EFFECT OF CAPITAL STRUCTURE ON FIRM PERFORMANCE
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EFFECT OF CAPITAL STRUCTURE ON FIRM PERFORMANCE
Chapter one
Introduction
Background of the study.
A company’s capital structure is the combination of debt and equity that it uses to finance its operations and investments. For many years, economists and financial experts have debated how capital structure affects corporate performance.
Some say that having a higher amount of debt in the capital structure increases the risk of financial distress, while others believe it improves financial performance through tax breaks and increased leverage.Majumdar, Chhibber (1999)
The relationship between capital structure and business performance can be examined using a variety of financial measurements, including return on equity (ROE), return on assets (ROA), earnings per share (EPS), and debt-to-equity ratio (D/E).
In general, a corporation with a high level of debt in its capital structure is considered highly leveraged. High leverage can increase financial risk because the corporation must pay interest on its debt even during periods of economic uncertainty or decline.(Brigham E. 2004).
On the other hand, a higher level of leverage can lead to higher returns on equity because the company can use the borrowed cash to invest in profitable prospects. Debt can also give financial advantages because interest payments are tax deductible, lowering the company’s tax liability.
As a result, a company with a higher proportion of debt in its capital structure may have a higher ROE than one with a smaller percentage of debt.(Pratomo, 2006).
However, the impact of capital structure on business performance varies depending on a number of factors, including industry, economic conditions, and management.
High leverage may be more acceptable in companies with steady cash flows, such as utilities or telecommunications, because these industries generate predictable cash flows that can cover loan interest payments.
In contrast, excessive leverage may not be feasible in businesses with fluctuating cash flows, such as technology or biotech, because the company may face financial trouble if it is unable to satisfy the debt’s interest payments.(Leon, 2013)
Furthermore, the appropriate capital structure is determined in large part by the company’s management. Before determining the proper quantity of debt, management should take into account the company’s growth potential, cash flows, and profitability. Too much debt can cause financial difficulties, whereas too little debt might limit a company’s growth potential.
The impact of capital structure on firm performance is a complicated problem that necessitates thorough evaluation of numerous elements. High leverage can result in better equity returns and tax benefits, but it also increases the danger of financial distress.
As a result, organisations should assess their financial state, industry conditions, and managerial capabilities before establishing the best capital structure.
Statement of the Problem
A firm’s capital structure is crucial to its performance because it influences the company’s capacity to meet financial obligations and maintain long-term growth. Nestle Nigeria Plc, Nigeria’s major food and beverage firm, has had fluctuating financial performance in recent years.
There is a need to research the impact of capital structure on business performance, with a special emphasis on determining the ideal capital structure that will improve the company’s performance.
What influence does capital structure have on Nestle Nigeria Plc’s performance, and what is the best capital structure for the company?
The objectives Of The study
The study’s aims are:
To study Nestle Nigeria Plc’s present capital structure, including the debt-to-equity ratio, leverage ratio, and other financial metrics.
Analyse Nestle Nigeria Plc’s financial performance over the last five years using key financial measures such as return on equity (ROE), return on assets (ROA), and net profit margin.
Determine the relationship between capital structure and financial performance, as well as the factors that influence it.
Research Hypotheses
H1: Nestle Nigeria Plc has no existing capital structure, including a debt-to-equity ratio, leverage ratio, and other financial metrics.
H2: Nestle Nigeria Plc has had no financial performance in the last five years, as measured by major financial measures such as return on equity (ROE), return on assets (ROA), and net profit margin.
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