Leverage With High And Low Debt Equity Ratios - Free Essay Example

Sample details Pages: 20 Words: 6093 Downloads: 5 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? The theme of the study is to inspect the effect of the leverage with high and low debt to equity ratios on identified portfolios required rate of returns listed in Karachi Stock Exchange (KSE). The multivariate regression has been used to identify the relationship among market premium, debt à ¢Ã¢â€š ¬Ã¢â‚¬Å" to à ¢Ã¢â€š ¬Ã¢â‚¬Å" equity premium and portfolio returns. The sample has been selected from 21 sectors consisting 100 listed- Pakistani firms for the period of January 2001 to December 2007. Don’t waste time! Our writers will create an original "Leverage With High And Low Debt Equity Ratios" essay for you Create order The P-value at 95% confidence level shows the relationship with CAPM is positive and significant related to portfolio returns (P1 to P10), while the leverage premium (DER premium) is positively insignificant. The proposed multi-factor model explains that the value of R2 indicated that there is no contribution by adding the identified variable (Leverage premium). Therefore the security analysts, institutional investors, fund managers and other stakeholders should not consider the leverage premium as an important factor for determinant of required rate of returns. INTRODUCTION Leverage refers to the use of fixed cost in attempt to increase profitability. The two principles of leverage are Operating leverage and financial leverage. The former is due to the fixed operating costs associated with the production of goods or services, whereas the latter is due to the existence of fixed financing cost. Both type of leverage affect the level and variability of firms stock return. These studies fall out that several of the CAPM average returns anomalies are interrelated. The CAPM has been one of the most frequently used, but today many empirical studies have pointed out some deficiencies in the model, as an explanation of the link between risk and return. CAPM is weak as it based on Efficient Market Hypothesis, which means: transparency; no transaction costs; no significant restriction to investment; investors rational behavior and expectations. These assumptions imply that the market is not affected by imperfections. There is mixed support for a positive linear association between required rates of return and systematic risk for portfolios of stock. Some recent evidence indicated the need to consider the additional risk variables or different risk proxies. Thats why several studies criticize the tests of the model and usefulness of the model in portfolio evaluation because of its dependence on a market portfolio of risky assets. Empirical studies have shown the accessibility of extra required rate of returns by using active investment strategies base on a number of firm variables such as leverage (Bhandari, 1988), size (Banz, 1981), price earnings ratio (Basu, 1977), book to market ratio (Stattman, 1980); Rosenberg, Reid and Lanstein, (1985), etc. These evidences, since inconsistent with the CAPM, are popularly known as CAPM anomalies. The asset-pricing model of Sharpe (1964), Linter (1965) and Black (1972) has long formed the mode academics and practitioners thought about average required rate of returns and risk. There are various observ ed contradictions of the Sharpe-Linter-Black (SLB) model. One of the contradictions of the Sharpe-Linter-Black (SLB) model is inverse relation between leverage and return acknowledged by Bhandari (1988). It has been brought into the account that the leverage is related with risk and expected return. The most leading work of Fama-French (1992) three factor model in which they attach two variables in addition to the market return, the returns on small minus big stocks (SMB) and the returns of high book to market value minus low book to market value stocks (HML). This particular study discussed the two-factors that included one variable other than market premium i-e the returns with high leverage stocks minus the low leverage stocks (Debt/equity ratio premium). Leverage effect is the most important assets pricing anomalies. The recognition of the leverage effect leads the researchers to investigate its possible causes, as its presence implies that either the CAPM is miss-specified or t hat market is inefficient. The leverage ratio of the firm in this study was high and it has been argued that the small firms usually do not have almost as much collateral as big firms and would not have the similar capability to increase outdoor finances. Consequently, small firms would be more negatively affected by lower liquidity and higher short-term interest rates. This study tests the leverage effect in Pakistan stock market over a long period of seven years. The leverage is the most important factor that determines the leveraged. There are various sources of corporate financing, financial leverage is one of among it and is supposed to have both positive and negative features as a debt- financing tool. The issuance of debt makes a firm liable to pay cash as interest and principal. Bhandari (1988) concluded in his study that the expected returns on common stocks are inversely linked to the debt to equity ratio. This particular study examines how the stock price of a firm reacts to the overall change of its leverage ratio. It is a significant subject since the option of capital structure is possibly one of the mainly important decisions managers face, and a change in the leverage ratio can affect a firms financing capability, risk, cost of capital, investment and planned decisions, and eventually shareholder wealth. The descriptive statistical trend of the calculated portfolios on the base of leverage follow the abnormal behavior as the general theoretical phenomena is that the firms with high debt to equity ratios have high risk adjusted high return, but this particular study has reported the high volatility in low debt to equity ratio in compare to the high debt to equity ratio. The required rate of return of the firms with low debt to equity ratio (P1 to P5) is high and there is an increasing trend, while there is decreasing trend in the firms with high debt to equity ratio. The findings reveal a positive and insignificant relationship between leverage premium and expected returns. The same result supported by Ho et al (2006) in Singapore. The study is aim to; 1. To evaluate the effect of leverage on stock return through CAPM. 2. To determine the direction of relationship between leverage and required rate of return. LITERATURE REVIEW Bhandari (1988) proposed to use Debt/ Equity ratio as an additional variable to explain the stock returns. He argued in his paper that an increase in debt/ equity ratio of a firm increases the risk of common equity. He concluded that the debt/ equity ratio has a significant positive effect on the expected common stock returns though in the month of January is much larger. Empirical studies have shown the accessibility of extra normal required rate of returns by using active investment strategies based on a number of firm variables such as size (Banz, 1981), leverage (Bhandari, 1988), price earnings ratio (Basu, 1977). These evidences, since inconsistent with the CAPM, are popularly known as CAPM anomalies. Fama and French (1992) reported that average returns on small stocks are too high with given estimated beta, while average returns on large stocks are too low. This study reported that the relationship between beta and average return disappeared during the period 1963à ¢Ã¢â€š ¬Ã ¢â‚¬Å"1990 and weak relation between beta and average return during (1941 à ¢Ã¢â€š ¬Ã¢â‚¬Å"1990). Their study reported that size beta of size portfolios were highly correlated (- 0.988, in their data) so problem arose to separate the effect of size and beta on average return. When portfolio was formed alone on size, there is strong negative relationship between size and average return. Fama French (1992) concluded that for the period 1963 à ¢Ã¢â€š ¬Ã¢â‚¬Å" 1990 French (1996) argued in their study that the small stocks tend to have higher returns than big stocks and high-book-to-market stocks have high returns than low BE/ME stocks. Moreover, stocks with low long-term past returns revealed a significant relationship between the fundamental financial variables (earnings yield, size, book to market ratio, and cash flow yield) and expected returns in the Japanese market. The book to market ratio and cash flow yield has the most significant positive impact on expected returns. Anothe r variable, cash flow yield, also has a positive and in general highly significant impact on expected returns. Their findings confirmed the existence of a size effect; small firms tend to outperform larger firms, after adjusting for market risk and the other fundamental variables but the statistical significance of the market capitalization variable is sensitive to the specification of the model; indeed, in some cases it is not significant. Choi, J. (2009) reported that the large positive alpha from the high book to market portfolios came from financial leverage. When the risk premium was high, book to market firms equity beta tends to increase more than those of low book to market firms. Their study showed that the book to market changes driven by changes in market leverage. The result suggested that the firms become high book to market firms because their equity value falls after negative shocks. Nishat (2000) concluded in his study that in Pakistan, industry leverage is high, hen ce there were negative and significant relationships between return and volatility change. Kane, Marcus and McDonald (1985) concluded that benefit to debt finance is the difference in the rate of return (premium return) earned by optimally levered and un-levered firms. Odit, Chittoo (2008) conducted empirical study in Stock Exchange of Mauritius and found relationship between leverage and investment. There study has investigated the two kinds of firms, that is: (1) high-growth firms; and (2) low- statistically significant both for the firms with low growth and as well as the firm with high growths. Maroney, Naka and Wans (2004) conducted a study in the context of 1997 Asian financial crisis; it included 6 Asian countries (Malaysia, South Korea, Taiwan, Indonesia Thailand and Philippines). Their study considers leverage as a key feature for financial crisis that the firms were highly levered with dollar denominated debt. The devaluation in currency resulted in increase in leverage an d interest payments. Leverage increased with exchange rate depreciation caused equity betas to rise; investors suffered capital losses because the equity they hold became more risky. The positive correlation between exchange rates and local returns were consistent with leverage linked to exchange rate. The local returns have positive correlation with exchange rate changes because they were associated with capital gains and losses in local market. The increased leverage contributes to the rise in equity beta and raises expected returns. Cai, Zhang (2008) examined the extensively inverse cause of the change in leverage ratio on the portfolio returns. There was a significant, inverse result of the change in long-term debt leverage on stock returns, but a weaker cause for the change in short-term debt leverage. Their study reported straight indications that rise in leverage proportion lead to lower investment in future, which is an inverse cause of leverage change on future investment. Hull (1999) analyzed whether the stock value was influenced by how a firm changed its leverage ratio in relationship to its industry leverage ratio norm. He found out in his study that the stock returns for firms moving away from debt-to- equity norms were significantly more negative than return for firms moving closer capital structure theory if industry debt-to- equity norms were reasonable approximations of wealth-maximizing leverage ratios. Ho, Tjahjapranata, and Yap (2006) conducted a study in Singapore which investigated that a firms ability to arise the growth opportunities from RD investments depend on its size, leverage, and the industry concentration. The analysis of the firm size, financial leverage, and industry concentration interactions showed that the levels of financial leverage moderate the firm size benefits. The RD investments were positively associated with growth opportunities as firm size increases when financial leverage is high. The study concluded the effect iveness of RD investment in generating growth opportunities has a significant positive effect for firm size and a significant negative effect for industry concentration, whereas non-significant ambiguous results for the independent effect of financial leverage. The current study conducted is to find the multifactor model, to test the application of CAPM, to express the relationship between leverage premium and equity returns in Pakistan equity market. These finding suggest fund managers, analysts, institutional investors and individual investors to consider the identified variables to obtain optimal expected average returns. III. RESEARCH METHODOLOGY Stephen Ross in 1976, create the theory by which to predict the association between the returns of a single asset and the returns of a portfolio through a linear combination of many independent macro-economic variables. The asset pricing model is frequently viewed as substitute to the capital asset pricing model (CAPM), since the arbitrage pricing theory (APT) has more elastic supposition requirements, while the CAPM require the markets predictable return. The basis of arbitrage pricing theory is the initiative that the price of an asset is determined by a number of factors. These numbers of factors can be divided into two groups: micro factors and macro factors. The name of the theory comes from the fact that this division, together with Arbitrage can be used to derive the following formula: r = rf + ÃŽÂ ²1f1 + ÃŽÂ ²2f2 + ÃŽÂ ²3f3 +à ¢Ã¢â€š ¬Ã‚ ¦.. ÃŽÂ ²nfn. r = rf + ÃŽÂ ²1f1 + ÃŽÂ ²2f2 8Where r is the expected return on the security, rf is the risk free r ate, each f is a separate factor, f1 denote market premium while f2 represent the difference of high and low leverage stocks portfolio and each coefficients are the risk sensitivities of returns for market risk (ÃŽÂ ²1) and leverage (ÃŽÂ ²2). The two-factor model is an addition of a sole factor CAPM; lot of literature today supports other additional factors beside the traditional beta. Fama French (1992) have done wide investigate in this region and initiate factors describing value and size to be the most considerable factors, other than the market risk, they value risk. The word SMB means small minus big, ià ¢Ã¢â€š ¬Ã¢â‚¬Å"e, the firm with low market capitalization and the firm with high market capitalization. HMB stands for high minus low, has been designed to determine the value premium. The two factors model allows the investors to weight their portfolios in such a way that they have larger or lesser coverage to each of the particular risk factors and there fore can mar k more accurately various levels of expected return. To test the two factor model this particular study follow the traditional multivariate regression framework and convert the above equation into a simple time series model represented as follows: RÃŽÂ ¯ = R?+ÃŽÂ ²ÃƒÅ½Ã‚ ¯ (Rm-R?) + hÃŽÂ ¯ (DER Premium). This study constructs two factors; (Rm-R?) address market premium and (DER Premium) address debt to equity ratio premium. (DER Premium) stands for the leverage premium that is the differentiation of the high and low debt to equity ratio. As regression analysis is used to predict dependent variable by using one or more independent variables. Where RÃŽÂ ¯ present the return on portfolios, it is the dependent variable that is to be predicted, (Rm-R?) and (DER Premium) are the independent variables that is use to predict it, ÃŽÂ ²ÃƒÅ½Ã‚ ¯ and hÃŽÂ ¯ are the coefficients or multipliers that describe the level of the effect, the independent variables has on dependent variable. Population The study has been conducted in Karachi Stock Exchange (KSE) that is Pakistan equity market. There are three markets in Pakistan where stocks are traded that is Islamabad Stock Exchange (ISE), Lahore Stock Exchange (LSE) and Karachi more active stock market in Pakistan. According to accounting information 65 to 70% value of total transaction of the country recorded at KSE on 1st October 2004. It was stated the Best performing stock market of the world for 2002 Suliaman et al (2009). In 1991, KSE was declared as an open market and it is considered as an emerging stock market and is therefore consider different from the developed markets. There are 34 sectors that have been traded, and each sector consist bundle of companies. As for the particular study is concerned, the population to be studied includes 34 sectors from Karachi Stock Exchange (KSE). It contains a large number of listed firms. Sample The secondary data has being used for this particular study. The data collected from the financial data available in the Karachi stock exchange web site (www. kse .com. Pk), cover a phase from 2001 to 2007. The sample include 100 listed- Pakistani firms at Karachi Stock Exchange among the identified sample ià ¢Ã¢â€š ¬Ã¢â‚¬Å"e 21 sectors which is almost equal to 60%, from 2001 to 2007, the monthly data on closing price of stocks and Karachi Stock Exchange index gathered from the www.brecorder.com and Ready Board Quotations issued by Karachi Stock Exchange at the closing of trading day, that is also accessible in the documents of Security and Exchange Commission of Pakistan (SECP). The procedure to create a sample size from the identified population is to select those 100 companies that are traded eight (8) months a year at least, while as the companies that has been traded less than eight months a year has been excluded, the analysis of the relationship between stock returns and th e identified variables is conducted at the portfolio level. To find out the leverage ratio (debt à ¢Ã¢â€š ¬Ã¢â‚¬Å" to à ¢Ã¢â€š ¬Ã¢â‚¬Å" equity ratio) of the sorted companies the value of debt divided by the value of equity. These values of debt and equity of the sorted company are obtained from the annual report of companies. The companies with low leverage ratio have been placed in small and those with high leverage ratio have been placed in large. The treasury-bill rate is used as risk free rate and KSE Index as the return rate of market. The data on treasury-bill rates are taken from Monthly Billiton of State Bank of Pakistan. The financial sector including banks, insurance and leasing etc; are excluded from the total selected sample, as the majority of the studies exclude the financial sectors while conducting the study because of highly differentiated risk profiles, Fama and French (1992). The industries to be studied listed at Karachi Stock Exchange 1. Textile Spinning . 2. Transport. 3. Technology and Communication. 4. Woolen. 5. Jute. 6. Sugar and Allied Industries. 7. Cement. 8. Tobacco. 9. Refinery. 10. Power Generation and Distribution. 12. Oil and Gas Exploration Companies. 13. Automobile Assembler. 14. Automobile Parts and Accessories. 15. Cable and Electronic Goods. 16. Fertilizer. 17. Pharmaceuticals. 18. Chemical. 19. Leather and Tanneries. 20. Food and Personal Care Products. 21. Miscellaneous. IV. ANALYSIS AND EMPIICAL RESULT The empirical estimation is based on a cross-sectional regression analysis of the relationship between stock prices in form of portfolios and the firm debt to equity ratio. It actually test the relationship of portfolio return as dependent variable and two independent variables i.e. market premium (Rm-Rf) and leverage premium. Dependent Variable PORTFOLIO RETURNS The average returns of the firms included in sample of all stocks by creating portfolios, represented by P1 to P10 is to be cosidered as dependent variable for the two factor model. Stock returns are calculated as; Rit = Ln (Pit-1/ Pit) Where Pit is the stock price of the i- th firm in time period t and the average return of this stock is the return of portfolios that has been regressed as dependent variable on two factors namely market premium premium and leverage premium. The independent variables include market premium and leverage premium. Independent Variables 1. Market premium (Rm-Rf) 2. Lever age premium (DER PREMIUM) 1. MARKET PREMIUM (Rm-Rf) Market premium, it is calculated as the differentiation among risk free rate and return on market, that presents the excess return that investor could receive if he invests in market both CAPM and three factor model, but today the empirical studies have shown the accessibility of extra normal returns by adding other factors that has the affect on the returns of the stocks. In this particular paper other two independent variables are; Return of market is calculated as; Rm = Ln (KSE Indexit -1/ KSE Indexit) Market premium (Rm-Rf) is calculated as, the difference between the return on KSE index and T-bill yield. This factor is enough to found the CAPM, however there is another risk factors to be studied in this study that is leverage. 2. LEVERAGE PREMIUM (DER PREMIUM) Leverage premium, is measured as the difference between the firms with high debt to equity ratios and the firms the low debt to equity ratios. Leverage premium (DE R premium) is computed as; There are two ways to measure the capital structure supported by literature: book leverage and market leverage. This paper use the book leverage, which equates the historical (book) value of total liabilities, divided by the book value of total assets. As for this study is concern the market leverage inappropriate, as its change is automatically linked with stock price. Therefore, the particular studies use the 3book leverage to determine the debt ratio. The book value of the assets is stable as compare to the market value. DER = Total Liabilities /Total Equity Total Liabilities = Total Asset à ¢Ã¢â€š ¬Ã¢â‚¬Å" Total Equity Leverage Premium = High DER last 30% à ¢Ã¢â€š ¬Ã¢â‚¬Å" Low DER top30% liabilities on the book value of total equity at the ending period of each year of the sample. The identified sample then ranked and grouped into 3 different groups based on the bottom 30% classified as low debt to equity ratios, middle 40% classified as Med ium and top 30% classified as high debt to equity ratios. The firms were sorted into ten portfolios, with portfolio one (P1) having the lowest leverage ratio and portfolio ten (P10) having the highest leverage ratio. The firms in Pakistan are highly levered; the average equity is 35% while the average debt is 65% of the identified population that contain approximately 400 companies. The Table 4.1 shows the descriptive statistical trend of the calculated portfolios on the base of leverage. The 1st portfolio (P1) present the firms with low debt to equity ratio and the last portfolio (P10) present the firms with high debt to equity ratio. It follow the abnormal behavior as the general theoretical phenomena is that the firms with high debt to equity ratios have high risk adjusted high return, but this particular study report the high volatility in low debt to equity in compare to the high debt to equity ratio (Fig. 4.1.A). At extreme level the expected return of the firm with high debt to equity ratio is high than the firm with low debt to equity ratios but overall the expected return of the firms with low debt to equity ratio (P1 to P5) is high and there is an increasing trend, while there is decreasing trend in the firms with high debt to equity ratio (Fig. 4.1.B). The reason for such behavior may be the industry effect that the firms in these portfolios mostly belong to textile spinning, sugar and chemical industry. The trading volume in these industries is low in this particular period that may miss priced the securities. The 6 th portfolio (P6) reported in Fig. 4.1. B also affected by the industry factor that is textile spinning and sugar. MEAN P 1 P 2 P 3 P 4 P 5 P 6 P 7 P 8 P 9 P 1030Mean 0. 0028 0. 0116 0.0151 0. 0145 0. 0182 0. 0059 0. 0140 0.10139 0. 0107 0. 0053 Standard Error 0. 0095 0. 0096 0. 0080 0. 0083 0. 0074 0. 0079 0. 0080 0. 0066 0. 0077 0. 0089 Median -0. 0001 0. 0084 0. 0113 0. 0028 0. 0161 -0. 0004 0. 0096 0. 0182 -0. 0017 -0. 0007 18Mode # N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A Standard Deviation 0. 0870 0. 0875 0. 0729 0. 0760 0. 0680 0. 0725 0. 0736 0. 0605 0. 0702 0.0819 Sample Variance 0. 0076 0. 0077 0. 0053 0. 0058 0. 0046 0. 0053 0. 0054 0. 0037 0. 0049 0.0067 Kurtosis 0.7974 1.5235 1.1644 0.3897 0.0609 0.5231 0.9866 -0.2800 0.3757 1.3534 5Skewness 0. 0467 0. 7305 0. 2540 0. 2827 0. 1311 0. 2868 0. 7281 0. 0441 0. 3698 0. 4540 1Range 0. 4565 0. 4933 0. 4404 0. 4160 0. 3548 0. 3761 0. 3909 0. 2908 0. 3741 0. 5089 Minimum -0. 2179 -0. 2033 -0. 1781 -0. 1780 -0. 1507 -0. 1512 -0. 1487 -0. 1196 -0. 1362 -0. 2186Maximum 0. 2385 0. 2900 0. 2623 0. 2379 0. 2042 0. 2248 0. 2422 0. 1712 0. 2379 0. 2903 Sum 0.2372 0.9723 1.2656 1.2151 1.5262 0.4959 1.1793 1.1674 0.8960 0.4432 Count 84.0000 84.0000 84.0000 84.0000 84.0000 84.0000 84.0000 84.0000 84.0000 84.0000 Confidence Level (95%) 0.0189 0.0190 0.0158 0.0165 0.0148 0.0157 0.0160 0.0131 0.0152 0.0178 Fig. 4.1.A. Graph of Leverage sorted portfolio returns (2001 to 2007) 2001 to 2007 0.0200 0.0150 0.0100 0.0050 0.0000 R.P 1 R.P 2 R.P 3 R.P 4 R.P 5 R.P 6 R.P 7 R.P 8 R.P 9 R.P 10 Portfolios Standard Deviation Fig. 4.1.B. Graph of Leverage sorted portfolio of standard deviation (2001 to 2007) 2001 to 2007 0.1000 0.0800 0.0600 0.0400 0.0200 0.0000 R.P 1 R.P 2 R.P 3 R.P 4 R.P 5 R.P 6 R.P 7 R.P 8 R.P 9 R.P 10 Portfolios The data is further classified into two- sub group for more precise examination. The table 4.2 presents the statistical behavior of 1 st sub group that is from January 2001 to December 2003. The 1 st sub group follows almost the same behavior. The effect of industry is found in both P6 and P10. The P10 present the most high leverage ratios because of the textile spinning industry. Most of the firms belong to textile sector has negative equity that result in low trading and that also result in low returns. Mean P 1 P 2 P 3 P 4 P 5 P 6 P 7 P 8 P 9 P 1054Mean 0. 0092 0. 0166 0. 0270 0. 0201 0. 0249 0. 0176 0. 0201 0. 0302 0.0238 0. 0168 Standard Error 0. 0176 0. 0177 0. 0138 0. 0141 0. 0133 0. 0135 0. 0133 0. 0102 0.0123 0. 0161 Median -0. 0013 0. 0240 0. 0266 0. 0178 0. 0195 0. 0088 0. 0135 0. 0312 0. 0253 0. 0094 Mode 16#N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A Standard Deviation Sample Variance 0. 1053 0. 1062 0. 0829 0. 0849 0. 0795 0. 0807 0. 0796 0. 0611 0. 0735 0. 0967 0. 0111 0.0113 0.0069 0.0072 0.0063 0.0065 0.0063 0.0037 0.0054 0.0094 ]Kurtosis 0. 1066 0. 8914 0. 6407 -0. 1493 -0. 1222 0. 5813 0. 9614 -0. 2317 -0. 4227 1.3774 Skewness 0. 1930 0. 6009 0. 5844 -0. 0209 0. 1658 0. 5579 0. 4964 0. 0643 -0. 1648 0. 4486 Range 0. 4565 0. 4933 0. 3946 0. 3758 0. 3548 0. 3459 0. 3907 0. 2535 0. 2843 0. 5089 Minimum -0. 2179 -0. 2033 -0. 1323 -0. 1780 -0. 1507 -0. 1211 -0. 1487 -0. 0823 -0. 1362 -0. 2186 Maximum 0. 2385 0. 2900 0. 2623 0. 1977 0. 2042 0. 2248 0. 2420 0. 1712 0. 1481 0. 2903 Sum 0.3298 0.5977 0.9710 0.7221 0.8968 0.6328 0.7243 1.0862 0.8585 0.6035 Count 36.0000 36.0000 36.0000 36.0000 36.0000 36.0000 36.0000 36.0000 36.0000 36.0000 Confidence Level(95%) 0.0356 0.0359 0.0280 0.0287 0.0269 0.0273 0.0269 0.0207 0.0249 0.0327 Fig. 4.2.A. Graph of Leverage sorted portfolio returns (2001 to 2003) 2001 to 2003 0.0350 0.0300 0.0250 0.0200 0.0150 0.0100 0.0050 0.0000 R.P 1 R.P 2 R.P 3 R.P 4 R.P 5 R.P 6 R.P 7 R.P 8 R.P 9 R.P 10 Portfolios Mean Standard Deviatio 2001 to 2003 0.1200 0.1000 0.0800 0.0600 0.0400 0.0200 0.0000 R.P 1 R.P 2 R.P 3 R.P 4 R.P 5 R.P 6 R.P 7 R.P 8 R.P 9 R.P 10 Portfolios Standard Deviation The table 4.3 presents the 2 nd sub group that contains the data from January 2004 to December 2007. In this particular duration there is a high variation in mean of the firms with high debt to equity ratio in portfolios as compare to other identified periods, even in some cases their trend is negative (P6 and P10 see Fig 4.3.A) which indicate the industry factor followed by P6 in each period. In 2 nd sub group period the negative trend of P10 is because of industr y factor. In which most of the companies belong to textile spinning and sugar. In this particular time large numbers of textile companies were de listed from KSE. There may some macro economic indicator also involve in this particular period that is the interest rate, exchange rate and inflation rate increase at increasing rate. P 1 P 2 P 3 P 4 P 5 P 6 P 7 P 8 P 9 P 10Mean -0. 0019 0. 0078 0.0061 0. 0103 0. 0131 -0. 0029 0. 0095 0. 0017 0. 0008 -0. 0033 Standard Error 0. 0103 0. 0103 0. 0092 0. 0100 0. 0084 0. 0094 0. 0100 0. 0083 0. 0096 0. 0099 Median -0.0001 0. 0047 0. 0012 -0. 0101 0. 0148 -0. 0093 0. 0014 -0. 0063 -0. 0110 -0. 0098 Mode 16#N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A Standard Deviation Sample Variance 0. 0711 0. 0714 0. 0639 0. 0693 0. 0582 0. 0653 0. 0693 0. 0577 0. 0667 0. 0685 0. 0051 0.0051 0.0041 0.0048 0.0034 0.0043 0.0048 0.0033 0.0044 0.0047 Kurtosis 1.0956 1.4548 0.8971 1.3503 -0.4150 -0.4151 1.2643 -0.4202 2.0809 -0.4177 5Skewness -0. 5540 0. 7717 -0. 5549 0. 6067 -0. 1664 -0. 2848 0. 9538 -0. 0488 0. 8397 0. 0785 Range 0. 3622 0. 3809 0. 3134 0. 3722 0. 2381 0. 2581 0. 3412 0. 2423 0. 3657 0. 2953 Minimum -0. 1948 -0. 1456 -0. 1781 -0. 1343 -0. 1091 -0. 1512 -0. 0990 -0. 1196 -0. 1277 -0. 1505 Maximum 0. 1674 0. 2353 0. 1353 0. 2379 0. 1291 0. 1068 0. 2422 0. 1227 0. 2379 0. 1448 Sum -0.0926 0.3746 0.2945 0.4930 0.6294 -0.1368 0.4550 0.0812 0.0375 -0.1603 Count 48.0000 48.0000 48.0000 48.0000 48.0000 48.0000 48.0000 48.0000 48.0000 48.0000 Confidence Level (95.0%) 0. 0206 0. 0207 0. 0185 0. 0201 0. 0169 0. 0190 0.0201 0. 0167 0. 0194 0. 0199 Standaiationrd De Mean 2004 to 2007 0.0150 0.0100 0.0050 Mean 0.0000 -0.0050 R.P 1 R.P 2 R.P 3 R.P 4 R.P 5 R.P 6 R.P 7 R.P 8 R.P 9 R.P 10 Portfolios Fig. 4.3.B. Graph of leverage sorted portfolio of standard deviation (2004 to 2007) 2004 to 2007 0.0800 0.0700 0.0600 0.0500 0.0400 0.0300 0.0200 0.0100 0.0000 R.P 1 R.P 2 R.P 3 R.P 4 R.P 5 R.P 6 R.P 7 R.P 8 R.P 9 R.P 10 Portfolios Standard Deviation Table 4.4: CAPM P1 to P10 (2001 to 2007) 2001 to 2007 P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 Rm-Rf 0. 6139 0. 5538 0. 4958 0. 4584 0. 4897 0. 5342 0. 6992 0. 7182 0. 9143 0. 9301 T-statistics 4.4118 4.6371 4.8907 5.6019 5.9395 7.1472 8.4852 10.1047 13.9437 22.1909 P- value 713.09E-05 1. 32E -05 4.93E -06 2. 76E-07 6. 63E-08 3.32E-10 7.61E-13 4.64E-16 2.4E-23 2.06E-36 35R2 0. 1918 0. 2077 0. 2258 0. 2767 0. 3008 0. 3838 0. 4675 0. 5546 0. 7033 0. 8572 The regression use the natural logs to found out the empirical link between the risk and return of portfolios that is the market premium, in other word to test the CAPM that is most frequently used. The P-value at 95% confidence level shows the relationship is highly significant at each portfolio (P1 to P10). A higher value of R 2 is associated with more explanatory power of a model but the table 4.4 suggests space for other variable, as the value of R 2 is not high. Table 4.5: Regression Market Premiums and Leverage P1 to P10 (2001 to 2007) P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 Rm-Rf 0. 6402 0. 5813 0. 6110 0. 6382 0. 5959 0. 7007 0. 5539 0. 4837 0. 5451 0. 6437 T- statistics 6.8075 5.6327 7.8876 8.1968 8.6013 11.4118 6.6843 7.3051 7.0040 7.3814 4P- value 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 DER (PREMIUM) -0. 6282 -0. 3881 0. 0729 -0. 3754 -0. 1046 0. 5139 0. 2662 -0. 0996 0. 2246 0. 5054 T- statistics -3.2207 -1.8134 0.4537 -2.3252 -0.7281 4.0355 1.5490 -0.7255 1.3914 2.7944 4P- value 0. 0018 0. 0735 0. 6513 0. 0226 0. 4686 0. 0001 0. 1253 0. 4702 0. 1679 0. 0065 R2 0. 4153 0. 3041 0. 4348 0. 4751 0. 4800 0. 6414 0. 3658 0. 4004 0. 3848 0. 4319 By adding other factor the regression predict that the dependent variable is not more effected by leverage premium (DER premium), the P-value at 95% confidence level is highly significant at market premium but almost insignificant at leverage premium. The R 2 increase highly in small firms (P1 to P5), this makes R 2 sensitive to number of expl anatory variables including in model. The difference between the values of R 2 is almost equal to zero by adding 2 nd factor (DER premium) that predict no contribution towards the equity returns. Conclusive result of all the two tables in the period of 2001 to 2007 clearly suggest that the market premium does exit contribution towards the stock returns, while the leverage ratio dose not affect the stock returns in identified period and time. 2001 to 12003 P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 Rm-Rf 0. 6097 0. 4567 0. 4208 0. 4734 0. 4875 0. 5643 0. 7017 0. 7997 1.0423 1.0005 T-statistics 3.5320 2.4908 3.1141 5.6393 4.2490 6.5681 6.3983 8.8634 11.5965 22.2875 20P-value 0. 0012 0. 0178 0. 0037 0.0000 0. 0002 0.0000 0.0000 0.0000 0.0000 0.0000 R2 0. 2684 0. 1543 0. 2219 0. 4833 0. 3468 0. 5592 0. 5463 0. 6979 0. 7982 0. 9359 The table 4.6 regresses the sub period from 2001 to 2003 to predict the linear relationship between the portfolio returns and risk. The P-value at 95% confidence level is highly significant at each portfolio, as reported in table 4.6. The value of R 2 is high with same factor (market premium) and same model (CAPM) in sub period. The higher value of R 2 indicates more explanatory power of model in sub period. Table 4. 7: Regression Market Premium and Leverage P1 to P10 (2001 to 12003) P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 Rm-Rf 0. 6290 0. 6884 0. 7096 0. 6444 0. 6691 0. 7033 0. 6065 0. 4875 0. 5616 0. 7450 T- statistics 4.5695 4.5780 7.7303 6.5886 7.2923 8.6674 5.8244 6.5908 5.8158 5.9996 4P- value 0. 0001 0. 0001 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 DER (PREMIUM) -1.1500 -0.7034 0.0954 -0.7578 -0.2427 0.2865 -0.2597 -0.3164 -0.1302 0.1314 T- statistics -4.0704 -2.2791 0.5065 -3.7753 -1.2890 1.7201 -1.2153 -2.0840 -0.6570 0.5156 4P- value 0. 0003 0. 0293 0. 6159 0. 0006 0. 2064 0. 0948 0. 2329 0. 0450 0. 5158 0. 6096 R2 0. 5117 0. 4269 0. 6493 0. 6202 0. 6191 0. 7109 0. 5108 0. 5812 0. 5064 0. 5288 Almost same behavior is followed in tabl e 4.7 by regressing two factors for 1st sub period that is the market premium is highly significant at 95% confidence level, while the leverage is insignificant. 1P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 Rm-Rf 0. 6156 0. 6892 0. 5999 0. 4327 0. 4940 0. 4898 0. 6923 0. 5907 0. 7156 0. 8234 T-statistics 2.6730 4.3240 3.8005 2.9263 3.9416 3.8017 5.3308 5.2482 7.8105 11.4892 43P 0. 0104 0. 0001 0. 0004 0. 0053 0. 0003 0. 0004 0.0000 0.0000 0.0000 0.000020R2 0. 1344 0. 2890 0. 2390 0. 1569 0. 2525 0. 2391 0. 3819 0. 3745 0. 5701 0.7416 The CAPM in 2nd sub period that is from 2004 to 2007 predict that it is highly significant at 95% confidence level; the P -value of 1st portfolio is significant at 90% confidence level. The value of R 2 is low as compare to the CAPM applied in 1st sub group (see table 4.6). The 2nd period that is 2004 to 2007 Pakistan stock market suffers due to macro factors. Table 4. 9: Regression Market Premium and Leverage P1 to P10 (2004 to 12007) P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 Rm-Rf 0. 7533 0. 4714 0. 4358 0. 6988 0. 5015 0. 7318 0. 5765 0. 4951 0. 5745 0. 5517 T- statistics 6.4090 3.2099 3.3728 5.8465 4.5757 7.7722 4.8593 4.5264 4.7426 4.5422 4P- value 0.0000 0. 0025 0. 0015 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 DER (Premium) 0. 2092 0. 0121 -0. 1219 0. 2262 0. 0257 0. 8464 1.0852 0. 1508 0. 7328 0. 9958 T- statistics 0. 8331 0. 0387 -0. 4416 0. 8861 0. 1099 4.2085 4.2820 0.6455 2.8320 3.8384 4P- value 0. 4092 0. 9693 0. 6609 0. 3803 0. 9130 0. 0001 0. 0001 0. 5219 0. 0069 0.0004 R2 0. 4780 0. 1911 0. 2183 0. 4320 0. 3235 0. 6027 0. 4403 0. 3133 0. 3698 0. 3991 In 2 nd sub period lot of variation has been experienced (see mean value, table 4.3), the same impact is found in table 4.9 by regressing the 2 nd factors, the P-value of market premium is highly significant at 95% confidence level at each portfolios, while the same consistency is not followed by leverage (DER premium). The another independent variable that is the leverage, is highly s ignificant in few portfolios (P6, P7, P9 and p10) at 95% confidence level that predict the contribution of last identified factor. The value of R 2 is also high as compare to previous periods that indicate the high contribution by 3 rd factor in this particular period. V. SUMMARY, CONCLUSION AND RECOMMENDATIONS 5 .1 Summary This study was conducted to determine the affect of market premium and one of CAPM anomaly in Pakistan equity market. The anomaly that has been studied is the leverage premium. The study uses the secondary data of the firms that has been traded in Karachi stock exchange (KSE). The data has been collected from the financial data published in the Karachi stock exchange web site (www. kse .com. Pk), covering a phase from 2001 to 2007. The sample includes 100 listed- Pakistani firms at Karachi Stock Exchange among 21 sectors, the monthly data on ending price and Karachi Stock Exchange index collected from the www.brecorder and Ready Board Quotations that is iss ued by Karachi Stock Exchange at the closing of trading day, which are also presented in the records of Security and Exchange Commission of Pakistan (SECP). The multivariate regression model has been used to identify the relationship among market premium, debt à ¢Ã¢â€š ¬Ã¢â‚¬Å" to à ¢Ã¢â€š ¬Ã¢â‚¬Å" equity premium and portfolio returns. The P-value at 95% confidence level shows the relationship with CAPM is positive and is significant related to portfolio returns (P1 to P10), while the leverage premium (DER premium) is positively insignificant. The proposed multi-factor model explains that the value of R2 indicated that there is no contribution by adding the identified variable (Leverage premium). 5.2 Conclusion This study relates cross-sectional differences in returns on Pakistan stocks to the underlying behavior of two identified variables i-e market premium (Rm-Rf) and DER (Premium). It has been experienced that there exist lot of variation in Pakistan and the multivariate regression model. It includes 21 sectors consisting of 100 listed- Pakistani firms for the period of January 2001 to December 2007. The data has been classified into there different time periods. First time period follows the abnormal behavior as the general theoretical phenomena is that the firms with high debt to equity ratios have high risk adjusted high return. But this particular study report the high volatility in low debt to equity in compare to the high debt to equity ratio (Fig. 4.1.A) by using descriptive statistics (Table 4.1). At extreme level the expected return of the firm with high debt to equity ratio is high than the firm with low debt to equity ratios but overall the expected return of the firms with low debt to equity ratio (P1 to P5) is high and there is an increasing trend, while there is decreasing trend in the firms with high debt to equity ratio (Fig. 4.1.B). The reason for such behavior may be the industry effect that the firms in these portfolios mostly be long to textile spinning, sugar and chemical industry. The trading volume in these industries is low in this particular period that may miss priced the securities. The 6 th portfolio (P6) reported in Fig. 4.1.B also affected by the industry factor that is textile spinning and sugar. The data is further classified into two- sub group for more precise examination. The 1 st sub group consists of three years from January 2001 to December 2003. The 1st sub group follows almost the same behavior. The effect of industry is found in both P6 and P10. The table 4.3 presents the 2nd sub group that contains the data from January 2004 to December 2007. In this particular duration there is a high variation in mean of the firms with high debt to equity ratio in portfolios as compare to other identified periods, even in some cases their trend is negative (P6 and P10 see Fig 4.3.A) which indicate the industry factor followed by P6 in each period. In 2 nd sub group period belong to textile spinning a nd sugar. The regression uses the natural logs to found out the empirical link between the identified variables and portfolios return. Conclusive result of all the two tables (Table 4.4 and 4.5) in the period of 2001 to 2007 clearly suggest that the market premium does exit contribution towards the stock returns, while the leverage ratio dose not affect the stock returns in identified period and time. The first sub period (Table 4.6) from 2001 to 2003 predict that the P-value at 95% confidence level is highly significant at each portfolio. The value of R 2 is high with same factor (market premium) and same model (CAPM) in sub period. Almost same behavior is followed in table 4.7 by regressing two factors for 1st sub period that is the market premium is highly significant at 95% confidence level, while the leverage is insignificant. In 2nd sub period Pakistan stock market suffers due to macro factors. In 2nd sub period lot of variation has been experienced (see mean value, table 4.3) , the same impact is found in table 4.9 by regressing the 2nd factors, the P-value of market premium is highly significant at 95% confidence level at each portfolios, while the same consistency is not followed by leverage (DER premium). 5.3 Recommendation As conclusive result suggest that the market premium does exit contribution towards the stock returns, while the leverage ratio dose not affect the stock returns in identified period. This particular study recommends that there might many other independent macro-economic or micro-economic variables that predict a relationship between the returns of a portfolio. Today lot of literature support other company price earnings ratio and book to market ratio etc. ABSTRACT CAPM anomalies. The asset-pricing model of Sharpe (1964), Linter (1965) and firms risk premium. The company by more debt finance than equity finance is to be considered highly Chan et al. (1991) conducted a study in Tokyo stock market; their findings growth firms. The association between leverage and corporate value is negative and to these norms. He also mentioned that there finding was consistent with optimal constructed two factors; SMB to address size risk and book -to- market to address34Stock Exchange (KSE). The Karachi Stock Exchange (KSE) is the highly liquid and To find out the leverage ratio (debt à ¢Ã¢â€š ¬Ã¢â‚¬Å" to à ¢Ã¢â€š ¬Ã¢â‚¬Å" equity ratio) of the sorted 11. Oil and Gas Marketing Companies. portfolio instead of investing in a risk free asset. The market premium is the same in Debt to equity ratio (DER) ratio is calculated by dividing book value of total Table 4 .1: Descriptive Statistics of portfolios sorted on leverage (2001 to 2007) Table 4.2: Descriptive Statistics of portfolios sorted on leverage (2001to 2003) Fig. 4.2.B. Graph of leverage sorted portfolio of standard deviation (2001 to 2003) Table 4.3. Descriptive Statistics of portfolios sorted on leverage (2004 to 2007) Fig. 4.3.A. Graph of leverage sorted portfolio r eturns (2004 to 2007). Table 4.6: CAPM P1 to P10 (2001 TO 2003) Table 4.8: CAPM P1 TO P10 (2004 to 2007) in relation to portfolio returns the particular study use the descriptive statistical trend the negative trend of P10 is due to industry factor that is most of the companies specific (micro) factors to determine the required rate of return i-e size premium, 1 2 3 4 tend to have positive SMB HML slopes and higher future average return. 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 equity returns as in other developing countries. To determine the identified variables 26 27 28 29

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Wal Mart Case Free Essays

string(45) " usually beyond the corporations’ control\." http://www. economist. com/node/2593089 http://www. We will write a custom essay sample on Wal Mart Case or any similar topic only for you Order Now authorstream. com/Presentation/akmohideen-193472-wal-mart-case-study-education-ppt-powerpoint/ How Could Wal Mart Continue Its Extraordinary Growth Management Essay Introduction The history of Wal-Mart started in 1962 with the opening of its first store in Arkansas, USA. The store stared as a retailer in the United States, but grew to reach extraordinary levels in the years to come. Wal-Mart grew rapidly, and used several methods to accomplish this growth. They opened their own stores as well as acquiring existing stores and chains to facilitate their entry to the new markets. The growth was not limited to the number of stores that the company opened, but it extended to the areas of operation for the store. For example, Wal-Mart entered new areas of business as it grew like pharmacies and jewelries. Wal-Mart followed an aggressive expansion strategy that was the model for their business for years, redefining concepts as they grew. But what is Wal-Mart. The store can be described as the following. It is chain of discount department stores that operate with the purpose of reducing prices, and focusing on the volume of sales. The company’s growth is extraordinary in every sense; Wal-Mart is currently the world’s largest company by sales. Wal-Mart has recorded $260 billion in sales in 2005. The company manages over 5000 stores worldwide, 3200 of the stores located in the US, 900 in the Americas, 350 in Europe, and 440 in Asia. Wal-Mart employs a very large workforce, it has over 2 million employees, and the number is gradually increasing. Wal-Mart has adopted advance mean of technology to help it run its operations, this methods helped the growth of the company. But can Wal-Mart continue with the same level of growth. A company needs to maintain growth, and to Wal-Mart a reduction in the level of growth would be a cause of concern for the company’s stakeholders, because growth has a competitive advantage for Wal-Mart ever since it started. But in the saturated business of retail can Wal-Mart sustain the levels of growth anymore. SWOT Analysis Can Wal-Mart maintain the level of growth it has seen any longer? The company has made a reputation on the bases of their growth can they keep it up, to answer that we need to conduct an analysis of the company and see elements that could determine this. A SWOT analysis would give us the needed insight. Strengths Wal-Mart is the largest company in the world; it has large volume of sales and operates over 500 stores worldwide, with 100 million clients a week. Wal-Mart has a great standing in the domestic market based on the low pricing methods they have used. Wal-Mart can change their formula to fit the market. (stores, supercenters, sam’s club, and neighborhood markets) Wal-Mart utilizes the latest technologies in inventory management to control their large inventory, and they have a wide range of products reaching over 100,000 items. Weaknesses Wal-Mart has faced criticism regarding their management of human resources, including accusation of the use of child labor, low pay for employees by industry standards, lack of benefit like health care, and reliance on temporary workers to lower their cost. The huge size of the company causes issues, like in the case of acquiring international ventures and integrating then in the Wal-Mart system. Despite its size it has a week presence and brand image in the international market. Opportunities Wal-Mart has a competitive advantage over its rivals; their incorporation of the latest technologies in their daily operation increases the efficiency of these operations and saves them some money while trying to enter new markets. So they would have an easier time that their rivals. Wal-Mart can further expand into Europe and Asia, both huge markets that Wal-Mart have not began to fully pursue. Wal-Mart can use their adaptability and introduce cultural clusters products. For example utilize the model that worked in Mexico in Latin America. Threats The market is saturated, and Wal-Mart faces intense competition in both domestic and international market. Also they face competition from specialty stores. Wal-Mart faces different laws by different countries that force it to change it methods. For example being forced to unionize the workers in china under pressure from the government. Summary Wal-Mart faces several challenges in order to sustain the levels of growth it has experienced. But it is possible Wal-Mart to grow further. The company has to use the opportunities that are present to it. They can pursue international markets more aggressively, expand in under developed markets, and continue to incorporate technology to increase efficiency and reduce costs and delays. Wal-Mart could also begin appealing to the niche markets by introducing and focusing on some special products. Question 2- What would be the limits of that growth? Introduction Growth is an essential an essential aspect of every successful corporation, and Wal-Mart in particular has made it their trademark. The rapid growth and expansion has been a competitive edge for Wal-Mart since the beginning of its operation. However, as previously mentioned, for how long can the company maintain this level of growth? Wal-Mart’s domestic market in the United States is already saturated and they face heavy competition as well, therefore, it is logical to assume that Wal-Mart’s options lies in its international ventures. The company has started to successfully dominate several foreign markets, especially in Mexico, Canada, and to some degree, the United Kingdom, at the same time, it remains absent from other regional markets in Europe and Asia. These unused markets would be the next step for Wal-Marts’ expansion, and their ability to cultivate those opportunities would be the key factor that would determine the limit of their growth. When a company ventures into international markets and unfamiliar cultures, they could face challenges that exist in adapting and changing to fit the culture. In addition, there are always external forces that would affect the growth potential of a corporation, and these factors are usually beyond the corporations’ control. You read "Wal Mart Case" in category "Papers" So in order to determine the limit of Wal-Marts growth, we have to first analyze the external environments that would affect it, the analysis is named the PESTLE analysis of external forces. PESTLE Analysis The PESTLE analysis is a tool, used to examine the external forces that could affect a company or a corporation. This analysis tool would focus on six aspects which are the political forces, the economical factors, social elements, technological innovations, legal issues, and environmental considerations. Political Forces The political orders and systems differ from one country to another; they vary depending on the region you target. A company would be under the mercy of the political forces in each country it tries to enter; this will be a huge burden on companies and especially Wal-Mart. Since Wal-Mart prefers standardization methods, it would be a deviation from their successful methods of operation if they have to cater and change in every country they enter. To further elaborate, if Wal-Mart had to change in every country they entered, they would have to create different processes for every time they penetrate a new market, including, administration, training, and management. When it comes to growth, those factors could very well limit the growth of Wal-Mart in a new market or make it too expensive to be economically feasible. Economic Factors The economic cycle would obviously have a great effect on all aspects of any corporation. The economic booms encourage companies to expand, while the economic downturns force them to retreat. The effects of an economical downturn would limit or end the growth of a corporation, when a company plans to venture into new markets; they would have to take into consideration the type of economy they enter or the forecasted performance of said economy. Wal-Mart could expand into a market and be faced with an unexpected situation that would force it to cease operation, thus incurring a loss. Wal-Mart is in a constant state of expansion, so, suffering a loss in any of its fronts would reduce the profitability of the company and would damage future international expansion plans. Social Elements Societies differ from one country to another, the differences could be unimportant to a multinational corporation like Wal-Mart, or they could be severe enough that Wal-Marts would not be able to operate in that market. For example, Wal-Marts retail chain depends on low prices with low profit margins, but large volume of sales. That method could very well not work in other countries in which the society has different purchasing habits. The inability of a company to adapt to the social characteristics of a new country would severely limit their clients’ base in that country, or it could end their operations completely. Technological Innovations Wal-Mart has always utilized state of the art technology to gain a competitive edge, they have an integrated system of inventories that controls and monitors replenishing the stock in every store, this aspect dramatically increases the companys’ efficiency. Furthermore, the company is always looking for new technological ways to cut costs and increase efficiency. In the case of expansion into foreign markets, this vital aspect of Wal-Marts operation would be threatened. If a certain country does not have the infrastructure to support this kind of technology, Wal-Mart would lose that competitive edge in that market. As a result, the Wal-Mart model would not be fully usable in that market, which would decrease profitability and eventually limit the organizations growth. Legal Issues Laws that are different from one country to another could very well limit the growth of a company, by restricting certain aspects and eliminating others; they disturb the work flow of a company. These limitations forced by foreign laws are a major concern for an international company. Environmental Considerations The environment and the quest to maintain it has a great effect on major international corporations. Wal-Mart in specific, have had their run-ins with this certain issue, they have faced criticism and limitations in several countries due to a wide range of basis. Issues such as building stores on historic sites, or selling products that used wood from protected forests are issues that have more than once halted the expansion of Wal-Mart. Summary As seen, the company has no choice but to seek new markets to keep expanding, the growth rate could not be sustained in the US retail market. The limit of the Wal-Marts growth would be their abilities in penetrating international markets, and how they deal with the barriers that those external forces push them into. Ultimately, it would come down to flexibility and willingness to change from the companies’ part. On the other hand, Wal-Mart can recreate its amazing growth performance in its domestic market by fully analyzing all the possible external forces that could have a hand in limiting their growth and formulating the strategic plans that would allow them to carry the essence of their successful model into new markets, even if it was in a new form. Question 3- Did Asia and Europe offer Wal-Mart real opportunities for international market dominance? Introduction One of the major aims of any company is growth; they seek to expand their market share or client base or any of the several elements. Eventually, the growth is their goal, due to that fact that when a company stops growing it gives the image of trouble to its stakeholders. Companies will at some point have to consider exploring new markets, these markets would most likely be outside the companys home country. Expansion into a foreign market offers many advantages to companies and is very appealing to most of them, however, it is important that all corporations carefully analyze the environments that they are about to enter. In these foreign markets, there could be forces that if ignored could cost a company greatly. Wal-Mart is not new to international expansion and they already operate in several countries. Despite that fact, Wal-Marts performance in some international markets did not match their extraordinary domestic growth. To better understand those reasons, we have to analyze the environments that Wal-Mart ventured into, as well as the forces they faced. Porters Five Forces The Porter Five Forces is a tool used to analyze the competitive environment in any industry in order to determine the level of threats that the company faces. Porter categorized the threats into five headings. Threat of new entry Wal-Mart is in the retail business and more specifically the discount retail industry, the threat of new entry is low to medium. Wal-Mart is a well established company that has mastered the processes and has set up highly efficient operations, especially their distribution networks. Threats on this level is low due to the barriers that a new competitor would face in order to compete against Wal-Mart. This point is at its strongest in Wal-Marts domestic market, the situation is different when Wal-Mart ventured abroad where Wal-Marts lesser presence acts against it, but even then, Wal-Mart could enter the market and use its pricing methods to successfully obtain a share in the new market. Threat of Rivalry This threat is medium to high; Wal-Mart has a lot of competitors in both domestic and international markets and as a result of Wal-Marts nature, it has a large number of competitors. Wal-Mart faces intense competition from organizations such as Target and Best Buy, each of those companies are a threat to Wal-Marts dominance in the market. In the international field, Wal-Mart faces competition from well established multinational corporations like Carrefour, the level of competition that Wal-Mart faces abroad is significantly higher due to their weaker presence in those markets. The bargaining power of customers The bargaining power of customers is how much of an effect can the reaction and interaction of customers have on the strategies that companies use. This force is medium, while it is true that customers would have a wide range of choices and options to choose from other than Wal-Mart, the company possesses the characteristics that attracted people to it in the first place, that aspect being convenience. A single individual/customer would have no bargaining power if he/she sought the convenience of having everything in one place; however, customers that have specific needs would simply go to another store for their purchases. The bargaining power suppliers Wal-Mart sells general items in addition to some of its own product lines; they are a dominant force in the domestic US market, which means that suppliers have very little bargaining power over them. As a dominating force, Wal-Mart can move from one supplier to the other very easily, and with the massive variety they have, they can afford to remove some products. Larger companies that deal with Wal-Mart have somewhat more bargaining power, but in general, Wal-Mart is safe from this threat. Threat of substitutes This threat could be viewed from two different perspectives, if you consider that Wal-Mart has been selling general products, then it is easily changeable, however, if we look at it and view that the convenience of having everything in one place combined with low prices is Wal-Marts main product, then this threat is very low. There are very few places that could even offer a similar level of convenience. Summary Wal-Mart has different situations in Europe and Asia. In Europe, Wal-Marts methods were successful in the UK, but less so in other parts of the continent. They faced stiff competition and the unfamiliarity of some of those markets played a role in limiting their dominance. In Asia, their situation is rather different; many of the Asian countries are ones that have developing economies. Wal-Marts low price strategy and their ability to function with low profit margins will enable them to establish themselves in those markets. Question 4- How could the company take advantage of its global reach to propel itself through the years to come? Introduction Few companies can successfully expand to the extent that Wal-Mart has; the companys growth has been extraordinary to say the least, however, taking into consideration the companys size, Wal-Mart has a weak international presence. It is true that Wal-Mart has hundreds of stores operating outside its domestic market, which gives it a certain level of international reach. By strengthening their presence in foreign markets, they are lowering their risks and also increasing their profitability. When a company operates in many different markets, the risk of an economic downturn is less severe since the company would not depend on only one market for its profitability. Moreover, foreign markets are opportunities for growth and untapped potential. Wal-Mart could use their presence in foreign markets to grow and penetrate other close by regions. By going international, the company guarantees their presence in several markets. Companies need a strategic plan for the future, without it they have no hope of maintaining any success they might have had. Strategic Planning Strategic planning is a process in which every company plans what to do for the future; the process requires that the company have clear goals and understanding of themselves. Wal-Mart is a company that has been well aware of this process, the organization has built its name by focusing on providing items at low prices, in technical terms, and they are following the generic strategy of cost leadership. Wal-Mart aimed to be the competitor that attracts clients on the basis of low cost, despite having a wide range of products, Wal-Mart appeals to its clients’ base with their low prices. After going international, Wal-Mart attempted to immolate the formula that led to its success. However, they were faced with difficulties stemming from the cultural and social differences between its domestic market and the foreign market. Wal-Mart partially overcame that obstacle by abandoning the strategy of standardization, and adapting a flexible mean of market penetration, they have on several occasions changed their store formula to fit the local image. Wal-Marts success overseas could almost entirely be attributed to its ability to formulate their stores around local concepts by partnering up or buying out well established local chains, thus, not forcing a clash with the American image of Wal-Mart. Summary Wal-Mart has a dominating presence in their domestic market and a strong presence in several other countries. The company can use that global reach to sustain its growth for many more years to come by using the strategies that made it succeed in the first place and applying them to those new markets. This feature backed up by the companys ability to adapt to differences from one country to another would help make the penetration of the new markets run smoothly. Moreover, the global reach would allow it to make use of the ideas and resources of their partners in those markets, the ideas could benefit Wal-Mart in the fact that they could transfer it to other markets without the need of creating entirely new models. Read more:Â  http://www. ukessays. com/essays/management/how-could-wal-mart-continue-its-extraordinary-growth-management-essay. php#ixzz2NFqxWBIn How to cite Wal Mart Case, Papers

Financial Management Production and Material Budget

Question: Describe about the Financial Management for Production and Material Budget. Answer: Introduction In this given project I have to check the budget of VGL Ltd, which is the Distributor Company, as well as Milbourn Manufacturer which happens to be the manufacturer of the new and exciting product. For Milbourn Manufacturer we have to create different budgets also such as Material, Production and Labour Budget. While for VGL Ltd, we have make only the cash budget for the month of January, February, March, April. For the Milbourn Manufacturer we have to prepare the budget for the month of December, January, February and March. Milbourn and VGL Ltd are expecting the sales to start from 220000 units and gradually falling up to 100000 units in the month of May. VGL Ltd is expecting the sale price to $ 510 in the first two month and then gradually decreasing. Cash Budget Cash Budget for VGL Ltd. (Amount in $) Particulars January February March April Beginning Cash 1900000 (12410000) 49690000 109612500 Add: Sources Of Cash - Accounts Receivable Collected 22440000 89250000 81472500 60084045 Total Cash Available (A) 24340000 76840000 131162500 169696545 Less: Uses Of Cash - Direct Material From Milbourn 35200000 25600000 20000000 19200000 (160 * 120000) - Cash Expense 1550000 1550000 1550000 1550000 Total Usage Of Cash (B) 36750000 27150000 21550000 20750000 Net Cash Position (A-B) (12410000) 49690000 109612500 148946545 (Budgeting Topics, 2016) Sale Price per unit of VGL Ltd. (Amount in $) Particulars January February March April Sale Price Per unit 510 510 464.10 422.33 % Fall in Price - - 9% 9% Calculations - - 510 (510 * 9%) 464.10 (464.10 * 9%) Calculation of Total Sales of VGL Ltd. (Amount in $) Particulars January February March April Sale price per unit (a) 510 510 464.10 422.33 Units sold (b) 220000 160000 125000 120000 Total Sales (a * b) 112200000 81600000 58012500 50679600 Total Sales amount received per month of VGL Ltd. (Amount in $) Particulars January February March April Total Sales for the month: Total Sales 112200000 81600000 58012500 50679600 Payment Received from the Debtors - January 22440000 (112200000 * 20%) - - - 22440000 - February 72930000 16320000 - - 89250000 - March 16830000 53040000 11602500 - 81472500 - April - 12240000 37708125 10135920 60084045 - May - - 8701875 32941740 41643615 - June - - - 7601940 7601940 Debtors will pay in the following way: Current Month 20% 30 Days 65% 60 days 15% Manufacturing Budget Production Budget for Milbourn Manufacturing Ltd. Particulars December January February March Units forecasted to be sold 220000 160000 125000 120000 Add: Closing inventory of units - - - - Less: Opening Inventory - - - - Units to be produced 220000 160000 125000 120000 (Budgeting Topics, 2016) Material Budget for Milbourn Manufacturing Ltd. (Material A) Particulars December January February March Unit to be Produced 220000 160000 125000 120000 Material A required per unit 3 (220000*3) 3 (160000*3) 3 (125000*3) 3 (120000*3) Total Material A needed 660000 480000 375000 360000 Add: Closing Inventory - - - - Total Material A Required 660000 480000 375000 360000 Less: Opening Inventory - - - - Material A Purchased (a) 660000 480000 375000 360000 Material A cost per Kgs (b) $ 3.50 $ 3.50 $ 3.50 $ 3.50 Total Cost (a * b) ($) 2310000 1680000 1312500 1260000 Material Budget for Milbourn Manufacturing Ltd. (Material B) Particulars December January February March Unit to be Produced 220000 160000 125000 120000 Material B required per unit 6 6 6 6 Total Material B needed 1320000 (220000*6) 960000 (160000*6) 750000 (125000*6) 720000 (120000*6) Add: Closing Inventory - - - - Total Material B Required 1320000 960000 750000 720000 Less: Opening Inventory - - - - Material B Purchased (a) 1320000 960000 750000 720000 Material B cost per Kgs (b) $ 4.50 $ 4.50 $ 4.50 $ 4.50 Total Cost (a*b) 5940000 4320000 3375000 3240000 Material Budget for Milbourn Manufacturing Ltd. (Material C) Particulars December January February March Unit to be Produced 220000 160000 125000 120000 Material C required per unit 2 2 2 2 Total Material C needed 440000 (220000*2) 320000 (160000*2) 250000 (125000*2) 240000 (120000*2) Add: Closing Inventory - - - - Total Material C Required 440000 320000 250000 240000 Less: Opening Inventory - - - - Material C Purchased(a) 440000 320000 250000 240000 Material C cost per Kgs (b) $ 10.00 $ 10.00 $ 10.00 $ 10.00 Total Cost (a*b) 4400000 3200000 2500000 2400000 Particulars December January February March Material A Cost 2310000 1680000 1312500 1260000 Material B Cost 5940000 4320000 3375000 3240000 Material C Cost 4400000 3200000 2500000 2400000 Total Cost 12650000 9200000 7187500 6900000 (Budgeting Topics, 2016) Labour Budget for Milbourn Manufacturing Ltd. Particulars December January February March Unit to be Produced 220000 160000 125000 120000 Labour Hours per unit 0.50 0.50 0.50 0.50 Total Labour Hours Required (a) 110000 (220000*0.5) 80000 (160000*0.5) 62500 (125000*0.5) 60000 (120000*0.5) Machine Operating Cost per hour (b) 36.00 36.00 36.00 36.00 Total Labour Cost (a*b) 3960000 2880000 2250000 2160000 (Budgeting Topics, 2016) Cash Budget for Milbourn Manufacturing Ltd. (Amount in $) Particulars December January February March Beginning Cash 1550 (4890950) 17204050 30442475 Add: Sources Of Cash (A) - Cash Sales - - - - - Accounts Receivable Collected - 35200000 25600000 20000000 - Asset Sales - - - - Total Cash Available 1550 30309050 42804050 50442475 Less: Uses Of Cash (B) - Direct Material 632500 9925000 9811575 7545625 - Direct Labour 3960000 2880000 2250000 2160000 - Manufacturing Overhead 300000 300000 300000 300000 - Selling Administrative - - - - - Asset Purchase - - - - Total Usage Of Cash 4892500 13105000 12361575 10005625 Net Cash Position (A-B) 4890950 17204050 30442475 40436850 (Budgeting Topics, 2016) Calculations of Payment made to the creditors (Amount in $) Particulars December January February March Total Cost for the month: Total Cost 12650000 9200000 7187500 6900000 Payment Made to the Creditors - December 632500 (12650000 * 5%) 632500 - January 9465000 460000 9925000 - February 2552500 6900000 359375 9811575 - March 1840000 5390625 345000 7545625 - April 1437500 5175000 6612500 - May 1380000 1380000 Creditors will be paid in the following way: Current Month 5% 30 Days 75% 60 days 20% Behavioural Aspect Behavioural Problems faced by the company when they use budget as the performance target are as follows: Dysfunctional Behaviour: Budgets are very important for organisations, as it provides a direction to them and also help them to achieve their goal by providing the same objective. People who are associated with the making and use of budget feels motivated and are eager to achieve their goal. But sometimes due to inappropriate carrying out of the budget and expectation of more than normal by the managers lead to a negative impact between the employees. Such a behaviour is known as dysfunctional behaviour, where the goal and objective of the organisation is not in line with the goal and objectives of the individual. Excessive Pressure due to Budget: budget are used to command and organise the company. Too much pressure on the managers and other subordinates to achieve the goal of the budget creates a very bad environment, their motivation is longer high which puts the higher authority in an annoying mood as the subordinates are not showing and doing their work with enthusiasm. It also happens that when the budget is not that hard to achieve, the subordinates lose their interest in achieving it. Their participation level turns out to be very low. So either way, a budget needs to be planned carefully or should be set accordingly as the objective of the organisation to prevent such problems. (Agarwal, Rohit, 2016) Participative budget is the budget where people of all level who are impacted by the budget participates for the preparation of that budget. It is more of a bottom up approach. Advantage of Participative Budget Participation of the employees and subordinates makes them feel motivated and more eager to achieve the budget A Participative Budget make the environment a bit in a gaming spirit, it bridges the gap between higher and lower authority by making them contact on a regular basis, It makes the subordinate increase their team spirit, execution and initiative. It brings out the creative side of the employees as they take it upon themselves to achieve their budget and solve any problem they are facing related to their execution. It makes them responsible too. Since the managers and other level of people have the same goal as that of the organisation, it helps the organisation to achieve the goal more easily and in faster pace, with higher degree of goal congruence. Disadvantage: When all level of people are involved in the preparation of the budget, it creates too much havoc, as too much people are participated in the discussion of the budget, sometimes the difference in opinion among the people makes it impossible to form a budget. (Question Answers, 2010) Cash Management Strategies to overcome temporary shortage of cash: Sell unwanted assets: In an organisation there some assets which is of no need to the organisation, it creates unwanted cost also in the name of insurance, overhead and maintenance. These costs will lead to loss of cash. IF the asset is sold, then it will not only remove unwanted cost, but will also bring in cash which are in need by the organisation. Sell of Investment: Organisation invest not only on asset thought which they can manufacture or provide services, they also invest in investments. Once they invest in them, they dont keep a track on it much, if during such shortage of cash, they can calculate the worth of investment and sell them off to gain more cash. Call on your outstanding money: An organisation have debtors who have not yet paid the money, or other people from where the organisation is supposed to receive money. They can call them in to repay their money, so that they can overcome a situation of cash shortage. Sold Old stock: Many a times. Organisation keep old stocks thinking that they might need them in future, but they only increase their storage cost and money. To increase their shortage in cash they can sold these stocks in market and increase their cash. 5.2 Cash Shortage Effects: If there is a cash shortage in business it will tie up the hands of the company, which will make it impossible for them to overcome any situation. Proper investment to make the best product for customer will not take place as there will shortage of cash. Such Cash Shortage will create aggression in the debenture holder, as they will not be paid there interest, they might out of such aggression ask for full redemption. Any payment to be made to the Creditors who is asking to make good of his credit, will create a bad relationship between the company and the creditors. Such Problems will not only create a bad reputation of the company, but will also make the lender or creditors against them, which will hamper the business badly. Consequences of carrying too much cash: There are many consequences on having excess cash these are: Decrease in Cost of Capital: It can be well explained with an example, Suppose a business has a total asset of $ 1000,000, out of which your cash is around $ 100,000, which is to be appropriate 10%, if we have a Return on asset of about 10% and the cost of capital is 13% then it might so happen that the company will bleed eventually due to such excess cost of capital. If the company use these extra cash to reduce their equity, this will eventually bring down the Cost of capital, which will make the Return on asset higher than the cost of capital. Over Confidence in Management: Management are over confident when they have excess in cash with them, they try to deal with any problem by using that excess cash they have, instead of actually solving it they pay more money to come out of that problem easily. For example, during mergers when they are having a problem relating to deciding the terms, they pay more cash for acquisition to make it easier. Which ultimately reduces the value of the company paying such huge amount of cash. Environmental Performance Environmental Report Milbourn Manufacturers Ltd. Environmental Cost Report For the year Ended Particulars Environmental Cost (Amount $) Percentage of Selected Operating Cost/Total Costs (%) Percentage of Selected Operating Cost/Total Sales (%) Prevention Costs: Initial evaluation of environmental standing of new suppliers 2100 Performing environmental studies 7500 Training employees 1400 11000 0.27 0.21 Detection Costs: Testing for contamination 28000 28000 0.68 0.53 Internal Costs: Treating and disposing of toxic waste 215000 Maintaining pollution equipment 39000 Operating pollution equipment 19000 Revising evaluation of some existing suppliers 700 Inefficient material usage 70000 343700 8.38 6.48 External Costs: Cleaning up chemically contaminated soil 260000 260000 6.34 4.91 Total: 642700 15.68 12.13 (Technical Articles, 2010) Total Cost = $ 4100,000 Total Sales = $ 5300,000 Strategy to reduce negative outcome by prioritizing some environmental costs: There are many environmental saving cost which is being incurred by the company to reduce their effect on the environment, if we follow a proper strategy we can reduce these cost by decreasing their impact on the environment. These costs are: Treating and disposing of toxic waste: IF we go through the cost incurred in this, we will surely find this the 2nd highest cost incurred to control environmental damage. These can be reduced, by making sure that the waste disposal is minimising. If these are not minimised then they can create huge cost. Cleaning up chemically contaminated soil: This is the highest environmental cost incurred by Milbourn Ltd., these can be reduces if chemicals used are prevented from getting into the soil. If these are reduced, then the soil will not be required to be cleaned, and the cost will also reduce. References Budgeting Topics (2016). Cash Budget [online] Accounting Tools. Available at: https://www.accountingtools.com/cash-budget [Accessed 27 Sept. 2016] Budgeting Topics (2016). Production Budget [online] Accounting Tools. Available at: https://www.accountingtools.com/production-budget [Accessed 27 Sept. 2016] Budgeting Topics (2016). Material Budget [online] Accounting Tools. Available at: https://www.accountingtools.com/material-budget [Accessed 27 Sept. 2016] Budgeting Topics (2016). Production Budget [online] Accounting Tools. Available at: https://www.accountingtools.com/direct-labor-budget [Accessed 27 Sept. 2016] Agarwal, Rohit (2016). Behavioural Implications of Budgeting [online] Your Article Library. Available at: https://www.yourarticlelibrary.com/accounting/budgeting-accounting/behavioural-implications-of-budgeting-6-implications/52800/ [Accessed 27 Sept. 2016] Question Answers (2010). What is Participative Budget? [Online] Accounting Tools. Available at: https://www.accountingtools.com/questions-and-answers/what-is-participative-budgeting.html [Accessed 27 Sept. 2016] Technical Articles (2010). Environmental Management Accounting [Online] Acca Global. Available at: https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f5/technical-articles/Env-MA.html [Accessed 27 Sept. 2016]