Final thesis Academy of finance ENGAGEMENT I would like to engage that I made this thesis by myself The figures and information in the thesis are all honest The author Tran Thi Minh Nguyet Tran Thi Minh Nguyet 1 CQ50/11.18 Final thesis Academy of finance TABLE OF CONTEND Tran Thi Minh Nguyet 2 CQ50/11.18 Final thesis Academy of finance LIST OF ABBREVIATED WORDS DFL EBIT EPS NWC ROA ROE ROS WACC Tran Thi Minh Nguyet : : : : : : : : Degree financial leverage Earning before interest and tax Earning per share Networking capital Return on assets Return on equity Return on sale Weight average cost of capital 3 CQ50/11.18 Final thesis Academy of finance LIST OF TABLE AND PICTURE PICTURE 2.1: THE ORGANIZATION CHART OF THE COMPANY TABLE 2.1: THE CAPABILITY OF SKILLED WORKMANSHIP THANG LONG MECHANICAL FOUR AND CONSTRUCTION JOINT STOCK COMPANY TABLE 2.2: SOME FINANCIAL RATIOS OF THE COMPANY IN RECENT YEARS TABLE 2.3: SIZE, STRUCTURE AND FLUCTUATION OF CAPITAL STRUCTURE FROM FISCAL 2013 TO 2015 TABLE 2.4: GEARING AND DEBT/EQUITY OF THE COMPANY FROM FISCAL 2013 TO FISCAL 2015 TABLE 2.5: DEGREE OF FINANCIAL LEVERAGE FROM FISCAL 2013 TO FISCAL 2015 TABLE 2.6: THE EFFECT OF FINANCIAL LEVERAGE TO ROE TABLE 2.7: THE RATIOS OF THE ABILITY TO PAY FOR CREDITORS OF THE COMPANY TABLE 2.8: THE SITUATION OF NET WORKING CAPITAL OF THE COMPANY Tran Thi Minh Nguyet 4 CQ50/11.18 Final thesis Academy of finance PREFACE In the market economy, to start a business, people need to the certain amount of capital Capital is the important condition with business process of the company Morever, when the competition between companies in the market is more and more violent, the decisions which relate to capital management will influence on the success of the companies, so they are not easy for managers And one of those decisions is to establish capital structure to maximize the value of the company and owners It also decides the company’s product ability in the market Because of Understanding the importance of establishing capital structure, I decided chose the topic “ Capital structure – case study in Thang Long mechanical four and construction joint stock company” Research problem Research problem is about overview and the solutions of capital structure in Thang Long mechanical four and construction joint stock - - company: capital structure and target capital structure with its affects Purpose and thesis questions Systematizing the issues about capital structure in the company and the factors affecting target capital structure Researching situation of capital structure : + Studying and evaluating about situation of capital structure in Thang Long mechanical four and construction joint stock company + Proposing solutions for establishing capital structure in mechanical - four and construction joint stock company Scope of research About space: Studying about capital structure and solutions for establishing capital structure for Thang Long mechanical four and construction joint stock - company About time: the figures provided by financial statements of the company in 2014 and 2015 Tran Thi Minh Nguyet 5 CQ50/11.18 Final thesis Academy of finance Methodology The thesis uses the methodologies: analytical method, statistical method, experimental method…to clear the topic of the thesis Thesis structure Apart from preface, conclusion and bibliography,the thesis structure includes three major parts: Chapter 1: Overview of capital structure and target capital structure Chapter 2: Situation of capital structure of company in Thang Long mechanical four and construction joint stock company Chapter 3: Solutions for establishing the Thang Long mechanical four and construction joint stock company ‘s target capital structure Because of limited time and knowledge, my thesis also has some mistakes in research process I would like to express my thanks to PhD Pham Thi Thanh Hoa and the managers of Thang Long mechanical four and construction joint stock company because they helped me finish this thesis Tran Thi Minh Nguyet 6 CQ50/11.18 Final thesis Academy of finance CHAPTER OVERVIEW OF CAPITAL STRUCTURE AND TARGET CAPITAL STRUCTURE 1.1 Capital structure 1.1.1 Definition In market economy, a company is able to use many different sources of capital to satisfy its demand in the business However, it is very important to combine sources of capital to establish the best capital structure for the value objective Capital structure is a term that refers to the propotion of capital sources in total of capital which the company finances for its business operations In other word, it can show how a company decides to finance its assets by various sources of capital like: borrowing from banks, issuing shares or bonds, retained earning from the business… The dicision about capital structure is very important with the company because: - Capital structure of the company affects the cost of capital - Capital structure affects the company’s return on equity or earning per share and financial risk Capital structure of the company is usually expressed by the relationship between debts and equity ( owner’s capital) Capital structure is discribed through some main ratios: This ratio shows the percentages of debt in capital structure of the company Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance Debt/ Equity The company can have various capital structure, but all of them are to maximize the value of the company 1.1.2 The theories of capital structure 1.1.2.1 Modigliani and Miller approach This theory was devised by Modigliani and Miller during 1950s Modigliani and Miller advocates capital structure irrelevancy theory The valuation of a firm does not depend on the capital structure of a company Whether a firm is highly leveraged or not in the financing mix, the value of the company is not affected Modigliani and Miller Approach proposes that the market value of a firm is affected by its future growth prospect apart from the risk involved in the investment If a company has high growth prospect, its market value is higher and its stock prices would be high Assumptions of Modigliani and Miller Approach o There are no taxes o Transaction cost for buying or selling securities and bankruptcy cost are zero There is symmetry of information This means that an investor can have o access to same information that a company can access o The cost of borrowing is the same for investors as well as companies o Debt financing does not affect to companies EBIT Modigliani and Miller Approach: Two Propositions without Taxes Proposition 1: With the assumptions of no taxes, the capital structure Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance does not influence the valuation of a firm In other way, if the company finances debt, it does not increase the market value of the company Proposition 2: It says that financial leverage is in direct proportion to the cost of equity With increase in debt component, the investors realize a higher risk for the company So the cost of equity is higher to make up the risk, the weight average cost capital of the company does not change, because the increase in the cost of equity is same to the decrease in the cost of debt Modigliani and Miller Approach: Propositions with Taxes (The TradeOff Theory of Leverage) Proposition 1: The value of the company which combines debt in capital structure is higher than the value of the company which does not use debt In other word, the value of the company which has a mix of debt and equity equals the value of the company which does not use plus present value tax shield Proposition 2: If there is income tax, the cost of equity of a company which has a mix of debt and equity is higher than the company which doesnot The more debt financing the company uses, the higher required rate of return of the owners is, because of the higher risk However, the increase in the cost of equity is lower than the defference between the rate of return of asset and the cost of debt, the weight average cost capital decreases 1.1.2.2 Capital Structure theory – Traditional approach This theory states that there is a optimal capital structure where the value of the company can be magnified by suitable financial leverage level Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance According to this theory, the cost of capital can be decreased by using debt financing However, when the company increases debt financing, risk of the company will increase too The creditors require the higher rate of return When the gearing increases to a certain level, risk is higher, the increase in the required rate of return of debt and equity makes the cost of capital increase too It makes the the benefit of using debt disappear Assumptions under Traditional Approach: The rate of interest on debt is constant for a certain period and thereafter with increase in leverage, it increases The expected rate by equity shareholders remains constant or increase gradually After that the equity shareholders starts perceiving a financial risk and then from the optimal point and the expected rate increases speedily As a result of activity of rate of interest and expected rate of return, the WACC first decreases and then increases The lowest point on the curve is optimal capital structure Diagrammatic Representation of Traditional Approach to Capital Structure PICTURE 1.1 COST OF CAPITAL AND TRADITIONAL APPROACH 10 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance real estate after economic crisis So the commercial banks lends the company money with preferred rate of interest So the company borrowed more debt to finance the business operation from commercial banks - The characteristics of transform of capital is one of the reasons explaining the capital structure of the compay Because revenue from projects depends on rate of finish constructions while the value of them is too great, the time to finish the projects is usually very long The company has to use money from account payable or deferred revenue When they worry about the company’ability to pay for loans or the customers don’t transform money for the company, it has to borrows money with long term - The features of business operation of the company: because the firm operates in construction and mechanical industry, its projects are mainly roads, brigdes, steel structure,… and their value are great While the money of the owners is limited, it is obvious for the firm to raise debt with high level - After economic crisis, many firms still have difficult recovering operation Therefore, it may be that they don’t have enough money for payment in this year Because the partners of the company can’t pay within short time so it is obsivious for the compapny to borrow more money 50 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance CHAPTER SOLUTIONS FOR ESTABLISHING THANG LONG MECHANICAL FOUR AND CONSTRUCTION JOINT STOCK COMPANY ’ TARGET CAPITAL STRUCTURE 3.1 The development strategies of Thang Long mechanical four and construction joint stock company 3.1.1 Social and economic background Vietnam has boosted its international economic integration as it enters into more free trade agreements with the Eurasian Economic Union, the European Union, South Korea and the Trans-Pacific Partnership At the same time, the ASEAN Economic Community was established on December 31, 2015, and is likely to create more opportunities for the country to integrate into regional and global economies This situation brings more opportunities for our companies to develop their business and learn morden technology from developed countries in the world But while global integration has advanced well, with Vietnam embedding itself in global value chains, the benefits are constrained by the absence of linkages with domestic firms This means that the companies in local area will have to face to the competitions agains the foreign coperations It requires the company to innovate its technology and improve its competiveness by increasing quality of projects and training labour more carefully To make those requirements come true, the company has to face to the econimic conditions After economic crisis, the economy is still recovering slowly and the real estate of market also has trouble restoring This condition will cause much difficulty for the company in construction and mechanical projects 51 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance Morever, in the future, the price of material such as steel, cement, iron… will be not stable because of approaching from the firms in China The supply of material can be limited when there are a lot of constructions performed This makes the company have difficult working the new projects Beside, the real estate market hasn’t recovered strongly, preferred policy of 30.000 billion VND exprises in April 2016 It means that the company in construction industry will have difficulties to develop 3.1.2 The development strategies of Thang Long mechanical four and construction joint stock company 3.1.2.1 Objectives of business operation In 2016, the company will have to continue finishing the projects from previous years, including: - Bo Ao bridge project which is begun in July 2015 - Rach Chiec Bridge project which is begun in 2015 - 10A project begun in May 2015 - 1A highway in Nha Trang – Khanh Hoa 3.1.2.2 The orientation of business - To direct the implementation of projects with required period - To improve the ability to organize and manage of the staffs in departments , factories and the production team - To renovate equipments, technology and machines to increase the quality of projects - To establish more sensible capital structure and decrease gearing of the company 52 Tran Thi Minh Nguyet CQ50/11.18 Final thesis 3.2 Solutions for Academy of finance establishing Thang Long mechanical four and construction joint stock company ’ target capital structure 3.2.1.Improving capital structure by decreasing gearing Accorrding to chapter 2, we can see that the firm raises mainly debt inspite of equity to finance for business It can cause financial risk and insolvency or bankruptcy for the firm So in the next year, the company should improve capital structure by decreasing gearing  Adjusting devidend policy Because in fiscal 2016, the company issued new common shares to raise money for building a new factory and some projects, so it is possible to raise fund from profit of the years The company is applying fixed devidend policy with 10% of capital invested by shareholders It is reason why the company usually spends almost earning for sharing devidend and the amount of retained earning is limited To increase the proportion of equity in capital structure, the managers should establish a sensible devidend policy It means that the company needs to retain more profit to reinvest the next years The average gearing of industry is 0,72 so the firm should adjust to the same level Accorrding to the development plan of fiscal 2016, some financial items: - Revenue in 2016: 400.000 million VND Net income: 5.500 million VND The company should spend all profit to reinvest in business: 5.500 million VND If the shareholders want to receive devidend, the company can apply the form of devidend in shares However, in 2015, it issued new common shares, this policy can face to difficulty and make the price of shares in the market reduce  Raising capital with the target gearing for each projects 53 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance Example, in 2016, the company will have a project with the value of 18.000 million To finance for this project, the company establish capital structure with gearing of 0,72 - Total demand of capital: 18.000 millon VND - Target gearing : 0,72 The company can raise money accorrding to this solution: - Borrowing money from banks or different sources: 18.000 x 0,72 =12.960 million VND - Raising equity: 18.000 – 12.960 = 5.040 million VND The firm can that with orthers to establish target capital structure If the equity is not enough , the company can finance for this project by requiring the owners to contribute money in the form of fixed assets, raw material or orthers This solution helps the company reduce pressure of raising capital  Liquidating fixed assets which are not in good productivity Beside, the company should liquidate the asset which is ancient or its effectiveness of production is not good This can generate revenue for purchasing new equipments  Improving management of expenditure in business operation The cost price of the company almost is at high level, it appropriate more than 90% of annual revenue The firm needs a policy to reduce expenditures in production, as a result, retained earning for reinvestment increases and it can limit to borrow money from the banks To manage the cost price, the managers can apply some solutions: - The cost price of construction projects depends on the price of raw material in the market This items usually change very quickly because the demand of customers Therefore, the company should store enough raw 54 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance material and establish the relationship with the suppliers who provide at stable price The company can determines the quantity of raw material by Economic Order Quantity ( EOQ): C: Relevant total cost C1: Total holding cost C2: Total ordering cost c1: Holding cost per unit c2: Ordering cost per order Qn: Annual demand quantity QE: Economic optimal quantity Relevant total cost: Example : in fiscal 2016, the demand quantity of raw material ( Steel) will be 500.000 ton c1 = 5000 VND/kg, c2 = 8000 VND/Kg ( This figures are caculated by the author from the information of the company) we can caculate the economic order quantity of steel : Therefore, the company should order 4000 ton of steel for an order to reduce cost of holding With others, the firm can apply this model to determine the quantity for a purchase This activity can help the company control the holding cost to decrease expenditure - It is possible to have the plan of maitaining and repairing equipments,machines,…to advoid breaking down of them - The manager should adjust to pay salary for workers by job wages, or strengthen to supervise at work It can make effectiveness of production 55 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance increase and advoid misuse of resources 3.2.2 Reducing gearing of the company to decrease financial risk and insolvency of the company by borrowing less money and establishing a flexible devidend policy Finding the source of capital which will be used to finance the project and decrease gearing of the company - The manager should limit to borrow new loans from other the partners if the company can find the other sources of capital It means that the company should consider to raise capital from available sources like retained earning - from previous years To spend more money for business, the company should establish a flexible devidend policy inspite of the fixed policy which is used at moment with 10% of net income 3.2.2.Strengthening the management of recievable account to recover capital in short term If the company can reduce the period of recovery recievable account, it will have more capital to finance for business inspite of borrowing money This makes gearing of the company and interest expense go down Therefore, it helps the company decrease WACC and NWC The fact is that cash flow is a crucial element of overall financial perfomrnace Managing your accounts receivable well doesn’t just keep your business running smoothly from day to day; it also helps ensure a long and profitable future for your company To improve management of recievalbe account to ensure the company has enough money for business, the managers can considers these ways 56 Tran Thi Minh Nguyet CQ50/11.18 Final thesis • Academy of finance Reduce Payment Terms Reducing payment terms is one motivator, but it works even better if you it with email One of the many benefits of invoicing via email is that it allows companies to reduce their payment terms Because of the delays that accompany paper mail, businesses used to allow 30 days or more for payment However, the immediacy of email invoicing means that businesses can now specify that payment be due upon receipt rather than allowing for net 30 billing • Maintain a Healthy Work Relationship Happy customers are more likely to pay their bills on time In the event that a customer is short on cash, he will likely prioritize those companies with whom he has a positive relationship over the ones that regularly underperform If you want to avoid late collections, strive to fulfill your obligations and develop strong working relationships with all your business clients Just making a few personal calls to the payment departments can ensure you never wait on a late invoice again As a result, the company can collect on bills faster, ensuring sufficient cash flow for the coming weeks Additionally, the firm should send your invoices as soon as a project is completed rather than waiting until the end of the monthly billing cycles This helps keep work "fresh" in clients’ minds • Offer Multiple Payment Methods If you want to get paid on time, then give your customers as many options as possible to satisfy their debts While sending a check each month is 57 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance still commonplace, some clients may prefer to pay invoices via PayPal or credit card Additionally, the company may want to consider utilizing electronic funds transfer (ETF), which allows customers to transfer payments from their bank accounts to yours for a fee, provided they have your bank name and account number You may want to include this information on your invoice to make EFT an easy option for paying bills • Set Clear Credit Policies If the company has worked with a customer for years, you may be tempted to offer a credit on your products and services Extending too much credit, however, can take a serious toll on your accounts receivable Before setting up a credit account, check a business’ credit history to ensure it has a record of paying bills on time Additionally, you should set up clear terms and inform your clients of all the details before any agreements are made 3.2.3 The solutions to improve the situation of net working capital of the company Although the construction company should establish the finance model with long term sources of capital more than short term because it usually has to recover capital in long time, the company still needs to control this situation carefully When the firm uses mainly long term sources, net working capital will be greater than zero In 2015, Thang Long mechanical four and construction joint stock company has net working capital of more than 120.000 million VND The company raised capital with almost long term debt It results in the increase in WACC and financial risk To improve this 58 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance situation, the company should perform these solutions: - Defering payment long term debt which is stagnant If the company also has any debt which is not spent on working projects, the managers need to pay it back for the creditors to advoid wasting resources Example, at the end 2015, the company borrowed the amount of money from Seabank to finance a bridge project of over 5.000 million VND, but this project was cancelled So the managers should pay 5.000million VND back for the banks or creditors to decrease interest expense - Strengthening to appropriate short term sources of capital such as defferred revenue When the firm signs contracts, the manager should establish the rule which requires the customers to give an advance of certain amount of money To receive this condition, the comompany needs to bring the benefit for customers like giving them a discount if they agree this condition - Establishing the close relationship with supliers to get account payable conveniently This source not only is a short term debt but also helps the company make up the difference of capital the company can give them the benefit which orthers don’t like engaging to buy their products for a long time, helping them advertis their reputaion to orthers, ensuring a certain sale for them in a period… - The company only should consider to hire equipment or machinery inspite of purchasing With the project which will be finished in short time, the company can hire equipment or factory inspite it has to borrow money in long term to buy them 3.2.4.4 The company should have solutions to improve the performance in 59 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance next fiscal year to increase the benefit for shareholders Because of issuing new shares, the company ‘s market value of stock may be reduced The company needs to make the result of business develop: - Enhaning the qualify of equipments, machines and traning workers carefully The company needs to update the mordern technology in the developed countries to catchught the foreign companies and increase its competition in the market.This helps the company increase the quality of projects and save expenditures in business - The company needs to put in an estimate for cost of every projects carefully, manage the expenditures with detailed system This helps the firm avoid wasting money and increasinge operating cost - Establishing rate of progress of projects which is reasonable with financial plans to make sure that the company can provide enough money for building - Promoting the activities which involve in marekting plan to make the reputation of the firm more popular: marketing by banners, facebook or developing website more attractively It brings more chance for the company to increase revenue and expand market shares in local market 3.3 The petitions for the government - The state shoud establish a fully worked- out system of law to generate convinent, equal and clear business enviroment for the companies in the market - Developing research institutes about capital structure to generate 60 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance basics for the companies in approaching agruments of capital structure and applying them into their business - Enforcing the rules which helps the financial market or monetary market, capital market develop more effictivelly The companies can raise capital more convinient through these markets, their capital structure can be established more flexible - The sate should reduce interest rate and enforce the conditions which are more benefitive for the companies to encourage them to expand its operation - The sate needs to have a system of prediction about the fluctuation of interest rate, market, inflation and exchange rate Thank to this system, the company can build business plans to reduce risk in operation 61 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance CONSCLUTION Nowadays, Vietnam has boosted its international economic integration as it enters into more free trade agreements with the Eurasian Economic Union, the European Union, South Korea and the Trans-Pacific Partnership The intergration not only brings more opportunities for the companies in local market, but also make the firms face to more competition To exsit in this condition, the companies in Vietnam have to consider more detailedly the financial problems, and capital structure is one of the most important issues which determines the development of the companies Thank to overview of capital structure, through the topic: “Capital structure – case study in Thang Long mechanical four and construction joint stock company”, I studied about the situation of capital structure in the company from fiscal 2013 to 2015 Thang Long mechanical four and construction joint stock company has been a company with good reputation and performance for many years Although the firm had to face the economic crisisin 2008, it still didn’t stop to innovate the technology and try to improve the qualify of goods and services Morever, the firm also expanded the operation and increased net income for its shareholders The managers had thedecisions which reduced gearing and improved capital structure However, in establishing capital structure of the firm also exsits the shortcomings So I decided to propose the solutions which can help the firm limit them Because there is also the limit of knowledge and time to study, my 62 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance thesis still has some shortcomings I hope to receive many comments of the lecturers in corporate finance department Finally, I would like to express my thanks to PhD Pham Thi Thanh Hoa and the staffs in Thang Long mechanical four and construction joint stock company because they helped me finish this thesis successfully 63 Tran Thi Minh Nguyet CQ50/11.18 Final thesis Academy of finance BIBLIOGRAPHY PhD Vu Van Ninh, PhD Bui Van Van (2013), Corporate finance book Tai Chinh Publisher Dr Nguyen Thi Ha, Dr Pham Thi Thanh Hoa (2015), Corporate finance case studies and assignments , Tai Chinh Publisher Cophieu68.com.vn Cafef.vn Dictionary online Financial statements of Thang Long mechanical four and construction joint stock company from 2013 to 2015 Regulation and website of Thang Long mechanical four and construction joint stock company 64 Tran Thi Minh Nguyet CQ50/11.18 ... of capital structure in Thang Long mechanical four and construction joint stock company + Proposing solutions for establishing capital structure in mechanical - four and construction joint stock. .. of capital structure of company in Thang Long mechanical four and construction joint stock company Chapter 3: Solutions for establishing the Thang Long mechanical four and construction joint stock. .. finance CHAPTER SITUATION OF CAPITAL STRUCTURE OF COMPANY THANG LONG MECHANICAL FOUR AND CONSTRUCTION JOINT STOCK COMPANY 2.1 Overview of company Thang Long mechanical four and construction joint