Finance Management Report: Optimal Capital Structure and Risk Analysis

This report provides a comprehensive analysis of a company's capital structure, financial risks, and mitigation strategies. It begins by defining optimal capital structure and its impact on profitability, referencing the MM model and the importance of a balanced mix of debt and equity. The report examines the company's historical capital structure, detailing the shift from debt to equity financing and its effect on the cost of debt. It includes figures illustrating the cost of debt and equity share over time, concluding that the optimal capital structure consists of approximately 50-55% debt. The report also analyzes capital structure decisions, including dividend payments and new equity issuance, and discusses the company's financial risks, such as those related to pension plans, exchange rates, interest rates, and credit ratings. It outlines mitigation methods, including pension plan investment reviews and hedging strategies. Finally, the report details the company's financing policy, which involves a mix of equity and debt, and assesses the company's share price return, comparing its performance to a benchmark index, highlighting both outperformance and associated risks.

Running head: REPORT
Report
Name of the Student:
Name of the University:
Author Note:

1REPORT
Table of Contents
Report:........................................................................................................................................2
Optimal Capital Structure:.....................................................................................................2
Capital Structure of the Company:.........................................................................................2
Capital Structure decision:.....................................................................................................4
Financial Risk analysis of the Company:...............................................................................4
Mitigation methods of the Risk:.............................................................................................5
Financing Policy of the Company:.........................................................................................5
Share Price Return:................................................................................................................5
References:.................................................................................................................................7

2REPORT
Report:
Optimal Capital Structure:
The capital structure is an important aspect which has a significant impact on a
company profitability. The capital structure literature such as the MM model which
highlights the importance of capital structure and its impact on the profitability of the
company. The literature highlights that a capital mix of equity and debt is important for a
company to reduce the cost of capital. As debt holders create a charge on the assets of the
company which tend to increase the risk for the equity shareholders which leads to the rise in
the cost of equity and simultaneously the cost of debt for the company (Dhankar 2019).
Capital Structure of the Company:
The capital structure of the company at the beginning was financed by primarily debt,
which comprised of almost 70% of the capital structure of the company. The equity value in
the books of the company became negative due to payment of dividend to the shareholders
which lead to the negative value of equity. However, the market capitalization which is the
true value of equity determined by the market was positive for the company. However, the
cost of debt for the company is determined by dividing the interest expense which is incurred
by the company with the long term non-current liabilities.
Figure 1: Cost of debt
Source: By the Author

3REPORT
The figure highlights the cost of debt of the company in 2010 which was at 4.21% and
started to reduce from the next year onwards due to the fall in the level of debt for the
company. The effective cost in 2011 and 2012 for the cost of debt was high even the level of
debt fell down due to the charge of the current portion of the long term debt in the current
liabilities of the company. The interest expense for the current portion is paid in those years
which leads to an increase in the effective cost of debt. This cost of debt is further reduced
due to the tax rate which provides a tax shield to the company for bearing interest expense
and further reduces the cost (Tsoy and Heshmati 2017).
Figure 2: Equity share
Source: By the Author
As per the above figure, it is observed the share of equity of the company is
increasing with the passage of time while the debt holders are reduced. The company is
increasing the level of equity which leads to the reduction in the cost of debt of the company
which is according to the MM model. Thus, upon analysing the share of debt and equity in
the capital structure of the company and the fall in the cost of debt highlights that the optimal
capital structure of the company is around 50% - 55% debt while the remaining is to be
funded with equity.

4REPORT
Capital Structure decision:
As per the various parts in the company annual report, it is analysed that the company
has been paying dividend to the shareholders and the amount of dividend increases each year.
The average number of shares of the company also increases each year and the company has
been financing its activities with the issue of new equity shares to increases the percentage of
ownership of the equity shareholders of the company. The company has also been paying of
its debt holders of the excess funds to reduce the percentage of debt in the company.
Figure 3: Capital Structure
Source: By the Author
However it is observed from the cash flow statement of the company, the company
has been acquiring assets and tangible properties which require financing. This financing of
the assets is done by the company using a mix of debt and equity while maintaining the
overall capital structure of the company (Mugwe and Makori 2019).
Financial Risk analysis of the Company:
The financial risk of the company as per the annual report of the company is exposed
from two parts which are the financial risk of the pension plan and the market financial risk.
The financial risk from the pension plan is due to the reduction in the investment returns from
the plan, which is also accompanied with the high levels of inflation. The life expectancy of
the plan participants is also increasing which leads to an increase of financial burden on the
company and adds to the financial risk of the company.

5REPORT
The company has its operations which is spread around the globe and has greater
exposure of the business is affected by the changes in the exchange rate, interest rate, changes
in credit ratings and liquidity and tax risk. Thus, if the exchange rate of the company changes
negatively along with the interest rate a significant impact on the financials of the company is
expected. The credit default if from consumers affect the company it can create a liquidity
crisis for the company which affects profitability (Hafeez, Khan, Majeed and Azeem 2018).
Mitigation methods of the Risk:
The financial risk from the pension plan is mitigated by the pension plan committee
which reviews the investment of the plan periodically and aims to take the investment to a
risk free environment. The committee also reviews the investment in assets which are
expected to appreciate over time with the rise in inflation. Thus, the company can mitigate
the pension riskj by these two methods.
The company has a treasury team which analyses the liquidity requirements of the
company along with the exposure of the company to various risk. Hedging is taken place to
lock in an exchange rate to avoid volatility in the financial statement of the company.
Financing Policy of the Company:
The company majorly finances its operation with a mix of equity and debt, where the
level of non-current debt in 2019 is around 55% of the company. The short term financing of
the company is done by the use of accounts payable and accruals, which provide the company
some relaxation in liquidity. However, short term financing from banks is also availed by the
company so as to meet all the liquidity requirements of the company.
Share Price Return:
The monthly returns from the share of the company is taken for the past ten years to
evaluate the return and the volatility of the company.

6REPORT
Figure 4: Share Price Return
Source: By the Author
The company has provided an annual return of 6.65%, while the index has presented a
return of 0.74%. The company has outperformed the benchmark however the risk which is
measured by the standard deviation is greater for the company at 23.68% while the FTSE 100
has a risk of 12.69%. The correlation among the company and the benchmark is 0.4601
which highlights a slight positive correlation between the company and the benchmark.

7REPORT
References:
Annual reports (2020). Available at:
https://www.btplc.com/Sharesandperformance/Financialreportingandnews/
Annualreportandreview/index.htm (Accessed: 28 March 2020).
Dhankar, R.S., 2019. Cost of Capital, Capital Structure, Dividend Policy and Value of Firm.
In Capital Markets and Investment Decision Making (pp. 187-196). Springer, New Delhi.
Dhankar, R.S., 2019. Optimal Capital Structure and Investment Decisions. In Capital
Markets and Investment Decision Making (pp. 197-210). Springer, New Delhi.
Hafeez, M.M., Khan, H.H., Majeed, F. and Azeem, A., 2018. Impact of Capital Structure on
Islamic Banks Performance:(Evidence from Asian country). Global Journal of Management
And Business Research.
Mugwe, M.M. and Makori, D., 2019. Firm Characteristics and Capital Structure of Small and
Medium Enterprises in Kenya. International Journal of Current Aspects, 3(V), pp.42-56.
Tsoy, L. and Heshmati, A., 2017. Impact of financial crises on dynamics of capital structure:
evidence from Korean listed companies.
Yahoo is now a part of Verizon Media (2020). Available at:
https://finance.yahoo.com/quote/%5EFTSE%3FP%3DFTSE/history?
period1=1269734400&period2=1585353600&interval=1mo&filter=history&frequency=1mo
(Accessed: 28 March 2020).
Yahoo is now a part of Verizon Media (2020). Available at:
https://uk.finance.yahoo.com/quote/%5EFTMC?p=%5EFTMC (Accessed: 28 March 2020).