The Effects of Capital Structure on Profitability of Manufacturing and Allied Companies Listed In Kenya Capital Market

A Project Report Submitted to the Chandaria School of Business in Partial Fulfilment of the Requirement for the Degree of Masters in Business Administration (MBA)The purpose of the study was to assess the effects of capital structure on profitability of manufacturing and allied companies listed in the Kenya capital market. The study was led by the following research questions; what is the influence of equity financing on profitability of firms in the manufacturing sector in Kenya? What is the effect of debt on profitability of firms in the manufacturing sector in Kenya? What is the impact of the preference share financing on profitability of firms in the manufacturing sector in Kenya? The study assumed a descriptive research design in collecting, analyzing, inferring, and presenting data. The descriptive research design helped in focusing on the direction and strength of the relationship between net profits and capital structure of listed manufacturing companies. The study used secondary data that was obtained from the Capital Markets Authority (CMA) data bank. The study used census technique whereby all nine (9) manufacturing and allied companies trading on the Nairobi Securities Exchange were used in the study. The study assumed descriptive and inferential statistics in data examination, analysis and interpretation. The data was presented using tables and figures. The study examined how equity financing influences profitability of firms in the manufacturing and allied sector. The study found that equity financing contributes to a significant change to the net profits of Kenyan listed manufacturing and allied companies. The study reveals that through the sale of shares of a company, the company raises capital for its business operations in a process known as equity financing. In equity financing, the study found that an organization can either issues new shares of stock or reinvest in new assets the profits generated by its existing assets. When a company generates profits, it may hold the cash in reserve for future investments or it may pay the cash back to the shareholders. The study found that when a business organization pays the cash back to its shareholders, it reduces it net profits that would be used to expand or rather diversify the business operations. The study found that the correlation coefficient (r) was 0.526, beta (β) which is the slope was -0.526 and R2 was 0.467, which means that 46.7% of net profits can be explained by equity financing The study revealed how debt financing affects net profits in Kenyan listed manufacturing and allied companies. From the study, linear regression analysis was used to determine the relationship between the level of leverage and organizational performance. The study found that through debt financing in manufacturing and allied companies are able to enhance their profitability. The study revealed that manufacturing companies have strategies of choosing capital structure that enhance their profitability. The study found that the successful selection and use of the debt-to-equity ratio is one of the key elements of firms’ financial strategy. The study revealed that profitable manufacturing companies borrow more as they greatly shield income from corporate tax and enhance net profits. It was found from the study that a company’s profit performance is a good indicator of its fundamental health and competitive position. The study confirms that profit margin indicates whether a company can sustain its present cash accruals. The study revealed that the correlation coefficient (r) was 0.792, β which is the slope was 0.792 and R2 was 0.627, which means that 62.7% of net profits can be explained by debt financing. The study examined the effect of preference share financing on net profits of Kenyan listed manufacturing and allied companies. The study shows that like bonds, preferred shares are rated by the key credit-rating institutions. The study established that usually, preferred stock has preference in paying dividends. The preference doesn’t warranty the disbursement of dividends, but the business organization must pay the assured dividends on preferred stock ahead of paying any dividends on common stock. The study found that preferred stock resembles debt in that it promises pre-determined levels of dividends. It was also revealed that preferred dividends aren’t tax-deductible to the issuing companies like interest on debt. From the research, it was demonstrated that many issuers of preferred stocks are industrial companies or rather firms. The study illustrated that it is profitable for manufacturing and allied firms to issue preference shares in place of debt, hence meeting regulators' equity limitations. The study also reveals that manufacturing and allied companies that issue preference shares can pass their costs on to the consumers and hence are less affected by the tax disadvantages of preferreds. From the study, it is clear that the correlation coefficient (r) was 0.780, β which is the slope was 0.780 and R2 was 0.609, which means that 60.9% of net profits can be explained by preference mode of financing. The study concludes that there is a positive relationship between equity financing and net profit. Maximizing wealth for the shareholders require perfect combination of debt and equity and that cost of capital is negatively correlated and therefore to be reduced to minimum level. From the study it is concluded that debt financing enhances net profits of manufacturing and allied companies. The study concludes that preference share financing is a very important method of enhancing net profits of manufacturing and allied companies. The study recommends the manufacturing companies to use equity to finance their operations as equity financing enhances net profits. The management of manufacturing companies should develop techniques of determining how capital structure should be divided. The study recommends a successful selection and use of the debt-to-equity ratio as it is one of the key elements of firms’ financial strategy. The study recommends the use of preference shares because preferred dividends are not tax-deductible to the issuing firms and that omission of dividends will not result in bankruptcy