A study on

CAPITAL STRUCTURE AND ITS IMPACT ON

PROFITABILITY
(With reference to Everest Bank Limited and Kumar Bank Limited)

A THESIS

SUBMITTED TO
Office of the Dean
Faculty of Management
Tribhuvan University

In Partial Fulfillment of the requirement for the Degree of

Masters of Business Studies (MBS)

SUBMITTED BY
Prativa Mahato
Pashupati Multiple Campus
T.U. Regd. No. 7-2-278-998-2008
Campus Roll No: 16 (2063-2065)
Exam Roll No. 4066 (2065)

Kathmandu, Nepal
April, 2013
RECOMMENDATION

This is to certify that the thesis submitted by PRATIVA MAHATO entitled A

STUDY ON CAPITAL STRUCTURE AND ITS IMPACT ON

PROFITABILITY (With reference to Everest Bank limited and Kumari Bank

Limited) has been prepared in the prescribed format as approved by this department,

Faculty of Management.

This thesis is recommended for examination.

………………………. ……………………….. …………………………

Gyan Bahadur Tamang Gyan Mani Adhikari Bishnu Pd. Pant

(Thesis Supervisor) (Head, Research Department) (Campus Chief)
VIVA – VOCE SHEET

We have conducted the Viva – Voce of the following thesis:

Presented by: Prativa Mahato

Entitled: A STUDY ON CAPITAL STRUCTURE AND ITS IMPACT ON

PROFITABILITY (With reference to Everest Bank Limited and Kumari
Bank Limited)

We found that the thesis is an original work of the student and written according to
the prescribed format. We recommend this thesis to be accepted as partial fulfillment
of the requirement for the degree of Master of Business Studies.

Viva-voce Committee

Head, Research Department …………………………

Member (Thesis Supervisor) …………………………

Member (External Expert) ………………………….

DECLARATION

I hereby declare that this work entitled "A Study On Capital Structure and its
Impact on Profitability (With reference to Everest Bank Limited and Kumari
Bank Limited)” submitted to office of the Dean, Faculty of Management, Tribhuvan
University, is my own original work, except wherever acknowledged, as a partial
requirement for the degree of Masters in Business Studies under the supervision of
Gyan Bahadur Tamang, Pashupati Multiple Campus, Kathmandu. Error, if any, is the
responsibility of my own.

……………………………

Prativa Mahato
Pashupati Multiple Campus
T.U. Regd No: 7-278-998-2008
Campus Roll No: 16 (2063-2065)
Exam Roll No: 4066(2065)

Date: 10th April, 2013

ACKNOWLEDGEMENT

I would like to express my deep gratitude to my supervisor, Gyan Bahadur Tamanag,

Pashupati Multiple Campus, Tribhuvan University, for his constant supervision and
support to the thesis. It has been greatly benefited from his valuable suggestions,
constructive comments on drafts. His constant interest and encouragement were the
main motivation to make the thesis possible.

I owe depths of gratitude to Gyan Mani Adhikari, Head of Research Department

Pashupati Multiple Campus, for his genius support and supervision throughout the
study. The drafts were much benefited from his constructive comments and
suggestions. I would like to extend my gratitude to all my teachers for providing me
invaluable information, suggestion and comments.

This work would not have been possible without the help of Library staffs, Shanker
Dev Campus. I would like to give my special thanks to them for providing their
valuable data, suggestions generously for the completion of this thesis. And I would
like to say thanks to my colleagues who provided their help directly or indirectly in
my study. I wish to thank staffs of Kumari Bank and Everest Bank for providing me
the relevant data needed for the study.

Finally, my greatest recognition goes to my beloved parents and my brothers for their
inspiration, motivation and moral support for this study and in each and every pace of
my life.

Prativa Mahato
LIST OF ABBREVIATION

CV Coefficient of Variation
D/E Debt to Equity
DFL Degree of Financial leverage
DOL Degree of Operating Leverage
DPR Dividend Payout Ratio
EBIT Earning Before Interest and Tax
EBL Everest Bank Limited
EBT Earning Before Tax
EPS Earning Per Share
FY Fiscal Year
KBL Kumari Bank Limited
I Interest
i.e that is
Kd Cost of Debt
Ke Cost of Equity
Ko Overall Cost of Capital
Ltd Limited
MBS Master of Business Studies
M.M Modigliani and Miller
NI Net Income
NOI Net Operating Income
NP Net Profit
NRB Nepal Rastra Bank
P/E Price Earning Ratio
R Correlation Coefficient
ROA Return on Assets
ROE Return of Equity
SD Standard Deviation
TU Tribhuvan University
TABLE OF CONTENTS

RECOMMENDATION
VIVA – VOCE SHEET
DECLARATION
ACKNOWLEDGEMENT
TABLE OF CONTENTS
LIST OF TABLES
LIST OF FIGURES
ABBREVIATIONS

CHAPTER-ONE: INTRODUCTION
1.1 Background of the Study .....................................................................................1
1.2 Introduction of the Financial Institutions Under Study .......................................2
1.2.1 Kumari Bank Limited .......................................................................2
1.2.2 Everest Bank Limited .......................................................................2
1.3 Statement of Problem ...........................................................................................2
1.4 Objectives of the Study ........................................................................................3
1.5 Significance of Study ...........................................................................................3
1.6 Limitations of the Study.......................................................................................4
1.7 Organization of the Study ....................................................................................4

CHAPTER – TWO: REVIEW OF LITERATURE

2.1 Conceptual/ Theoretical Review ..........................................................................6
2.1.1 Meaning of Capital Structure ...........................................................6
2.1.2 Profitability .......................................................................................9
2.1.3 Profitability of Commercial Bank ....................................................10
2.1.4 Assumptions of Capital Structure.....................................................10
2.1.5 Theories of Capital Structure ...........................................................11
2.1.5.1 Net Income Approach .........................................................11
2.1.5.2 Net Operating Income Approach ........................................12
2.1.5.3 Traditional Approach ..........................................................15
2.1.5.4 The Modigliani Miller Approach ........................................16
2.1.6 Some Related Items to Capital Structure ..........................................18
2.2 Review of Articles ...............................................................................................19
2.3 Review of Thesis..................................................................................................21

CHAPTER – THREE: RESEARCH METHODOLOGY

3.1 Research Design...................................................................................................27
3.2 Population and Sample ............................................................................27
3.3 Sources of Data ........................................................................................27
3.4 Data Processing ........................................................................................27
3.5 Tools and Techniques Applied ................................................................27
3.5.1 Financial Tools .................................................................................27
3.5.2 Statistical Tools ................................................................................30

CHAPTER – FOUR: DATA PRESENTATION AND ANALYSIS

4.1 Capital Structure Analysis ...................................................................................33
4.1.1 Calculation of Debt to Total Assets Ratio ........................................33
4.1.2 Calculation of Debt Equity Ratio .....................................................34
4.1.3 Calculation of Interest Coverage Ratio ............................................36
4.1.4 Calculation of Degree of Financial Leverage...................................37
4.1.5 Calculation of Return on Total Assets .............................................38
4.1.6 Calculation of Return on Shareholders' Equity ...............................39
4.1.7 Calculation Earning per Share ..........................................................41
4.1.8 Calculation Dividend per Share .......................................................42
4.1.9 Calculation Price Earning Ratio .......................................................43
4.1.10 Overall Capitalization Rate ............................................................45
4.1.11 Equity Capitalization ......................................................................46
4.2 Statistical Analysis ...............................................................................................47
4.2.1 Coefficient of Correlation between EBIT and Interest Payment .....47
4.2.2 Coefficient of Correlation between Overall Capitalization Rate
and Debt Equity Ratio .....................................................................48
4.2.3 Coefficient of Correlation between Return on Equity and Debt
Equity Ratio ......................................................................................49
4.2.4 Coefficient of Correlation between Return on Assets and Debt
Equity Ratio ......................................................................................49
4.3 Simple Regression Analysis ................................................................................50
4.3.1 Relationship between Cost of Equity and Leverage ........................50
4.3.2 Relationship between Return on Shareholders' Fund and Leverage 50
4.3.3 Relationship between Earning per Share and Leverage ...................51
4.3.4 Relationship between Price Earning Ratio and Leverage ................51
4.4 Major Findings .....................................................................................................52

CHAPTER – FIVE SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 Summary ..............................................................................................................54

5.2 Conclusions ..........................................................................................................55
5.3 Recommendations ................................................................................................56

BIBLIOGRAPHY

APPENDICES
LIST OF TABLES

Table No Page No

Table 1: Debt to Total Assets Ratio ...........................................................................33

Table 2: Debt Equity Ratio ........................................................................................34

Table 3: Interest Coverage Ratio ...............................................................................36

Table 4: Degree of Financial Leverage ......................................................................37

Table 5: Return on Total Assets.................................................................................38

Table 6: Return on Shareholders' Equity ...................................................................40

Table 7: Earning per Share ........................................................................................41

Table 8: Dividend per Share ......................................................................................42

Table 9: Price Earning Ratio ......................................................................................44

Table 10: Overall Capitalization Rate........................................................................45

Table 11: Equity Capitalization Rate .........................................................................46

Table 12: Correlation between EBIT and Interest Payment ......................................48

Table 13: Correlation between Debt Equity and Overall Capitalization Rate ...........48

Table 14: Correlation between Return on Shareholders' Equity and Debt

Equity Ratio ...............................................................................................49

Table 15: Correlation between Return on Assets and Debt Equity Ratio..................49

Table 16: Relationship between KE and Leverage.....................................................50

Table 17: Relationship between ROSE and D/E .......................................................51

Table 18: Relationship between EPS and D/E ...........................................................51

Table 19: Relationship between P/E and D/E ............................................................52

LIST OF FIGURES

Figure No Page No

Figure 1: Capital Structure .........................................................................................8

Figure 2: Net Income Approach ................................................................................12

Figure 3: Net Operating Approach ............................................................................14

Figure 4: Traditional Approach .................................................................................15

Figure 5: Debt to Total Assets Ratio..........................................................................34

Figure 6: Debt Equity Ratio .......................................................................................35

Figure 7: Interest Coverage Ratio ..............................................................................36

Figure 8: Degree of Financial Leverage ....................................................................38

Figure 9: Return on Total Assets ...............................................................................39

Figure 10: Return on Shareholders' Equity ................................................................40

Figure 11: Earning per Share .....................................................................................41

Figure 12: Dividend per Share ...................................................................................43

Figure 13: Price Earning Ratio ..................................................................................44

Figure 14: Overall Capitalization Rate ......................................................................45

Figure 15: Equity Capitalization Rate........................................................................47

CHAPTER – I
INTRODUCTION

1.1 Background of Study

The capital structure decision is crucial for any business organization. The decision is
important because of the need to maximize returns to various organizational
constituencies, and also because of the impact such a decision has on a firm’s ability
to deal with its competitive environment. The capital structure of a firm is actually a
mix of different securities. In general, a firm can choose among many alternative
capital structures. It can issue a large amount of debt or very little debt. It can arrange
lease financing, use warrants, issue convertible bonds, sign forward contracts or trade
bond swaps. It can issue dozens of distinct securities in countless combinations;
however, it attempts to find the particular combination that maximizes its overall
market value.

A number of theories have been advanced in explaining the capital structure of firms.
Despite the theoretical appeal of capital structure, researchers in financial
management have not found the optimal capital structure. The best that academics and
practitioners have been able to achieve are prescriptions that satisfy short-term goals.
For example, the lack of a consensus about what would qualify as optimal capital
structure has necessitated the need for this research. A better understanding of the
issues at hand requires a look at the concept of capital structure and its effects on firm
profitability.

Capital structure is the composition of the debt and equity securities and is considered
as financing decision undertaken by the financial manager. The financial manager
must strive to obtain the best financing mix or optimum capital structure for his firm.
The firm attains capital structure where the debt-equity proportion maximizes the
market value of the shares .the uses of debt affect the return and risk of the equity
shareholder, it increases the return on equity fund and at the same time it also
increases risk. A proper balance must be strike between the risk and return in order to
maximize the market value of shares (Pandey, 1995:54).

Capital structure is very crucial part of financial management as the various

composition of debt and equity capital may impact different on risk and rate of return
to equity capital may impact differently on risk and enterprises are raised either
through the ownership securities and creditor ship securities. A business enterprise
has to maintain a proper mix of both the securities in a manner that the cost and risk
perception to the shareholders are minimized. The mix of different securities is
portrayed by the firms’ capital structure (Koirala, 1990:105).

Financial decision must be very sensitive in misappropriate composition of debt

equity in capital structure may lead to bankruptcy of the firm. The optimal capital
structure is attaining at the level where the risk perception of shareholder is
minimized and returns are maximized. As the return to shareholder is maximized
automatically the market value of the firm is maximized.

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1.2 Introduction of the Financial Institutions' under Study

Financial institutions are playing leading role in the economic growth of Nepal.
Among the listed institutions, bellow is some of them which are sampled for study.

1.2.1 Kumari Bank Limited

Kumari bank limited came into existence as the fifteenth commercial bank of Nepal
by starting its banking operation from Chaitra, 21 2057 B.S( April 03, 2001) with an
objective of providing competitive and modern banking service in the Nepalese
financial market. The bank has paid up capital of Rs. 1,603,800,000 of which 70% is
contributed from promoters and remaining from public.

KBL has been providing wide range of modern banking services through 29 points of
representatives located in various urban and semi urban part of country, 20 outside
and 9 inside the valley. The bank is providing the latest lucrative banking services like
E-banking and SMS banking services in Nepal. The bank has been providing 365
days banking facilities, extended banking hours till 7 PM in the evening, Utility Bill
Payment service, Inward and outward remittance service, online remit services and
various other banking services.

1.2.2 Everest Bank Limited

Everest Bank Limited (EBL) started its operations in 1994 with a view and objective
of extending professionalized and efficient banking services to various segments of
the society. The bank is providing customer-friendly services through its branch
network. All the branches of the bank are connected through Anywhere Branch
Banking System (ABBS), which enables customers for operational transactions from
any branches. Punjab National Bank is the Joint venture partner of Everest Bank
Limited holding 20% equity share. The bank has 45 branches, 55 ATM counters and
21 revenue collection counters across the country making it very efficient and
accessible banks for its customers anytime anywhere. The bank has been conferred
with 'Bank of the year 2006, Nepal' by the publication of financial times, London. The
bank was bestowed with the "NICCI Excellence Award" by Nepal India Chamber of
Commerce for its spectacular performance under finance sector. EBL was first bank
to introduce Any Branch Banking System (ABBS) and to launch e-ticketing system in
Nepal.

1.3 Statement of Problem

Nepalese companies are not taking Capital Structure seriously. So, optimum capital
structure does not exist at all. Companies are ruined by the excess burden of cost of
capital among the sampled commercial banks.

Different companies have its own policy to operate business activities. Some business
use only equity capital and others use only debt capital whereas some companies use
both. So the determination of capital structure depends on company policy and cost of
capital. In the beginning period of any companies they want to use only equity capital
and do not want debt in their capital structure due to high interest charge.
In this situation, there might arise some question such as

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 Are Joint Venture commercial banks and commercial banks using optimum
capital structure?
 Could there be any factor besides the capital structure that hinders the
optimum capital structure and the value of the firm as a whole?
 Are there any possibilities to reduce the cost of capital with change in
leverage?
 To what extent, profitability has been raised?
 What is the relationship between capital structure and profitability?

1.4 Objectives of the Study

The main objective of this study is to reset the relationship between capital structure
and the value of firm by analyzing the effect of leverage (debt – equity mix) on the
risk and return. This study also attempts to find out the selected explanatory variables
such as size, growth, risk, return dividend pay-out ratio, liquidity and earning
variability.

 To study the strength and weakness of various aspects of capital structure.

 To analyze relationship between the capital structure, cost of capital and
profitability.
 To reveal the comparative impact of different capital structure on profitability.

1.5 Significance of Study

The capital structure decision is a significant managerial decision. It influences the
shareholder's return and risk. Consequently the market value of the share is affected
by capital structure decision.

 This study is based on the capital combination (capital structure) and profit
output by that combination of the financial institution which helps the
concerned to formulate the best structure of capital that yield maximum profit
which supports to compete in the cut thread competition and achieve targeted
objective and goal.
 To judge the long term financial position of the institution, this analysis
supports.
 This study will provide information to those who are planning to invest in the
financial institution.
 With the help of the report of this study, management may apply corrective
measures for the institution's performance.
 It will be useful for potential investors, lenders, creditors, management,
government, and shareholders.
 This study will be helpful for future researcher.

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1.6 Limitation of the Study

This study attempts to evaluate capital structure decision of Nepal's leading financial
institution in the sector of banking transaction. Following points can be considered as
limitation for the study:

 This study is based on secondary data like Balance Sheet, profit and loss
account, other related journals.
 Only five years data observation covering from F/Y 2007/08 to 2011/12 limits
the study. Conclusion is derived from above period of time.
 The accuracy of study is based upon the record keeping of Joint Venture
Banks and its accuracy.
 It only studies about capital structure and profitability whereas ignores all
other affecting factors.
 Limited resources and time has been utilized for preparing thesis, so micro
analysis may not be available.

1.7 Organization of the study

This study has been comprised into five chapters, each devoted to some aspects of
capital structure and profitability. The titles of each of these chapters are summarized
and the contents of each of these chapters of this study are briefly discussed bellow.

Chapter I: Introduction

Chapter II: Review of Literature

Chapter III: Research Methodology

Chapter IV: Data Presentation and Analysis

Chapter V: Summary, Conclusion and Recommendations

Chapter I: Introduction
The first chapter deals with the subject matter consisting of background of study , a
brief profile of the sampled banking institutions, identification of problem,
significance of the study, objectives , limitations, and organization of the study.

Chapter II: Review of Literature

The second chapter concerns with literature review that includes a discussion on the
conceptual framework and review of major relevant studies with fund mobilization of
a commercial joint venture bank.

Chapter III: Research Methodology

The third chapter describes the research methodology adopted in carrying out the
present research. It deals with research design, sources of data, data processing

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procedures, population and sample, period of the study, method of analysis and
financial and statistical tools.

Chapter IV: Data Presentation and Analysis

The fourth chapter is concerned with presentation, analysis and interpretation of data.
The segment where the data required for the study are presented analyzed and
interpreted by using the tools and techniques of financial management and statistical
tools.

Chapter V: Summary, Conclusion &Recommendations.

The fifth chapter and the final chapter are concerned with the suggestive framework
that consists with overall findings, conclusion and recommendations of the study.

The bibliography and appendices are incorporated at the end of the study.

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CHAPTER – II
REVIEW OF LITERATURE

Review of literature is the process of learning and understanding the concept of

related topics. It is the process of studying different educational materials which are
related with the topic mater. It provides required depth of knowledge for conducting
research. The purpose of literature review is to find out what principles are established
and research studies have been conducted in the field of study, and what remains to be
done. To make meaningful research study, the conceptual review is done through the
study of various books and articles. In addition, researches conducted by the previous
researchers in the field of capital structure and profitability are also reviewed by
studying their research works, theses and dissertations etc. literature review has been
divided into two sections.

 Conceptual/ theoretical review

 Review of related studies

2.1 Conceptual /Theoretical Review

In this section, various books written by different writers are reviewed. This makes
clear about the conceptual foundation of this study. Views of different writers and
scholars have been reviewed to extract broad concept. Under this section, concept of
capital structure and profitability, assumptions and definitions are well reviewed to
make the study more clear.

2.1.1 Meaning of Capital structure

In finance, capital structure refers to the way a company finances its assets through
some combination of debt, equity or hybrid securities. A firm's capital structure is
then the combination or structure of its liabilities. The term capital structure refers to
the percentage of capital (money) at work in a business by type. There are two form
of capital: equity and debt capital. Each has its own benefits and drawbacks. The
capital structure is all about how firm finances its overall operations and different
sources of fund.

2.1.1.1 EQUITY CAPITAL

The amount of capital, which has been collected from the selling of shares, is known
as Equity capital. There can be different types of shares as

 Common Stock
 Preference Stock
 Bond
 Retained Earning

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In capital, certain amount is provided to the shareholders who are regarded as owners’
of the institution. So, all the shareholders will receive dividend for investing their
capital in the shares.

2.1.1.2 DEBT CAPITAL

This is another source of money collection to run the company. Here the debt capital
is used in the company and certain amount of interest is paid to the creditors. There
can be various debt in terms of expire of time.

 Short Term Debt

 Long Term Debt

"Capital structure is the mix (or proportion) of a firm's permanent long term financing
represent by debt, preferred stock and common stock equity." (Van Horne, 2007).

"Capital structure is concerned with the analyzing the capital composition of the
company" (Weston and Brigham, 1996).

“Capital structure refers to the mix of long term sources of fund, such as debenture,
long term debt, preference share capital and equity share capital including reserves
and surpluses i.e. retained earnings” (Pandey, 1981).

"The optimum capital structure may be defined as that capital structure or

combination of debt and equity that leads to the maximum value of the firm." (Khan
and Jain, 1997).

Hence by all these definition it conclude to only one thing that is the mixture of debt
and capital should be done in a optimal way from which we can get maximum result.

Although there are many more parts/components of capital structure but major
component are
 Common Stock
 Debenture
 Retained Earning

The structure of capital structure can be presented through bellow figure as well.

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Capital Budgeting Decision

Needs to Raise Funds

Capital Structure Decision

Existing Capital Structure Debt Equity Mix Financial Dividend

Leverage

Effects on EPS Effects on Risk

Effects on capital structure

3st Stage

Degree of Leverage

Optimal Capital Structure Degree of Leverage

Effects on Cost of Capital

Value of Firm

Figure 1: Capital Structure

As shown in the Figure 1, every organization will go through same process such as
they have to collect some capital so they will get multiply choice either using the
present capital structure, or use from the dividend or to Debt equity mix which will
have later effect on Earning per share and risk, which after all effects the cost of
capital and hence market value of firm.

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2.1.2 Profitability
Each and every organization is established to earn some amount which is regarded as
a profit. Therefore we can say that every organization's motive will be to maximize its
profit. In a simple word the difference of total revenue and total expenses is
considered to be profit. Many people may argue that Governments Bank's first
priority is service not profit, but they should not ignore the importance of profit,
which ultimately makes the efficiency of any organization better.

Profitability is combination of two words "profit" and "ability". Here in an

organization more way of increasing monetary value is considered to be profitability
increment of that organization. In a Commercial bank, its more efficiency can be seen
by more amount of profit gained by that bank. Profit can be considered as a measuring
rod, which reflects to all aspects of entire business organization which all also
includes quality output. A profitable company is likely to offer not only security of
employment but also promotion, prospects, job opportunities and the intense
personnel motivation that comes from being associated with success. Profit is the
basic factor of any organization and the ability means the capacity of organization to
earn more and more profit.

Profitability is relative measure; it is utilized to check the degree of efficiency of

management of any organization. This measure helps the investor to calculate the
amount of risk present in the business, what amount of interest can be expected or
generated from such organization. Measure, or forecast of profitability is again
prepared by the help of current profit and one trend line is prepared and for the next
year profit is forecasted.

The main objective of profitability is to see whether the organization is using its
resources effectively or not, if not which sector is lacking the attention everything
should be analyses. Though there are two definitions regarding of profit but both
relates to the good of the organization. Some reasons are given below which illustrate
importance of profit.

2.1.2.1 MEASUREMENT OF PERFORMANCE

In any kind of business, profit is considered as a measuring rod of performance. Profit
finalized what are the things, which the company should achieve and in which
direction the company is going on in future.

2.1.2.2. PREMIUM TO COVER COST OF STAYING IN BUSINESS

Risk and uncertainties always follows business environment. To grasp the globally
challenging technologies to stay in the market uncertainties, to replace and acquire
assets enhancing business scope etc. call for a profit margin for a long stay in the
business.

2.1.2.3 TO ENSURE SUPPLY OF CAPITAL FOR FUTURE

Profit is necessary to plough back in the investments like innovations, business
expansion and self-financing. It attracts investors for investment.

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2.1.3 Profitability of a Commercial Bank
Commercial bank invests public deposits on those sectors that derive the maximum
income or higher rate of return in their assets. Hence the investment or granting of
loan and advance by them are highly influenced by profit margin. The profit of
commercial banks depends upon the interest rate of the bank, volume of the loan
provided, time period of loan and nature of investment in different securities. To
cover all the expenses as interest to the depositors and other administrative cost, profit
is required. Commercial bank also should pay dividend to the shareholders who have
given their share to build the capital of bank.

Banks today are under great pressure to perform to meet the objective of their
shareholders, employees, depositors and borrowing customers, while somehow
keeping government regulators satisfied that the bank's policies, loans and
investments are sound.

A successful bank is one who invests most of its fund in different earning assets
standing safely from the problem of liquidity i.e. keeping cash reserve to met day to
day requirement of the depositors. After all a commercial bank is simply a business
corporation organized for the purpose of maximizing the value of the shareholders
wealth invested in the firm at an acceptable level of risk.

Profitability and liquidity maintain a highly negative co-relation. Since both are
equaled important for commercial bank, banks cannot ignore any of them. So the
crucial decision for the management of the bank is to trade off between them. The
more liquidity the less will be profitability and vice versa.

2.1.4 Assumption of Capital Structure

Regarding capital structure different kinds of theories are propounded by different
personalities. Some of the main types of theories are:

 Net Income Approach

 Net Operating Income Approach
 Traditional Approach
 The Modigliani-Miller Approach

Assumptions
Two types of capital are employed, long term debt and shareholder's equity.

i. The firm's total assets are fixed but its capital structure can be changed
immediately by selling debt to repurchase common stocks or vice versa.
ii. The net operating income (NOI or EBIT) is not expected to grow.
iii. All earning of the firm's are paid out in the form of cash dividend.
iv. There is no corporate income tax.
v. The firm's is expected to continue indefinitely.

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SOME BASIC FORMULAS

1. Cost of Equity (Ke):

Dividend ( D1)
Cost of Equity ( Ke)   Growth rate (G)
Cost of Equity ( P0)

When Dividend per share (D1) = Earning per Share (EPS) and Growth rate (G) = 0,
EPS
Ke 
P0

2. Cost of Debt (Kd):

Interest ch arg e ( I )
Cost of Debt ( Kd ) 
Value of Debt ( D)

3. Overall Cost of Capital /Weighted Average Cost of Capital (Ko):

Equity Debt Net Operating Income ( NOI )

Ko  Ke   Kd  
Value of Firm Value of Firm Value of Firm (V )

4. Total Value of Firm:

Total Value of Firm  Total Market Value of Common Stock  Total Market Value of Debt

2.1.5 Theories of Capital Structure

A. Relevant Theory (Capital structure affects the value of firm)

 Net Income Approach
 Traditional Approach

B. Irrelevant Theory (Capital structure does not affects the value of the firm)
 Net Operating Income Approach
 Modigliani and Miller Approach

2.1.5.1. NET INCOME APPROACH

The essence of net income approach is that the firm can increase its value or lower the
overall cost of capital by increase the proportion of debt in the capital structure. Some
assumptions for this approach are:-

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Assumptions of Net Income Approach
 The use of debt does not change the risk perception of investors; as a result the
equity capitalization rate (Ke) and debt capitalization rate (Kd) remain
constant with changes in leverage.
 The debt capitalization rate is less than the equity capitalization rate (Kd < Ke)
 The corporate income tax does not exist.

Cost of Equity (ke)

Cost of Capital

Overall Cost (Ko)

Cost of Debt ( Kd)

Degree of Leverage
Figure 2: Net Income Approach

As shown in the Figure 2, the degree of leverage is shown horizontally where as cost
of capital is shown in vertical way. Cost of equity (Ke) and cost of debt (Kd) remains
constant as according to the assumption and cost of equity (Ke) is more than cost if
debt (Kd). The capital structure will be optimum if value of firm is increased by
maximizing the overall cost of capital; Under Net Income approach the firm will have
the maximum value and the lowest cost of capital when it has more financing in debt
(Pandey, 1999:678). Since there is no tax and no preferred stock

EBIT D S
Ko   Kd  Ke
V V V

I NI
Where, D  and S  and V  B  S
Kd Ke

2.1.5.2. NET OPERATING INCOME APPROACH

Net operating income approach theory was propounded by Durand. In this approach
any change in leverage will not lead to any leverage in the total value of the firm and
the market price of share, as the overall cost of capital is independent of the degree of
leverage.

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The market value of firm  Debt value  Equity value
Net Operating Income

Overall cos t of Capital
NOI

Ko

Ko is overall cost of capitalization rate and it depends on the business risk of the firm.
It is not affected from financial mix. If net operating income and overall cost of
capital are independent of financial mix then value of the firm will be constant and
independent of change of capital structure.

Assumptions Net operating income

 The market capitalizes the value of firm as a whole so splitting of debt and
equity has no importance.
 Cost of debt remains constant.
 The market uses an overall capitalization risk (Ko) to capitalize risk. If
business risk is assumed to remain unchanged, Ko will be constant.
 Cost of equity increase as leverage is increased.
 The corporate income tax does not exist.

Other name for net operating income (NOI) is earning before interest and taxes.

Net Operating Income

Value of Firm (V ) 
Overall Cost of Capital
NOI

Ko
EBIT

Ko

We know –
Value of firm (V )  Debt Value ( D)  Equity Value (S )

That is –
Equity Value  V  D

NOI  I NI
The Cost of Equity ( K E )  
V D S

D S
Ko  Kdt  KE
T T

- 13 -
If tax rate is given, value of unlevered firm –

EBIT 1  t  NI
Vu  
K E (u ) KE

Thus, value of firm is the value of equity.

Value of Levered firm –

VL  VU  PV of debt tax shield

If company uses excess debt –

VL  VU  PV of debt tax shield  PV of bankruptcy rate

If corporate and personal tax rate is given, then –

 (1  Tc)(1  Tps) 
PV of debt tax shield  D1  
 (1  Tpd ) 
Where,
Tc = corporate tax rate
Tps = Personal Tax rate on stock Income
Tpd= Personal Tax rate on debt income

Cost of Equity (ke)

Cost of Capital

Cost of Debt (Kd)

Over all Cost ( Ko)

Degree of Leverage

Figure 3: Net Operating Income Approach

This figure explains Ko and Ke are constant and Ke increases with leverage
continuously. As the average and cost of capital k is constant this approach implies
that there is not any unique optimum capital structure. In other words as the cost of
capital is the same at all capital structure, every capital structure is optimum (Pandey,
1999:683).

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2.1.5.3. TRADITIONAL APPROACH
Traditional approach is the combination of net income approach and net operating
approach. In this approach either value of a firm will be increased or cost of capital
can be reduced by combination of debt and equity. This approach justifies cost of
capital decreases with limitation of debt and hence increased with leverage. So we can
say that optimum capital structure requires maximum cost of capital where as the
maximum value of the firm. This kind of concept is propounded because debt is
considered to be comparatively cheaper source of fund collection than from ordinary
share. As we know cost of equity is higher than cost of debt and if we borrow funds
from cost of debt more than overall cost of capital will decrease. Traditional approach
can be studied with respect to market situation in their stages.

First Stage
In the first stage, cost of equity remains constant or rises slightly with debt this
increase will not have affect for low cost debt. Keeping these things in mind, use of
debt can be good option. As a result the value of the firm will increase and overall
cost of capital declines with increasing leverage.

Under this assumption, Ke remains constant for some condition of debt then the value
of firm will be
NOI D
V  (K E  K D ) 
KE KD
As long as Ke and Kd are constant, the value of the firm increase at the constant rate
when amount of debt increases.

Second Stage
Once the firm has reached a certain degree of leverage increase in leverage have a
negative effect in the value or the cost of capital of the firm. The reason behind this is
the increase in the cost of equity due to the added financial risk affects the advantages
of low cost debt. Within the range at the specific point, the value of the firm will be
maximized or the cost of capital will be minimized (Pandey, 1999).

Third Stage
In this third and final stage, if the amount of debt is increased then now, overall cost
of capital also increases where as it increases the risk factor also. This increment will
be faster than the risk in the earnings from the introduction of the debt.
Cost of capital

First stage Second stage Third stage

Figure 4: Traditional Approach

Degree of Leverage

- 15 -
As shown in the figure the cost of capital depends upon degree of leverage. The cost
of capital declines until and unless it reaches optimum value then it started rising.
Here in the first stage cost if capital is decreased so Ko line is moving down. At
second stage it reaches optimum state so decline of cost of capital is stopped here.
Then after it started rising slowly in the beginning and then at a faster rate. The cost of
capital (Ko) makes U - shaped curve which represent incline and decline of cost. In
that curve there is such a point at which cost of capital will be minimized and this
point is known as optimum capital structure.

2.1.5.4. THE MODIGLIANI - MILLER APPROACH

Modigliani and Miller approach also relates with irrelevant theory which means
capital structure of the firm will not affect the value of the firm so they came in one
agreement that whatever rational choice of debt and equity will have same cost of
capital. So in this approach we do not have optimum mix of debt and equity. As long
as business risk remains the same the cost of capital will remain constant. As the firm
increase the amount of leverage in its capital structure, the cost of debt capital
remaining constant the cost of equity capital will rise just enough to affect the gains
resulting from application of low cost of debt.

Assumption of Modigliani Miller approach

 Existence of perfect capital markets
 Information is cost less and readily available to all investor
 Absence of transaction cost and infinite divisibility of the securities.
 Investors are rational and behave accordingly.
 Homogenous expectation of investors.
 An individual can borrow or lend at the same rate at which a corporation
borrow or lend.
 Dividend payout is 100 percent.

Modigliani and Miller say that total cost does not change as it is divided into debt,
equity and other securities. The sum of the parts must be equal to whole, so regardless
of financing mix the total value of the firm stays the same.

Proposition 1
Modigliani and Miller argue in the same risk, the overall cost of capital (Ko) and the
value of the firm (V) are independent of its capital structure.
This first proposition can be express as
NOI
V SD
Ko
where,
V = value of the firm
S = the market value of common stock
D = the market value of debt
Ko = the capitalization rate appropriate to the risk class of the firm.
Again,
S D
V  KE  Kd
SD SD

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Proposition 2

Proposition 2 explains cost of equity (Ke) is equal to the capitalization rate of pure
equity plus a premium for financial risk –
NOI  Kd
KE 
S

As we know that –
NOI
Ko 
V
Then –
NOI  Ko  V  Ko(S  D)

Hence –
V=S+D

Substituting the value of NOI

Ko( S  D)  Kd  D ( Ko  Kd ) D
KE   Ko 
S S

This relation explain that cost of equity (ke) is equal to the constant average cost of
the capital (ko) plus premium for the financial risk which is equal to debt equity ratio
( Ko  Kd ) D
times the difference between constant cost of capital and cost of debt
S

As the cost of equity is measured by the market value of debt to equity so this fact
will increase earning per share and cost of equity.

Arbitrage Process
M-M approach does not consider NI approach as valid approach. Their optimum
clarify in two identical firms have market values arbitrage will take place to enable
investors to engage personal or homemade leverage to restore equilibrium in the
market except for the degree of leverage (Pandey,1991).

The importance of Arbitrage is to purchase securities or assets whose price are

undervalued and sell those securities whose price are higher in related market.

ARBITRAGE PROCESS

From levered to Unlevered (U - L )

Step 1:-Investor sells ….% of share of leveled firm xxx

Step 2:-Investors borrows an equal amount of share

in debt capital of leverage firm. xxx
Total fund available of investment (A) xxx

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Step 3 :-Investor purchases equal % shares of

Unlevered firm (B) xxx

Reduction of Investment outlay (A - B) xxx

From Unlevered to levered (U - L)

Step 1:-Investor sells..% of share of unleveled firm xxx

Total fund available of investment xxx

Step 2 :-Investors lends (to the same firm or elsewhere) an equal

amount of his/her share in debt of leverage firm. (A) xxx

Step 3 :-Investor purchases equal % shares of levered firm. (B) xxx

Reduction of Investment outlay (A - B) xxx

2.1.6 Some Related Items to Capital Structure

A. EARNING PER SHARE

Earning per share is the amount, which is separated from net profit to each and every
shareholder.

Net Pr ofit After Tax  preference Dividend

EPS 
Number of Common Share Outs tan ding

Earning per share is one of the most used measures of firm's performance. To
maximize EPS the plant will chose the highest level of debt. Earning per share is
calculated after different phase such as first there will be earning before interest and
tax then interest will be reduce so that earning before tax is left. Again tax amount is
remained which is earning to equity. Then we use above formula to find Earning per
share.

B. COST OF CAPITAL
“The impact of financing decisions on the overall cost of capital should be evaluated
and the criteria should be to minimize the overall cost of capital or to maximize the
value of the firm” (Pandey, 1991).

C. FLEXIBILITY
It means the firm's ability to adopt its capital structure to the needs of changing
conditions. The capital structure of a firm is flexible if it has no difficulty in changing
its capitalization or sources of funds. The company should be able to raise funds,
whenever needed to finance the profitability investment. The company should also in
position to redeem its preference capital or debt whenever warranted by the future

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conditions. The financial plans of the company should be flexible enough to change
the composition of the capital structure.

D. CASH FLOW ABILITY AND CONTROL

A company should be always prepared for the future so it should manage its cash
flow. Some amount of the company should be paid which are known as fixed charges
like interest, preference dividends and principal. Whenever the company things to
raise the funds it should calculates its expected future cash flow to meet fixed charges.
If such fixed charges are not maintained than the company is dissolved. Control in
any company depends upon voting rights of shareholders so to manage the control
debt capital can be used. But when a company use large amount of debt, lot of
restriction are put by debt-holder on company to protected their interest. Large
amount of debt can also cause bankrupt which means total loss of control.

E. SIZE OF THE COMPANY

In large companies, there is greater degree of flexibility for capital structure. The
larger company is easy to make available long - term loan and easy selling of
common shares, debentures etc. But this kind of flexibility cannot be seen in small -
scale companies. Hence size of the company is an important consideration to make
appropriate capital structure.

F. INTEREST RATES AND TAXES

Interest rates affect the choice of securities to be offered to investors. High interest
rates make financing costly, when fund are obtained easily and cheaply. The
advantage of using debt will be greater if a firm's tax rate is higher. Financial
statement means the statement, which have all financial matter of the company, just as
trial balance, profit and loss a/c and balance sheet. In balance sheet we record assets
and liabilities. In balance sheet

Total Assets  Total Liabilitie s  Equity Capital

The balance sheet is just the mirror of the company. It reflects all assets, liabilities of
company and also equity from shareholders.

G. OPERATING INCOME AND NON OPERATING INCOME

Operating income for the business entity is the regular and prime source of revenue
for the business; it is the main identity of a business regarding what a business stand
for. Non operating incomes are the casual source, not the regular source of revenue
for business entity. These incomes are not from regular course of business but from
other source where the business entity can be involved legally as prescribed by the
directives if related government authority.

2.2 Review of Articles

Many organizations have been following different capital structure and such
structures have been studied and analyzed periodically.

Modigliani and Miller (1958): They used the previous work of Allen Smith in
support of their independence hypothesis. In the first part of their work, MM tested

- 19 -
their proposition I the cost of capital is irrelevant to the firm’s capital structure, by
correlating after tax cost of capital, with leverage (B\V). They found that the
correlation coefficient is statically insignificant and positive in sign. The regression
line is “U” shaped cost of capital key of traditional view, and then the data are shown
in scatter diagram.

In the second part of their study, they tested their proposition II, the expected yield on
common shares, is a linear function of debt to equity ratio. The second part of their
study is consistent with their views, i.e. if the cost of borrowed funds increases, the
cost of equity will decline to offset this increase.

Weston (1963): Weston did research on "A test of cost of capital proposition ". He
came up with some important improvement in the cost of capital model. Firm's size
and growth are the additional explanatory variable in his model. The findings were:

 The regression coefficient of leverage to be positive and significant.

 Using multiple regression, he found the correlation coefficient is
significant and the regression coefficient negative and significant.

When the growth factor is isolated, leverage is found to be negatively correlated with
cost of capital. . He concluded that the apparent lack of influence of leverage on the
overall cost of capital observed by MM was due to the negative correlation of
leverage with earning growth. Weston also tested MM proposition II. When he used
the MM model, his results were found to be consistent with their results i.e. cost of
equity is the linear function of debt equity ratio.

Keshar J. Baral (2004) in the Journal Determinants of capital structure; A case study
of listed companies of Nepal, has made an attempt to examine the determinants of
capital structure – size, business risk, growth rate, earning rate, dividend payout, debt
service capacity and degree of operating leverage of the companies listed to Nepal
stock exchange Ltd as of July 16 2003. Eight variables multiple regression model has
been used to assess the influence of defined explanatory variables on capital structure.
The study shows that size growth rate and earning rate are statistically significant
determinants of capital structure of listed companies.

Fadzlan Sufian ( 2012) in the study " Determinants of bank profitability in

developing economies: empirical evidence from south Asian banking sector" seeks to
examine the performance of 77 Bangladeshi, Sri Lankan and Pakistani commercial
banks between 1997 and 2008. The empirical findings suggest that bank specific
characteristics- in particular, liquidity, non –interest income, credit risk, and
capitalization – have positive and significant impacts on bank performance, while cost
is negatively related to bank profitability. As for the impact of macro economics
indicator, the result suggests that economic growth has positive and significant
impact, while inflation has no significant impact on bank profitability. During the
period under study, the empirical findings indicate that private investment is
positively related to bank profitability, while private consumption expenditure
exhibits negative impact. However, the impact is not uniform across countries studied.

Ranjana Risal & Surya Bahadur G.C. ( 2010) in the paper Corporate Governance
and Capital Structure of Nepalese listed firms analyzes the relationship between some

- 20 -
characteristics of the corporate board and the firm's capital structure in Nepalese listed
firms using panel data models. The findings provide some preliminary empirical
evidence and seem to suggest that stronger governance practices leads to lower
financial leverage and lower agency conflicts. However, the empirical results of the
relationships are statistically significant only in the case of board consumption and
CEO tenure. The results are statistically insignificant in the case of the board size and
board skill. The result shows positive association between the number of executive
directors on board and debt level and also suggests that entrenched CEO pursue
higher debt policy. The findings indicate that managements of Nepalese firms are
employing higher debt level as an expropriation device for minority shareholders
rather than a disciplinary measure.

2.3 Review of Thesis

This section is developed to the review of major related studies in thesis related to
capital structure analysis and profitability. In this part, past thesis are reviewed.

Chiranjeebi Upadhya (2008 Feb) conducted a study entitled "The study of capital
structure and cost of capital of manufacturing trading and Hotel sectors enterprises of
Nepal." The objectives of this study were:

 To examine the relationship between leverage and cost of capital in

Manufacturing trading and hotel sector enterprises in Nepal.
 To analyze the relationship of leverage and cost of capital in
manufacturing trading and hotel sector enterprises in Nepal.
 To examine leverage and cost of capital in manufacturing trading and hotel
sector enterprises in Nepal.

The researcher followed descriptive research model. The researcher conducted its
research considering population size 117 companies listed in Nepal stock Exchange
and the sample size was 9 companies among them. The primary data were collected
for the analysis. Method used for analysis was Econometric Analysis.

The major findings of the study are listed below:

 Hotel sector enterprises have highest average leverage, size of capital

employed, growth in total assets and liquidity ratio. DPR, earning
variability and tax adjusted yield are highest in trading sector. Cost of
equity, cost of capital and leverage are highest in manufacturing sector.
 With respect to financing pattern of the companies, majority of
representatives stated, they used the mixed fund of short and medium term
in companies.
 Debt employed- short term debt is with maturity period less than one year.
 There is no use of optimal debt ratio.

Neela Shrestha (2008 April) conducted a study entitled "A study on analysis of
capital structure of joint venture banks of Nepal". The objectives of study were:

- 21 -
 To analyze the relationship of the capital structure and the cost of capital
of selected joint venture banks.
 To analyze the comparative capital structure of selected JVs.
 To analyze the profitability position of selected JVs.

The research is based on analytical and descriptive method. The population size of the
study is 6 JVs and the sample size is 5 JVs among them. The data used for analysis
and interpretation is secondary data. The method of data analysis is financial and
statistical stool.

The major findings of the study are:

 There is use of high % of total debt in raising assets.
 NSBI has high degree of financial risk.
 All selected JVS are highly leverged.
 Shareholders equity are utilized in efficient way.
 Satisfactory return on earning achieved.
 Private sectors banks have been successfully increasing their deposits and
credit portfolio.

Dipesh Pokhrel (2009 April) conducted his Master's thesis entitled "A case study on
capital structure of manufacturing companies using Financial Ratios". The objectives
of the study were:

 To examine the capital structure of selected companies.

 To assess the debt servicing capacity of the selected companies.
 To analyzes cost of capital and return on capital in relation to capital
employed.
 To analyze the financial and operating leverage effect on the capital
structure.
 To identify whether there exist an optimum finance mix in terms of
maximum value to the firm's standard.

The study is based on analytical and descriptive method. The research has considered
population size 38 manufacturing companies and 2 manufacturing companies; Nepal
lube oil limited and Bottlers Nepal limited. The source of data used for study is
secondary data. The method of data analysis used in the study is financial analysis.

The major findings of the study are:

 Average DOL of BNL is negative which shows inefficient earning of firm.
 Average DFL of NLOL is higher than BOC which shows NLOL has
higher financial risk in comparison to BOL.
 NLOC has more debt to equity ratio.
 Interest coverage ratio is in increasing trend.
 Average return on assets of NLOL has low ratio which indicates the assets
of the company is generating low profit.
 Net profit is fluctuating and profit margin ratio is also decreasing where
the sales is increasing.
 Investors of BNL are getting more return from investment.

- 22 -
 There is negative relationship between NP and TD, NP and LTD & ROE
and Debt ratio.

Rajendra Aryal (2009 April) conducted a study entitled "Capital structure and its
impact on risk and return analysis, A case study of Dabur Nepal Pvt Ltd". The
objectives of the study were:

 To analyze the cost of capital.

 To study the profitability position.
 To assess the debt servicing capacity.
 To examine the relationship between EAT and Total debt, Debt equity
ratio and ROE, Debt ratio and ROE.

The study is based on descriptive and analytical research design. The researcher has
used secondary data for the study purpose. The method of data analysis used is
financial and statistical method of data analysis.

The major findings of the study are listed below:

 Capital structure is composed of equity, short term and long term loan.
 Short term loan is in increasing trend and long term loan is in decreasing
trend.
 Financial leverage is in fluctuating trend.

Sanu Maharjan (2010 April) conducted "A study on capital structure and cost of
capital" of commercial banks. The objectives of this study were:

 To study relationship between cost of capital and capital structure of

selected banks.
 To analyze the relationship between cost of equity and leverage of selected
banks.
 To test the relationship between profitability and debt equity ratio.
 To examine the effect of other factors such as size of firm, growth, DPS
and liquidity on cost of capital.
 To provide suggestion on basis of findings for further growth of banks
under study.

The research is based on descriptive and analytical method. The research has
population size 25 commercials banks and among them 4 private commercials banks
as sample size. The research is based on secondary data. The method of data analysis
used by researcher is financial and statistical tool.

The major findings of the study are listed below

 The trend of long term debt to total debt ratio is fluctuating.
 Sampled banks have either no debt or very low % of debt in comparison to
equity capital.
 Sample banks are able to pay their interest amount.
 ROSE of sample banks are fluctuating.
 HBL has highest earning per share.

- 23 -
Vikash Shahi (2010 April) conducted a study entitled "A study of capital structure
management of selected commercials banks" with reference to NABIL, SCBL, EBL
and HBL with following objectives.

 To examine the current capital structure of sample commercial banks.

 To analyze the capital of selected banks of mix of debt and equity.
 To analyze the relationship between capital structure, cost of capital and
profitability.

The research design used in the study is descriptive and evaluative. The researcher has
conducted the study with the sample of 4 commercial banks traded in stock market.
The researcher has used secondary data for the purpose of study. The collected data
are analyzed by using financial and statistical tool of data analysis.

The major findings of the study are:

 The creditor margin of safety of selected samples is very low.
 The debt ratio is in fluctuating trend.
 ROA of selected banks has mixed trends.
 Least ROE of selected banks shows the weak performance of banks.
 The EPS of banks during the study period is in fluctuating trend.
 HBL has distributed bonus share which is advantageous and reduces the
market price per share.
 Over all price earning is in fluctuating trend.
 There is insignificant relationship between cost of capital and profitability.

Goma Pandey ( 2011) conducted her Master's thesis entitled "Capital structure and
profitability management, A case study of Machhapuchhre Bank ". The objectives of
the study were:

 To evaluate whether the capital structure affects the cost of equity of

MBL.
 To analyze the debt servicing capacity of MBL.
 To analyze the relationship between capital structure and profitability, cost
of capital and EPS of MBL.
 To identify problem in the capital structure of the company and provide
suggestion and recommendation.

The research design used in the study is descriptive and evaluative design. The nature
of data used for the analysis is secondary data. Here financial statement of concerned
bank is taken as population size and statement taken for study is sample size.

The major findings of the study are as below:

 Debt equity ratio is fluctuating during the study period.
 Bank has maintained excess capital fund to safeguard the deposits interest.
 Bank cannot be said to have sufficient interest coverage ratio.
 Highest debt capital used in the bank.
 Overall capitalization rate is in increasing trend because of decrease in the
value of firm and increased EBIT.
 More provision for staff bonus of MBL has decreased profit.

- 24 -
 Return on total deposit is found fluctuating in the study period.
 Bank has insufficient return from assets.
 Bank is not able to use its long term debt sufficiently.
 Satisfactory ROSE indicates utilization of internal sources.
 EPS found to be fluctuating.
 Bank is unable to provide sufficient dividend to investors.

Binod Thapa (2011 July) conducted a study entitled " Capital structure Management
of commercial banks of Nepal, with reference to HBL, SBI, EBL and NIB ". The
objectives of the study are:

 To examine the current capital structure of sampled commercials.

 To analyze the mix of debt and equity of selected bank.
 To analyze the relation between capital structure, cost of capital and
profitability.

The research design used in the study is analytical and descriptive. The study is based
on secondary data with sample of 4 commercials banks from population size of 29
commercials banks. The method of data analysis is financial and statistical method.

The major findings of the study are:

 Selected banks are highly levered.
 HBL is able to maintain highest interest coverage ratio.
 HBL has higher degree of financial leverage, which represents high
financial risk.
 EBL has highest average ROA, it indicates EBL has utilized its assets to
generate profit.
 HBL has highest EPS among the sample which posses strength on EPS
which helps to maximize the shareholder wealth.
 HBL pays relatively more dividend, which is advantageous and reduces
the market price per share.
 Overall trend of price earning shows fluctuating trend.
 Equity capitalization rate of banks was fluctuating. Overall trends shows
decreasing trend over the study period.

Shiva Shrestha (2012 April) conducted a study entitled "Capital Structure and
profitability of banks - With reference to NABIL, Nepal Investment Bank and Nepal
Industrial and Commercial Bank." The objectives of the study were:

 To analyze the capital structure of NABIL, NIBL and NIC bank.

 To evaluate the effect of capital structure on profitability of banks.
 To evaluate the return on equity
 To provide the appropriate suggestion on the basis of findings.

The research is based on analytical and descriptive method. The population size of the
study is 32 commercial banks and sample is NABIL. NIBL and NIC bank. The data
used for analysis and interpretation is secondary data. The method of data analysis is
financial and statistical tools.
The major findings of the study are:

- 25 -
 The debt equity ratio of selected bank is low leveraged during the study
period. It means debt equity financing is higher than equity financing .
 The use of long term debt in term of total debt is comparatively very low
in all three banks.
 The current assets is more promising to meet the short term debt in all
three banks.
 The EBIT of NABIL is stronger than that of NIBL and BIC in meeting the
interest liability.
 The EPS of NABIL is more than other two banks.
 NABIL is much efficient than NIBL and NIC in mobilizing equity capital.

Prakash Raj Rimal (2012) conducted his Master's thesis entitled"Capital Structure
and Profitability Analysis of Bank of Kathmandu and MachhaPuchhere Bank
Limited". The objectives of the study were:

 To examine the capitals structure of selected commercial banks.

 To evaluate whether the capital structure affects, the cost of equity of
MBL and BOKL.
 To analyze the relationship between capital structure and profitability of
MBL and BOKL.
 To suggest and recommend on the basis of findings.

The research design used for this study is descriptive and evaluative using secondary
data. The method of data analysis used in the study is done using statistical and
financial tools. The population size taken for the study is 31 commercial banks and
MBL and BOKL are the sample among the population.
The major findings of the study are:

 The paid up capital of MBL and BOKL is in increasing trend.

 On the basis of debt equity ratio, BOKL is more risk taker than MBL.
 On the basis of long term debt to total debt. MBL is more risk taking than
BOKL.
 The total assets of each bank bears greater risk. More specifically, the total
assets of BOKL is slightly risky than that of MBL.
 On the basis of interest coverage ratio, BOKL has greater capacity to meet
the interest expenses.
 The overall capitalization rate of BOKL is higher than MBL.
 On the ground of ROA, BOKL is more efficient than MBL in effetely
mobilizing the total assets.
 On the basis of ROE, it can be concluded that BOKL is more efficient in
mobilizing the equity capital.
 Higher average EPS indicates that BOKL is able to earn more per share to
the common shareholders than MBL.

- 26 -
CHAPTER– III
RESEARCH METHODOLOGY

3.1. Research Design

Research Design is strategy concept of investigation. The study is evaluative and

analytical type of study regarding the effect of capital structure on cost of capital. The
research design used in the study is descriptive and evaluative. The data related to
topics are collected through financial statements of related companies and other
available sources. The data for five years had collected and various financial and
statistical tools had used to resolve the objective.

3.2. Population and Sample

The time limited and unavailability of the relevant data had forced me to make
research on the few commercial banks functioning all over the country and most of
their stocks are traded in the stock market out of them some commercial banks have
been chosen . Sample commercial and joint venture banks are as follows:

 Everest Bank Limited

 Kumari Bank Limited

3.3. Sources of Data

The data used in the study is fully based on secondary data. The data are collected
from annual reports of the bank, websites and also report published by Nepal Rastra
Bank Booklets, Documents other published and unpublished materials, thesis
newspaper are the important source of data.

3.4. Data Processing

All the data which are required are identified and selected. These data's are taken out
from financial statement of Banks. These data are managed properly for the study.
The data are collected from the balance sheet, profit and loss A/C, security board and
Nepal Rastra bank.

3.5. Tool and Techniques Applied

For the data processing and analysis technical tools can be used .thus for these two
types of tools are taken

3.5.1. Financial Tools

Ratio analysis is the major tools used to represent the relationship of the numerical
values between two terms in financial statement. The relationship between two
accounting figures, expressed mathematically is known as Financial Ratio (Ratio
analysis) [Pandey, 1991:110]. Ratio helps to summarize large quantities of financial

- 27 -
data and to make qualitative judgment about the firm's financial performance. We can
calculate different kinds of ratios as:

1. Liquidity Ratio
2. Leverage Ratio
3. Activity Ratio
4. Profitability Ratio

Although there are four kinds of ratio but we are going to discuss two ratios: Leverage
Ratio and Profitability Ratio. Leverage ratio explains about the capital structure of the
banks where as profitability ratio explains about the financial condition of the
company

LEVERAGE RATIO
The terms that are related with capital structure are studied within this ratio. Leverage
ratio studies for the funds employed by the firms or from the lender. Financial
leverage raises the expected rate of return to stock holders for two reasons (a) since
interest is deductive, the debt financing lower the tax bill and leaves more of the firms
operating income available to its investors. (b) If the rate of return on assets
(EBIT/Total Assets) exceeds the interest rate on debt as it to finance assets pay the
interest on the debt and have something left over as a "Bonus" for its shareholders
(Weston & Brigham 1982 Pg.290).

i. Debt to Shareholder's fund Ratio:

Here we can know the proportion of Debt holder's amount in respect to share
holder's fund. Debt means the amount which bears interest and fund of
shareholder has share capital and general reserves. If the ratio is higher than, it
means creditors have more proportion than owners.
Total Debt
Debt Shareholder ' s Fund Ratios 
Shareholder ' s Fund

ii. Debt to Total assets Ratio:

This ratio shares the relationship between Debt and total assets of the firm.

Funded Debt
Debt Total Assets 
Total Assets

Lower the ratio is, better for the company.

iii. Interest Coverage Ratio:

Debt ratios describe the static nature and fail to indicate the firm's ability to
meet interest obligation. The interest coverage ratio used to test the firm's debt
describing capacity.

EBIT
Interest Coverage Ratios 
Annual Interest

iv. Capital structure Analysis:

Under NI and NOI approach we can sort out some formulae.

- 28 -
NI Approach (Overall Capitalization Rate)
The overall cost of capital is measured by dividing net of capital is measured
by dividing net operating income by the value of the firm. The value of the
firm is the book value of debt and market value of the equity.

EBIT
Overall Cost of Capital ( Ko) 
Vo

NOI APPROACH (Equity Capitalization Rate)

This approach argues that the value of the firm remains constant to the degree
of leverage and equity capitalization rate tends to increase with the degree of
leverage.

EBIT  I
Equity Captalizat ion Rate ( K E ) 
S

PROFITABILITY RATIO
The profitability ratio can be study in relation to sales and investment.

i. Return on Total Assets:

This ratio is measures the productivity of the assets, higher ratio shows the
higher return on the assets used in the business thereby indicating effective use
of the business available and vice versa.

Net Pr ofit after tax

Re turn on Total Assets 
Total Assets

ii. Return on Shareholder's fund:

This ratio shows the return on the owner's investment. This ratio also indicates
how profitability the owner funds have been utilized by the firm and high ratio
reveals the efficient use of owner investment and vice versa.

Net Pr ofit after tax

Re turn on Shareholder ' s Equity 
Shareholder ' s Fund

EARNING PERFORMANCE RATIOS

i. Earning per Share:

Ordinary shareholders want some return on their investment which is known
as Earning per Share. This measure the profit available to equity shareholder's
per share.
Net Pr ofit after Tax  Perferred Dividend
Earning per Share ( EPS ) 
Number of Equity Share

- 29 -
ii. Price Earning Ration:
Price Earning ratio indicates investor's expectation about the growth of the
firm's earnings.
Market Pr ice of Share
P / E Ratio 
Earning per Share

3.5.2. Statistical Tools

Statistical and Research cannot be separated whenever research work is carried on

statistics should have output of the research. In today's world there is hardly any
research work which we can find complete without statistical data and statistical
methods. The statistical tools used in the study are as follows:

i. Arithmetic Mean:
Arithmetic mean can be expressed as the average value or sum of all
values divide by number of value.

X 1  X 2  ......  X n  X
Airthmetic mean ( X )  
N N

Where, X = Sum of all values of the variables.

N = Number of observation

ii. Standard Deviation:

The standard deviation measures the absolute dispersion or variability of a
distribution. The greater the amount of dispersion or variability the greater
the standard deviation, the greater will be the magnitude of the deviation
of the values from their mean X and vice-versa.

S tan dard Deviation ( SD)  

X2
N

iii. Correlation Coefficient (r):

Two variables are said to be correlated if change in the values of one
variable appears to be related or linked with the change in the other
variable. Correlation is an analysis of the covariance between two or more
variables and correlation analysis deals to determine the degree of
relationship between variables.

Between different processes of correlation, we use Karl Pearson's

Coefficient of correlation method. The correlation coefficient between two
variables X and Y for n observation is measure by:

r
 XY
x y
2 2

Where, x  X  X and y  Y  Y

- 30 -
The correlation coefficient 'r' always varies from '-1' to '+1'. When r=+1, it
reveals there is perfect positive correlation between the variables. When
r=-1 is obtained, it reveals there is perfect negative correlation between the
variables.

iv. Probable Error (PE):

The probable error of the coefficient of correlation helps in interpreting its
value. The probable error helps to determine reliability of computed
correlation coefficient so far as it depends on the conditions of random
sampling. The Probable Error (PE) is defined by:

0.6745(1  r 2 )
PE 
n
Where,
r=Coefficient of correlation
n=Number of observation

 If r<PE, there is no evidence of correlation, i.e. r is not all significant.

 If r>6PE(r), then r is definitely significant.

The PE of correlation coefficient may be used to determine the limits

within which the population correlation coefficient lies. By adding and
subtracting the PE from the 'r' we get respectively the upper and lower
limit within which 'r' in the population can be expected to lie. Therefore
the limit of the population correlation coefficient is r PE.

v. Simple Regression Analysis:

Regression analysis shows how variables are related .Regression is the
estimation of unknown values or prediction of one variable from known
value of the other variables. The regression equation can be determined by:

y  a  bx

Where, a=Intercept or Regression Constant

b=Slope of Regression line or Regression coefficient.

Regression Constant (a)

It is known as numerical constant directly above or below the origin
(i.e. y intercept) The value of the constant, which is intercept of the
model, indicates the leverage level of dependent variable when
independent variables is zero. In other words, it is between to
understand that constant indicates mean or average effect on dependent
variable if all the variables omitted from the mode.

Regression Coefficient (b)

The regression coefficient of each independent variable (b) indicates
the marginal relationship between that variables and value of
dependent variable, holding constant effect of all other independent

- 31 -
variable in the regression model. It is known that the slope of
regression line. In other words the coefficient describes how changes
in independent variable estimate. It is also known that the numerical
constant change is independent variable.

vi. t-statistics:
In order to that whether the sample correlation coefficient is significant of
any correlation between the variables in the population, T-test for
significance of an observed sample correlation coefficient is applied.

The T-statistics is calculated by following formula under H0

 n 
t  r ( 2 
)
 1 r 

Decision: T calculated T tabulated at a level of significance, it is not

significant.

- 32 -
CHAPTER – IV
DATA PRESENTATION AND ANALYSIS

This chapter is the heart of the research report. The main objective of this study is to
examine the capital structure and profitability of listed firms. In this chapter, all the
relevant data and information of listed Banks annual reports from fiscal year 2007/08
to 2011/12 are analyzed. Using different financial and statistical tools, the collected
and tabulated data have been analyzed. This chapter includes presentation analysis of
data collected as per the requirement of objectives set.

4.1 Capital Structure Analysis

The capital structure analysis of selected companies had been carried by analyzing
funded debt and shareholder's fund. Net profit and total assets analysis, financial ratio
and capitalization ratio

4.1.1 Calculation of Debt to Total Assets Ratio

The debt funded consists of interest bearing debt i.e. Bills payable, borrowing and
other liabilities. In the same way the total assets consists of fixed assets and current
assets.

Table 1: Debt to Total Assets Ratio

Banks/ Years EBL KBL

2007/08 92.25 90.98

2008/09 93.38 91.20

2009/10 91.36 90.52

2010/11 91.96 89.16

2011/12 92.44 90.09

Mean 92.28 90.39

S.D 0.74 0.81

C.V 0.80 0.90

Source: Appendix-I (A)

- 33 -
Figure 5: Debt to Total Assets

Above table and figure shows the practice of debt financing of EBL; a JV commercial
bank and KBL; a private commercial bank during the study period. In EBL, the
practice of financing the total assets through debt capital has increased in first fiscal
year from 92.25% to 93.38% and then decreased in the next year to 91.36% and then
again increased two years. The average assets financing through debt capital are
92.28%, indicating greater risk taking attitude of bank and the variation in the ratio is
0.80%, indicating high stability.

Similarly, in KBL, the debt capital to assets ratio is in fluctuating trend from 89.16%
to 91.20% throughout the study period. In average, 90.39% of total assets of KBL
have been financed through debt capital with variation of 0.90% in the ratio.

Comparing the above data, total assets of EBL is risky than that of KBL. Although
each bank bears greater risk, KBL has more fluctuation in the ratio than EBL as
shown by standard deviation.

4.1.2 Calculation of Debt –Equity Ratio

The Debt Equity Ratio establishes the relationship between debts and shareholder's
funds. It indicates the safety, margin to long term creditors. A low debt –equity ratio
implies the use of more shareholders funds than long term debt which means a larger
safety for creditors. A ratio of 1:1 is considered as ideal ratio" (Sharma, 1998:246).

Table 2: Debt Equity Ratio

Banks/ Years EBL KBL

2007/08 2.07 9.65

2008/09 15.26 9.15

- 34 -
2009/10 13.30 9.96
2010/11 13.31 7.85
2011/12 11.97 9.42
Mean 11.18 9.21
S.D 5.23 0.81
C.V 46.75 8.85

Source: Appendix-I(B)

Figure 6: Debt to Equity Ratio

The above table and figure shows the total debt to shareholders' equity ratio of EBL
and KBL during the study period. The table shows the usage of debt amount in EBL
is very low in first fiscal year i.e. 2.07 and then it rise to 15.26 in the year 2008/09 and
then again it fall down to 11.97 in the year 2011/12. It shows the ratio is fluctuating
during the study period. The debt equity ratio clarifies that in each fiscal year the
usage of total debt is greater than usage of equity capital. In average the debt equity
ratio of bank is 11.18 and the variation in the ratio is 46.75%. The standard deviation of 5.23
indicates high fluctuation in the ratio.

In case of KBL bank, the usage of debt amount in KBL is 9.65 times in the fiscal year
2007/08, then it fall to 9.15 times in the year 2008/09, again rise to 9.96 in the year 2009/10,
and again it fall to 7.85 in the year 2010/11 and again it rise to 9.42 in the year 2011/12. The
ratio of KBL is fluctuating through the study period. In average, the debt equity ratio of bank
is 9.21 times and the coefficient of variation is 0.81% indicating consistency in the ratio. The
standard deviation is 9.21 indicating fluctuation in the ratio.

- 35 -
Comparing the banks on the basis of debt equity ratio, it can be concluded that EBL is more
risk taker than KBL. Since, the debt equity ratio of EBL is greater than KBL, and as a result
the capital structure of EBL is more dominated by the debt capital percentage than EBL.

4.1.3 Calculation of Interest Coverage Ratio

Interest Coverage ratio measures the debt servicing of a firm. Here interest refers to
interest charged on long term loan. The ratio shows how many times the interest
charges are covered by the EBIT out of which they will be paid. Too high ratio
implies unused debt capacity whereas low ratio implies a danger signal that the firm is
using excessive debt and doesn’t have the ability to offer assured payment of interest
to creditors.

Table 3: Interest Coverage Ratio

Banks/ Years EBL KBL

2007/08 31.42 8.49
2008/09 39.31 7.40
2009/10 37.06 5.85
2010/11 35.31 4.93
2011/12 91.56 10.33
Mean 46.93 7.40
S.D 25.11 2.14
C.V 53.51 28.89
Source: Appendix-I(C)

Figure 7: Interest Coverage Ratio

- 36 -
The above table and figure shows interest coverage ratio of EBL and KBL. The
interest coverage ratio of EBL area 31.42, 39.31, 37.07, 35.31 and 91.56 times in the
fiscal year 2007/08, 2008/09, 2009/2010, 2010/11 and 2011/12 respectively. The ratio
was fluctuating during the study period. On average the bank had 46.93 times interest
coverage ratio which is quite appreciable ratio. Its variation is 53.51 % which seems
to consistent. Its standard deviation is 25.11 showing high level of fluctuation in the
ratio.

The interest coverage ratio of KBL is in decreasing trend from 8.49 to 4.93 from first
year to fourth year and it gradually increased to 10.33 in the fifth year. The average
ratio was 7.40 and it has variation of 28.89%. It has standard deviation of 2.14
showing fluctuation in the ratio.
Comparing the data of banks, EBL has greater capacity to meet the interest expenses
on long term rather than EBL.

4.1.4 Degree of Financial Leverage.

The degree of financial leverage indicates the degree of financial risk, i.e. higher the
value of degree of financial leverage, higher the degree of financial risk and vice-
versa. The degree of financial leverage can be calculated as:

Percentage change in EBT EBIT

DFL  
Percentage change in EBIT EBT

Table 4: Degree of Financial Leverage

Banks/ Years EBL KBL

2007/08 1.033 1.133
2008/09 1.026 1.156
2009/10 1.028 1.206
2010/11 1.029 1.254
2011/12 1.011 1.107
Mean 1.03 1.17
S.D 0.01 0.06
C.V 0.82 5.03
Source: Appendix-II (A)

- 37 -
Figure 8: Degree of Financial Leverage

Above table and figure shows the financial risk to banks. According to the above
table, degree of financial leverage of EBL has decreased from 1.033 times to 1.011
from fiscal year 2007/08 to fiscal year 2011/12. It has average financial leverage of
1.03 and variation of 0.82 which indicates high stability in the ratio. It has standard
deviation of 0.01 which shows very low level of fluctuation in the risk.

The degree of financial leverage of KBL is fluctuating from 1.107 to 1.254 from fiscal
year 2007/08 to fiscal year 2011/12. It has average ratio of 1.17 with variation of
5.03%. It has standard deviation of 0.06 showing low level of fluctuation in risk.

Comparing data of both banks, it can be conclude that KBL has high degree of
financial leverage than EBL which indicates greater financial risk.

4.1.5 Return on Total Assets

Return on total assets studies the relationship between net profit and total assets. It
indicates the firm's ability of generating profit per rupee of total assets. This ratio
indicates efficiency towards of assets mobilization. It also evaluates the present return
on the total assets as a guide for returns expected on future purchase of assets. Higher
the ratio, the more efficient in utilizing its overall resources and vice versa.

Table 5: Return on Total Assets

Banks/ Years EBL KBL

2007/08 1.65 1.16

2008/09 1.73 1.41

- 38 -
2009/10 2.09 1.59

2010/11 2.1 1.23

2011/12 2.11 1.1

Mean 1.94 1.30

S.D 0.23 0.20

C.V 11.70 15.44

Figure 9: Return on Total Assets

The above table and figure shows analysis of return on total assets of EBL and KBL
over the study period. The return on assets of EBL is increasing from 1.65 % in the
fiscal year 2007/08 to 2.11% in the fiscal year 2011/12. It has average ratio of 1.94%
with variation of 11.70 % in the ratio. Its standard deviation is 0.23 which indicates
fluctuation in ratios.

Moving on to KBL, return on total assets of KBL has increased from 1.16 % to 1.59
% fiscal year 2007/08 to 2009.10 and then it decreased to 1.1 % in the fiscal year
2011/12. It has average ratio of 1.30% with variation of 11.70%. Its standard
deviation is 0.23 which indicates fluctuation in the ratio.

Comparing the banks on the ground of ROA, it can be concluded that EBL is more
efficient than KBL in effectively mobilizing the total assets as net profit generation
from mobilizing equal amount of total assets is higher in EBL than KBL.

4.1.6 Return on Shareholders' Equity

The ratio measures a relationship between net profit after interest and tax, and
shareholders' fund. ROE measures an available return for investor from investment.
This ratio can be calculated by dividing net profit by common shareholders' equity. It

- 39 -
indicates the firm's ability of generating profit per rupee of shareholders' fund. Higher
the ratio, more efficient the management and utilization of shareholders' fund is. It
builds trustworthiness to the customers as well as reputation of the bank.

Table 6: Return on Shareholders' Equity

Banks/ Years EBL KBL

2007/08 23.49 12.81
2008/09 28.99 16.09
2009/10 30.15 17.72
2010/11 29.91 11.35
2011/12 26.11 11.59
Mean 27.73 13.912
S.D 2.86 2.85
C.V 10.33 20.46

Figure 10: Return on shareholders' Equity

Above table and figure shows the return on shareholders' equity of EBL and KBL.
ROSE of EBL was found increasing from 23.49% in the year 2007/08 to 30.15% in
the year 2009/10, but it decreased to 26.11% in the year 2011/12. The bank has
maintained an average return of 27.73% during the study period with variation of
10.33% in the ratio which means the bank has generated Rs 27.73 net profit from
mobilization of Rs. 100 of shareholders; equity. It has standard deviation of 2.86
indicating fluctuating in the return.

- 40 -
ROSE of KBL has been fluctuating from 11.35% to 17.72% during the study period.
It has highest ratio of 17.72% in the year 2009/10 and lowest ratio of 11.35% in the
year 2010/11. Its average return is 13.91% indicating Rs 13.91 net profit generated
form Rs100 investment of equity capital with variation 20.46% that shows low level
of consistency. Its standard deviation is 2.85 which show fluctuation in return.

Comparing the banks on the basis of ROSE, it can be concluded that EBL is more
efficient in mobilizing the equity capital as EBL has earned more profit from same
rupees of investment if equity.

4.1.7 Earning Per Share

EPS measure the firm's performance. It shows per share profitability of firm. EPS are
the earnings returned on the initial investment amount. It refers to the rupee earned
per share of common stock outstanding. It measures the return of each equity
shareholders'. The higher earning indicates the better achievements of the profitability
of banks by mobilizing their funds and vice versa. It is computed by dividing net
profit available to equity shareholders by numbers of share outstanding.

Table 7: Earning per Share

Banks/ Years EBL KBL

2007/08 91.82 16.35
2008/09 99.99 22.04
2009/10 100.16 24.24
2010/11 83.18 15.67
2011/12 88.55 17.18
Mean 92.74 19.10
S.D 7.37 3.81
C.V 7.95 19.95

Figure 11: Earning per Share

- 41 -
The above table and figure shows the trend of EPS of EBL and KBL. EPS of EBL is found to
be increasing from 91.82 in the year 2007/08 to 100.16 in the year 2009/10 and then
decreasing to 83.18 in the year 2010/11 and again increasing to 88.55 in the year 2011/12. In
average, EBL has earned Rs 92.74 per share with variation of 7.95%. Its standard deviation is
7.37 which show a fluctuation in ratio.

EPS of KBL is found to increasing from 16.35 in the year 2007/08 to 24.24 in the year
2009/10 and then decreasing to 15.67 in the year 2010/11 and again increasing to 17.18 in the
year 2011/12. It has earned an average of 19.10 rupees per share with variation of 19.955. Its
standard deviation is 3.81 which shows fluctuation in the ratio

Higher average ratio of EBL indicates that the bank is able to earn more profit to common
shareholders than KBL. EPS has been criticized as the measure of profitability as it doesn’t
considered the amount of assets capital required to generate that level of earning.

4.1.8 Dividend per Share

Dividend implies that portion of net profit which is allocated to the share holders as return on
their investment on cash. The net profit after taxes belongs to shareholders. But the income
which they really receive is the amount of earning distributed as cash dividends. The earnings
per share implies what the owner are theoretically entitled to get form the company
while dividend per share is that portion of earning which is allocated to shareholders
divided by total number of outstanding. Thus DPS is computed by dividing the total
amount of dividend paid by the number of share outstanding.

Table 8: Dividend per Share

Banks/ Years EBL KBL

2007/08 30.00 10.53

2008/09 30.00 10.58
2009/10 30.00 12.00
2010/11 10.00 8.44
2011/12 1.58 -
Mean 20.32 8.31
S.D 13.59 4.82
C.V 66.90 57.95

- 42 -
Figure 12: Dividend per Share

The above table and figure shows the dividend paid by the EBL and KBL during the
study period of five years. EBL has paid 30% dividend on the share from 2007/08 to
2009/10 but the percent decreased to 10% in the year 2010/11 and again decreased to
1.58 % in the year 2011/12. The average dividend paid is 20.32 rupee per Rs 100 of
share with variation of 66.90%. Its standard deviation is 13.59 showing fluctuation in
ratio.

DPS of KBL has increased from 10.53% in the year 2007/08 to 12.00% in the year
2009/10 and then decreased to 8.44% in the year 2010/11 but paid no dividend in the
year 2011/12. KBL has paid an average dividend of 8.31 rupees per Rs100 of share
with variation of 57.95%. Its standard deviation is 4.82 which show fluctuation in
ratios.

In conclusion, it can be said EBL has remained more success to retain its existing
shareholders and to attract potential shareholders towards it by paying more consistent
and stable dividend.

4.1.9 Price Earning Ratio

P/E ratio measures the amount investors are willing to pay for each rupee of the firm's
reported profit. It refers to the price currently being paid by market for each rupee of
currently reported EPS. It also measures investors' expectation and the market
appraisal of firms' performance. It is an indication of the way that the investors think
the firm would perform better in future. The higher P/E ratio, the greater is the
investor confidence.

P/E ratio= market price of a share/ Earning per share.

- 43 -
Table 9: Price Earning Ratio

Banks/ Years EBL KBL

2007/08 34.11 61.47

2008/09 24.55 31.76

2009/10 16.27 19.31

2010/11 13.15 16.98

2011/12 11.67 14.09

Mean 19.95 28.72

S.D 9.35 19.51

C.V 46.89 67.92

Figure 13: Price Earning Ratio

The above table and figure shows price earning ratio of EBL and KBL during the
study period. The P/E ratio of EBL was 34.11 in the year 2007/08 and then it stared
decreasing up to 11.67 in the year 2011/12. It shows it was in decreasing trend. The
average P/E was 19.95 with variation of 46.89%. Its standard deviation is 9.35 that
show fluctuation in the ratio.

- 44 -
P/E ratio of KBL was 61.47 in the year 2007/08 and then it decreased to 14.09 in the
year 2011/12. It has average P/E ratio of28.72 with variation of 67.92%. Its standard
deviation is 19.51 that show fluctuation in ratio.

Comparing P/E ratio of both banks, KBL's average P/E ratios is higher than EBL. So,
in conclusion we can say KBL will perform better in future.

4.1.10 Overall Capitalization Rate

Overall cost of capital reflects the total cost of capital collected from various sources
by the firm. The overall capitalization irate is calculated on the basis of NI Approach.
It assumes that the cost of debt is less than the cost of equity. Based on this approach
Overall capitalization rate of the firm can be decreased by increasing the amount of
debt.
Table 10: Overall Capitalization rate

Banks/ Years EBL KBL

2007/08 65.62 20.97
2008/09 75.04 23.65
2009/10 82.77 27.15
2010/11 86.29 21.99
2011/12 88.31 21.25
Mean 79.61 23.00
S.D 9.31 2.54
C.V 11.70 11.05
Source: Appendix-II(C), Appendix-III (A)

Figure 14: Overall Capitalization Rate

- 45 -
The above table and figure shows overall capitalization rate of EBL and KBL which
measures the financial degree of leverage of the banks. Overall capitalization rate of
EBL is in increasing trend during the study period. It has highest ratio of 88.31% in
the year 2011/12 and lowest ratio of 65.62% in the year 2007/08. In average, its ratio
was 79.61% with variation of 11.70%. Its standard deviation is 9.31 that show
fluctuation in ratio.

Overall capitalization ratio of KBL is increasing in the year 2007/08 with ratio of
20.97% till the year 2009/10 with ratio of 27.15%, but it decreased to 21.25% in the
year 2011/12. The average ratio of KBL is 23.00% with variation of 11.05%. It has
standard deviation of 2.54.

Comparing ratios of both banks, EBL ratio is found to be higher than KBL which
indicates higher financial leverage of EBL.

4.1.11 Equity Capitalization Rate

The equity capitalization rate is calculated based on NOI approach. This approach
argues that the value of firm remains constant to the degree of leverage and equity
capitalization rate trends to increase.

Table 11: Equity Capitalization Rate

Banks/ Years EBL KBL

2007/08 2.93 1.63
2008/09 4.07 3.15
2009/10 6.14 5.18
2010/11 16.74 5.89
2011/12 8.57 7.10
Mean 7.69 4.59
S.D 5.50 2.19
C.V 71.45 47.73

Source: Appendix-III(B)

- 46 -
Figure 15: Equity Capitalization

The above table and figure shows the equity capitalization rate of EBL and KBL during the
study period of five years. The Ke ratio of EBL is increasing from 2.93 % in the year 2007/08
to 16.74% in the year 2010/11 and it fall down to 8.57% in the year 2011/12. It has highest
Ke ratio in the year 2010/11 and the lowest in the year 2007/08. It has average Ke of 7.69%
only with variation of 71.45%. Its standard deviation is 5.50 that show fluctuation in the Ke
ratio.

In case of KBL, Ke ratio is in increasing trend. Its ratio has increased from 1.63% in the year
2007/08 to 7.10% in the year 2011/12. It has highest Ke of 7.10% in the year 2011/12. Their
average ratio is of 4.59% with variation of 47.73%. Its standard deviation is 2.19 which show
fluctuation in the ratio.

Comparing the data calculation of both banks, it can be concluded that EBL has
highest equity capitalization rate than KBL.

4.2 Statistical Analysis

The statistical analysis incorporates various techniques for measuring the relationship
between two or more than two variables as well as their significance. In this study,
simple regression, Pearson's coefficient and probable error has been used for
measuring significance.

4.2.1 Coefficient of Correlation between EBIT and Interest Payment

The relation between EBIT and interest payment is evaluated in order to measure
debt-serving capacity of banks. It is assumed that there is significant relationship
between EBIT and interest payment. Here EBIT (X) is independent variable and
Interest payment (Y) is dependent variable. Positive values show the positive relation
and negative values show the negative relation.

- 47 -
Table 12: Correlation between EBIT and Interest Payment

Banks r r² PE 6PE Level of significant

KBL 0.800470211 0.640753 0.108445729 0.650674376 Significant

EBL 0.215719061 0.046535 0.287821781 1.726930688 Insignificant

According to above table, EBIT has positive relationship with interest payment as
correlation value of KBL is 0.80 and EBL is 0.22. It shows that increase in EBIT
increases interest payment. The relationship between EBIT and interest payment of
KBL is statistically significant. It would better if KBL increases its EBIT or decreases
its interest expenses. On the other hand, the relationship between EBIT and interest
payment of EBL is statistically insignificant which means it is not obligatory that
interest payment should increase with increase in EBIT.

4.2.2 Coefficient of Correlation between Overall Capitalization rate and Debt

Equity Ratio

Correlation of coefficient between overall capitalization rate (X) and debt equity ratio
(Y) in terms of total debt to net worth is calculated in order to measure whether
increase in the debt equity ratio decrease overall capitalization of the banks. Applying
Karl Pearson's correlation coefficient, following result is obtained.

Table 13: Correlation between Debt Equity ratio and Overall Capitalization rate

Banks r r² PE 6PE Level of significant

KBL 0.528385317 0.279191 0.217590006 1.305540039 Insignificant

EBL 0.931813331 0.868276 0.03976339 0.238580342 Significant

Source: Appendix-IV (A)

Above table shows the Correlation between overall capitalization and debt equity of
selected banks over the period. The correlation coefficient of both banks is positive
which shows positive relationship as correlation of KBL is 0.56 and EBL is 0.87. The
positive correlation indicates increase in D/E ratio leads to increase in Ko. The
relationship between D/E ratio and Ko of KBL is statistically insignificant. It means
KBL has to increase portion of debt in the capital structure to be significant, whereas
correlation of EBL is statistically significant.

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4.2.3 Coefficient of Correlation between Return on Equity and Debt Equity ratio

The correlation between ROE (Y) and D/E ratio (X) gives us information on increase
debt capital portion in the capital structure increases return on equity. Positive values
shows positive relation and negative values shows the negative relation.

Table 14: Correlation between Return on Shareholders' Equity and Debt Equity Ratio

Banks r r² PE 6PE Level of significant

KBL 0.56471567 0.318904 0.205601953 1.233611718 Insignificant

EBL 0.872881173 0.761922 0.071868548 0.431211288 Significant

Source: Appendix-IV (B)
The above table shows positive relationship between ROSE and D/E ratio as
correlation value of KBL is 0.56 and of EBL is 0.87. The positive relationship
indicates increase in D/E ratio leads to increase in ROSE. EBL is statistically
significant; it means increase in D/E ratio increases ROSE, whereas KBL is
statistically insignificant, it means KBL needs to increase its D/E ratio to increase its
ROSE.

4.2.4 Coefficient of Correlation between Debt Equity Ratios and Return on

Assets

The correlation of coefficient between Debt Equity ratio and Return on Assets of
selected banks are analyzed in order to examine which debt capital is significant in
generating more return. It is assumed that there is significant relationship between
return and debt capital. Positive values show the positive relation and negative values
the negative relation.

Table 15: Correlation between Return on Assets and Debt Equity Ratio

Banks R r² PE 6PE Level of significant

KBL 0.310072682 0.096145 0.272845944 1.637075666 Insignificant

EBL 0.544529504 0.296512 0.212361229 1.274167371 Insignificant

Source: Appendix-V (A)

The above table shows correlation coefficient between ROA and D/E of EBL and
KBL. The correlation value of KBL is 0.31 and of EBL is 0.54. There seems to be
positive relation but both banks are statistically insignificant being 'r' > 6 p.e. It
indicates there is relationship between ROA and K/E. Any change in D/E ratio
doesn’t make change in ROA.

- 49 -
4.3 Simple Regression Analysis

The simple regression helps to determine relationship between different variable

considering one as dependent variable and other as independent variable. With the
help of one known variable, one unknown variable can be estimated and it also
determines the relation between each dependent variable and independent variable.
The regression analysis has been considered for the study.

4.3.1 Relationship between Cost of Equity (Ke ) and Leverage (D/S)

The main objective of this section is to determine the relationship between leverage
and cost of equity of the selected banks. Based on the traditional view Ke either
remain constant or raises slightly with moderate level of debt and increase with
leverage at increasing rate. Beside, the MM proposition argues that the cost of equity
increases linearly with leverage. Above stated view states the equity decreases or
remains constant up to a point with the leverage. The relation between Ke and D/S
can be present mathematically as bellow:
D
K E  a  b 
S
D
Where, K E  Cost of Equity and  Leverage
S

Table 16: Relationship between Ke and Leverage

Regression
Banks Intercepts Correlation Coefficient T-statistics
Coefficient

KBL -9.8467223 4.16866416 0.61704849 1.358146

EBL 79.66126789 1.66041246 0.71621637 1.777564

Source: Appendix-V (B)
The above table shows relationship between Ke and D/E ratio. The regression
coefficient of Ke on D/S for both banks were positively related, it indicates that
increase in leverage leads to increase in Ke. Regarding correlation coefficient, EBL
has highest value. T- Statistics is insignificant in case of all.

4.3.2 Relationship between Return on Shareholder's Fund (ROS) and Leverage

(D/S)

The relationship between ROS and D/S of the selected banks reveals whether the
ROS changes linearly or not with the change in D/S. ROS is the taken as dependent
variable on D/S which is independent variable. The relation between ROS and D/S are
shown bellow.
D
ROS  a  b 
S
D
Where, ROS  Re turn on Shareholders' Fund and  Leverage
S

- 50 -
Table 17: Relationship between ROS and D/S

Regression
Banks Intercepts Correlation Coefficient T-statistics
Coefficient
KBL -4.258861728 1.973806 0.564716 1.185185

EBL 22.38308818 0.478171 0.872881 3.09853

Source: Appendix- V,C,D,E
The above table shows the relationship between ROSE and D/S ratios of KBL and
EBL during the study period. The regression coefficients of ROSE on D/S of both
banks are positively related. It indicates that increase in leverage increases return on
ROSE. The t- statistic for both banks is not significant. The regression coefficient for
KBL was 1.97 and for EBL is 0.48.

4.3.3 Relationship between Earning Per Share (EPS) and Leverage (D/S)

In this section, using simple regression the relation between the EPS and D/S for
selected banks has been calculated. The impacts of leverage on EPS of selected banks
have been explored by taking EPS as dependent variable and D/S as independent
variable.
D
EPS  a  b 
S
D
Where, EPS  Earning per Share and  Leverage
S

Table 18: Relationship between EPS and D/E

Banks Intercepts Regression Coefficient Correlation Coefficient T-statistics

KBL -4.25493 2.53649 0.542158 1.117544

EBL 89.66875 0.27466 0.194737 0.343878

Source: Appendix-V (F,G)
The above table shows the relationship between EPS and D/S ratio during the study
period. The regression coefficient of EPS on D/S was positively related for EBL and
KBL. It means change in D/S ratio leads to change in the ratio of EPS. The coefficient
correlation is higher for KBL with value of 0.54 the t-statistic shows correlation
coefficient insignificant at 5% level of significance.

4.3.4 Relationship between Price Earning Ratio (P/E) and Leverage (D/S)

The objective of this section was to determine the empirical relationship between D/S
and P/E ratio. The study tries to find out whether P/E ratio changes proportionately or
not with the changes in leverage. It is calculated using simple regression model in
which P/E ratio is taken as dependent variable and D/S as independent variable.
D
P / E  a  b 
S

- 51 -
D
Where, P / E  Pr ice Earning Ration and  Leverage
S

Table 19: Relationship between P/E and D/E

Regression
Banks Intercepts Correlation Coefficient T-statistics
Coefficient

KBL -40.8932 7.561937 0.315711 0.576302

EBL 34.17704 -1.27232 -0.710976 -1.75116

Source: Appendix- V (H,I)

The above table shows the relationship between P/E ratio and D/S ratio of EBL and
KBL during the study period. The regression coefficient of P/E on D/S is found to be
positive for KBL whereas it is negatively related for EBL. Positive relationship
indicates linear relationship which means increase in D/S leads increase in P/E ratio.
Correlation coefficient for positive regression is positive and is negative for negative
regression coefficient. All the selected banks seem to be insignificance at 5% level of
significance.

4.4 Major Findings

 Debt to total assets ratios of banks shows portion of financing the total assets
through debt financing. The practice of financing total assets through debt
capital of KBL is fluctuating during the five years period. EBL's total assets
financing is in increasing trend in the study period. The study shows totals
assets of JV commercial bank bear greater risk than private commercials bank.
 Debt equity ratio shows use of debt amount. In case of all sampled banks, use
of debt amount is increasing in first year and then decreasing gradually and
again increasing in fifth year. Comparing average ratios, it can be concluded
that JV commercial banks depends more on outside fund than private
commercial banks.
 Interest coverage ratio concludes that JV commercial bank has greater
capacity to meet the interest expenses on long term debt than private
commercial bank.
 Degree of financial leverage shows the level of financial risk for banks.
Private commercial banks have higher degree of financial leverage than JV
commercial banks which indicates high level of financial risk to commercials
banks than JV banks.
 Comparing the ROA, it can be concluded that private commercial banks are
more efficient in mobilizing total assets than JV commercial banks, since net
profit generation from mobilizing total assets is higher in commercials banks.
 Comparing ROE, it can be concluded that JV commercial banks are more
efficient in mobilizing equity capital than private commercial banks as JV
banks have earned more rupee from investment of equity.
 Higher average EPS of JV commercial banks indicates that JV commercial
banks are able to earn more profit per share to the common shareholder's than

- 52 -
private commercial banks. EPS has been criticized as the measure of
profitability because it does not consider the amount of assets and capital
required to generate that level of earning.
 Private commercials banks are found to pay more dividend rupee more
consistently to shareholder than JV commercial banks.
 Trend of price earning shows more fluctuation in JV commercial banks than
private commercials banks.
 Overall capitalization rate measures the financial degree of leverage of banks.
The overall capitalization rates of JV commercial banks are higher than
private commercial banks.
 Equity capitalization rate of JV commercial banks are higher than private
commercial banks.
 The correlation coefficient of interest payment on EBIT of KBL and EBL has
positive relationship. It indicates increase in EBIT leads to increase in interest
payment. The value of 'r' is significant for KBL but Insignificant for EBL
which means EBL is unable to meet the debt expenses with the available
EBIT.
 The correlation coefficient of Ko on D/E ratio is positive for EBL as well as
KBL. It means increase in D/E ratio leads to increase in Ko and vice versa.
The value of 'r ' is significant for EBL but Insignificant for KBL.
 The correlation coefficient of ROSE on K/E is positive for EBL as well as
KBL. It means change in K/E leads to change in ROSE. The value of 'r' is
insignificant for KBL but significant for EBL.
 The correlation coefficient of ROA on D/E ratio is also positive for both EBL
and KBL. It means alteration in D/E ratio leads alteration in ROA as well. The
value of 'r; is Insignificant for both EBL and KBL which means the change is
very minute.
 The regression coefficient for Ke on D/E is positive for both EBL and KBL. It
means increase in D/E ratio leads to increase in Ke. The T-statistic for both
banks is insignificant with 5% degree of freedom.
 The regression coefficient of ROSE on D/E ratio is also positive for both EBL
and KBL. It means change in D/E ratio brings change in ROSE. The T-
statistic for both banks is insignificant with 5% degree of freedom.
 The regression coefficient of EPS on D/E is also positive for both EBL and
KBL. It means change in D/E ratio brings change in EPS. The T-statistic for
both banks is insignificant with 5% degree of freedom.
 The regression coefficient of P/E ratio on D/E ratio is also positive for both
EBL and KBL. It means change in D/E ratio affects the P/E ratio. The T-
statistic for both banks is insignificant for both banks with 5% degree of
freedom

- 53 -
CHAPTER – V
SUMMARY CONCLUSION AND RECOMMENDATIONS

This chapter is the extract of all the previously discussed chapters. This chapter
consists of three parts; summary, conclusion and recommendation. In summary part,
revision or summary of all the four chapters have been made. In conclusion part, the
result from the research is summed up and in recommendation part, suggestion and
recommendation has been made based in the analysis. Recommendation is made for
improving the present situation to the concerned as well as further research.

5.1 Summary
Capital structure plays a vital role in the real life of an enterprise. Capital structure is
the structure of financial management and cost of capital is touchstone of financing,
investment decision and evaluation of financial performance of enterprise. The capital
structure is the combination of long term debt and equity. It is a part of financial
structure i.e. comprised to the total combination of preferred stock, common stock,
long term debt and current liabilities: if current liabilities are removed from it, we get
capital structure. Similarly, the capital structure is the permanent financing of the
firm, represent primary by long term debt, preferred stock and common equity but
excluding all short- term credit. Basically the entire research work focuses on the
study of capital structure and profitability management of JV banks and Commercial
banks.

The study is based on secondary data. All the data have been taken from the
concerned banks' annual report, website, related books and booklets, journals, articles.

Financial institution includes banks, finance companies, co-operative organizations

and insurance companies. All of them do contribute something to the economy of the
country. Financial institutions play a vital role in the proper functioning of an
economy. Among them, banking sector plays an important role in the economic
development of the country. Commercial banks are one of the vital aspects of this
sector, which deals in the process of channeling the available resources in the needed
sectors. It is the intermediary between the deficit and surpluses of financial resources.

Capital is a scare sources and much more essential to maintain smooth operation of
any firm. The available capital and financial sources should be utilized so efficiently
that could generate maximum return. The term of capital structure is used to represent
the proportionate relationship between debt and equity. The debt and equity mix of a
firm is called capital structure. The capital structure design is a significant financial
decision since it affects the shareholders return, risk and market value of share. Both
debt and equity are used in most large corporation. The choice of amount of debt and
equity is made after a comparison of certain characteristics of each kind of securities
of interest factor related to the firm's and of external factors can affect the firm.
The main theories of capital structure are net income approach, net operating income
approach, traditional approach and Modigliani-Miller approach, EBIT/EPS analysis
and cost of capital. Without study of these elements the company cannot make
appropriate capital structure and analysis of leverage may be incomplete.

- 54 -
Profitability is basically an arc around which the every business revolves. Profit is the
main financial indicator of business of firm, which is indeed a need to survive and
grow the business environment. Profit is essential to raise the market price of shares
and to attract additional capital investment. Profit is the outcome of good
management, cost control, credit-risk, management, efficiency of operation etc. Profit
is described in two ways, one is traditional approach (profit maximization) and
another is modern approach (sales maximization).

Capital structure concept holds a major place in the financial management which is a
very important element for firm's profitability. Firms may use their debt-to- equity
ratio to affect profitability. Some firms choose a high debt-to-equity, whereas others
prefer to choose a lower one. It differs from individual to individual one is risk taker
or risk averter. A perfect balance between debt and equity is required to ensure the
trade –off between risk and return to shareholders. Thus, optimal capital structure
means the capital structure having logical and reasonable proportion of debt and
equity.

With this activity, any banking institution can increase its return in its risk level or
lower its risk level in the same class of return. Further a rational capital structure as
important, investment in intangibles such as business building, sales and marketing.

After this research work on the subject matter, it can be inferred that the banks with
stable and predictable cash flow as well as limited investment opportunities should
include more debt in their capital structure. Banks that face high uncertainty because
of vigorous growth or the cyclical nature of their industries should carry less debt, so
that they have enough flexibility to take advantage of investment opportunities or to
deal with negative events. Eventually, it can be said that the capital structure has
greater impact in profitability.

5.2 Conclusions
Analyzing the data, it is assumed that growth and stability of the banks mainly
influence the capital structure banks. And the capital structure of the banks has
substantial impact on profitability. Following conclusion can be made from analysis
and findings.

Comparing the banks on the basis of Debt to total assets, it can be concluded that JV
commercial banks bear more risk than private commercial banks. It means practice of
financing total assets through debt capital is high in JV commercial banks than private
commercial banks. Debt equity ratio shows the amount of debt amount from outside
fund and JV commercial banks depends more on outside fund rather than private
commercial banks. It means JV commercial banks are more risk taker than private
commercial banks. Since debt equity ratios of JV commercial banks are greater than
private commercial banks, the capital structures of JV commercial banks are more
dominated by the debt capital percentage than private commercial banks. In regard to
interest coverage ratio, JV commercial banks have greater capacity to meet the
interest expenses on long term debt than private commercials banks. In matter of
financial risk, private commercial banks have higher degree of financial leverage
which indicates higher financial risk to the banks. The overcall capitalization rates of

- 55 -
JV commercial banks are higher than commercial banks. So equity capitalization rate
of JV commercial banks are higher than commercial banks.

On the basis of return on assets, net profit generation from total assets mobilization is
higher in JV commercial banks rather than private commercials banks. It means JV
commercial banks are more efficient in mobilizing equity capital. Even JV
commercial banks are efficient in mobilizing equity capital as well. JV commercial
banks have earned more rupees from investment of equity. EPS shows the profit
earning capacity. JV commercial banks are able to earn more profit per share to the
common shareholders' than private commercial banks. EPS has been criticized as the
measure of profitability because it does not consider the amount of assets and capital
required to generate that level of earning. Private commercial banks are found to pay
more dividend rupee more consistently to the shareholders' than JV commercial
banks. Trend of price earning shows more fluctuation in JV commercial banks than
private commercial banks.

5.3 Recommendations
On the basis of analysis and findings of the study, following recommendations are
made.
 The financing pattern of most Nepalese commercial banks includes short term
and medium term fund. It may bring the solvency problem. So it is
recommended that both JV commercial banks and private commercial banks
should increase the proportion of long term fund in their financing pattern.
The amount of long term debt should be raised to minimize the risk as short
term debt carries high risk.
 Both types of banks have more proportion of total debt to total assets ratio,
which shows the largest proportion of assets, is covered by external debt
financing, which may not be good for the banks. So the banks should optimize
the debt ratio.
 Both types of banks are bearing high interest expenses due to use of long term
debt in its capital structure. As result, the return of the firm is not satisfactory.
So both types of banks are recommended to minimize interest expense by
using short term debt as well as decrease other operating expenses to increase
the return on the firm.
 ROA and ROE are not satisfactory. Both types of banks are not sufficiently
using their assets and equity capital. Due to which they are having less ROA
and ROE.
 The capital structure of bank is highly leveraged. The proportion of debt and
equity capital should be decided minding the effects of tax advantage. The
bank requires maintaining improved capital structure by issuing more capital,
expanding general reserve and retaining earning.
 Capital investment should be increases to increase the return to equity
shareholders by employing the equity capital so that the return would be
greater than the overall cost of capital.

- 56 -
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Annual Reports of KBL (2007/08 – 2011/12)

Annual Reports of KBL (2007/08 – 2011/12)

APPENDIX -I
A. Debt to Total Assets

Banks/ Total Debt Total Assets Ratio

Years EBL KBL EBL KBL EBL KBL
2007/08 25,046,169,827 13,671,364,159 7,149,342,884 15,026,599,175 92.25 90.98
2008/09 34,474,620,969 16,906,793,663 36,916,848,654 18,538,565,109 93.38 91.2
2009/10 37,808,506,482 18,543,003,692 41,382,760,711 20,485,578,742 91.36 90.52
2010/11 42,518,868,365 18,271,366,924 46,236,212,262 20,491,785,309 91.96 89.16
2011/12 51,595,882,217 22,642,059,630 55,813,129,057 25,131,400,971 92.44 90.09

B. Debt Equity ratio

Banks/ Debt Shareholders' Fund Ratio

Years EBL KBL EBL KBL EBL KBL
2007/08 24,276,296,535 13,174,281,014 11,721,237,580 1,364,885,269 2.07 9.65
2008/09 33,622,946,246 16,110,925,263 2,203,625,055 1,624,952,708 15.26 9.91
2009/10 36,692,310,008 17,832,253,032 2,759,137,855 1,785,759,048 13.3 9.99
2010/11 41,427,914,339 17,386,279,457 3,113,546,056 2,213,836,668 13.31 7.85
2011/12 50,006,100,272 22,385,198,273 4,177,302,887 2,377,075,338 11.97 9.42

C. Interest Coverage Ratio

Banks/ Annual Interest Charges EBIT Ratio

Years EBL KBL EBL KBL EBL KBL
2007/08 23,634,098 35,360,209 742,467,951 300,241,811 31.42 8.49
2008/09 25,397,027 55,699,081 998,347,353 412,181,355 39.31 7.4
2009/10 35,272,593 100,589,792 1,307,362,781 588,651,472 37.06 5.85
2010/11 41,342,675 96,717,931 1,459,740,575 476,950,445 35.31 4.93
2011/12 6,986,799 46,005,042 1,555,324,989 475,094,205 91.56 10.33
APPENDIX -II
A. Degree of Financial Leverage

Banks/ EBIT EBT Ratio

Years EBL KBL EBL KBL EBL KBL
2007/08 742,467,951 300,241,811 718,833,853 264,881,602 1.03 1.13
2008/09 998,347,353 412,181,355 972,950,326 356,482,274 1.03 1.16
2009/10 1,307,362,781 588,651,472 1,272,090,188 488,061,680 1.03 1.21
2010/11 1,459,740,575 476,950,445 1,418,397,900 380,232,514 1.03 1.25
2011/12 1,555,324,989 475,094,205 1,538,338,190 429,089,163 1.01 1.11

B. Value of Firm

Banks/ EBL KBL

Years Equity Debt Value Equity Debt Value
2007/08 831,400,000 300,000,000 1,131,400,000 1070000000 400000000 1470000000
2008/09 1030467300 300000000 1,330,467,300 1304935920 400000000 1704935920
2009/10 1279607490 300000000 1,579,607,490 1806015920 400000000 2206015920
2010/11 1391570439 300000000 1,691,570,439 1603800000 400000000 2003800000
2011/12 1761126410 0 1,761,126,410 1603800000 400000000 2003800000

C. Overall Capitalization rate of EBL

EBL
Banks/Years
EBIT V Ko
2007/08 742,467,951.00 1,131,400,000.00 65.62
2008/09 998,347,353.00 1,330,467,300.00 75.04
2009/10 1,307,362,781.00 1,579,607,490.00 82.77
2010/11 1,459,740,575.00 1,691,570,439.00 86.29
2011/12 1,555,324,989.00 1,761,126,410.00 88.31
APPENDIX -III

A. Overall Capitalization of KBL

KBL
Banks/Years EBIT V Ko
2007/08 300,241,811.00 1,431,641,811.00 20.97
2008/09 412,181,355.00 1,742,648,655.00 23.65
2009/10 588,651,472.00 2,168,258,962.00 27.15
2010/11 476,950,445.00 2,168,520,884.00 21.99
2011/12 475,094,205.00 2,236,220,615.00 21.25

B. Equity Capitalization Rate

Banks/ EPS MPVS Ratio
Years EBL KBL EBL KBL EBL KBL
2007/08 91.82 16.35 3132 1005 2.93 1.63
2008/09 99.99 22.04 2455 700 4.07 3.15
2009/10 100.16 24.24 1630 468 6.14 5.18
2010/11 183.18 15.67 1094 266 16.74 5.89
2011/12 88.55 17.18 1033 242 8.57 7.1

C. Correlation Coefficient between EBIT and Interest Payment

KBL EBL
Y X Y X
INTEREST INTEREST
EBIT EBIT
PAYMENT PAYMENT
35,360,209 300,241,811 23,634,098 742,467,951
55,699,081 412,181,355 25,397,027 998,347,353
100,589,792 588,651,472 35,272,593 1,307,362,781
96,717,931 476,950,445 41,342,675 1,459,740,575
46,005,042 475,094,205 16,986,799 1,555,324,989
Correlation 0.800470211 Correlation 0.215719061
r² 0.640752559 r² 0.046534713
Pe 0.108445729 pe 0.287821781
6pe 0.650674376 6pe 1.726930688
APPENDIX -IV

A. Correlation between Debt Equity Ratio and Overall Capitalization

rate

KBL EBL
Y X Y X
Ko D/E ratio Ko D/E ratio
18.02 9.65 63.53 2.07
22.48 9.15 85.43 15.26
28.61 9.96 80.53 13.3
18.98 7.85 83.85 13.31
21.41 9.42 87.35 11.97
Correlation 0.528385317 Correlation 0.931813331
r² 0.279191043 r² 0.868276083
Pe 0.217590006 pe 0.03976339
6pe 1.305540039 6pe 0.238580342

B. Correlation between ROE and D/E

KBL EBL
Y X Y X
ROE D/E ROE D/E
12.81 9.65 23.49 2.07
16.09 9.15 28.99 15.26
17.72 9.96 30.15 13.3
11.35 7.85 29.91 13.31
11.59 9.42 26.11 11.97
Correlation 0.56471567 Correlation 0.872881173
r² 0.318903788 r² 0.761921543
pe 0.205601953 pe 0.071868548
6pe 1.233611718 6pe 0.431211288
APPENDIX -V

A. Correlation between ROA and D/E

KBL EBL
Y X Y X
ROA D/E ROA D/E
1.16 9.65 1.65 2.07
1.41 9.15 1.73 15.26
1.59 9.96 2.09 13.3
1.23 7.85 2.1 13.31
1.1 9.42 2.11 11.97
Correlation 0.310072682 Correlation 0.544529504
r² 0.096145068 r² 0.296512381
Pe 0.272845944 Pe 0.212361229
6pe 1.637075666 6pe 1.274167371

B. Regression between KE and D/S of KBL

KE D/S
Y X
24.76 9.65
30.06 9.15
37.37 9.96
23.71 7.85
26.75 9.42

Regression Statistics
Multiple R 0.617048
R Square 0.380749
Adjusted R Square 0.174332
Standard Error 4.999715
Observations 5
ANOVA

Df SS MS F Significance F

Regression 1 46.10876059 46.109 1.845 0.2675324

Residual 3 74.99143941 24.997 - -
Total 4 121.1002 - - -

Standard Lower Upper Lower Upper

Coefficients
Error t Stat P-value 95% 95% 95.0% 95.0%
Intercept -9.84672 28.34502203 -0.347 0.751 -100.0532 80.35979 -100.053233 80.359788
X Variable
1 4.168664 3.069378185 1.3581 0.268 -5.599467 13.9368 -5.5994671 13.936795

C. Regression between KE/DE of EBL

KE D/S
Y X
86.46 2.07
115.99 15.26
99.41 13.3
101.93 13.31
87.35 11.97

Regression Statistics
Multiple R 0.716216
R Square 0.512966
Adjusted R Square 0.350621
Standard Error 9.76537
Observations 5

Df SS MS F Significance F

Regression 1 301.32 301.32 3.16 0.17

Residual 3 286.09 95.36 - -
Total 4 587.41 - - -
Standard P- Lower Upper Lower Upper
Coefficients t Stat
Error value 95% 95% 95.0% 95.0%
Intercept 79.66 11.32 7.04 0.01 43.63 115.69 43.63 115.69
X Variable 1 1.66 0.93 1.78 0.17 -1.31 4.63 -1.31 4.63

D. Regression between ROSE and D/S of KBL

ROSE D/S
Y X
12.81 9.65
16.09 9.15
17.72 9.96
11.35 7.85
11.59 9.42

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.56471567
R Square 0.31890379
Adjusted R Square 0.09187172
Standard Error 2.712771
Observations 5
ANOVA

Df SS MS F Significance F

Regression 1 10.34 10.34 1.4 0.32

Residual 3 22.08 7.36 - -
Total 4 33.4 - - -

Lower Upper Lower Upper

Coefficients Standard Error t Stat P-value
95% 95% 95.0% 95.0%
Intercept -4.26 15.38 -0.28 0.8 -53.2 44.69 -53.2 44.69
X Variable 1 1.97 1.67 1.19 0.32 -3.33 7.27 -3.33 7.27
E. Regression between ROSE and D/S of EBL

ROSE D/S
Y X
23.49 2.07
28.99 15.26
30.15 13.3
29.91 13.31
26.11 11.97

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.87288
R Square 0.76192
Adjusted R Square 0.68256
Standard Error 1.61334
Observations 5

ANOVA

Df SS MS F Significance F

Regression 1 24.99 24.99 9.60 0.05

Residual 3 7.81 2.60 - -
Total 4 32.80 - - -

Lower Upper Lower Upper

Coefficients Standard Error t Stat P-value
95% 95% 95.0% 95.0%
Intercept 22.38 1.87 11.97 0 16.43 28.34 16.43 28.34
X Variable 1 0.48 0.15 3.1 0.05 -0.01 0.97 -0.01 0.97
F. Regression between EPS and D/S of KBL

EPS D/S
Y X
16.35 9.65
22.04 9.15
24.24 9.96
15.67 7.85
17.18 9.42

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.542158
R Square 0.293936
Adjusted R Square 0.058581
Standard Error 3.697118
Observations 5

ANOVA
Df SS MS F Significance F

Regression 1 17.07 17.07 1.25 0.35

Residual 3 41.01 13.67 - -
Total 4 58.08 - - -

Lower Upper Lower Upper

Coefficients Standard Error t Stat P-value
95% 95% 95.0% 95.0%
Intercept -4.25 20.96 -0.2 0.85 -70.96 62.45 -70.96 62.45
X Variable 1 2.54 2.27 1.12 0.35 -4.69 9.76 -4.69 9.76
G. Regression between EPS and D/S of EBL

EPS D/S
Y X
91.82 2.07
99.99 15.26
100.16 13.3
83.18 13.31
88.55 11.97

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.19474
R Square 0.03792
Adjusted R Square -0.2828
Standard Error 8.35005
Observations 5

ANOVA

Df SS MS F Significance F

Regression 1 8.24 8.24 0.12 0.75

Residual 3 209.17 69.72 - -
Total 4 217.42 - - -

Lower Upper Lower Upper

Coefficients Standard Error t Stat P-value
95% 95% 95.0% 95.0%
Intercept 89.67 9.68 9.26 0.00 58.86 120.48 58.86 120.48
X Variable 1 0.27 0.80 0.34 0.75 -2.27 2.82 -2.27 2.82
H. Regression between P/E and D/S of KBL

P/E D/S
Y X
61.47 9.65
31.76 9.15
19.31 9.96
16.98 7.85
14.09 9.42

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.31571
R Square 0.09967
Adjusted R Square -0.2004
Standard Error 21.3736
Observations 5

ANOVA
Df SS MS F Significance F

Regression 1 151.72 151.72 0.33 0.60

Residual 3 1370.49 456.83 - -
Total 4 1522.22 - - -

Lower Upper Lower Upper

Coefficients Standard Error t Stat P-value
95% 95% 95.0% 95.0%
Intercept -40.89 121.17 -0.34 0.76 -426.52 344.74 -426.52 344.74
X Variable 1 7.56 13.12 0.58 0.60 -34.20 49.32 -34.20 49.32
I. Regression between P/E and D/S of EBL

P/E D/S
Y X
34.11 2.07
24.55 15.26
16.27 13.3
13.15 13.31
11.67 11.97

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.71098
R Square 0.50549
Adjusted R Square 0.34065
Standard Error 7.59567
Observations 5

ANOVA

Df SS MS F Significance F

Regression 1 176.92 176.92 3.07 0.18

Residual 3 173.08 57.69 - -
Total 4 350.01 - - -

Lower Upper Lower Upper

Coefficients Standard Error t Stat P-value
95% 95% 95.0% 95.0%
Intercept 34.18 8.81 3.88 0.03 6.15 62.2 6.15 62.2
X Variable 1 -1.27 0.73 -1.75 0.18 -3.58 1.04 -3.58 1.04