange”, submitted by

Lewis Mutswatiwa in partial fulfilment of the requirements for the Bachelor of Science Hons

Degree In Accountancy.

………………………………………

Name of Supervisor

………………………………………

Signature

………………………………………

Date

DEDICATION

I dedicate this project to my mother and my father Mr and Mrs Mutswatiwa, my brother lee

mutswatiwa, my sisters lisa and Joyline Mutswatiwa, and my wife to be Carol Matanhire.


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Acknowledgements

This research work would not have been successful without constructive and helpful advice

and the assistance provided by numerous people. My sincere gratitude goes to my supervisor

Mr J Mashonganyika for his immense contribution towards the success of this project by

patiently and carefully reading several drafts of this project and offering incisive comments,

corrections and suggestions. The same appreciation is forwarded to the staff in Accounting

and Science Department for their assistance as well.


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I also want to express my gratitude to the following important people who have supported me

financially: Mr Misheck Matsvai, Mrs Pengeline Matsvai, Mr Misheck Govha, Mrs Margaret

Govha and Mr Joseph Tachiva. I am also grateful to my friends at Chinhoyi University of

Technology for their support and ideas during my research.

The most enjoyable acknowledgement goes to my family and my parents for their support.

To my pastor, Mr Ado Nyakudya, my wife to be Tatenda Marume and my beloved friends

Tafadzwa Leon Njiri, Japhet Manjova, Admire Bakasa, Tatenda Gotosa, Wadzanai Chirova,

Vongai Mukotami and Pettina Tadya I appreciate your contributions.

Finally to the Almighty God, I thank you for all your ideas and resources you made available

to me.


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ABSTRACT

The main focus of this study was to research on the effect of capital structure on financial

performance of retail firms listed on the Zimbabwe Stock Exchange. The study was prompted

by the fact that several companies in the retail sector are struggling for survival with many

companies closing down and others being delisted from the ZSE because of poor

performance which is in most cases attributed to failure to employ the optimal capital

structure. The objectives of the research were to establish the relationship between capital

structure and financial performance, to establish the determinants of capital structure of listed

retail firms in Zimbabwe and to determine the optimal capital structure that maximises the

firms’ value in the current Zimbabwean environment. A longitudinal research design wasused for the study, making use of secondary data. Financial statements for a five year period

from 2010 to 2014 were used. Total population sampling was used for the retail sector which

consists four companies. This study used SPSS version 20 to examine the determinants of

capital structure and the relationship between capital structure and financial performance. The

gearing ratio was used as the capital structure measure while net profit margin (NPM) and

return on equity (ROE) were used as the financial performance measures. Pearson’s

correlation analysis and linear regression analysis were performed. Size and profitability as

determinants of capital structure were found to negatively affect gearing whereas a weak

positive relationship was found between asset tangibility and gearing. A negative association

was established between gearing and financial performance measures NPM and ROE. The

findings of the study revealed an optimum capital structure for the retail sector to be a gearing

level of 38%. The study recommended the retail firms to use the optimal capital structure mix

that maximises performance so as to maximise shareholders wealth as well as to reduce the

prevailing risk of closure in this economic hardships era. Finally further researchers were

encouraged to carry out the same research using other sectors besides the retail sector.


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TABLE OF CONTENTS

RELEASE FORM ....................................................................................................................... iDECLARATION ....................................................................................................................... ii

APPROVAL FORM ................................................................................................................ iii

DEDICATION ......................................................................................................................... iii

Acknowledgements ................................................................................................................... iv

ABSTRACT .............................................................................................................................. vi

LIST OF TABLES ..................................................................................................................... x

LIST OF FIGURES .................................................................................................................. xi

LIST OF APPENCICES .......................................................................................................... xii

LIST OF ACRONYMS ......................................................................................................... xiii

CHAPTER ONE ........................................................................................................................ 1

1.1 Introduction ...................................................................................................................... 1

1.2 Background of the study .................................................................................................. 1

1.3 Statement of the problem ................................................................................................. 2

1.4 Research objectives .......................................................................................................... 3

1.5 Research Questions .......................................................................................................... 3

1.6 Significance of the study .................................................................................................. 3

1.7 Delimitations of the study ................................................................................................ 4

1.8 Limitations ....................................................................................................................... 4

1.9 Definition of terms ........................................................................................................... 4

1.10 Chapter summary ........................................................................................................... 5

CHAPTER TWO ....................................................................................................................... 6

2.1 Introduction ...................................................................................................................... 6

2.2 Theoretical framework ..................................................................................................... 6

2.2.1 Modigliani-Miller Theory.......................................................................................... 6

2.2.2 Pecking Order Theory ............................................................................................... 7

2.2.3 Trade-Off Theory ...................................................................................................... 8

2.2.4 Agency Theory .......................................................................................................... 9

2.3 Determinants of Capital Structure .................................................................................. 10

2.3.1 Collateral Value of Assets ....................................................................................... 10


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2.3.2 Non-Debt Tax Shields ............................................................................................. 10

2.3.3 Dividend policy ....................................................................................................... 11

2.3.4 Size .......................................................................................................................... 11

2.3.6 Profitability .............................................................................................................. 12

2.3.7 Firm Age .................................................................................................................. 12

2.4 Components of Capital Structure ................................................................................... 13

2.4.1 Equity Financing...................................................................................................... 13

2.4.2 Debt Financing ........................................................................................................ 13

2.5 Financial Performance.................................................................................................... 14

2.5.1 Profitability .............................................................................................................. 14

2.5.2 Net Profit Margin ........................................................................................................ 14

2.5.3 Return on Investment and Return on Equity ........................................................... 14

2.6 The Optimal Capital Structure ....................................................................................... 14

2.7 Empirical Studies ........................................................................................................... 15

2.7.1 Positive association between capital structure and performance ............................. 16

2.7.2 Negative association between capital structure and performance ........................... 17

2.7.3 Insignificant or no association between capital structure and performance ............ 19

2.8 Conclusion ...................................................................................................................... 20

CHAPTER THREE ................................................................................................................. 21

3.1 Introduction .................................................................................................................... 21

3.2 Research Design ............................................................................................................. 21

3.3 Study Population ............................................................................................................ 21

3.4 Sampling......................................................................................................................... 22

3.5 Research Instruments ..................................................................................................... 22

3.4 Data Source .................................................................................................................... 22

3.5 Use of measures ............................................................................................................. 22

3.5.1 Gearing .................................................................................................................... 23

3.5.2 Return On Equity (ROE) ......................................................................................... 23

3.5.3 Net Profit Margin..................................................................................................... 24

3.7 Data Analysis ................................................................................................................. 24

3.8 Data validity and reliability ............................................................................................ 25

3.8 Chapter summary ........................................................................................................... 25

CHAPTER FOUR .................................................................................................................... 26


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4.1 Introduction .................................................................................................................... 26

4.2 Data availability ............................................................................................................. 26

4.3 Descriptive statistics on determinants of capital structure ............................................. 27

4.3.1 Firm leverage ........................................................................................................... 27

4.3.2 Profitability .............................................................................................................. 27

4.3.3 Size .......................................................................................................................... 28

4.3.4 Tangibility ............................................................................................................... 28

4.4 Correlation analysis of the determinants of capital structure ......................................... 28

4.4.1 Determinants of capital structure ............................................................................. 29

4.5 Regression analysis of the determinants of capital structure ......................................... 30

4.6 Relationship between capital structure and financial performance ................................ 32

4.7 Pearson correlation analysis of gearing and performance proxies ................................. 34

4.8 Regression analysis model for gearing and performance proxies .................................. 35

4.9 The optimal capital structure .......................................................................................... 36

4.9.1 The relationship between capital structure and net profit margin ........................... 37

4.9.2 The relationship between capital structure and return on equity ............................. 38

4.9.3 Net Profit Margin and Return on equity in relation to gearing ............................... 39

4.10 Chapter summary ......................................................................................................... 40

CHAPTER FIVE ..................................................................................................................... 41

SUMMARY CONCLUSIONS AND RECOMMENDATIONS ......................................... 41

5.1 Introduction .................................................................................................................... 41

5.2 Summary of findings ...................................................................................................... 41

5.3 Conclusions .................................................................................................................... 42

5.4 Recommendations .......................................................................................................... 43

5.5 Suggestions for further research ..................................................................................... 43

LIST OF REFERENCES ......................................................................................................... 45


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LIST OF TABLES

Table 4.1 Descriptive statistics............................................................................................. 27

Table 4.2 Correlations .......................................................................................................... 28

Table 4.3 Regression model ................................................................................................. 30

Table 4.4 Coefficients .......................................................................................................... 30

Table 4.5 Capital structure and financial performance statistics ......................................... 33

Table 4.6 Correlations .......................................................................................................... 34

Table 4.7 Regression analysis .............................................................................................. 35

Table 4.8 Coefficients .......................................................................................................... 35

Table 4.9 Regression model for gearing and Return on Equity ........................................... 36

Table 4.10 Coefficients ........................................................................................................ 36


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LIST OF FIGURES

Fig 2.1 Trade off theory. ........................................................................................................ 8

Fig 2.2 Optimal capital structure .......................................................................................... 15

Fig 4.1 Data availability ....................................................................................................... 26

Fig 4.2 Gearing trend ........................................................................................................... 31

Fig 4.3 Net Profit Margin ..................................................................................................... 32

Fig 4.4 The relationship between capital structure and net profit margin............................ 37

Fig 4.5 The relationship between capital structure and return on equity ............................. 38

Fig 4.6 Net Profit Margin and Return on equity in relation to gearing ................................ 39


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LIST OF APPENCICES

Appendix I ZSE retail sector

Appendix II Consolidated financial statements extract

Appendix III Descriptive statistics

Appendix IV ZSE company financials


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LIST OF ACRONYMS

NPM: Net Profit Margin

ROE: Return On Equity

SPSS: Statistical Package for Social Science

WACC: Weighted Average Cost of Capital

ZSE: Zimbabwe Stock Exchange


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CHAPTER ONE

INTRODUCTION

1.1 Introduction

This chapter sets the foundation of the study and covers background of the study, statement

of the problem, research objectives and questions, significance and scope of the study,

limitations as well as assumptions associated with the study.

1.2 Background of the study

Myers, (2001) pointed out that capital structure studies aim to explain the mix of the sources

of finance used by companies to finance investments. Brigham, (2004) alluded capital

structure to be the way in which a company finances its operations, which can either be debt

or equity or a combination of both. Myers, (2001) acknowledged that there is no universal

theory on capital structure choice but noted the existence of some theories that attempt to

explain the capital structure mix. He also referred to the trade-off theory which expresses that

organizations look for gearing levels that balance the tax relief of using debt capital against

the potential financial distress that debt capital brings. The pecking order theory postulates

that firms first utilise internally generated funds and would rather borrow than issue new debt

capital, (Myers, 2001). In conclusion the theory states that the debt level of a firm shows its

cumulative need for external funding. Another theory, the free cash flow theory says high

gearing increases the firm’s value notwithstanding the threat of financial distress posed when

the operating cash flow of a company outweigh its profitable investments.

Erasmus, (2008) highlighted that financial performance measures like profitability and

liquidity provide a useful tool to stakeholders for evaluation of the firm’s past financial

performance and the current position of a firm. Brigham and Gapenski (1996) argued that the

validity of the Modigliani and Miller model was only in theory as bankruptcy costs did exist


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in practice and the costs were directly proportional to the gearing levels in a firm. This

inferred a direct relationship between capital structure and financial performance of a firm.

Berger and di Patti, (2006) presumed that more profitable firms were more likely to yield a

higher return from a given capital structure, and that higher returns can go about as a shield

against portfolio risk so that more effective firms are in a superior position to substitute

equity for debt in their capital structure. This is an incidental of the trade-off theory where

differences in efficiency enable firms to adjust their ideal capital structure either upward or

downwards. Also, Singh and Hamid, (1992) in their research, utilized information on the

largest companies in developing nations and found that organizations in developing nations

employed more of debt finance in financing their investments than was the situation in

industrialized countries. Abor, (2005) likewise discovered a positive relationship between

total assets and return on equity and that profitable companies in Ghana depended more on

debt as a main financing alternative because of low financial risk. Empirical studies, like

those of Ruland and Zhou, (2007) and Robb and Robinson, (2009) concur with Modigliani

and Miller (1963) that the gain from gearing are significant, and that the utilization of debt

increases the market value of a firm. Another empirical study, however of non financial firms

listed on Karachi Stock Exchange (KSE) that has been completed in Pakistan for a six year

period from 2004 to 2009 presumed that aggregate debt has negative effect on profitability,thus performance. As a synopsis, there is no universal theory of the debt-equity choice.

Diverse perspectives have been advanced in regards to the financing decision.

In Zimbabwe interest rates are high (above 14%) as shown by the Trading Economics (2014).

Eighty seven companies were closed in 2014, a situation that can be minimised if strategic

decisions such as the optimal capital structure were employed. This, in addition to the

absence of a universally accepted capital structure theory, leaves the optimal capital structure,

especially for the current Zimbabwe’s economic environment, an area of more questions than

answers. It is a critical area to facilitate survival of the local companies.

1.3 Statement of the problem

Several companies in the retail sector are struggling for survival with many companies

closing down and others have been delisted from the Zimbabwe Stock Exchange because of

poor performance. As a result investors have lost wealth and confidence on the stock market.


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The poor performance is largely attributed to the capital structure mix as the cost of debt

capital is high therefore there is need to establish the optimal mix of debt and equity for the

retail companies operating in local current economic environment in Zimbabwe.

1.4 Research objectives

The main objective of this research is to determine the effect of capital structure on financial

performance of listed retail firms in Zimbabwe and the specific objectives of the research are:

1. To establish the relationship between capital structure and financial performance of listed

retail firms in Zimbabwe.

2. To establish the determinants of capital structure of retail companies listed on the

Zimbabwe Stock Exchange.

3. To determine the optimal capital structure that maximises the firms’ value in the curren t

Zimbabwean environment.

1.5 Research Questions

1. What is the relationship between capital structure and financial performance of listed retail

firms in Zimbabwe?

2. What are the determinants of capital structure of retail companies listed on the ZimbabweStock Exchange?

3. What is the optimal capital structure that maximises the firm’s value in the current

Zimbabwean environment?

1.6 Significance of the study

1.6.1 To the researcher

The research gave the researcher a smooth platform to integrate the theoretical fundamentals

mastered during his studies at University with the practical aspects of the business

environment as far as capital structure is concerned. The research can be viewed as the

training ground to the researcher for future academic researches. The research gave the

researcher an in depth understanding and knowledge of the field under study as going through

the process added knowledge on the subject and it was also in partial fulfilment of an

Honour’s degree in Accountancy.


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1.6.2 To the University

If incorporated, this research will add literature on the relevance of adequate knowledge of

the optimal capital structure thereby providing a line of thought to other succeeding students.

Other researchers and scholars may borrow ideas from this research project and use it as a

research tool on any related study.

1.6.3 To the corporate world

The Corporate World will be assisted by the findings of the study to achieve the best

sustainable capital structure that is to the best interest of the shareholders. It is hoped that this

project would assist companies to improve performance and escape closure as a result of

taking advantage of the most favourable capital structure. This research study will helpdifferent stakeholders of various organizations to assess the well being of the organizations

using the capital structure as a measure.

1.7 Delimitations of the study

The research was limited to retail companies listed on the Zimbabwe Stock Exchange. The

researcher used data from financial statements of the companies for the five year period from

2010 to 2015. The listed retail companies are Edgars Stores Limited, OK Zimbabwe Limited,

Pelhams Limited and Truworths Limited.

1.8 Limitations

This research was carried out under a short period of time but the researcher could use all the

free time to concentrate on the research. The researcher also faced some financial constraints

during this research; he had to look for assistance from friends and relatives. Financial

statements for the year 2009 were not available in full due to the changeover from the highly

inflationary Zimbabwean dollar era to the multicurrency era. The year was therefore left out

of the scope of the study.

1.9 Definition of terms

Listed firm: A firm with its shares being traded on an official stock exchange

Capital structure: The mix between debt and equity of a company.

Financial performance: The monetary measurement of the company’s policies and

operations.


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1.10 Chapter summary

The chapter gave a brief summary of the challenges being faced by the companies in

Zimbabwe, the statement of the problem, research objectives and questions, significance and

scope of the study, limitations as well as assumptions associated with the study. The purpose

of the chapter was to put the research study into an intelligent context as well as to give

theoretical statement. The following chapter will give a review of related literature on the

effects of capital structure on financial performance.


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CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter reviews theoretical and empirical literature relevant to the study. The views of

different authors and researchers were scrutinized in order to shade more light into the subject

under study and the literature under review was obtained from text books, journal articles and

websites. The main aim of this section is to give an insight and critique of what has been

written on the role of capital structure in determining financial performance by different

accredited scholars and researchers. The chapter ends with a summary.

2.2 Theoretical framework

Capital structure theories try to explain capital structure and the factors that contribute to cost

of capital and whether there is an optimal capital structure mix that maximises firm

performance by minimising the cost of capital.

2.2.1 Modigliani-Miller Theory

Modigliani and Miller (1958) came up with a capital structure commonly known as the MM

theory, before which no generally accepted theory of capital structure existed. Their theory

comprise of two express propositions which assume a perfect capital market, no transaction

costs, bankruptcy costs, symmetry information and a world with no taxes.

Modigliani and Miller’s first proposition assert that the company’s value is independent from

its capital structure, implying that whatever capital structure chosen for a company, its value

would be the same. In other words, they assert that the value of a levered firm is the same as

the value of an unlevered firm therefore managers need not to stress themselves on the choice

of the capital structure, they can employ any capital structure of their choice.

VL = VUL


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sources with the lowest levels of asymmetric information. The pecking order theory,

expresses that organizations like to fund new investments, first by making use of internally

generated funds, then with debt, and the issue of additional share capital is the last option.

Myers contends that an ideal capital structure is hard to ascertain as equity shows up at the

top (as retained earnings) and the bottom (as new shares) of the pecking order. An

organisation with access to market financing information would accordingly be in a superior

position to fund its investments conveniently and at a low cost thus gaining the desired

capital structure.

2.2.3 Trade-Off Theory

Fig 2.1 Trade off theory.

Source: Determinants of capital structure

In the trade off theory firms measure the benefits against the cost of debt financing. Fig 2.1

above shows how the value of a firm is affected by gearing. It shows that gearing increases


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the value of a firm but only to a certain extent beyond which the cost of debt outweighs the

benefit of debt. The benefit of debt capital is the tax shield on interest paid, that is, it lowers

the cost of capital, and also the discipline laid upon the management because of the loan

covenants. Brigham & Ehrhardt (2005), lays it down that the value of a levered firm is

equivalent to the value of an unlevered firm plus the value of side effects (tax shield and

expected costs due to financial distress). At the point when an organisation has zero or low

levels of debt, the likelihood of liquidation is low and immaterial. Baxter (2007) contended

that high gearing of a company increases its probability of insolvency which in turn makes

creditors to charge higher rates of interest because of the increased risk. He recommended

that organizations ought not to use debt past the point where the cost of debt surpasses the tax

advantage. The higher the gearing, the higher the bankruptcy costs therefore the effect of the

tax advantage of debt will be reduced.

As per the trade off theory the ideal capital structure is the point where the marginal tax

shield is equivalent to the marginal bankruptcy related costs. In this way, organisations would

first give priority debt financing up to the point where the likelihood of financial distress and

bankruptcy costs begins to be vital. Bas et al. (2009) recommended that this theory could be

applicable for large firms with a high probability of generating huge profits. Pettit and Singer,

(2005) say small firms may not have the option to choose debt capital for the tax shield asthey are less likely to generate huge profits.

2.2.4 Agency Theory

Agency theory concentrates on the behavioural relationship between the proprietors

(principals) and those entrusted by the proprietors (agents) to perform the business tasks on

their behalf. The management may shun high level of leverage in the event that they feel that

it puts their jobs at risk. On the contrary, proprietors, because of their ability to diversify

away the unsystematic risks that are specific to the company, may prefer the organisation to

invest in risky projects. Neilson, (2004) recommends that managers may forgo projects that

have positive net present values when the gains would accumulate primarily for debt holders.

Despite the best interests of the shareholders (principals), the managers (agents) are tempted

to employ a capital structure which does not threaten their job security. To mitigate the


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agency problems managers can increase their share of ownership so as to align their interests

with those of the shareholders (Jensen and Meckling, 2006)

2.3 Determinants of Capital Structure

The capital structure choice is influenced by factors such as corporate governance practices,

economic environment, level of investor protection, relationship between borrowers and

lenders and capital markets. Literature has also identified firm level determinants of capital

structure including asset tangibility, Non-Debt Tax Shields, Dividend policy, firm size,

business risk, profitability and firm age.

2.3.1 Collateral Value of Assets

Most of the capital structure theories acknowledge that the assets owned by a company

somehow influences its capital structure decision. Scot (1976) propounds that, by offering

secured debt, companies boost equity value by seizing wealth from their existing unsecured

lenders. Contentions set forth by Myers and Majluf (2000) additionally recommend that

organizations may find it profitable to offer secured debt. Their model shows that there may

be costs connected with issuing securities about which the company's directors have upperhand information over outside shareholders. These costs can be evaded by issuing debt

secured by assets with known monetary values. Hence, companies that have properties that

can be utilised as collateral are expected to exploit that opportunity to issue more debt.

Availability of collateral security mitigates costs associated with moral hazard and adverse

selection. More funding can be availed where there is high collateral security therefore

tangibility of assets is positively associated with leverage, (Ramjee and Gwatidzo, 2012).

Asset tangibility is calculated by dividing fixed tangible assets by total assets.

2.3.2 Non-Debt Tax Shields

Tax shields have the effect of bringing down the effective marginal tax rate. Ali et al . (2013)

stated that the availability of non debt tax shields can reduce the attractiveness of debt

financing for tax bill minimisation. Such shields include capital allowances, research and

development costs and pension funds. Firms can take advantage of such tax shields, instead

of interest tax shield, to reduce their tax bills. Organisations with high non debt tax shield are


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chances of defaulting because it is more likely that the organisation will fail to service its

debt.

2.3.6 Profitability

Myers (1984) stated that organizations’ financing preference order is from retained earnings

first, debt second and issuing new shares as the last preference. He proposes that this

preference order may be because of the costs involved in issuing new equity. These can be

transaction costs or the costs that arise because of asymmetric information. Whichever the

case, the organisation’s past profitability, which translates to the amount of retained earnings

available, should be an important factor that contributed to its current capital structure. Chen

et al . (1998) supported this when he revealed that Dutch firms prefer internal funds over

external funds, but debt is still more essential than equity finance. The higher the level of

profits, the more funds are available for financing the organisations’ activities and therefore

the less the organisation’s reliance on external sources, (Jamal et al , 2013). On the contrary,

other researches shows that, more profits push a firm to depend more on debt because of its

ability to service it. Profitability can be both negatively and positively related to leverage,

(Chechet et al , 2013). Profitability can be measured as follows; Operating Income divided by

Total Revenue.

2.3.7 Firm Age

The number of years that the company has been in existence is believed to play a part on its

capital structure. Newly emerged organisations tend to rely more on equity finance, whereas

larger and old companies firms are able to increase their leverage in order to finance new

investment opportunities, (Noulas and Genimakis 2011). More debt capital is expected in the

capital structure of companies that have managed to establish themselves over the years.

Gwatidzo (2012) shows that a company builds its reputation over the years and lenders tend

to consult the firm’s relations with others over its period of existence. Therefore, a positive

association has been found to exist between both long and short term debt and the age of a

firm. Firm age is measured by the number of years the organisation has been in operation.


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2.4 Components of Capital Structure

Capital structure is made up of two components, equity and debt. Equity (also known as the

shareholders’ funds) comprises of share capital and reserves while debt (also known as

borrowed funds) consists of loans and debentures.

2.4.1 Equity Financing

In the event that a company does not utilize debt financing, it is alluded to as an unlevered

firm (Brigham 2004). This brings about business risk, which is described as riskiness inherent

to the organisation’s operations in the event that it doesn't utilize debt. If an organisation does

not utilize debt then the return on capital investment should be measured by dividing net

income to common stock holders by common equity.

ROE = Net income to common stock holdersCommon equity

This just implies that the business risk of an unlevered organisation will be measured by the

standard deviation of its ROE (Brigham & Houston, 2007).

2.4.2 Debt Financing

At the point when a company chooses to utilize debt financing for its operations it is

confronted with a financial risk and it is alluded to as a levered firm. Financial risk is that

extra risk set on common stock holders as a consequence of the choice to utilise debt

(Brigham & Houston, 2007). Financing risk is the likelihood that the income of the company

will not be as anticipated in light of the strategy for financing. He additionally proceeds by

saying that financing risk emerges in light of the fact that debt has a fixed financing

commitment (interest) which must be met when it falls due before the shareholders can

partake in the retained profit.


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2.5 Financial Performance

2.5.1 Profitability

The idea of profitability takes into account the comparison of the required cash outflows for

the implementation of a strategic alternative and the expected inflows to be generated by the

alternative. As determined by Pandey (2006), profitability measures included profitability in

relation to investment and profitability in relation to sales.

Profitability in relation to sales is measured by the Net Profit Margin (NPM):

2.5.2 Net Profit Margin

This is arrived at by expressing net profit (arrived at after operating expenses, financing costs,

and tax expense are subtracted from gross profit) as a percentage of sales. It establishes the

relationship between net profit and sales and also shows the efficiency of the management in

manufacturing, administration and selling the firm’s products. The general principle is to

convert every dollar invested into profits (Johanson and Runsten, 2005).

2.5.3 Return on Investment and Return on Equity

Both Return on Investment (ROI) and Return on Equity (ROE) relate profitability

investment. ROI is calculated by expressing after tax profit as a percentage of investment and

ROE is calculated by expressing after tax profit as a percentage of the net worth of the

company. The ratios demonstrate how well managers are using the resources of the

shareholders to increase their wealth (Johansson and Runsten, 2005).

2.6 The Optimal Capital Structure

According to Weston, Eugene and Brigham (2010), optimal capital structure is a mix of debt

and equity which results in minimum weighted average cost of capital (WACC). Optimal

capital structure is acquired by firms by trading off the costs of debt and equity by their

benefits (Myers, 2001). At a point where the weighted average cost of capital is minimized

the value of the firm is maximized. Although optimal capital structure is a topic that had

widely been done in many researches, researchers failed to find any formula or theory that


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decisively provides an optimal capital structure for a firm. In reality, capital structure of a

firm is difficult to determine. Financial managers find it difficult to exactly determine the

optimal capital structure of the firm (Saad, 2010). A firm has to issue various securities in

countless combinations to come up with particular combinations that can maximise its overall

value, meaning it has an optimal capital structure.

Fig 2.2 Optimal capital structure

Source: CFA study notes

At a point where the WACC is minimised the value of the firm is maximised. Fig 2.2 above

demonstrates that there is a certain mix of debt and equity that can minimise WACC.

2.7 Empirical Studies

The studies on the effect of capital structure on firms’ performance have generated mixed

results ranging from those supporting a positive relationship to those opposing it. Some of the

researches came up with no effect on performance; they found that capital structures did not


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revealed that at significant level of 0.05 and 0.1 debt to equity ratio, debt to asset ratio and

long term debt positively correlate with net profit margin, gross profit margin, return on

capital employed, return on assets, and return on equity.

Fosu (2013), examined 257 listed companies in South Africa with the aim to explore the

relationship between capital structure and organisation performance, giving much

consideration to the level of industry rivalry. The study revealed that leverage affects

performance positively.

Muhammad et al (2014) in an empirical exploration of the effect of capital structure on

company’s performance carried out a study using cement companies on the Karachi Stock

Exchange for a five-year period from 2009 to 2013. The study performed Pearson ’s

correlation and multiple regression analysis and the results showed a positive relationship

gearing and performance variables (gross profit margin and net profit margin), and a negative

relationship between debt to equity and return on assets and return on equity. The study

concluded that the capital structure has a significant impact on the organisation’s

performance and it concurred with the pecking order theory by recommending that

organisations should attempt to make use of internally generated funds and make debt the last

option.

2.7.2 Negative association between capital structure and performance

Mwangi et al (2014), were motivated to carry out a study of the relationship between capital

structure and performance by the fact that corporate failures in Kenya were largely attributed

to companies’ financing behaviour. The study which was carried out using an explanatory

non experimental research had a census of forty-two non financial companies listed on the

Nairobi Stock Exchange. Secondary data from the companies’ annual reports and financialstatements was used. The results were that leverage has a negative relationship with

performance, return on assets (ROA) and return on equity (ROE) being the measures of

performance.

Mohammadzadeh (2011) examined companies listed on Tehran Stock Exchange and found

that organizations’ performance as measured by earnings per share and return on assets have

negative relationship with capital structure. These findings are in line with those of Zeitun

and Tian (2007) and Abor (2007) who show performance as having been negatively affected


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by capital structure while it contradicts with the study of Berger and Patti (2006) who found a

positive relationship of capital structure and performance.

Thamila and Arulvel (2013) examined the relationship between capital structure and

performance basing on a sample of thirty companies listed on Colombo Stock Exchange

during the five year period from 2007 to 2011. Secondary data was used for the study

(financial statements of the companies). Performance measures used are return on capital

employed (ROCE), return on equity (ROE) and net profit ratio. The results revealed a

negative relationship between capital structure and companies’ performance.

Muritala (2012) carried out a study on the impact of capital structure on organisation

performance by using a sample of ten listed non financial organisations in Nigeria over a five

year period of time covering from 2006 to 2010. Return on assets and return on equity were

used as the performance measures while debt ratio, growth opportunities and investment in

tangibles assets were used as the explanatory variables. Organisation size and age were

presented as control variables in the study to examine their impact on performance. Panel

Least Square (PLS) was utilized for data. The study show negative correlation between debt

proportion and performance and further show a significant negative correlation between asset

tangibility and return on assets (ROA).

Sovbetov (2013) carried out an investigation of the relationship between capital structure and

profitability for banks in United Kingdom. He used gearing as the capital structure measure

and return on equity and return on assets as the measures of performance. The significant

result for this study provided confirmation of a negative relationship between capital structure

and firm performance.

In a study to investigate the effect of capital structure on the performance of pharmaceutical

businesses in Kenya, Adekunle (2009) utilized gearing as a measure of capital structure and

return on equity and return on assets as performance measures. The Ordinary Least Squares

estimation technique was used for the purposes of the study. A significant negative impact of

debt ratio on measures of financial performance was revealed by the study.

Pratheepkanth (2011) investigated the effect of capital structure on company performance for

the time from 2005 to 2009. For this reason, thirty companies listed on Colombo Stock

Exchange were chosen and regression analysis was employed for data analysis. Gross profit

(GP), net profit (NP), return on assets (ROA) and return on investment (ROI) have been


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utilized as dependant variables whereas debt to equity ratio was utilized as explanatory

variable. The regression analysis showed that debt to equity used under the study has no

relevant relationship with performance. Correlation analysis demonstrated that only the gross

profit has a positive but weak relationship with debt to equity ratio while other performance

measures have negative relation with debt to equity ratio.

2.7.3 Insignificant or no association between capital structure and performance

Ibrahim (2009) analyzed the effect of capital structure mix on company performance in

Egypt, utilizing a multiple regression analysis to assess the relationship between gearing and

performance. The study covered the period from 1997 to 2005. Return on equity (ROE),

return on assets (ROA) and gross profit margin (GPM) were used as the performance

measures. The outcome uncovered that capital structure choice in general has minimal or no

effect on organisation’s performance.

Musilo (2005) did an exploration on capital structure decisions of industrial firms in Kenya.

His goal was to figure out the components that spur management of industrial firms in

picking their capital structure. The exploration figured out that industrial firms are more

prone to follow the financing pecking order than to keep up a target debt to equity proportion,

and that the models in light of corporate and individual taxes, bankruptcy and other debt

related expenses are not as helpful in deciding the financing mix just like the models that

propound that new financing shows the company’s marginal performance. The study further

included that the significance managers give to particular capital structure theories is

independent from administrative view of market efficiency.

Ebaid (2009) carried out a study to examine the effect of capital structure decisions on the

performance of firms in Egypt. Return on equity, return on assets and gross profit were themeasures of performance. Capital structure measures used were long term debt to asset ratio,

short term debt to asset ratio and total debt to total assets. Multiple regression analysis was

utilised for estimation of the relationship between gearing and performance. The study

demonstrated that capital structure has practically no effect on a firm’s performance.

Matarirano and Fatoki, (2010) agreed with the Modigliani and Miller theory of the "capital

structure irrelevancy principle" without bankruptcy costs, asymmetric information and an

efficient market, the value of the firm is unaffected by how it is financed. However, the


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Zimbabwean environment is somehow different in that the interest costs are higher than the

average global rates due to the current market liquidity crunch.

2.8 Conclusion

The chapter looked at the theoretical and empirical literature on the effect of capital structure

on financial performance. It made use of the findings that were made by past researchers on

the same issue and what they used to measure the relationship between the aforesaid

variables. The literature reveals no universally accepted relationship between capital structure

measures and the financial performance measures. Some researchers found that there is a

relationship between capital structure and financial performance, either positive or negative,

while others found no relationship at all. Chapter 3 is going to look at research techniques

and sampling methods that were used to collect secondary data. It shall also go further giving

a justification of the selected research methodology.


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3.4 Sampling

The study used a type of purposive sampling called “total population sampling” where all the

companies constituting the study population were used for the study. This sampling technique

was used as the population size is relatively small as there are only four companies. It is also

a perfect representation of the population as all the listed retail companies are included in the

study.

3.5 Research Instruments

Document analysis was used in this study. It is the most appropriate instrument on the subject

as all the necessary information can be obtained from the abridged financial statements and

annual reports. It clearly gives answers to the research questions and helps in meeting the

research objectives. The greatest advantage of document analysis is that it overcomes the

respondents’ tendency of distorting responses once they get conscious of being studied.

Web-Based Survey was also employed to gather data needed for document analysis. It offers

the researcher immediate results as time is one of the constraints faced. This is linked to an

online databases and the major one being the Zimbabwe Stock Exchange with all the required

information for all the listed retail companies.

3.4 Data Source

The study made use of secondary data. The data was collected from audited financial

statements of the companies for the financial years ranging from 2009 to 2014.The data was

extracted from the websites of the Zimbabwe Stock Exchange and those of the companies

used for the study. Various capital structure researches that deal with listed organisations

utilise data from the stock exchange. Leon (2013) gathered secondary data from Colombo

Stock Exchange in assessing the impact of capital structure on financial performance on

corporate performance.

3.5 Use of measures

When assessing an organization's execution, Johansson and Runsten (2005) contend that net

profit is useless as a measure. On its own, it does not give information as to whether an


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organization is generating any return to the shareholders, which is essential with a specific

end goal to guarantee the organization's survival. Net profit is rather important first when it is

expressed in relation to the capital that was needed to generate the profit. Basing on this

regard, financial performance was measured by the financial ratio Return On Equity (ROE).

As indicated by Johansson and Runsten (2005), ROE is the most critical financial ratio from a

shareholders’ point of view as they can easily compare it with the market cost of capital. It is

computed as a percentage of the net profit after tax compared to shareholders’ equity.

Net Profit Margin was also used as a measure of performance. It measures the company’s

effectiveness in converting revenue into profits for shareholders. It is arrived at by dividing

net profit after tax by revenue. It is expressed as a percentage.

On the capital structure side, figures of debt and equity on their own also do not provide

meaningful information. Ratios are used to derive sense out of the debt and equity figures.

For this study the gearing ratio was used as the measure of capital structure.

3.5.1 Gearing

Gearing measures the proportion at which the company is financed by debt. The gearing ratio

was arrived at by expressing fixed cost capital (long term loans) as a proportion of total

capital (total of long term loans and equity shareholders’ funds).

Gearing =debttermlongfundsrsshareholdeEquity

debtterm-Long

100%

Equity shareholders’ funds constitute issued ordinary share capital and reserves.

3.5.2 Return On Equity (ROE)

The return on equity is arrived at by dividing profit attributable to equity holders by the book

value of the shareholders’ funds. The profit attributable to equity holders is arrived at afterdeducting all expenses of the business, including tax and inter est. The shareholders’ funds


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comprise of the issued share capital, retained earnings and other reserves. ROE expresses the

return in dollars for each dollar of the shareholders’ funds.

ROE =fundsrs'shareholdeof Book value

taxandinterestafterProfit

3.5.3 Net Profit Margin

It measures profit made per dollar of sales made by a company

Net Profit Margin =revenueSales

profitNetX 100

3.7 Data Analysis

The data for all the four companies are summed up so the consolidated data will be analysed

and not individually. Descriptive statistics were utilized to portray the characteristics of the

population under study. SPSS version 20 was utilised to calculate the mean and variance.

Pearson’s correlation analysis was used to explain the relationship between capital structure

and its determinants. The same analysis was employed by Siro (2011) in a similar study for

firms listed on the Nairobi Stock Exchange. The relationship between gearing and

performance was established utilizing the linear regression model:

ROE = c + m(g)

Where:

ROE is the return on equity

c is the intercept

m is the incline


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g is the gearing

SPSS v20 was also utilised to get the correlation coefficients.

3.8 Data validity and reliability

All the companies listed on the Zimbabwe Stock Exchange are required to prepare their

financial statements in accordance to the International Financial Reporting Standards (IFRS).

All the data was collected from the Zimbabwe Stock Exchange and the companies’ official

websites. Validity and reliability of the data is enhanced by the fact that the financial

statements used were audited by independent external auditors.

3.8 Chapter summary

This chapter described the methodology and the design of the study. It stated the population

and sample of the study; the sampling technique used the source of the data, the measurement

of the variables used and a summary of how the data analysis was done. The following

chapter takes a look at data analysis and presentation.


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CHAPTER FOUR

DATA PRESENTATION, ANALYSIS AND INTERPRETATION

4.1 Introduction

This chapter focused on the presentation, analysis and interpretation of the data collected

using different research instruments discussed in the previous chapter on methodology.

Regression model and correlation analyses were employed for the study. The chapter went on

to interpret the results, give a conclusion based on the findings done on the retail firms onZSE. The findings are based on the objectives and research questions on the determinants and

relationship between capital structure and financial performance. The researcher also

attempted to establish the optimal capital structure that maximises the shareholders wealth

based on the current Zimbabwean economic environment.

4.2 Data availability

Fig 4.1 Data availability

The researcher intended to make use of the financial statements of the retail companies for a

six year period ranching from 2009 to 2014 but some of the 2009 financial statements were

not available because of the change of the functional currency from the highly inflationary

Unavailable

17%

Available

83%

Data availability


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Zimbabwean dollar to the US dollar therefore the year was left out of the scope of this study.

The financial statements from the year 2010 were all available representing a response rate of

83% as shown by fig 4.1 above.

4.3 Descriptive statistics on determinants of capital structure

Table 4.1 Descriptive statistics

N Minimum Maximum Mean Std. Deviation

LEV 5 .28 .52 .3600 .09695

SIZE 5 19.30 20.19 19.8774 .38964

TANG 5 .28 .47 .3435 .07356

PROF 5 .04 .17 .1073 .04763

Valid N

(listwise) 5

Descriptive statistics were utilized to provide summaries of the measures. Table 4.1 above

provides information for the mean, the standard deviation, the maximum and the minimum

values of the variables for the period 2010 to 2014. LEV represents leverage, TANG

represents asst tangibility, PROF represents profitability.

4.3.1 Firm leverage

From the information on the table, the mean leverage for the firms over the period under

study is 0.36 implying that approximately 36% of the companies’ total assets are financed by

borrowings. This average is slightly higher than the 29% that Frank and Goyal (2009) got,

which demonstrates that the organizations in this study are marginally more geared than the

American organizations they studied. On the other hand, Kouki and Said (2012) on the study

of French firms got a higher average mean of 51%.

4.3.2 Profitability

Profitability was measured by expressing earnings before interest and tax (EBIT) as a

percentage of total assets. A mean of 10.73% was found and a respective standard deviation

of 0.48. The mean profitability is higher than the 8% the research of Song (2005). The proxy

reflects how efficient the firms use their assets to generate profits. On average the retail firms


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are achieving a profit equivalent to slightly above 10% of the book value of their assets

annually. Though the standard deviation of 0.48 is higher than that of Song (2005) which was

0.28, the conclusion is that the variability of the annual profitability from the mean was

relatively low over the years under study.

4.3.3 Size

Size is represented by the logarithm of revenue. It had a mean of 19.88. The calculation of the

proxy makes it make little economic sense. However the standard deviation of 0.39 reveals

that there are minor variations from the mean size over the years. This is further shown by the

fact that both the minimum of 19.30 and the maximum of 20.19 are close to the mean of

19.88.

4.3.4 Tangibility

The proxy used for total assets is property, plant and equipment to total assets. It has a mean

of 0.34. This means that on average, of the assets of the firms, 34% is property plant and

equipment. Therefore considering the fact that tangible assets are highly considered by

lenders, it is difficult and expensive for the firms to borrow beyond 34% of the book value oftheir assets. The mean tangibility of the retail firms under study is a bit less than the 0.35 that

Frank and Goyal (2009) found in their research. The research of Song (2005) got 0.288 as the

tangibility ratio mean, which is about 0.05% less than of this research.

4.4 Correlation analysis of the determinants of capital structure

Table 4.2 Correlations

Correlations

FLEV SIZE TANG PROF

FLEVPearson

Correlation1 -.810 -.345 -.667

SIZEPearson

Correlation-.810 1 .416 .802

TAN

G

Pearson

Correlation-.345 .416 1 .499

PROFPearson

Correlation-.667 .802 .499 1


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A correlation analysis was performed so as to test the level of linearity of the variables. Table

4.2 above shows the correlation matrix and presents an overview of the variables’ correlation

coefficients.

4.4.1 Determinants of capital structure

At 5% level of significance, profitability had a significant negative coefficient of -0.667

which implies that as the profitability of the companies increase, they tend to utilise less of

debt. The result suggests that a 1 percentage point increase in profitability will lead to a 0.667

percentage point decrease in leverage. That is to say more profitable firms utilise less of

borrowed funds as they will use retained earnings to fund their projects instead of using

external debt. In contrast, the trade-off theory assumes that companies that are profitable

shield their earnings from tax, and therefore borrow more than the less profitable companies.

The negative relationship between leverage and profitability is consistent to the results from

Mojtahedzadeh and Nejati (2011) and Titman and Wessels (1988).

A negative relationship was revealed between size and leverage. An increase by 1 percentage

point in size will lead to a decrease in leverage of 0.81 percentage points. This outcome

contradicts the trade-off theory which predicts a positive relationship between the companies’

profitability and their leverage basing on the assumption that as a company grows bigger it

diversifies therefore its default risk will be lower. The negative relationship is consistent to

the findings of Wahap and Ramli (2014) and Yolanda and Soekarno (2012).

At 5% level of significance, the study reveals a negative relationship between asset tangibility

and the gearing of the companies. An increase by 1 percentage point in asset tangibility will

lead to a decrease in leverage of 0.345 percentage points. These findings contradict the tradeoff theory which anticipate a positive relationship between asset tangibility and leverage as

the assets can be used as collateral security for securing loans. Most studies reveal a positive

relationship between asset tangibility and leverage. However the results are supported by the

agency theory as it is easy for debt finance providers to monitor the use of tangible assets, the

managers may not willing to issue debt for such a reason.


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4.5 Regression analysis of the determinants of capital structure

A multiple regression test was performed to predict leverage from size, profitability and

tangibility. For the interpretation of the coefficients, all the other variables are held constant.

Table 4.3 Regression model

Regression model for determinants of capital structure

Mode

l

R R Square Adjusted R

Square

Std. Error of the

Estimate

1 .811a .657 -.372 .11358

a. Predictors: (Constant), PROF, TANG, SIZE

The R square value is calculated to identify the effect of profitability, tangibility and size on

capital structure (gearing). The R square value is 0.657. This means profitability, tangibility

and size contributed 65.7% to determine the net profit margin. The remainder is contributed

by some other factors that are not considered for this research.

Table 4.4 Coefficients

Coefficientsa

Model UnstandardizedCoefficients

StandardizedCoefficients

t Sig.

B Std. Error Beta

1

(Constant) 4.180 4.679 .893 .536

SIZE -.192 .244 -.770 -.785 .576

TANG .001 .891 .001 .001 .999

PROF -.102 2.095 -.050 -.048 .969

a. Dependent Variable: FLEV

The findings presented in table 4.4 above suggest firm size is the major determinant of capital

structure for the listed retail companies in Zimbabwe. A negative relationship exists between

size and leverage. As the size increase by 1 percentage point, leverage will decrease by -0.92

percentage points. This is consistent with the findings of Wahap and Ramli (2014) and

Yolanda and Soekarno (2012). The relationship contradicts the trade off theory which

assumes a positive relationship between size and indebtedness, the rationale being that larger

firms have less risk of defaulting. However the results are not a surprise given the currenteconomic situation in Zimbabwe where interest rates are very high, larger companies find it


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Fig 4.3 Net Profit Margin

The companies may be trying to lower gearing as much as they can due to their level of

performance which is also very low as shown by low net profit margin which for the period

under study ranged from a minimum of as low as 1.1% and a maximum of only 3.1%, the

mean being 2.4%. The net profit margins for the period under study are depicted by Fig 4.3

above.

4.6 Relationship between capital structure and financial performance

Capital structure was measured by the level of gearing while financial performance was

measured by the return on equity and the net profit margin. The table below provides

information for the mean, the standard deviation, the maximum and the minimum values of

the variables for the period 2010 to 2014.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

2010 2011 2012 2013 2014

NPM

NPM


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Table 4.5 Capital structure and financial performance statistics

N Minimum Maximum Mean Std.

Deviation

Statistic Statistic Statistic Statistic Statistic

Gearing 5 27.69 51.55 35.8270 9.50302

Net Profit

Margin5 1.13 3.13 2.3656 .79616

Return On

Equity5 10.77 23.90 16.9749 5.39660

Valid N

(listwise)5

Gearing was used as the capital structure proxy. The mean gearing of 35.83% shown on

Table 4.5 above means that on average 35.83% of the companies’ operations for the period

2010 to 2015 were funded by borrowings. The gearing is higher than a 29% found by Frank

and Goyal (2009) on the American companies that they studied. For the period under study,

the minimum gearing of the retail sector was 27.69% while the maximum was 51.55%. There

were relatively high variations from the average gearing as shown by the standard deviation

of 9.5.

A mean net profit margin of 3.13% was revealed for the combined retail companies during

the period. It means on average approximately 3.13% of revenue was converted into profit.

The percentage is very low implying that the companies have high operating expenses. It had

little variations from the mean over the period as evidenced by the low standard deviation of

0.78. The mean is slightly higher than the 2% that was revealed in the case of Frank and

Goyal (2009). However, the difference in results could be the proxy used for profitability

because in their research they used profit before interest and tax divided by total sales while

in this research the proxy used was profit after tax divided by total assets.

Return on equity had a mean of 16.97%. It is slightly less than the 17.75% that was found by

Musiega et al (2013) in their research. The proxy mean implies that the average rate of return

for the common stock holders is 17c per every dollar of equity.


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4.7 Pearson correlation analysis of gearing and performance proxies

A correlation analysis was performed using Karl Pearson correlation coefficient. A negative

coefficient shows that an inverse relationship exists between the variables correlated meaning

an increase in one variable result in a decrease in the other variable and vice versa. On the

other hand a positive coefficient shows a direct relationship of the variables meaning an

increase or decrease in one variable would result in an increase or decrease of the other

variable respectively.

Table 4.6 Correlations

Correlations

Gearing Net Profit

Margin

Return On

Equity

Gearing

Pearson Correlation 1 -.631 -.330

Sig. (2-tailed) .254 .588

N 5 5 5

Net Profit Margin

Pearson Correlation -.631 1 .931*

Sig. (2-tailed) .254 .022

N 5 5 5

Return On Equity

Pearson Correlation -.330 .931* 1

Sig. (2-tailed) .588 .022

N 5 5 5

*. Correlation is significant at the 0.05 level (2-tailed).

The results in table above on Pearson correlation coefficient, a significant negative

correlation exists between gearing and net profit margin (r = -0.631, p


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4.8 Regression analysis model for gearing and performance proxies

Table 4.7 Regression analysis

Regression model for capital structure and Net Profit Margin

Mode

l


Square

Std. Error of

the Estimate

Durbin-

Watson

1 .631a .398 .198 .71318 1.383

a. Predictors: (Constant), Gearing

b. Dependent Variable: Net Profit Margin

The R square value is calculated to identify the effect of gearing ratio on net profit margin.

The R square value is 0.398. This means gearing contributed 39.8% to determine the net

profit margin. The remaining 60.2% is contributed by some other factors that are not

considered for this research.


Coefficientsa

Model Unstandardized

Coefficients

Standardized

Coefficients

t Sig.

B Std. Error Beta

1(Constant) 4.260 1.382 3.083 .054

Gearing -.053 .038 -.631 -1.409 .254

a. Dependent Variable: Net Profit Margin

From the table above, the regression equation could be derived as follows:

Y = 4.26 – 0.053X

The b value is -0.053. It shows that gearing ratio and net profit margin tend to move in

opposite directions. The relationship concurs with the findings of Yogendrarajah (2011) on

his study on the effect of profit margin on capital structure of manufacturing companies on

Colombo Stock Exchange.


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Table 4.9 Regression model for gearing and Return on Equity

Regression model for gearing and Return on Equity

Mode

l


Square

Std. Error of

the Estimate

Durbin-

Watson

1 .330a .109 -.188 5.88252 1.476a. Predictors: (Constant), Gearing

b. Dependent Variable: Return On Equity

The R square value is 0.109. This means gearing contributed 10.9% to determine the return

on equity. The remaining 39.8% is contributed by some other factors that are not considered

for this research.


Coefficientsa

Model Unstandardized

Coefficients

Standardized

Coefficients

t Sig.

B Std. Error Beta

1

(Constant) 23.688 11.397 2.078 .129

Gearing -.187 .310 -.330 -.605 .588

a. Dependent Variable: Return On Equity

From the table above, the regression equation could be derived as follows:

Y = 23.688 – 0.187X

The b value is -0.187. It shows that gearing ratio and return on equity tend to move in

opposite directions. The negative relationship is in consistent with the findings Leon (2013)

4.9 The optimal capital structure

This study seeks to establish the optimal capital structure which maximises the financial

performance, which is measured by the net profit margin and the return on equity in this

study. Over the period of years under study, the overall capital structure of the companies has

been shifting and so was the financial performance. Analysing the trends by the variables

helps to establish the optimal capital structure mix


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4.9.1 The relationship between capital structure and net profit margin

Fig 4.4 The relationship between capital structure and net profit margin

The graph above shows that the net profit margin increases as the gearing ratio increases, but

up to a certain point beyond which the a further increase in gearing results in a decrease in net

profit margin. The companies strive to maximise the net profit margin hence the point where

the net profit margin is at the peak is considered to be the optimal point. The study as shown

on the Fig 4.4 above, reveals the peak net profit margin of 3.1% at a point where gearing is at

38%. These results support the trade off theory of capital structure which propounds that

there is a certain point where the benefits of debt (interest shield and discipline instilled on

management) are equivalent to the cost of debt (interest and bankruptcy costs). Such a point

of gearing is what the theory describes as the optimal capital structure. Using a gearing ratio


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below such a point results in a higher WACC by foregoing the debt interest shield and using

a gearing ratio higher than that point results in increased expenses (due to bankruptcy costs).

4.9.2 The relationship between capital structure and return on equity

Fig 4.5 The relationship between capital structure and return on equity

Return on equity, as evidenced by the Fig 4.5 above, is following the same trend as the net

profit margin. It also has a point where it is at peak, before and after which it begins to fall.

The maximum return on equity is 23.9%. The point is the same as the one shown by the net

profit margin, which is a gearing of 38%. These results, as stated above, support the trade off

theory of capital structure. Boodhoo (2009) during his study using evidence from Mauritius

established an optimal capital structure of 50%. His optimal gearing is higher than for the

Zimbabwean retail firms most likely because the interest rates in Zimbabwe at the present

moment are not favourable for sustaining high levels of debt.


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4.9.3 Net Profit Margin and Return on equity in relation to gearing

Fig 4.6 Net Profit Margin and Return on equity in relation to gearing

Fig 4.6 above presents how financial performance responds to various gearing levels and

depicts the existence of an optimal capital structure maximises performance. According to the

trade off theory, at such a point the benefits of debt are equivalent to the costs of debt. For the

retail companies to strike that balance they have to employ a gearing ratio of 38%.


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4.10 Chapter summary

The chapter analysed in detail the findings on the objectives of the research which was basedthe review of secondary data obtained mainly from the Zimbabwe Stock Exchange website

and also the companies’ official websites. The researcher used tables, graphs and pie charts to

interpret and analyse data by making use of SPSS v20. The research revealed that size is a

negative determinant of capital structure. It also established the relationship between capital

structure and financial performance of the retail companies. The next chapter brings the

whole research to an end by laying down the findings which the researcher gathered and

recommendations shall be given thereon.


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CHAPTER FIVE

SUMMARY CONCLUSIONS AND RECOMMENDATIONS

5.1 Introduction

This chapter focused on the summary, conclusions and recommendations of findings

pertaining to the relationship between capital structure and financial performance for retail

companies listed on ZSE. It also focused on establishing the determinants of capital structure

for the listed retail firms. Conclusions and recommendations were drawn from the summed

up answers to the research questions basing on the findings presented in the previous chapter.

5.2 Summary of findings

The study was motivated by the fact that there are many companies that are collapsing and

the closures are largely attributed to failure to adopt optimal capital structure. The research

aimed to gather capital structure data of all the four listed retail companies in Zimbabwe.

Descriptive analysis, linear regression and Pearson’s correlation coefficient was employed for

data analysis. SPSS v20 was used to analyse the data. Data for all the four companies that

form the population of the study was used. The data was available for the period from 2010 to

2014.

On attempting to establish the determinants of capital structure for the retail listed firms, a

negative relationship was found between gearing and size and profitability. Though in

literature it is believed that asset tangibility gives organisations an advantage to increase debt

using the assets as collateral security, the results of the study implies the companies are

reluctant in exploiting that advantage as an insignificant positive association between the

variables was revealed.

The mean gearing was found to be 35.83% which means on average the retail firms are

funded by equity more than debt. The aggregate debt is shown to be continuously

diminishing from 51.5% in 2010 to 27.7% in 2014. The retail firms are shunning debt in their

capital structure mix.


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A negative association was established between gearing and net profit margin and return on

equity. A coefficient of -0.053 was found between gearing and the net profit margin which

means as gearing increases, net profit margin decreases. The results also reveal that capital

structure contributed 39.8% to the net profit margin. For return on equity, the association is

explained by a coefficient of -0.187. Capital structure contributed 10.9% to determine the

return on equity.

The findings of the study revealed an optimum capital structure for the retail sector to be a

gearing level of 38%. At such a point net profit reaches its peak of 3.1%. At the same gearing

level the return on equity also reaches its peak of 23.9%

5.3 Conclusions

The study concludes that for listed retail companies in Zimbabwe, as the size increases, the

level of gearing decreases. The negative relationship is attributable to the fact that size makes

it easier to raise more equity either by issuing more share capital or by

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Lewis Mutswatiwa