The capital structure of the company. Indicators ebit and ebitda: features of calculation according to IFRS reporting Operating profit volatility method

02.06.2021

Paid interest for the case of share repurchase without increasing debt;

The total number of ordinary shares outstanding after the share repurchase due to an increase in debt;

The total number of ordinary shares outstanding after share repurchases without increasing debt.

Let's compare the current value of operating profit (2011) and the value at the point of indifference:

EBIT current = 276,533,000 rubles, EBIT* = 282,940,124.

The value at the point of indifference exceeds the current value of operating profit. Under the EBIT-EPS method, the company should have rejected the option of financing the share buyback with debt capital, as this policy does not maximize earnings per share.

The optimal financial leverage adopted in the framework of the considered simulation minimizes the value of WACC. The value of the company is maximized while minimizing the cost of capital. The WACC value is calculated as follows:

where is the cost of borrowed capital;

The cost of equity;

Income tax rate;

The amount of debt financing;

Market value of equity;

The amount of capital.

The amount of equity is equal to the product of the market value of one share by the number of shares in circulation. At the same time, the equity capital of the company consists only of ordinary shares. Borrowed capital for each case was found through known values of financial leverage and equity capital. Interest payable was calculated as the product of debt financing and the cost of borrowed capital. The unlevered beta was determined earlier for companies producing medical products, the levered beta was found using the previously used formula (6).

According to the calculation results, it can be seen that, according to the considered method, the optimal capital structure is achieved when the financial leverage is 30%. The current value of the financial leverage of the company "DIOD" is 42.83%, so the company should reduce the share of borrowed capital.

The operating profit volatility method allows you to determine the acceptable level of debt in the company's capital structure, based on the likelihood of financial difficulties (bankruptcy). It is assumed that for more unstable company profits, the probability of being unable to pay off debts and falling into a situation of insolvency is higher. For a given level of bankruptcy probability, the target level of the company's financial leverage is determined. If the level of financial leverage is greater than the maximum allowable, then recommendations are given to reduce it. If the actual level of financial leverage is less than acceptable, then options for increasing it are considered.

Table 10. Initial data of JSC "DIOD"

Table 11 Correlation between Bankruptcy Probability and Credit Rating

	Default probability, %

	Default spread, %

All necessary calculations for the company JSC "DIOD" by the method of operating profit volatility are presented in Table. 13.

Table 13. Estimation of the optimal capital structure of DIOD OJSC using the operating profit volatility method

Average EBIT, RUB
EBIT Standard Deviation

Default probability, % (Table 12)
Default spread, % (Table 13)
Confidence interval, %
t-statistic with 3 degrees of freedom for confidence. interval 85.4% ()
Amount of eligible annual interest payments (DP), rub.
Risk-free return (),%
Required yield on debt (),%
Maximum amount of debt, rub.
Current value of debt, rub.
Actual value of financial leverage, %
Maximum value of financial leverage, %

where - the average value of operating profit;

The amount of eligible annual interest payments;

Variance of operating profit;

T-statistic having Student's distribution with (n-1) degrees of freedom;

n is the number of years for which operating profit values are known.

The change in operating profit was analyzed over 4 years. Therefore, a t-statistic was found having a Student's distribution with 3 degrees of freedom for a confidence interval of 85.4%, which was calculated as (). The amount of acceptable annual interest payments or the critical level of annual payments was determined from formula (9):

The maximum allowable debt for the company was calculated using the perpetual annuity formula, while the required return on debt is equal to the sum of the risk-free return and the default spread:

Thus, according to the operating income volatility method, the company should reduce the amount of borrowed capital in cases where the credit rating is BB+ and BBB, since the current value of borrowed capital exceeds the maximum possible debt values. In all other options, the current value of the debt does not exceed the maximum allowable value, respectively, the company can increase borrowed capital.

The effect of financial leverage is to increase the company's return on equity (ROE) through the use of debt financing. But, on the other hand, an increase in borrowed capital leads to an increase in the risk of insolvency of the company. In this case, the manager must ensure that the profitability of the organization's activities exceeds the cost of capital. The problem of optimizing the effect of financial leverage is as follows:

where - the rate of return on investment capital, equal to the ratio of post-tax operating profit to the value of the company's capital;

Post-tax borrowing rate, which is equal to the product of the required return on borrowed capital and (1 - income tax rate);

The amount of borrowed capital of the company;

The amount of equity capital of the company.

The relationship between return on equity and operating return on invested capital is determined by the following formula:

Owners will benefit in the form of a higher rate of return if borrowed capital is raised at a rate no higher than the operating return on capital invested ().

Thus, when considering two alternatives, the option with the greater effect of financial leverage is selected. To analyze the optimal structure of JSC DIOD, using this method, it was also assumed that the company is considering two alternative options for changing the capital structure in 2012: buyback of the company's shares by increasing borrowed capital and buyback of shares without increasing debt. All necessary calculations are presented in Table. fourteen.

Table 14. Estimation of the optimal capital structure of JSC "DIOD" by the method of maximizing the return on equity

	Alternatives
	Buyback of shares by increasing debt	Buyback of shares without increasing debt
Increase in borrowed capital, rub.
Borrowed capital, rub.
Own capital, rub. (Table 9)
Capital, rub.
Operating profit, rub.
Tax rate, %
Post-tax operating profit, rub.
Return on investment capital (ROCE), %
Cost of borrowed capital, % (Table 8)
After-tax borrowing rate, %
Effect of financial leverage, %

Post-tax operating profit for share repurchases without increasing debt is equal to operating profit multiplied by (1-tax rate). For the option of repurchasing shares by increasing debt, there is a decrease in profit by the amount of interest on additionally attracted debt, which is equal to the product of additional borrowed capital and the after-tax borrowing rate.

Thus, the effect of financial leverage is much higher for the case of share repurchase without an increase in debt, in which case the optimal capital structure of DIOD OJSC is achieved. For the case of an increase in debt, the effect of financial leverage takes a negative value. Company "DIOD" should not have increased the amount of borrowed capital.

When calculating the optimal structure using the APV method, it is assumed that an increase in borrowed capital allows saving on the company's income tax with an increase in the costs of financial instability compared to the value of a company without debt financing. According to this method, the value of the company is calculated as follows:

where - the value of the firm, taking into account financing decisions;

The value of the firm without debt;

Benefits from the effect of the tax shield, which is calculated as the product of the tax rate by the amount of additional borrowed capital;

Costs of financial instability of the company.

Increasing the amount of financial leverage will save on tax payments, and until these benefits exceed the costs of bankruptcy, the value of the entire company will increase.

To analyze the optimal capital structure of DIOD, several options for the value of financial leverage were considered, with each value corresponding to its own credit rating and the probability of bankruptcy . Accounting for the loss of solvency is implemented through the introduction of two estimates: the probability of financial difficulties and a quantitative assessment of the loss of value. In practical calculations, the assessment of the loss of value is introduced according to industry statistics of the decline in capitalization due to emerging financial difficulties. For companies with a high share of liquid tangible assets, there is a loss of value in the range of 10-20% of the original value. The assessment of the loss of value of DIOD JSC was taken at the level of 25%, since the company does not have a large amount of highly liquid tangible assets.

The value of own capital did not change, while the borrowed capital for each case was found through the known values of financial leverage and equity. The expected costs of bankruptcy were calculated as the product of debt capital, the probability of bankruptcy, and the estimated loss of company value. According to the results of Table. 18 we can say that the value of the company with the use of financial leverage is less than the value of the company without its use in almost all cases. The exceptions are cases where the financial leverage is 0% and 10%. When the leverage is greater than 40%, the company's leveraged value becomes negative, as the expected costs of financial instability far outweigh the tax shield.

3.3 Reasons for deviating from the optimal capital structure

Based on the results of the analysis of the capital structure of DIOD OJSC using different methods, it can be concluded that the company should not have raised additional borrowed capital in 2012, since the considered methods revealed a deterioration in the company's position with an increase in debt financing. It was found that the optimal capital structure of the company is achieved with a financial leverage of 30%, and the current value is 42.83%. The increase in the debt of JSC "DIOD" has led to the fact that the actual value of the financial leverage significantly deviates from the optimal value. The company should reduce the amount of borrowed capital to optimize the capital structure. This gap can be explained, including behavioral factors. Let's compare the average values of the variables for the sample studied in the second chapter of the work and the values of the variables for the company JSC "DIOD" (Table 15).

Table 15. Analysis of behavioral factors

	Sample mean values of variables	Values of variables for JSC "DIOD"

The share of shares owned by the head of his company,%
Risk taken by the manager, %
Index financial risk, shares
Leader's age, years

The share of shares owned by the head of JSC "DIOD" is much higher than the average value for the study sample. The head of the company can be considered irrational, since he does not diversify his investment portfolio and owns a fairly large block of shares in his companies. According to the manager's professional experience, it was revealed that he has been working in the DIOD organization since September 1994. For such a long period of time, the CEO is well aware of the company's activities and is confident in its further development. Thus, the head of the company is quite confident and optimistic, so he could attract additional borrowed capital, deviating from the optimal structure. In addition, the risk taken by the manager is relatively high and does not differ much from the sample average. The company's cost of equity, reaching almost 20%, can be considered quite high. The head of JSC "DIOD" takes a high risk, which indicates his self-confidence and optimism. CEO expects that the risk he takes will be justified, and the company will be able to achieve high profits in the future. All this may also indicate the manager's inclination to increase the company's debt burden. The age of the head turned out to be below the average value, so the head of JSC "DIOD" can be considered relatively young. According to the conclusions drawn in the work, younger managers often follow a risky company management strategy, they are more optimistic, and therefore attract a high proportion of borrowed funds. The financial risk index is low compared to the average value for the sample, so it does not greatly affect the deviation in the choice of the capital structure of the company "DIOD".

Thus, the analysis of behavioral factors showed that the head of the company "DIOD" may be characterized by behavioral deviations in rational behavior, this could affect the financial decisions that he made, in particular, the choice of the company's capital structure.

capital profit profitability financial

Conclusion

Existing approaches to the formation of the capital structure of companies suggest that all financial market participants are rational, but company leaders are characterized by behavioral deviations that significantly affect their financial decisions. In this paper, using various variables, we analyzed the significance of behavioral theories to explain the choice of financing policy by Russian companies. Several methods were used in the work to identify the degree of influence of the behavioral characteristics of managers on the formation of the capital structure. In addition to behavioral factors, traditional determinants were also included in the model. Among the traditional theories, the theory of the order of financing has an unambiguous confirmation on the data of the studied sample.

The results of the study for Russia are consistent with the results for developed countries regarding the influence of the level of confidence and optimism of the head on the amount of financial leverage. With regard to the influence of fundamental indicators, many researchers have concluded that companies in developing countries follow the order of financing theory. However, it has not been clearly established which of the traditional theories is acceptable for companies in developed countries.

In the work, the emphasis was placed on the analysis of the behavioral characteristics of managers to explain the choice of financing policy by Russian companies. A new behavioral factor was proposed - the risk taken by the manager, which turned out to be significant. It is important to note that behavioral factors have a significant impact on the formation of the capital structure of companies, so it is necessary to take them into account when modeling.

In addition, this work is of practical importance, since the identified behavioral determinants can be used to explain the deviation of the actual value of financial leverage from the optimal value. For the operating company "DIOD", such a deviation was analyzed and recommendations were given to achieve the optimal capital structure.

In a further study in the field of capital structure of companies, it is planned to expand the sample, namely, to apply the identified behavioral variables for other countries, as well as to use new quantitative indicators to measure the behavioral characteristics of company leaders. Since the developed variables make it possible only indirectly to assess the presence or absence of behavioral characteristics of managers, but not to measure their depth and strength.

Essence, functions and classification of enterprise capital. The practice of applying the method of optimizing the capital structure based on the criterion of maximizing the return on capital and analyzing the dependence "EBIT-EPS" in Russian conditions on the example of JSC "Silvenit".

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Due to the high dynamism of this indicator, it requires constant monitoring in the process of managing the effect of financial leverage. This dynamism is due to a number of factors. First of all, during a period of deterioration in the financial market (primarily, a reduction in the supply of free capital on it), the cost of borrowed funds can increase sharply, exceeding the level of gross profit generated by the assets of the enterprise. In addition, a decrease in the financial stability of an enterprise in the process of increasing the share of borrowed capital used leads to an increase in the risk of its bankruptcy, which forces creditors to increase the interest rate for a loan, taking into account the inclusion of a premium for additional financial risk. At a certain level of this risk (and, accordingly, the level of the general interest rate for a loan), the financial leverage differential can be reduced to zero (at which the use of borrowed capital will not increase the return on equity) and even have a negative value (at which the return on equity will decrease, because part net profit, generated by own capital, will go to service the used borrowed capital at high interest rates). Grachev A.V. Growth of own capital, financial leverage and solvency of the enterprise / A.V. Grachev // Financial management. A.V. - 2002. - No. 2. - p.21-34

Finally, in a period of deteriorating market conditions commodity market the volume of sales of products is reduced, and, accordingly, the size of the gross profit of the enterprise from operating activities. Under these conditions, a negative value of the financial leverage differential can form even at unchanged interest rates for a loan due to a decrease in the gross return on assets.

The formation of a negative value of the financial leverage differential for any of the above reasons always leads to a decrease in the return on equity ratio. In this case, the use of borrowed capital by the enterprise has a negative effect.

The financial leverage ratio is the leverage that multiplies (in proportion to the multiplier or coefficient changes) the positive or negative effect obtained due to the corresponding value of its differential. With a positive value of the differential, any increase in the financial leverage ratio will cause an even greater increase in the return on equity ratio, and with a negative value of the differential, an increase in the financial leverage ratio will lead to an even greater rate of decline in the return on equity ratio. In other words, an increase in the financial leverage ratio multiplies an even greater increase in its effect (positive or negative, depending on the positive or negative value of the financial leverage differential). Similarly, a decrease in the financial leverage ratio will have the opposite effect, reducing its positive or negative effect to an even greater extent.

Thus, with the differential unchanged, the financial leverage ratio is the main generator of both the increase in the amount and level of return on equity, and the financial risk of losing this profit. Similarly, with a constant financial leverage ratio, the positive or negative dynamics of its differential generates both an increase in the amount and level of return on equity, and the financial risk of its loss.

Knowledge of the mechanism of the impact of financial leverage on the level of return on equity and the level of financial risk allows you to purposefully manage both the cost and the capital structure of the enterprise.

Now we can formulate some rules related to the effect of financial leverage.

1. EGF differential must be positive. The entrepreneur has certain levers of influence on the differential, but such influence is limited by the possibilities of increasing the efficiency of production.

2. The financial leverage differential is an important information impulse not only for the entrepreneur, but also for the banker, as it allows you to determine the level (measure) of the risk of providing new loans to the entrepreneur. The larger the differential, the lower the risk for the banker, and vice versa.

3. The shoulder of financial leverage carries fundamental information for both the entrepreneur and the banker. Large leverage means significant risk for both participants in the economic process.

Thus, we can argue that the effect of financial leverage allows you to determine the possibility of attracting borrowed funds to increase profitability. own funds and the associated financial risk.

The rules formulated above allow the firm to specifically solve the problem of determining the amount of possible attraction of credits and loans. Lee Ch.F., Finnerty J. Corporate Finance: Theory, Methods and Practice / Lee Ch.F., Finnerty J. - M.: Infra-M, 2000. - P. 436-438.

2.2 The practice of applying the method of optimizing the capital structure based on the criterion of maximizing the return on equity in Russian conditions on the example of JSC "Silvenit"

To assess and determine the optimal capital structure of an enterprise, it is necessary to determine the actual ratio of equity and borrowed capital, determine the average calculated interest rate for the use of borrowed capital, suggest possible options for the structure and interest rate. The results are shown in table. 2.1.

Obviously, this effect arises from the discrepancy between the return on assets and the "price" of borrowed capital, i.e. average bank rate. In other words, the company must provide for such a return on assets that there is enough cash to pay interest on the loan and pay income tax.

It should be borne in mind that the average calculated interest rate does not coincide with the interest rate accepted under the terms of the loan agreement.

The average settlement rate for a loan is set according to the formula:

Rt \u003d (In / D) H100

where Rt is the average settlement rate for a loan;

In - actual financial costs for all loans received for the billing period (the amount of interest paid);

Table 2.1

Initial data for the analysis of the capital structure of OJSC "Silvenit" by the ROE maximization method.

Index	Share of borrowed capital
		30% (fact on balance)

1. Own capital (f. No. 1, p. 490), thousand rubles
2. Borrowed capital, thousand rubles.
3. The total amount of capital, thousand rubles.
4. Expenses for the use of borrowed capital
4.1.Average calculated interest rate, %
4.2. Amount (line 2 of line 4.1: 100%), thousand rubles
5. Debt ratio

Financial leverage characterizes the use of borrowed funds by an enterprise, which affects the change in the return on equity.

Table 2.2

Analysis of the effect of financial leverage of Silvenit JSC

Index

Change in return on equity depending on different capital structure

Earnings before interest and taxes (EBIT), thousand rubles

Interest paid, thousand rubles

Taxable income, thousand rubles

Income tax, thousand rubles (twenty%)

Net profit (NP), thousand rubles

Return on equity (ROE), %

Level of financial leverage, coefficient

Change in EBIT, %

Change in NP, %

Range ROE

In other words, financial leverage is an objective factor that arises with the advent of borrowed funds in the amount of capital used by the enterprise, allowing it to receive additional profit on equity.

To analyze the effect of financial leverage of Silvenit OJSC, it is necessary to calculate taxable income, income tax, net profit, return on equity for each option of the capital structure, as well as assess the level of financial risk.

The calculation of the EFL value will be carried out according to the formula (1). The results of the analysis are given in table. 2.2.

As a result of data analysis table. 2.2. obtained that of all the options for the structure, the maximum value of the return on equity is achieved in the third case, i.e. with a share of borrowed capital of fifty percent. Return on equity will be 32.36%. This financing option can be characterized by several more indicators:

Net profit is less by 1376736.4 thousand rubles. than with the original capital structure;

Profitability growth amounted to 6.2%;

The increase in the level of financial leverage amounted to 0.18;

It can be concluded that the third financing option with EBIT = 13184379 thousand rubles. is optimal. This statement follows from the fact that:

3. CONTENT AND APPLICATION OF THE METHOD FOR OPTIMIZING THE CAPITAL STRUCTURE OF THE ENTERPRISE ON THE BASIS OF THE ANALYSIS OF THE DEPENDENCE "EBIT-EPS" ("EBIT-ROE")

3.1 The content of the method of optimizing the capital structure based on the analysis of the dependence "EBIT-EPS" ("EBIT-ROE")

Even in the conditions of the limited possibilities of the Russian financial market, the financial manager has certain alternatives in finding sources of financing for his organization. When making capital structure decisions, a financial manager is guided by two criteria; minimizing the weighted average cost of capital and maximizing earnings per share. Earnings per share (EPS) is calculated using the formula:

n is the number of outstanding ordinary shares.

Consider the graph of the dependence of the weighted average price of capital on the structure of sources of funds

As can be seen from the graph, the price of borrowed and own funds grows with an increase in the share of borrowed funds in liabilities. The weighted average price first falls and then starts to rise. Therefore, there is the “lowest” point on the WACC chart, dropping the perpendicular from which to the X axis, we will get the optimal capital structure. Financial management: textbook. allowance / A. N. Gavrilova [and others]. - 5th ed. - M. : KNORUS, 2010. - S. 296-300.

Rice. 3.1. Graph of the dependence of the weighted average price of capital on the structure of sources of funds

The WACC curve has a bowl-like shape without a well-defined minimum point. Thus, a relatively small deviation from the optimal capital structure will not have a significant impact on the value of WACC. Consequently, financial managers have the freedom to "maneuver" in the management of the capital structure, which is necessary in a changing financial market environment.

In addition to the graphical method, you can use the EBIT-EPS method, which allows managers to evaluate alternative financial projects. This method is based on the determination of equilibrium points, i.e. such EBIT values at which EPS will have the same value, regardless of the chosen financing scheme.

The essence of the EBIT-EPS model is to choose a source of resources that will provide the maximum amount of earnings per share (EPS) with a constant amount of operating income (EBIT).

To do this, the first step is to determine the amount of resources needed by the enterprise, set the interest that the company is willing to pay for debt obligations.

After that, the cash flow from operating profit to dividend payment for each option is considered and then the EPS indicator is calculated from them.

At the next stage, a graph is built, on which EBIT values are plotted along the X-axis, and EPS values are plotted along the Y-axis. This graph indicates the values of the obtained calculations for each of the possible sources of attracting resources.

The equilibrium point between any two funding methods can be determined by finding the EBIT value from the following equation:

where EBIT is earnings before interest and taxes, m.u.;

In - interest on borrowed funds attributable to expenses, m.u.;

T - profit tax rate, coefficient;

Dp - dividends paid on preferred shares, m.u.;

E1 -- the amount of equity in the first method of financing;

E2 - the number of ordinary shares in the second method of financing. Financial management: textbook. allowance / A. N. Gavrilova [and others]. - 5th ed. - M. : KNORUS, 2010. - P. 296-300.

The EBIT-ROE method is a special case of the EBIT-EPS method. For analysis, this method uses return on equity (ROE) instead of earnings per share (EPS).

The logic of building this model is based on the fact that the return on equity is determined not only by equity, but also by borrowed capital. Thus, in order to identify the degree of influence of borrowed capital on the return on equity, it is necessary to divide the return on equity into two parts: earned by it itself and accumulated by borrowed capital. In this case, the second component can be negative. Then the use of borrowed capital is unprofitable for the company - the profit received does not cover the financial costs of servicing the debt.

The construction of this dependence from a mathematical point of view is associated with the transformation of the formula for the return on equity, taking into account the use of borrowed funds.

A graphical interpretation of the dependence of the return on equity and profit before interest and income tax is shown in Fig. 3.3.

First situation? the use of borrowed capital along with its own gives an increase in net profit per ordinary share and an increase in the return on equity.

The second situation - the use of borrowed capital does not change the financial result, i.e. companies do not care what to use - borrowed or equity capital.

Rice. 3.3. Return on equity versus earnings before interest and income taxes

The third situation - the use of borrowed capital leads to a decrease in net income per ordinary share and return on equity.

Fourth situation? the use of borrowed capital costs the company so much that the profit received does not cover the interest and it suffers losses.

Graphically, the definition of the optimal financial structure of capital is presented in fig. 3.4.

The analysis of the optimal capital structure is based on the calculation of two indicators: the point of indifference and the financial critical point. The point of indifference characterizes such profit at which the return on equity and net earnings per share do not change when using borrowed capital. This is possible when the EFR is equal to zero, that is, the economic profitability is equal to the average calculated interest rate.

Rice. 3.4. Determination of the optimal capital structure

To determine the point of indifference and the financial critical point, two financing options are considered: a mixed financing scheme and financing only from equity (Fig. 3.4.).

The point of indifference (TB) characterizes such a value of profit before interest and taxes (Pr), under which, under given conditions, the return on equity is the same both with a mixed financing scheme and with the use of only equity capital. The financial critical point (FCP) characterizes the situation in which the company has earnings before interest and taxes (Pr), and the return on equity is zero. This is possible if the profit generated by the company is only enough to cover interest (financial costs).

Let's consider four possible situations for determining the optimal capital structure.

The first situation (1) on the graph corresponds to a ray going to the right from the point of indifference, i.e., if the company earns profit before interest and taxes more than at the point of indifference, its EGF is positive and it is more profitable for it to use borrowed capital to increase return on equity.

The second situation (2) corresponds to the point of indifference.

The third (3) is characterized by a segment from the point of indifference to the financial critical point. Here, the accumulated profit is enough to cover interest, pay taxes and generate net profit. However, when using a mixed financing scheme, there is a decrease in the return on equity compared to financing from own funds and 5FR "negative.

The fourth situation (4) corresponds to the segment from the financial critical point to the origin. The profit earned here is not enough even to cover financial costs, and the company suffers net losses, having a positive profit before interest and taxes. Lisitsina E.V. Assessment of the financial structure of capital on the financial result of the company / E.V. Lisitsina // Finance and credit. - 2004. -№2. - S. 15-20

3.2 The practice of applying the method of optimizing the capital structure based on the analysis of the dependence "EBIT-EPS" ("EBIT-ROE") in Russian conditions on the example of JSC "Silvenit"

The EBIT-ROE method allows you to evaluate alternative financial projects. This method is based on the determination of equilibrium points, i.e. such values of profit from operating activities (EBIT), at which the return on equity (ROE) will have the same value, regardless of the chosen financing scheme.

The essence of the EBIT - ROE model is the choice of a source of resources that will provide the maximum return on equity with a constant profit from operating activities.

In table. 3.1 shows the data used in this analysis method.

Table 3.1

Initial data for the analysis of the capital structure of Silvenit OJSC using the EBIT-ROE dependence analysis method

Index	Share of borrowed capital


1. Profit before interest and taxes (EBIT), you p. rub.
2. Interest paid, thousand rubles.
3. Taxable income, thousand rubles.
4. Income tax, thousand rubles. (twenty%)
5.Net profit (NP), thousand rubles
6. Own capital (f. No. 1, p. 490), thousand rubles
7. Return on equity (ROE), %

Let's calculate the equilibrium points for various options for the capital structure according to Table. 3.1. Formula (3) will be used for calculations

1) The first point of balance between options I-II

We get EBIT = 5123716.168 thousand rubles.

2) The second point of balance between options I-III

We get EBIT = 6270901.467 thousand rubles.

3) The third point of balance between options I-IV

We get EBIT = 11454846.46 thousand rubles.

4) The fourth point of balance between options II-III

We get EBIT = 6534147.38 thousand rubles.

5) Fifth point of equilibrium between options II-IV

We get EBIT = 11910884.25 thousand rubles.

6) The sixth point of balance between options III-IV

We get EBIT = 14370815.53 thousand rubles.

The obtained data will be presented in a graphical expression in Fig. 3.5.

Rice. 3.5. Relationship between return on equity and operating profit

Conclusions: 1) If the EBIT level is higher than 5123716.168 thousand rubles, the 2nd financing option with a share of borrowed capital of 30% is better than the 1st financing option with a share of borrowed capital of 20%. If EBIT is below 5,123,716.168 thousand rubles, then an inverse relationship will apply.

2) If the EBIT level is above 6270901.467 thousand rubles. The 3rd financing option with 50% leverage is better than the 1st financing option with 20% leverage. If EBIT is below 6,270,901.467 thousand rubles, then an inverse relationship will apply.

3) If the level of EBIT is above 11454846.46 thousand rubles. The 4th financing option with 70% leverage is better than the 1st financing option with 20% leverage. Below this equilibrium point, an inverse relationship will operate.

4) If the level of EBIT is higher than 6534147.38 thousand rubles. The 3rd financing option with a share of borrowed capital of 50% is better than the 2nd financing option with a share of borrowed capital of 30%. Below this equilibrium point, an inverse relationship will operate.

5) If the level of EBIT is above 11910884.25 thousand rubles. The 4th financing option with 70% leverage is better than the 2nd financing option with 30% leverage. Below this equilibrium point, an inverse relationship will operate.

6) If the level of EBIT is above 14370815.53 thousand rubles. The 4th financing option with 70% leverage is better than the 3rd financing option with 50% leverage. Below this equilibrium point, an inverse relationship will operate.

7) With the actual level of EBIT = 13184379 thousand rubles. Based on the graph, it can be seen that the 3rd financing option with a share of borrowed capital of 50% is better than the other three financing options, because Option 3 provides the maximum return on equity (32.36%). In second place is the 4th financing option (ROE = 29.35%). However, it is necessary to take into account the fact that with small differences in the obtained ROE value between the 4th and 2nd financing options (3%), the fourth option is much more risky. Therefore, taking into account all the indicators, the second financing option can be attributed to the second place.

CONCLUSION

Capital is the property of an organization free of obligations, the strategic reserve that creates conditions for its development, absorbs losses if necessary, and is one of the most important pricing factors when it comes to the price of the organization itself, capital can also be understood as long-term liabilities.

The capital of any enterprise can be represented by two components: own and borrowed funds.

Capital functions

1) Capital is a production resource

2) Capital - an object of ownership and disposal.

3) Capital - part of financial resources

4) Capital is a source of income

5) Capital is an object of time preference

6) Capital - the object of sale

7) Capital - the carrier of the risk factor

8) Capital - the carrier of the liquidity factor

The formation of the optimal structure of capital is inextricably linked with taking into account the characteristics of each of its components. Own capital is characterized by the following main positive features: ease of attraction; higher ability to generate profits in all areas of activity; ensuring the financial sustainability of the development of the enterprise, its solvency in long term, and, accordingly, a decrease in the bankruptcy market. At the same time, it has the following disadvantages: limited attraction; high cost in comparison with alternative borrowed sources of capital formation; unused opportunity to increase the return on equity ratio by attracting borrowed funds.

Borrowed capital is characterized by the following positive features: fairly wide opportunities to attract; ensuring the growth of the financial potential of the enterprise, if necessary, a significant expansion of its assets and an increase in the growth rate of its volume economic activity; lower cost in comparison with own capital due to the effect of the “tax bill”; the ability to generate an increase in financial profitability (return on equity ratio). At the same time, the use of borrowed capital has the following disadvantages: the risk of insolvency increases; assets formed at the expense of borrowed capital form a lower (ceteris paribus) rate of return, which is reduced by the amount of loan interest paid in all its forms; high dependence of the cost of borrowed capital on fluctuations in the financial market; the complexity of the recruitment process.

When forming the capital structure, one of the most important problems is the problem of the optimal ratio of own and borrowed funds.

Capital structure theories:

Traditionalist concept of capital structure;

The concept of indifference of the capital structure;

A compromise concept of the capital structure;

The concept of conflict of interests in the formation of the capital structure.

One of the main tasks of capital formation - optimization of its structure, taking into account a given level of its profitability and risk - is implemented by various methods. One of the main mechanisms for the implementation of this task is financial leverage.

Financial leverage characterizes the use of borrowed funds by an enterprise, which affects the change in the return on equity ratio. In other words, financial leverage is an objective factor that arises with the advent of borrowed funds in the amount of capital used by the enterprise, allowing it to receive additional profit on equity.

An indicator that reflects the level of additionally generated return on equity with a different share of the use of borrowed funds is called the effect of financial leverage.

The essence of the EBIT-ROE model is to choose a source of resources that will provide the maximum return on equity (ROE) with a constant profit from operating activities (EBIT).

As of December 31, 2009, the equity capital amounted to 37,595,829 thousand rubles. (70%), the amount of borrowed capital amounted to 14561682 thousand rubles. (thirty%).

Based on the analysis by the method of maximizing the return on equity, we can conclude that the third financing option with EBIT = 13,184,379 thousand rubles. is optimal. This statement follows from the fact that:

Provides the maximum value of ROE = 32.36%;

The level of financial risk and the amount of net profit are comparable with the corresponding values with a smaller share of borrowed capital.

Based on the analysis of the EBIT-ROE dependence, we can conclude:

With the actual level of EBIT = 13184379 thousand rubles. Based on the graph, it can be seen that the 3rd financing option with a share of borrowed capital of 50% is better than the other three financing options, because Option 3 provides the maximum return on equity (32.36%). In second place is the 4th financing option (ROE = 29.95%). However, it is necessary to take into account the fact that with small differences in the obtained ROE value between the 4th and 2nd financing options (3%), the fourth option is much more risky. Therefore, taking into account all the indicators, the second financing option can be attributed to the second place.

Based on the analysis of the capital structure by two methods, it can be concluded that the optimal

capital optimization structure

LIST OF USED SOURCES

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This work was downloaded from the site Bank of abstracts http://www.vzfeiinfo.ru Work ID: 27862

APPS

Attachment 1

Balance sheet

Continuation of Appendix 1

Annex 2

Report about incomes and material losses

Continuation of Appendix 2

Hosted on Allbest.ru

annotation scientific article on economics and business, author of scientific work - Zadorozhnaya A.N.

Topic. The paper presents methods for determining debt load to form an optimal loan portfolio that will increase the value of the company. As practice shows, the only true universal solution does not exist and the choice of optimization criteria debt load is part of the financial policy of each particular company. Goals. Study of models for substantiating the optimal capital structure based on the target function "risk return": EBIT volatility method, EBIT-EPS analysis model. Methodology. An analysis of the evolution of capital structure theories after the publication of Miller's Modigliani theorem gives grounds to assert that the practical implementation of the results of theoretical studies of the formation of the capital structure still causes difficulties. To analyze the possible practical use of models of the optimal level of debt with the target function "risk return", the EBIT volatility method and the EBIT-EPS analysis model were tested on the example of PJSC Rostelecom. Results. The results of the study allow us to conclude that the calculation credit capacity corresponding to the optimal level debt load, can be a tool for managing the company's financial flexibility. The results of testing the EBIT volatility method for PJSC Rostelecom led to the conclusion that the current level debt load is within acceptable limits, and to model the probability of default for various combinations of capital structure . Conclusions and significance. The EBIT-EPS analysis model for evaluating the buyback financing option allowed us to assess the level of financial break-even and determine the financing option for the transaction that maximizes earnings per share (EPS). Despite the fact that the models presented in the work for determining the optimal level debt load have a number of shortcomings, the results obtained allow financial management make more informed decisions in the area of capital structure management.

The procedure for applying the EBIT volatility method and the EBIT-EPS analysis model in the financial decision-making process

Importance The article presents methods for assessing the debt burden in order to form an optimal loan portfolio, which will boost the business value. As the practice shows, there is no versatile and correct solution, and each specific company should stipulate in its financial policy how to choose criteria for optimizing its debt burden . Objectives The research examines models for substantiating an optimal structure of the capital through the risk-return trade-off: EBIT volatility method, EBIT-EPS analysis method. Methods I analyzed how the theories of capital structure evolved after the Modigliani-Miller theory had appeared, and figured out that the outcome of theoretical researches into the capital structure formation was still difficult to be practically implemented. I tested the EBIT volatility method and EBIT-EPS analysis model and used the case of Rostelecom to analyze whether the optimal debt burden model could be practically applied in relation to the risk-return trade-off function. Results The calculation of the corporate debt capacity that correlates with the optimal debt burden , is a tool to manage the financial flexibility of the company. The outcome of the EBIT volatility method allows concluding that the current debt burden is within tolerable limits, and modeling the probability of default for various combinations of the capital structure . Conclusions and Relevance The EBIT-EPS analysis model allows evaluating the financial break-even point and determining an option for financing a transaction, so to derive maximum earnings per share. Notwithstanding that the article features the optimal debt burden models that have some weaknesses, the results may help financial executives take reasonable decisions on the capital structure management.

The text of the scientific work on the topic "The procedure for using the EBIT volatility method and the ebit-eps analysis model when making financial decisions"

ISSN 2311-8768 (Online) ISSN 2073-4484 (Print)

Valuation and valuation activities

HOW TO USE THE EBIT VOLATILITY METHOD AND THE EBIT-EPS ANALYSIS MODEL IN MAKING FINANCIAL DECISIONS

Anna Nikolaevna Zadorozhnaya

Candidate of Economic Sciences, Associate Professor of the Department of Finance, Credit, Accounting and Audit, Omsk State Transport University, Omsk, Russian Federation [email protected]

annotation

Topic. The paper presents methods for determining the debt burden for the formation of an optimal loan portfolio that will increase the value of the company. As practice shows, there is no single correct universal solution, and the choice of criteria for optimizing the debt load is part of the financial policy of each particular company.

Goals. Study of models for substantiating the optimal capital structure based on the objective function "risk - return": EBIT volatility method, EBIT-EPS analysis model. Methodology. An analysis of the evolution of the theories of the capital structure after the publication of the Modigliani-Miller theorem gives grounds to assert that the practical implementation of the results of theoretical studies of the formation of the capital structure still causes difficulties. To analyze the possible practical use of models of the optimal level of debt with the target function "risk - return", the EBIT volatility method and the EBIT-EPS analysis model were tested on the example of PJSC Rostelecom. Results. The results of the study allow us to conclude that the calculation of credit capacity corresponding to the optimal level of debt burden can be a tool for managing the company's financial flexibility. The results of testing the EBIT volatility method for PJSC Rostelecom made it possible to conclude that the current level of debt burden is within acceptable limits and to model the probability of default for various combinations of the capital structure. Conclusions and significance. The EBIT-EPS analysis model for evaluating the buyback financing option allowed us to assess the level of financial break-even and determine the financing option for the transaction that maximizes earnings per share (EPS). Despite the fact that the models for determining the optimal level of debt burden presented in the paper have a number of shortcomings, the results obtained allow financial management to make more informed decisions in the field of capital structure management.

Article history:

Accepted on 08/05/2015 Approved on 08/26/2015

UDC 658.14.17

Keywords: structure, capital, debt load, credit capacity, volatility

The most important direction of corporate policy is making decisions related to the order of financing. Combinations of various sources of financial resources determine the current capital structure of the company, which in turn affects the financial stability and creditworthiness of the organization. The search for the optimal capital structure is still an unresolved issue of modern financial management.

The foundations of the modern theory of the company's capital structure were first outlined in 1958 in the classic work of F. Modigliani and M. Miller "The cost of capital, corporate finance and investment theory". Basic theorem (theorem 1)

Modigliani-Miller, in the absence of taxes on corporate profits and personal income, and also on the basis of a number of assumptions, proves that the market value of a firm does not depend on the structure of its capital and is determined by the rate of capitalization of expected income in firms of its class.

The weakening of the introduced prerequisites and assumptions of the Modigliani-Miller theorem gave rise to several theoretical directions that are trying to justify the procedure for managing the financial structure of companies (Table 1).

At the same time, it should be noted that the practical implementation of the results of theoretical studies of the formation of the capital structure still causes difficulties.

Table 1

The evolution of capital structure theories after the Modigliani-Miller theorem

Founder

a brief description of

Relaxing Assumptions: Taxation and the Costs of Bankruptcy

Compromise theories (static and dynamic models)

A. Kraus, R. Litzenberger (1973) Statistical Models H. DeAngelo, R. Mazoulis (1980). E. Kim (1982). M. Bradley, A. Gregg (1984) Dynamic Models E. Fischer, R. Henkel and J. Zencher (1989)

statistical models.

The optimal level of borrowed capital is determined in such a way that the tax benefits associated with attracting borrowed funds, realized within the same period, are balanced by the costs of bankruptcy.

dynamic models.

The capital structure is a consequence of a constantly pursued financing policy, and the optimal capital structure can be considered such a structure in which the present value of tax shields fully covers the present value of the expected costs of bankruptcy

Assumption Weakening: Information Asymmetry Between Issuers and Investors

Hierarchy theory

sources

funding

G. Donaldson (1961). S. Myers & N. Maylouf (1984). Wu Krasker (1986). M. Narayanan (1988)

Information asymmetry gives rise to a certain hierarchy of external financing costs. Companies primarily use internal sources of financing, then external debt, and finally external equity financing. Within the framework of the hierarchy theory, it is impossible to determine the only option for the target (optimal) capital structure that the company would strive to achieve in the long run. In the short run, the amount of financial leverage is determined by the deficit internal sources funding

Signal models

S. Ross (1977).

H. Leland & D. Pyle (1977).

R. Heikel (1982)

Management can use the capital structure as a signal to outside investors, on the basis of which the latter can receive information about the company's development prospects. An increase in leverage will be regarded as a signal of the company's sound financial position and high expected cash flows, which will allow servicing debt obligations. Therefore, when announcing the issue of debt securities, the market value of the company should increase

Relaxing the Assumption: Agency Costs

agency theory

M. Jensen, Wu Meckling (1975). S. Grossman, O. Hart (1982) 16]. M. Jensen (1986)

Quite often, the determination of the permissible level of debt burden is carried out on the basis of general practice, current industry proportions, comparisons with similar companies. This approach is described by the theory of information cascades (Informational cascades theory), proposed by S. Bikhchandani, D. Hirschleifer and I. Welch, which is based on the “herd behavior” of agents. Scientists note that the optimal strategy of an individual's behavior is to repeat the actions (or decisions) of his

predecessors who find themselves in a similar situation, regardless of the personal information they have. On the other hand, in conditions of wide functionality and limited time resources for management, as well as in the absence of clear models, such an approach can be justified.

However, it should be noted that the management of the capital structure will be more effective if the credit capacity (debt capacity) as an indicator,

Picture 1

Methods for determining the optimal debt burden

characterizing the ability of the company to raise borrowed funds to finance its activities, calculated as the optimal amount of debt, will be assessed using more formalized models.

From a mathematical point of view, optimization is finding the extremum (minimum or maximum value) of the objective function.

Depending on the chosen target function, the following methods of quantitative substantiation of the company's debt burden and credit capacity are possible (Fig. 1):

1) model of the minimum weighted average cost of capital WACC - the optimal level of debt burden is achieved with minimal capital costs;

2) S. Myers' adjusted present value method (adjusted present value, APV). This method, like the WACC model, involves determining the capital structure at which the company's value will be maximized, taking into account the benefits of the tax shield and the costs of financial instability;

3) EBIT volatility method - allows you to determine the acceptable level of debt burden based on the probability of financial difficulties acceptable for the company (probability of default on obligations). It is assumed that the probability of default and the volatility of operating profit are linearly dependent;

4) The EBIT-EPS analysis model involves choosing a capital structure that maximizes earnings per share (EPS). The independent variable in this model is operating profit, the value

which is determined by the level of operational risk. The method of comparing funding sources involves building a linear relationship between EBIT-EPS and choosing for the forecasted value of EBIT such a capital structure that maximizes the value of EPS.

As part of the study, we will consider in more detail the second group of quantitative methods for determining the acceptable level of debt burden, based on the use of the optimal risk-return combination as the target function (the EBIT volatility method and the EBIT-EPS analysis model).

As noted, the EBIT1 operating income volatility method involves determining the acceptable level of debt based on a given default probability. In a simplified version, default is interpreted as the inability of the debtor to fulfill obligations related to the payment of interest and repayment of the current part of the debt. In other words, the probability of default can be defined as the probability that operating income EBIT will not be enough to cover interest payments and repay the current portion of the debt, i.e.

where EBITt is earnings before interest and taxes in period t;

DP (Debt Payment) - interest payments and the current part of the debt payable in period t.

Accordingly, the higher the volatility of operating profit, the higher the probability of default. Thus, this method allows

1 Istomin V.S. Quantitative approaches to the analysis of the capital structure of the company // Bulletin of AmSU 2009. No. 47. P. 96-100.

partially eliminate the shortcomings of the WACC model. The assumption of the EBIT volatility method is the assumption of the normal distribution of operating profit and the absence of dependence between financial leverage and the amount of profit.

Given the above, the default probability p can be defined as

f (EV1G SHV1T,

where p is the probability of default;

EB1G - earnings before interest and taxes;

VR - interest payments and the current part of the debt.

Quantitatively, the probability is calculated using statistics that have an inverse Student distribution with (n - 1) degrees of freedom:

table 2

Probability of default depending on the credit rating

Source: .

where EB1G is the average profit before interest and taxation;

l/s2 - standard deviation EB1T;

- ¿-Student's distribution with (n - 1) degrees of freedom;

n is the number of periods for which the values of EBIT are known.

The general algorithm of the EVGG volatility method can be represented as a sequential execution of actions.

1. An acceptable value of the company's default probability is set. For this purpose, the ratio of the credit rating and the probability of default can be used (Table 2).

2. Based on the data of the company's financial statements for a number of previous periods, the average operating profit EBIT, as well as the standard deviation, are calculated.

3. The value of the one-sided inverse Student distribution with (n-1) degrees of freedom from the admissible default probability is determined, where n is the number of periods for which the operating profit indicators were analyzed.

4. Based on a given acceptable default probability value, taking into account the formula

4 DP is calculated (annual

the amount of interest payments and the repayment of the current part of the debt).

5. Permissible value of borrowed capital, as well as its corresponding financial leverage, can be determined by capitalizing the annual amount of interest payments and repaying the current portion of BP's debt. As the capitalization rate, you can use the cost of borrowed capital kd as the sum of the risk-free rate and the default spread:

where B is the allowable (optimal) amount of borrowed capital.

In addition, this model can be used in a slightly different version. Based on the current value of the debt burden, calculate the probability of default, and then compare the resulting value with the acceptable (acceptable) probability of default for the company. If the introduced limit is exceeded, management decisions should be made to reduce the financial leverage.

Consider the procedure for calculating the optimal capital structure using the EVGT volatility method for PJSC Rostelecom, one of the largest telecommunications companies in Russia and Europe on a national scale, present in all

segments of the communication services market and covering more than 34 million households in Russia.

The results of the analysis of the company's capital structure allow us to draw the following conclusions:

In 2014, there was a noticeable reduction in the share of borrowed capital in the structure of funding sources, with a predominance of long-term liabilities in its structure;

The value of financial leverage exceeds one, i.e. borrowed capital, despite the decrease in its share, still exceeds equity capital in the structure of liabilities;

A positive trend in 2014 is a significant increase in the current liquidity ratio from 0.47 in 2013 to 0.62 in 2014, as well as a decrease in the net working capital deficit.

Despite the fact that in 2014 the company's financial policy was more conservative, debt service indicators, which characterize, among other things, the level of financial risk, worsened. Thus, the amount of operating profit is 2.7 times higher than current interest expenses (for comparison: in 2011 this indicator was at the level of 4.1). However, it should be noted that, despite the negative dynamics of this group

coefficients, their level is still high.

Let's carry out a comparative analysis of indicators of the capital structure of PJSC Rostelecom with the closest competitors: PJSC VimpelCom, PJSC MTS, PJSC Megafon (Table 4)

The share of borrowed capital in the structure of funding sources of competing companies significantly exceeds the value of PJSC Rostelecom. However, the share of long-term liabilities in the structure of borrowed capital of PJSC Rostelecom lags behind similar indicators of its closest competitors, in particular PJSC VimpelCom and PJSC MTS.

It is also worth noting that the liquidity and net working capital ratios of PJSC Rostelecom are significantly below the average level of competitors. The same is true for debt service indicators.

Taking into account the rather large spread in the values of capital structure indicators in this industry, as well as the previously noted disadvantages of using average (median) industry values as a benchmark to justify decisions on the capital structure, we will try to use more formalized models, in particular, the EBIT volatility method.

Despite the fact that the official website of the company presents consolidated financial statements prepared in accordance with IFRS, the period from 2009 to 2014 was chosen for analysis, since in 2010-2011.

Table 3

Indicators of the capital structure of PJSC Rostelecom for 2011-2014*

Indicator 2011 2012 2013 2014

Financial leverage ratio TD/EQ 1.22 1.37 1.81 1.24

Ratio of total liabilities to assets TD/TA 0.55 0.58 0.64 0.55

Ratio of long-term liabilities to assets LTD/TA 0.29 0.34 0.41 0.33

Debt Coverage Ratio ACR 1.95 1.79 1.60 2.04

Current ratio CR 0.43 0.48 0.47 0.62

Clean working capital NWC, million rubles -75 230 -70 874 -71 208 -46 890

Net debt to assets ratio ND/TA 0.53 0.55 0.63 0.52

Debt service indicators

Interest coverage ratio calculated through EBIT, ICR 4.12 3.31 2.84 2.73

Interest coverage ratio calculated in cash 5.82 5.94 5.42 5.06

flow from ICR operations

* Calculated by the author based on the company's consolidated financial statements. The methodology for calculating indicators characterizing the company's debt load is described in more detail in the author's article "The procedure for determining the company's debt load" // Financial Analytics: Problems and Solutions. 2014. No. 48. S. 39-50.

Table 4

Comparison of indicators of the capital structure of PJSC Rostelecom with competitors in 2014

PJSC PJSC PJSC PJSC

Index *

Rostelecom Vimpelcom MTS Megafon

Indicators of the components of the capital structure

Financial leverage ratio TD/EQ 1.24 2.56 2.59 1.90 -

Ratio of total 0.55 0.72 0.71 0.66 0.67

liabilities to TD/TA assets

Long-term ratio 0.33 0.49 0.48 0.40 -

liabilities to assets LTD/TA

Indicators of the level of coverage of liabilities with assets

Debt coverage ratio 2.04 1.22 1.27 1.37 -

ACR assets

Current ratio CR 0.62 0.78 1.11 0.88 1.07

Provision ratio -0.61 -0.28 0.10 -0.13 -1.11

own working capital

by means of NWC/CA

Net debt to assets ratio 0.52 0.61 0.60 0.61 -

Debt service indicators

Interest coverage ratio calculated through EBIT, ICR 2.73 2.74 6.22 5.93 -

Coverage ratio 5.06 3.63 9.70 8.31

percent, calculated through

cash flow from the operating room

ICR activities

* Data from the Federal State Statistics Service. URL: http://www.httpgks.ru.

there were reorganizations and mergers with a number of companies. Operating profit indicators of PJSC Rostelecom for the analyzed period are presented in Table. 5.

Given that the company has a Standard & Poor's credit rating of BB +, in accordance with Table 2, the default probability is 16.63%. With this default probability, the value of the one-sided inverse Student distribution with five degrees of freedom was: ¿2x0 1663.4 = 1.107. Thus, the allowable value of the annual

Table 5

Operating profit indicators of PJSC Rostelecom in 2009-2014, million rubles

Year Operating profit Average value of operating profit Standard deviation

2009 50 053 50 930,83 7 391,92

the amount of interest payments and repayment of the current part of the debt DP will be:

EBIT - t4C = 50,930.83 - 1.07-7,391.92 = 42,004.65 million rubles

For comparison: in 2014, the company's interest expenses amounted to RUB 15,722 million.

Let us also evaluate the default probability of this company depending on the level of financial leverage (Table 6).

Consider 10 financing scenarios with leverage ranging from 0 to 90%.

The cost of debt financing is determined as the sum of the risk-free rate, taking into account the country risk premium and the default spread.

The yield of US Treasury bonds with a maturity of 10 years was used as the risk-free rate. At the beginning of 2015, it amounted to 2.25%.

To apply this value for a Russian company, an adjustment has been made

Table 6

Assessment of the probability of default depending on the level of financial leverage using the EBIT volatility method

Indicator Scenario

1 2 3 4 5 6 7 8 9 10

Borrowed capital D, % 0 10 20 30 40 50 60 70 80 90

Own capital E, % 100 90 80 70 60 50 40 30 20 10

Financial leverage D/E 0.00 0.11 0.25 0.43 0.67 1.00 1.50 2.33 4.00 9.00

corresponding to financial leverage

Default probability, % 0.07 0.07 0.51 2.50 7.54 16.63 36.80 45 59.01 70

Equity E, 245,227

Borrowed capital, million rubles 0 60 644 121 289 181 933 242 577 303 222 363 866 424 510 485 154 545 799

Risk free rate, % 5.20 5.20 5.20 5.20 5.20 5.20 5.20 5.20 5.20 5.20

Credit spread in 0.40 0.40 0.70 1.20 1.75 3.25 5.00 6.00 7.00 8.00

Interest rate at 5.60 5.60 5.90 6.40 6.95 8.45 10.20 11.20 12.20 13.20

Annual interest 0 3,396 7,156 11,644 16,859 25,622 37,114 47,545 59,189 72,045

debt payments in

Average EBIT, million rubles 50,930.83

Standard deviation of EBIT, million rubles 7391.92

t-statistic 6.8901 6.4306 5.9220 5.3149 4.6093 3.4238 1.8691 0.4580 -1.1172 -2.8564

p-value 0.0009 0.0014 0.002 0.0032 0.0058 0.019 0.12 0.666 1 1

on the difference in the level of inflation, measured by the GDP deflator at the end of 2014, in Russia (5.54%) and the USA (1.17%)2. Thus, the risk-free rate rf was: 2.25% ■ 105.54% / 101.17% = 2.35%. CRP country risk premium - 2.85%.

The default spread was determined in accordance with the credit rating according to the method of A. Damodaran (Table 7).

For each financing option, a t-statistic and its corresponding p-value are determined with five degrees of freedom3, which reflects the probability of default. The obtained data are shown in Fig. 2.

The results of the calculations make it quite clear that a significant increase in the probability of default occurs with an increase in the share of debt capital over 60%, so this value can be considered a critical level when planning the company's debt load.

The main disadvantage of the volatility method

2 Inflation, GDP deflator (annual %) / The World Bank // data. worldbank.org.

3 The number of observed EBIT values is 6 (see Table 5).

Table 7

Interest coverage ratios and default spreads for large industrial companies, published by A. Damodaran as of 01/01/2015

100,000 - 0.199999 D 12

0.2 - 0.649999 C 10.00

0.65 - 0.799999 CC 8.00

0.8 - 1.249999 CCC 7.00

1.25 - 1.499999 B- 6.00

1.5 - 1.749999 B 5.00

1.75 - 1.999999 B+ 4.00

2.0 - 2.2499999 BB 3.25

2.25 - 2.49999 BB+ 2.75

2.5 - 2.999999 BBB 1.75

3.0 - 4.249999 A- 1.20

4.25 - 5.499999 A 1.00

5.5 - 6.499999 A+ 0.90

6.5 - 8.499999AA 0.70

8.50 - 100000 AAA 0.40

Source: Damodaran online // www.damodaran.com.

operating profit EBIT is that the estimate is based on historical data and does not take into account possible changes in external

Figure 2

Probability of default depending on the share of borrowed capital in the structure of funding sources, %

Default Probability

environment and prospects for the development of the company in the future. With high volatility in profit indicators, the reliability of this model sharply decreases. In addition, the introduced assumption about the absence of the influence of the capital structure on the volatility of operating profit does not always correspond to reality.

Like the EBIT volatility model, the EBIT-EPS analysis model estimates the optimal capital structure using the optimal combination of risk and return as the objective function.

Within the framework of the EBIT-EPS model, the optimal capital structure will be such a ratio between own and borrowed funds, which achieves the maximum value of net income per share EPS with minimal financial risk.

The concept of this method of analysis is to determine the amount of operating profit at which earnings per share for two different financing options (from own and from borrowed funds) will be the same.

The value of earnings per share is defined as the sum of net income remaining after payment of interest, taxes and dividends on preferred shares, divided by the number of ordinary shares of the company outstanding:

(1 - T)(EBIT -1) - Dn

where EPS is the amount of profit per ordinary share;

T - income tax rate;

EBIT - operating income (earnings before interest and taxes);

I - interest payments;

n is the number of ordinary shares in circulation.

The level of operating profit at which the value of earnings per share coincides with alternative options for the capital structure is commonly called the "point of indifference", or "critical point" (break-even point; indifference point) 4 . With operating profit above the "point of indifference", a higher EPS value will be provided by greater financial leverage. Accordingly, at

"Teplova T.V. Corporate finance. M.: Yurayt, 2014. C 399.

operating profit below the "critical point" a higher value of EPS will provide lower values of financial leverage.

You can determine the "point of indifference" in the EBIT-EPS model mathematically or graphically.

As noted, the "point of indifference" is the EBIT value at which the amounts of net earnings per share for all funding options are the same. We write this condition in terms of equalities:

(1 - T)(EBIT - p - Dnp

(1 - T)(EBIT -12) - Dn

(1 - T)(EBIT - Ii) - D (1 - T)(EBIT -12) - Du

where EPS1 EPS2 - earnings per ordinary share;

T - income tax rate;

I1 I2 - interest payments depending on the financing option;

n1 n2 - the number of ordinary shares in circulation, depending on the financing option.

Like any of the methods, the EBIT-EPS analysis model has its advantages and disadvantages. Among the advantages include the possibility of selecting the capital structure and drawing up financial plan, which would contribute to the achievement of the maximum value of earnings per share. However, the model also has disadvantages.

First, considering different financing options, the model does not allow them to be combined to make the final decision. management decision. In other words, the application of this method of analysis becomes much more difficult as the number of alternative financing options increases. Also, the model will need to be modified if the company considers convertible bonds or warrant bonds as a financing instrument.

Second, the objective function is to maximize earnings per share, not the market value of the company. EPS maximization does not always automatically meet the main

corporate goal - maximizing the welfare of the owners.

Thirdly, the analysis model is quite static and does not take into account the influence of factors such as information asymmetry on financial markets and, accordingly, signals for investors that a change in the capital structure can cause.

Fourth, risk is not included in the EBIT-EPS analysis model. Although it is well known that the growth of financial leverage is often accompanied by an increase in risk.

You can enter a risk score into the model in one of the following ways.

1. Evaluation of the probability distribution of operating profit (EBIT).

2. For options involving debt financing, comparing the “point of indifference” with the most likely EBIT. Evaluation of the likelihood of a situation where EBIT will be below the “critical point”.

3. Risk assessment by calculating the financial break-even point EBIT* for each financing option:

where EBIT* is the amount of operating profit (earnings before interest and taxes) required to pay interest, taxes and dividends on preferred shares;

I - interest payments;

D - dividends on preferred shares;

T - income tax rate.

The higher the value of the financial break-even point, the more risky this financing option can be considered.

4. Inclusion in the risk analysis by changing the cost of borrowed capital depending on the financial leverage with different financing options. As noted, the interest rate depends on the company's credit rating and the corresponding probability of default.

As a practical example of the application of the EBIT-EPS analysis model, consider the buyback (buyback) of PJSC Rostelecom shares in 2014 using two alternative financing options:

Through debt financing;

Through net profit.

At an extraordinary general meeting of shareholders, a decision was made to reorganize PJSC Rostelecom. Holders of ordinary and preference shares have the right to demand that the company buy out all or part of their shares if they voted against the decision to reorganize PJSC Rostelecom or did not take part in the voting on this issue. The share buyback price will be:

For one ordinary share - 123.93 rubles;

For one preferred share of type A -87.8 rubles.

Subject to legal restrictions (no more than 10% of net assets can be used for redemption), the company can buy back 6.4% of ordinary shares and 13.7% of type A preferred shares. The buyback amount will be 23,161 million rubles.

From the financial statements of PJSC Rostelecom, prepared in accordance with IFRS as of December 31, 2013, the following data were taken:

Operating income before interest and taxes EBIT for 2013 - RUB 44,868 million;

Current interest expenses - 15,800 million rubles;

Effective income tax rate in 2013 - 24.87%;

Net profit in 2013 - 24,131 million rubles.

In accordance with the company's dividend policy, 10% of the net profit is allocated annually to pay dividends on type A preferred shares.

Since the real cost of possible debt financing of the buyback transaction is unknown, we define it as the sum of the risk-free rate, the country risk premium and the default spread.

The yield of US Treasury bonds with a maturity of 10 years was used as the risk-free rate. At the beginning of 2014, it amounted to 2.73%. To apply this value for a Russian company, an adjustment was made for the difference in inflation measured by the GDP deflator at the end of 2013 (in Russia - 5.9%, in the USA - 1.5%)5.

5 Inflation, GDP deflator (annual %) / The World Bank // data. worldbank.org.

Table 8

Comparison of earnings per share with alternative financing options for the transaction LyuBask, RUB mln

Indicator Option 1 Option 2

EBIT 44,868 44,868

Interest payments 15,800 17,711

Balance of other income and expenses 3,051 3,051

Profit before tax 32,119 30,208

Income tax 7,988 7,513

Net income 24,131 22,695

Dividends on preferred shares 2,413 2,270

EPS, rub. 8.67 8.15

Thus, the risk-free rate f was: 2.73% ■ 105.9% / 101.55% = 2.85%. As of January 1, 2014, the country risk premium (CRP) for Russia was estimated at 2.4%6. Given that the company has a Standard & Poor's credit rating of BB+, the default spread will be 3%7. Thus, the estimated cost of borrowings will be 8.25%.

Calculation of earnings per EPS share when financing the buyback at the expense of own funds (option 1) and at the expense of debt financing (option 2) is presented in Table. 8. In the line "Interest payments" for the second financing option, interest payments at a rate of 8.25% for debt financing for the buyback transaction were added to the current interest expenses.

Thus, if the maximization of the EPS value is chosen as the evaluation criterion, then it is recommended to carry out the repurchase transaction at the expense of own funds.

To assess the possible level of risk, we calculate the financial break-even point EBIT * for each option. At the same time, despite the terms of the dividend policy on the payment of dividends on preferred shares in the amount of 10% of net profit, for option 2 we will leave them unchanged:

EBIT-, = 17,711 +-= 20,922.77 million rubles

If we take into account the positive balance of other income and expenses in the amount of 3,051 million rubles, then the point of financial stability for option 2 will be, respectively, 17,872 million rubles, which is significantly

6 Country Default Spreads and Risk Premiums // Damodaran online // www.damodaran.com.

7 Damodaran online // www.damodaran.com.

below the company's average annual operating income.

For the first option of financing the buyback transaction at the expense of net profit, we proceed from the fact that the level of net profit should correspond to the buyback amount of 23,161 million rubles. Accordingly, the level of operating profit is 46,627.89 million rubles, and if we take into account the presence of a positive balance of other income and expenses in the amount of 3,051 million rubles, then EBITj* will amount to 43,577 million rubles.

To test the probability of operating profit falling below the financial break-even level, we use a one-sample Student's t-test. As the main data for evaluation, we will analyze the values of operating profit indicators for six recent years(see Table 5).

We introduce the assumption that operating profit is modeled by a normal distribution. With an average value of EBIT over the past six years of 50,930.83 million rubles, a standard deviation of 7,391.92 million rubles. for the critical specified value of Ebit* - 43,577 million rubles, the value of the t-criterion will be 2.2245.

The tabular value of the Student's t-test with a probability of 95% and the number of degrees of freedom of 5 corresponds to 2.57. Thus, the null hypothesis about the equality of the mathematical expectation of EBIT and the financial break-even point can be confirmed. In other words, the financial break-even point falls within the operating profit confidence interval.

Thus, it can be argued that the methodology for making financial decisions based on the EPS maximization criterion is not perfect. An attempt to include a risk assessment in the EBIT-EPS model suggests that the conclusions obtained during the analysis cannot be considered unambiguous. Accordingly, according to the author, this analysis tool should be used to assess the sensitivity measure when comparing alternative financing options for a company.

Despite the fact that the practice of using more formalized models for determining the optimal level of a company's debt load (the EBIT volatility method, the EBIT-EPS analysis model) shown in the paper has a number of drawbacks, the results obtained allow financial management to make a more informed decision in the field of capital structure management.

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ISSN 2311-8768 (Online) ISSN 2073-4484 (Print)

Assessment and Appraisal Activities

THE PROCEDURE FOR APPLYING THE EBIT VOLATILITY METHOD

AND THE EBIT-EPS ANALYSIS MODEL IN THE FINANCIAL DECISION-MAKING PROCESS

Anna N. ZADOROZHNAYA

Omsk State Transport University, Omsk, Russian Federation [email protected]

article history:

Keywords: structure, capital, debt burden, borrowing capacity, volatility

Objectives The research examines models for substantiating an optimal structure of the capital through the risk-return trade-off: EBIT volatility method, EBIT-EPS analysis method. Methods I analyzed how the theories of capital structure evolved after the Modigliani-Miller theory had appeared, and figured out that the outcome of theoretical researches into the capital structure formation was still difficult to be practically implemented. I tested the EBIT volatility method and EBIT-EPS analysis model and used the case of Rostelecom to analyze whether the optimal debt burden model could be practically applied in relation to the risk-return trade-off function. Results The calculation of the corporate debt capacity that correlates with the optimal debt burden, is a tool to manage the financial flexibility of the company. The outcome of the EBIT volatility method allows concluding that the current debt burden is within tolerable limits, and modeling the probability of default for various combinations of the capital structure. Conclusions and Relevance The EBIT-EPS analysis model allows evaluating the financial break-even point and determining an option for financing a transaction, so to derive maximum earnings per share. Notwithstanding that the article features the optimal debt burden models that have some weaknesses, the results may help financial executives take reasonable decisions on the capital structure management.

1. Modigliani F., Miller M. The Cost of Capital, Corporation Finance and the Theory of Investment. American Economic Review, 1958, vol. 48, no. 3, pp. 261-297.

2. Modigliani F., Miller M. Skol "ko stoitfirma? TeoremaMM. Moscow, Delo Publ., 2001, 272 p.

3. Kraus A., Litzenberger R.H. A State-Preference Model of Optimal Financial Leverage. The Journal of Finance, 1973, vol. 28, iss. 4, pp. 911-922.

4. DeAngelo H., Masulis R. Optimal Capital Structure under Corporate and Personal Taxation. Journal of Financial Economics, 1980, vol. 8, pp. 3-29.

5. Kim E.H. Miller's Equilibrium, Shareholder Leverage Clienteles, and Optimal Capital Structure. The Journal of Finance, 1982, vol. 37, iss. 2, pp. 301-319.

6. Bradley M., Gregg A.J., Kim E.H. On the Existence of an Optimal Capital Structure: Theory and Evidence. The Journal of Finance, 1984, vol. 39, no. 3, pp. 857-878.

7. Fischer E.O., Heinkel R., Zechner J. Dynamic Capital Structure Choice: Theory and Tests. The Journal of Finance, 1989, vol. 44, iss. 1, pp. 19-40.

8. Donaldson G. Corporate Debt Capacity. Harvard University Press, Boston, 1961.

9. Myers S., Majluf N. Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have. Journal of Financial Economics, 1984, vol. 13, iss. 2, pp. 187-221.

10. Krasker W. Stock Price Movements in Response to Stock Issues under Asymmetric Information. The Journal of Finance, 1986, vol. 41, no. 1, pp. 93-105.

11. Narayanan M.P. Debt versus Equity under Asymmetric Information. The Journal of Financial & Quantitative Analysis, 1988, vol. 23, no. 1, pp. 39-51.

12 Ross S.A. The Determination of Financial Structure: the Incentive-Signalling Approach. The Bell Journal of Economics, 1977, vol. 8, no. 1, pp. 23-40.

13. Leland H., Pyle D. Informational Asymmetries, Financial Structure and Financial Intermediation. The Journal of Finance, 1977, vol. 32, no. 2, pp. 371-387.

14. Heinkel R. A Theory of Capital Structure Relevance under Imperfect Information. The Journal of Finance, 1982, vol. 37, iss. 5, pp. 1141-1150.

15. Jensen M., Meckling W. Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.

Journal of Financial Economics, 1976, vol. 3, no. 4, pp. 305-360.

16. Grossman S., Hart O. Corporate Financial Structure and Managerial Incentives. In: Economics of Information and Uncertainty. Chicago, University of Chicago Press, 1982.

17. Jensen M. Agency Costs of Free Cash Flow, Corporate Finance and Takeovers. The American Economic Review, 1986, vol. 76, no. 2, pp. 323-329.

18. Bikhchandani S., Hirshleifer D., Welch I. A Theory of Fads, Fashion, Custom and Cultural Change as Informational Cascades. Journal of Political Economy, 1992, vol. 100, no. 5, pp. 992-1026.

19. Bikhchandani S., Hirshleifer D., Welch I. Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades. The Journal of Economic Perspectives, 1998, vol. 12, no. 3, pp. 151-170.

20. Myers S. Interactions of Corporate Financing and Investment Decisions-Implications for Capital Budgeting.

The Journal of Finance, 1974, vol. 29, no. 1, pp. 1-25.

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