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m

CORPORATE FINANCE-

TERM REPORTFACTOR INFLUENCING THE CAPITAL STRUCTURE

OF TOBACCO SECTOR COMPANIES IN PAKISTAN

FALL

2011

SUBMITTED TO:

SIR JAMAL ZUBERI

SUBMITTED FROM:

FARAZ HALEEM 10226

SYED MUHAMMAD ALI 10320

FARAZ ILLAHI 10245

SECTION: A


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ACKNOWLEDGEMENT

We would like to thank Almighty Allah without whose blessings we would not had this

opportunity to work on this report. We are indebted to quite a few people who had helped us

from the beginning to the completion of this research report. Their timely and unconditional

support has been a source of inspiration for the whole group which has made possible to

complete our research report.

In the end, we would like to thank our teacher, Mr. H. Jamal Zubairi, Associate Professor and

Head of Department of Accounting and Finance at our Institute of Business Management for

his guidance throughout the project and has been acting as a facilitator and a mentor during this

time and his unconditional support has been the source of motivation to perform at our best.

Thank you Sir.


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LETTER OF TRANSMITTAL

December 28th, 2011

REPORT ON FACTOR INFLUENCING THE CAPITAL STRUCTURE OF TOBACCO

SECTOR COMPANIES IN PAKISTAN

Dear Readers:

Our team has completed the report on Factor Influencing the Capital Structure of TobaccoSector Companies in Pakistan, which is enclosed herewith. This report is a summary of our

research findings from the work that we completed during the December 2011. We completed

the report on schedule and try our level best to cover the highlights of the topic.

This report provides information regarding the concept of Capital Structure in Pakistani Tobacco

Companies, what are the structures of different companies, there related Policies, Corporate

Strategies and their effectiveness with a brief survey conducted.

We hope that this report will give you a broad understanding about the topic.

Yours sincerely,

NAMES ID CONTACT

NUMBER

Faraz Haleem

Syed Muhammad Ali

Faraz Illahi

10226

10320

10245

0333-7441212

0346-2211459

0332-3516339


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TABLE OF CONTENT

ContentsStatic Trade off Theory: ................................................................................................................................ 9

Pecking Order Theory: .................................................................................................................................. 9

Signaling theory: ........................................................................................................................................... 9

RESEARCH REVIEW ...................................................................................................................................... 11

Capital structure: ........................................................................................................................................ 12

Growth Rate:........................................................................................................................................... 12

Market Conditions: ................................................................................................................................. 12

DEPENDANT VARIABLES: ............................................................................................................................. 14

INDEPENDANT VARIABLES: ......................................................................................................................... 14

Pooled Regression Analysis ......................................................................................................................... 16

Linear regression ..................................................................................................................................... 16

PEARSON CORRELATION: HYPOTHESIS AND METHODOLOGY ................................................................... 17

The Regression Model ................................................................................................................................ 18

Table-1: Descriptive Statistics (3-year summary) ....................................................................................... 19Regression Analysis Results ........................................................................................................................ 20

Table-3.1: Regression Model Summary .................................................................................................. 20

Table-3.1: Regression Model Summary ........................................................................................... 20

Table-3.2: ANOVA (b) .............................................................................................................................. 20

Table-3.3: Regression Coefficients & their significance .......................................................................... 21


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ABSTRACT

Signifying the optimal capital structure is a critical decision for any organization. This

result is important to maximize returns and to find the impact of such a decision on

organizations ability. Still a well managed capital structure is extremely important to a firms

profitability, performance as well as liquidity needs and helps to create good prosperity of the

firm. This report investigates the factors influencing the capital structure of tobacco sector

companies in Pakistan. This study analyzed two firms in the tobacco sector, listed at the Karachi

Stock Exchange for the period 2009-2011 quarterly using pooled regression in a panel data

analysis. The results show that these six independent variables explain 98% of variation in the

dependent variables, only two variables which are tangibility of the assets and size of the firm,

were found to be highly significant. The objective of this research study is to determine the

influence of profitability: Return on Assets (ROA) and Return on Equity (ROE), Size of the Firm

(SZ), Growth (GT), Liquidity (Quick Ratio), Tangibility of Assets (TG) and Non-debt tax shield

(NDTS) on the capital structure of tobacco sector companies in Pakistan and this was to be tested

for consistency of the results over the range of data. The research holds importance for

researchers, investors, analysts and managers.

Similar research has been done by Jasir Ilyas in 2005 on combined non-financial sector of

Pakistan. The variation of Tobacco sector in Jasir Ilyass research was 99%. Jasir Ilyas used

same statistical tool that we are using.


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INTRODUCTION

In every business organization, capital is the main element to establish and run its

business activities smoothly. Capital can be collected by using two sources which are debt

capital and equity capital. Debt capital is collected by issuing debentures; bonds etc and this Debt

Capital are related with fixed cost of capital. Equity capital can be collected issuing different

shares like common stock, preferred stock etc. Therefore maintaining the balance of this capital

is known as corporate capital structure. Capital structure of a company is a mix of a company's

long-term debt, specific short-term debt, common equity and preferred equity. The capital

structure is how a firm finances its overall operations and growth by using different sources of

funds. Debts are in the form of bond issues or long-term notes payable, while equity is classified

as common stock, preferred stock or retained earnings. Short-term debt such as working capital

requirements is also measured to be part of the capital structure.

A company's proportion of short and long-term debt is considered when analyzing capital

structure. When people refer to capital structure they are most likely referring to a firm's debt-to-

equity ratio, which provides insight into how risky a company is. Usually a company more

heavily financed by debt poses greater risk, as this firm is relatively highly levered. It is not

possible to have an ideal capital structure, however, the management should target capital

structure and initial capital structure should be framed with subsequent changes in initial capital

structure to have it like target capital structure. Some companies do not plan capital structure but

they are still achieving a good prosperity.

There are significant variations in the capital structures of different industries anddifferent companies. There are many factors that affect capital structure. Following are the basic

factors which should be kept in view while determining the capital structure:-

Growth and stability of sales offirms that are growing rapidly generally need larger amount of

external capital. The floatation costs associated with debt are generally less than those for

common stock, so rapidly growing firms tend to use more debt. At the same time, however,

rapidly growing firms often face greater uncertainty which tends to reduce their willingness to

use debt. Firms whose sales are relatively stable can use more debt and incur higher fixed

charges than a company with unstable sales

Competitive structure or stability of profit margin of thefirms with high rate of return on

investment uses relatively little debt. Their high rate of return enables them to do most of their

financing with retained earnings. If profit margin is constant more debt is used. The selection of

capital structure is also influenced by the capacity of the business to generate cash inflows,

stability, and certainty of such inflows. Regularity of cash inflows is much more important than


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the average cash inflows. A company with unstable and unpredictable cash inflows can no longer

afford to depend on debts.

Cost of capitalif the cost of capital is too high, borrowing is costly. So at that situation equity

capital is preferable. As compared with other securities, the equity shares are more economical

because they have least cost of capital. In the processing of trading, no more floatation costs,

brokerage costs etc are incurred.

The consideration of retaining "Control" is also very important. The ordinary shareholder can

elect the directors of the company. If company sells the common stock, it will bring new voting

investors into the firm, making the control difficult. To maintain control within the hand of

limited members, a firm has to use more amount of debt or preferred stock because they have no

management and voting right. If the firm wants to more equity shares the management right will

be diversified.

Marketability or lender's attitude refers to the readiness of investors to purchase a security in a

give n period of time. The capital markets keep changing continuously. The capital structure will

have to be customized to the attitudes of investors prevailing at the time of issue of capital. If

investors demand preference shares, firm must have issue of preference share capital. Due to the

changing market sentiments, the company has to decide whether to raise funds with a common

shares issue or with a debt issue.

Size of the company is another factor.The availability of funds is greatly influenced by the size

of the enterprises. A small company finds it difficult to raise debt capital. The terms of

debentures are less favorable to small companies so they have to rely on equity share and retainearning for funding business. Large companies are generally considered to be less risky by the

investors and, thus, they can issue common shares, preference shares and debentures to the

public.

Floatation costs take place only when the funds are externally raised. Floatation costs consist of

some or all of the following expenses; printing of prospectus, advertisement, underwriting and

brokerage etc. Generally, the cost of floating a debt is less than the cost of floating an equity

issue. This may lure the company to issue debt than common shares. The company will save in

terms of floatation cost if it raises funds through large issue of securities but the company should

raise only that much of funds which can be employed profitably. In large companies flotationcost is not a significant consideration.

Development of capital market is an important factor in capital structure. It refers to the extent

which the capital market is developed (i.e. equity or debt market). More developed equity market

means more equity used and less developed equity means less equity used. Similarly, more

developed debt market means more debt used and vice versa.


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The growth opportunities of business can be either tremendous or very low. Depending upon the

growth opportunities the debt ratio fluctuates. Higher growth opportunities exist then higher debt

is used otherwise vice versa. Agency costs are another factor in determining the capital structure.

While determining capital structure, having least agency cost is preferred but if there is agency

problem than debt is used largely for funding the business.

Other sources of tax shield In order to take the advantage of low tax, borrowing is preferable for

a firm because interest is considered as deductible expenditure according to the income tax law.

But dividends are not considered deductible expenses and they are paid out of profits after tax.

Level of economic development is high then more debt is required. Level of economic

development plays significant role in capital structure. Wherever economic development is

taking place investors will be looking to invest there E.g. - In countries like China and India

where economic conditions are very suitable for business, investors from all over the world are

willing to invest in such countries.


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THEORETICAL FRAMEWORK

Static Trade off Theory:

Myers (1984) divides the contemporary thinking on capital structure into two theoretical

currents. The first one is the Static Tradeoff Theory (STT), which explains that a firm follows a

target debt-equity ratio and then behaves accordingly. The benefits and costs associated with the

debt option sets this target ratio. These include taxes, cost of financial distress and agency cost.

(1) As the interest payments are a tax-deductible expense, they decrease the tax liability thus

providing cash savings. Therefore Firms will use a higher lever of debt to take the advantage of

tax benefits if the tax rates are higher. If the firms incur losses, this tax benefit will fade away. Soif the operating earnings are enough to meet the interest expense then firms will get the benefit oftax deductibility of interest expenses.

(2) As the level of debt increases the chance that a company default increases so there must be an

optimal level of debt. If the firm goes ahead of this optimal point it will default on the repayment ofthe loan due to which the control of the firm will be shifted from shareholders to bondholders whowill try to recover their investments by liquidating the firm. A firm may face two types of bankruptcycosts due to this, direct and indirect costs. Direct costs include the administrative costs of the

bankruptcy process, if the firm is large in size; these costs constitute only a small percentage for thefirm. The indirect costs occur because of change in investment policies of the firm in case the firmforesees possible financial distress. In order to avoid bankruptcy, the firm will cut down expenditures

on research and development, training and education of employees, advertisements etc.

Pecking Order Theory:The Pecking Order Theory (POT) put forward by Myers (1984) and Myers and Majluf

(1984), states that firms follow a chain of command of financial decisions when establishing its

capital structure. Initially, firms prefer to finance their projects through internal financing i.e. retainedearnings but if they need external financing, they first they apply for a bank loan then for public debtand as a last resort, the firm will issue equity to finance its project. Pecking Order Theory has a moreimportant effect on capital structures for firms that are managed in the interests of equity holders,

rather than the combined interests of debt and equity holders. However, when financial distress costsare high, equity-maximizing and value-maximizing firms make similar capital structure choices.

Signaling theory:This approach, originally developed by Ross (1977), explains that debt is considered as a way

to highlight investors trust in the company, that is if a company issues the debt it provides a signal tothe markets that the firm is expecting positive cash flows in the future, as the principal and interest

payments on debt are a fixed contractual obligation which a firm has to pay out of its cash flows.Thus the higher level of debt shows the managers confidence in future cash flows. Another impactof the signaling factor is the problem of the under pricing of equity. If a firm issues equity instead ofdebt for financing its new projects, investors will interpret the signal negatively. Furthermore, acting

as an agent to shareholders, the manager tries to appropriate wealth from bondholders to shareholders

by incurring more debt and investing in risky projects.


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TOBACCO SECTOR OF PAKISTAN

There are two firms in this sector and this research study includes all of them.. Variationis related to the values of independent variable. Profitability of the firm is negatively related to

the firms leverage. Size of the firm in this sector is asignificant variable according to the bothregression techniques, showingnegative relationship with the firms debt ratio. Thus the studyacceptsthe null hypothesis of the study which states that with the increase in the size of the firm

the debt financing decreases. The study accepts thehypothesis which states that with the increase

in the Tangibility of thefirm, debt to equity ratio also increases, as found in slope of the

tangibility in both analysis techniques. This variable is found to be significant in both theanalysis techniques. With the increase in the growth opportunity of the firm, the debt ratio of the

firm also increases. The study found that the growth as independent variable is not significant in

any of the regression techniques. For Non Debt Tax Shieldas an independent variable the study

rejects the null hypothesis as the study found that the slope of NDTS variable is directingtowards the negative relationship of NDTS and firms leverage. However, both the tests were

significant for the growth variable. The study rejects the null hypothesis regarding the Tax Rateand accepts the alternative statement of the study which states that with an increase in the taxrate the firms debt also increases.


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LITERATURE REVIEW

RESEARCH REVIEW

Modigliani & Miller (1958) forms the basis for modern thinking on capital structure. The basic

theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and

in an efficient market, the value of a firm is unaffected by how that firm is financed. It does not

matter if the firms capital is raised by issuing stock or selling debt. It does not matter what the

firms dividend policy is.

Jenson and Meckling (1976) developed agency cost hypothesis and identifying the two types of

conflicts i.e. between shareholders and managers and debt holder and equity holders. Agency

cost hypothesis suggests that firms managers are mainly interested to maximize their ownbenefits than to maximize shareholders wealth. Therefore, the stockholders of the firm try to

discourage these interests by means of monitoring and control actions which also prospects cost

i.e. agency cost.

Myers and Majluf (1984) and Myers (1984) made a valuable addition in capital structure

literature by providing Pecking Order and Static Trade-off Hypothesis respectively. According to

the Pecking Order Hypothesis, the firm should follow specific hierarchy for financing its assets.

Initially, the firm utilize internally generated fund i.e. retained earnings then debt and If more

funds are required then assets are financed by equity capital. Trade-off hypothesis proposed that

firm should have optimal capital structure based on balancing between the benefits of debt andcosts of debt. In other words, firm sets target debt-equity ratio according to the nature and

requirements of business and then gradually moves to achieve it.

A study by Miao (2005) provides a competitive equilibrium model of capital structure and

industry dynamics. In the model, firms make financing, investment, entry, and exit decisions

subject to idiosyncratic technology shocks. The capital structure choice reflects the tradeoff

between the tax benefits of debt and associated bankruptcy and agency costs. The interaction

between financing and production decisions influences the stationary distribution of firms and

their survival probabilities. The analysis demonstrates that the equilibrium output price has an

important feedback effect. This effect has a number of testable implications. For example itimplies that high growth industries have relatively lower leverage and turnover rates.

Filbeck and Krueger (2005) highlighted the importance of efficient working capital

management by analyzing the working capital management policies of 32 non-financial

industries in the US. Their findings reveal that significant differences exist among industries in

working capital practices over time.


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IMPORTANT TERMS

Capital structure: The capital structure shows the way a corporation finances itself through

combination of equity sales, equity options, bonds, and loans. Optimal capital structure refers tothe combination that minimizes the cost of capital in order to maximize maximizing the stock

price.

Factors that Influence a Company's Capital-Structure Decision:-

Business Risk: Business risk of a company is the basic risk that company faces due to its

operations. The larger the business risk, the minor the optimal debt ratio of the company.

Company's Tax Exposure: all the debt payments of a company are tax deductible. If a

company's tax rate is high, using debt to finance a project is attractive because the taxdeductibility of the debt payments protects income from taxes.

Financial Flexibility: Financial flexibility is essentially the firm's ability to raise capital in bad

times. Companies should make an effort to be careful when raising capital in the good times

without expanding its capabilities too far. A company is more financially flexible when it has

lower debt level.

Management Style: when management's approach is more conservative, it is less inclined to use

debt to increase profits. An aggressive management may try to grow quickly and can use large

amounts of debt to speed up the growth of the company's earnings per share (EPS).

Growth Rate: Firms that are in the growth stage borrowing money to grow faster through debt

financing but high debt load is not appropriate. More stable and mature firms typically need less

debt to finance growth as its revenues are stable.

Market Conditions: Market conditions influence company's capital-structure condition. If the

investors are limiting companies' access to capital because of market concerns, the interest rate to

borrow may be higher than a company would want to pay. In that situation, it may be prudent fora company to wait until market conditions return to a more normal state before the company tries

to access funds for the plant.


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SAMPLE SIZE AND SOURCE OF DATA

Our study is about the Tobacco sector of Pakistan. The study used in the financial data of

these firms is over the years of 2009-2011 Quarterly. The data is obtained from balance sheet,income statement and cash flow statements of these companies quarterly reports.

The sample size for the report is 2 companies and they are:

1. Pakistan Tobacco2. Phillip Morris


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DEPENDANT & INDEPENDENT

VARIABLES DESCRIPTION

We used total of eight variables in our study and they are as follows: Leverage (CS),

Tangibility of Assets (TG), Firm Size (SZ), Growth (GT), Return on Assets (ROA), and Return

on Equity (ROE), Quick Ratio (QR) and Non-debt tax shield (NDTS). These variables were used

to identify positive or negative impact on the capital structure of tobacco sector companies in

Pakistan and are explained in detail below.

DEPENDANT VARIABLES:

A. Leverage: CS = Total Debt / Total Assets

Leverage refers to the percentage of assets financed by debt and it is calculated by taking

the total debt as a percentage of total assets. It shows the level to which an investor utilizes

borrowed money. Highly leveraged companies may be at risk of bankruptcy if they are unable to

make payments on their debt. Leverage can increase the shareholders return on their investment

and often has tax advantages

INDEPENDANT VARIABLES:

B. Tangibility of assets: TG = Fixed Assets / Total Assets

Its a measure of the extent to which fixed assets are financed with owners equity. High

ratio indicates an inefficient use of working capital which reduces the companys ability to carry

accounts receivable and maintain inventory and usually means a low cash reserve. This will

often limit the ability to respond to increased demand for products or services. Tangibility of

assets should be calculated as the ratio of fixed assets to total assets.

C. Firm Size: SZ = Log (sales)

Size of the firm should be measured by taking the natural log of the sales to smoothen the

variation over the periods considered. The size of a firm plays an important role in determining

the kind of relationship the firm enjoys within and outside its operating environment. The size of

a firm has a significant impact on the capital structure. The larger the firm, the greater the

influence it has on its stockholders as the larger size firms have enough resources.

D. = Increase in asset value this year over last year / last year value

This shows the percentage increase in Total Assets over the period of years.


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E. Return on Total Assets (ROA): ROA = (Net Income / Total Assets) x 100

It indicates how profitable a company is relative to its total assets and how efficiently a

company manages its assets in order to generate income. It tells you what earnings were

generated from invested capital (assets). ROA for public companies can vary substantially and

will be highly dependent on the industry that is why when using ROA as a comparative

measure, it is best to compare it against a company's previous ROA numbers or the ROA of a

similar company.

F. Return on Equity (ROE): ROE = (Net Income / Shareholders Equity) x 100

ROEmeasures the rate of return on the ownership interest (shareholders' Equity) of the

common stock owners. It is the amount of net income returned as a percentage of shareholders

equity. Return on equity measures a corporation's profitability by revealing how much profit a

company generates with the money shareholders have invested. ROE is equal to a fiscal year's

net income (after preferred stock dividends but before common stock dividends) divided by totalequity (excluding preferred shares).

G. Quick Ratio: QR = (Current Assets Inventory) / Current Liabilities

QR is an indicator of a company's short-term liquidity. The quick ratio measures a

company's ability to meet its short-term obligations with its most liquid assets. It is also known

as the "acid-test ratio" or the "quick assets ratio". The basics and use of this ratio is similar to the

current ratio in that it gives users an idea of the ability of a company to meet its short-term

liabilities with its short-term assets. If the current ratio is significantly higher, it is a clear

indication that the company's current assets are dependent on inventory.

H. Non-Debt Tax Shield: NDTS = Annual depreciation charges / Total Assets

A reduction in taxable income for an individual or corporation achieved through claiming

allowable deductions of depreciation and annual investment tax credits. These deductions reduce

taxpayers' taxable income for a given year or defer income taxes into future years. It is calculated

by dividing annual depreciation charges by the Total Assets of the company.


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STATISTICAL TOOLS

The software we are using to develop hypothesis and analyze the data is SPSS (Statistical

Package for Social Sciences) which is a computer program for statistical analysis.

The statistical tools used for analyzing the data are:-

Pooled Regression Analysis

Linear regression is an approach to modeling the relationship between a scalar variabley

and one or more variables denotedX. In linear regression, data are modeled using linear

functions, and unknown model parameters are estimated from the data. Such models are called

linear models. Most commonly, linear regression refers to a model in which the conditional mean

ofy given the value ofXis an affine function ofX. Less commonly, linear regression could refer

to a model in which the median, or some other quartile of the conditional distribution ofy given

Xis expressed as a linear function ofX. Like all forms of regression analysis, linear regression

focuses on the conditional probability distribution ofy givenX, rather than on the joint

probability distribution ofy andX, which is the domain of multivariate analysis.


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HYPOTHESIS

PEARSON CORRELATION: HYPOTHESIS AND METHODOLOGY

The object of the study is to see the linkage of financial indicators to Capital Structure which is

the Leverage (CS) of tobacco industry. In order to achieve this objective we tested the following

hypotheses:

Ho: Tangibility of Assets (TG) is not directly related to Leverage (CS) of the firm.

H1: Tangibility of Assets (TG) is directly related to Leverage (CS) of the firm.

Ho: Firm (SZ) is not directly related to Leverage (CS) of the firm.

H1: Firm (SZ) is directly related to Leverage (CS) of the firm.

Ho: Growth (GT) is not directly related to Leverage (CS) of the firm.

H1: Growth (GT) is directly related to Leverage (CS) of the firm.

Ho: ROA is not directly related to Leverage (CS) of the firm.

H1: ROA is directly related to Leverage (CS) of the firm.

Ho: ROE is not directly related to Leverage (CS) of the firm.

H1: ROE is directly related to Leverage (CS) of the firm.

Ho: Quick Ratio (QR) is not directly related to Leverage (CS) of the firm.

H1: Quick Ratio (QR) is directly related to Leverage (CS) of the firm.

Ho: Non-debt tax shield (NDTS) is not directly related to Leverage (CS) of the firm.

H1: Non-debt tax shield (NDTS) is directly related to Leverage (CS) of the firm.


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EMPIRICAL RESULTS & ANALYSIS OF

THE FINDINGS

The Regression Model

This study uses panel regression analysis. Panel data analysis facilitates analysis of cross-sectional and time series data. We use the pooled regression type of panel data analysis. The pooledregression, also called the Constant Coefficients model, is one where both intercepts and slopes are

assumed constant. The cross section company data and time series data are pooled together in asingle column assuming that there is no significant cross section or inter temporal effects.

Therefore the equation for our regression model will be:CS = 0+ 1(TG) + 2(SZ) + 3(GT) + 4(ROA) + 5(ROE) + 6(QR) + 7 (NDTS)

Where

CS = LeverageTG = Tangibility of assetsSZ = Firm Size measure by Log of sales

GT = Growth

ROA = Return On Assets

ROE = Return On Equity

QR = Quick RatioNDTS = Non-debt text shield


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Analysis & Results

This section contains the results of the descriptive and regression analysis. Table 1 shows the

summary of descriptive statistics for the variable values in the sample (11 quarters over a period

of 3 years, for each company).

Table-1: Descriptive Statistics (3-year summary)

Variable Mean StDev Minimum Maximum

CS 0.4758 0.1831 0.1556 0.7157

TG 0.4296 0.0711 0.3395 0.5754

SZ 14.47 1.299 11.61 15.68

ROA 0.0669 0.0381 -0.0054 0.1704

ROE 0.1378 0.0932 -0.0191 0.3919

QR 0.4645 0.4510 0.0672 1.7729

NDTS 0.0135 0.0024 0.0100 0.0190

GT 0.0547 0.1512 -0.1746 0.3520

Theoretically, total debt/total assets ratio should be less than one or one at maximum.

Theoretically speaking, fixed assets/total assets too should be lower than one. However, we use

gross fixed assets/ total assets ratio as a measure of tangibility. According to output, ourvariables are lying between -1 and +1, same as in Jasir Ilyas.


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Regression Analysis Results

The following tables present the results of pooled regression analysis.

Table-3.1: Regression Model Summary

Table-3.1: Regression Model Summary

Model R R Square

Adjusted R

Square

Std. Error of

the Estimate

1 .986 .973 .959 .036821

a. Predictors: (Constant), Growth, Non-Debt Tax Shield,

Return on Equity, Quick Ratio, Tangibility of Assets, Sizeof the firm, Return on Assets

b. Dependent Variable: Leverage

Table-3.2: ANOVA (b)

Model

Sum of

Squares df Mean Square F Sig.

1 Regression 0.685 7 0.097 72.247 .000a

Residual 0.018 14 .001

Total 0.704 21

a. Predictors: (Constant), Growth, Non-Debt Tax Shield, Return on Equity, Quick

Ratio, Tangibility of Assets, Size of the firm, Return on Assets

b. Dependent Variable: Leverage


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Table-3.3: Regression Coefficients & their significance

Model

Unstandardized

Coefficients

t Stat p - valueB Std. Error

1 (Constant) -0.381 0.128 -2.979 0.009

Tangibility 1.379 0.512 2.694 0.017

Firm Size 0.048 0.012 3.922 0.001

Growth 0.137 0.085 1.611 0.129

ROA -4.302 0.902 -4.768 0.0003

ROE 1.411 0.422 3.339 0.004

Quick Ratio -0.094 0.030 -3.064 0.008

NonDebt TaxShield -0.229 0.105 -2.168 0.047


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Regression Equation

CS = - 0.381 + 1.379 TG + 0.048 SZ + 0.154 GT 4.302 ROA + 1.411 ROE0.094 QR0.229

NDTS

The above tables show the results of the regression analysis. The value of R-square (R2=0.973:

Table 3.1) shows that the four variables i.e. growth, size, profitability and tangibility, non debt

tax shield and quick ratio explain nearly 98% of variation in the response variable leverage. This

means that the choice of capital structure is mainly defined by these six variables in the tobacco

sector. The Adjusted R-square is slightly below the R2.

Expected & Observed Relationships:

Determinant Measure Expected Relationship Observed Relationshi

Tangibility Fixed Assets/Total

Assets

Direct Direct

Firm Size Log Of Sales Inverse Direct

Growth percentage of increase in

total assets

Direct Direct

Profitabilty: ROA ROA Inverse Inverse

Profitability: ROE ROE Inverse Direct

Quick Ratio Net current

assets/current liabilities

Inverse Inverse

Non Debt Tax Shield AnnualDepriciation/current

liabilities

Inverse Inverse


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Conclusion

In this study we analyzed a sample of 2 firms in the tobacco sector by using a pooled

regression model to measure the determinants of capital structure of the firms in the Pakistantobacco industry.

The results were found to be as expected, besides firm size and ROE. Firm size ispositively correlated with leverage thus suggesting that the bigger the firm size the more debt

they will use. Thus the results comply with the Static Tradeoff Theory, which expects a positive

relationship between firm size and leverage.


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Journal of Managerial sciences volume 2 by Jasir Ilyaso www. philipmorrispakistan.com.pk/

www.ptc.com.pk Fama, E., 1980, Agency Problems and Theory of the Firm, Journal of Political

Economy, Vol. 88, No. 2

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