An Analysis of the Effects of Different Sources of Capital for Astra Holdings

Topics: Finance, Corporate finance, Debt Pages: 21 (5076 words) Published: January 31, 2011

1.1 Topic

The theme is about the analysis of the effects of different sources of capital on investment decisions in Astra Holdings Limited. An examination was carried out on specific components of debt, equity and working capital and the reasons for preferring one financing method to the other. Furthermore, the balance sheet movements of compositions of certain elements relating to debt, equity and to a lesser extent working capital were analysed over a period of three years. The main target of this scrutiny was to expose the effects of the sources of finance when utilised on an investment of the organisation’s choice.

1.2 Context

An insight into the three major research issues within the topic area was taken as explained below:

1.2.1 Effects

The topic places a greater emphasis on the aspects emanating from the employment of a specific source of capital. They can be financial or non financial, positive or negative and usually takes the forms of cost, taxation, risk, increased/decreased earnings or even restraints imposed by the fund provider or the regulatory authorities. The research project was designed to collect all the data on effects of all sources of capital being analysed.

1.2.2 Sources of capital

Describes the various options of financing an investment plan available, for instance debt finance can be used instead of equity. The extent to which an organisation uses either debt or equity for investment purposes will be reflected in the firms’ mix of both debt and equity on the balance sheet.

1.2.3 Investment decisions

Thus the application of the capital depending on the goal of the organisation: described by Van Horne (1998) as to maximise shareholders’ wealth in most cases. It took various dimensions in the research such as short term or long term and there were no restrictions on the sizes of investments being studied. However, mostly capital expenditures were analysed.

1.3.0 Reasons for choosing the topic

This was moulded under two areas:
• Problems
• Hypothesis

1.3.1 Problems

The motive to undertake this particular research cropped up after citing the following difficulties experienced by Zimbabwean companies.

a. High interest rates

Zimbabwean interest rates have soared beyond 700% (Reserve Bank of Zimbabwe, 2006) lately, making it extremely hard to operate profitably. Sithole (2005) went on to describe it as an economy characterised by high inflation and high and unstable interest rates.

b. Difficulty in strategising investment policies

Choosing a financing strategy proved to be a challenge considering the multiple uncertainties regarding the future of the economy. Gqabule (2005) afforded to summarise it by saying “short termism” is the order of the day meaning that managers can only afford to plan mostly on a short term basis.

1.3.2 Hypothesis

Contrary to the above problems, some companies are declaring huge profits and paying good dividends, in all terms, how is this possible? Originally by Modigliani and Miller, Vigario (1995) stated that an optimal capital structure exists and depends on the level of gearing. Attainment of this financing structure will result in the least Weighted Average Cost of Capital (WACC).

This shows that profitability operations hinge upon the identification of an optimal capital structure. But does the optimal capital structure exist? Are companies able to identify an optimal or a near optimal financing mix of debt and equity?

1.4.0 Research aim and objectives

1.4.1 Aim

Although companies are different, an in-depth study into the relevant financial practices of Astra Holdings and a wider view on other companies performing well will unearth key information about successful companies – their financing structure which blends well with the current economic climate. Upon completion, the project research to some extent provides valuable knowledge to enable mostly...
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