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28 pages
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Alaska Christian College
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The Hashemite University

January 10, 2021
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Capital Structure Optimization: Theoretical Problems and Empirical Solutions
ArticleinSSRN Electronic Journal · January 2017
DOI: 10.2139/ssrn.2966307
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Andrey Zahariev
D. A. Tsenov Academy of Economics - Svishtov
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Electronic copy available at: https://ssrn.com/abstract=2966307
Capital structure optimization: theoretical problems and empirical solutions 1
© Prof. Andrey Zahariev, PhD www.finance1952.com
Capital structure optimization: theoretical
problems and empirical solutions
Prof. Andrey Zahariev, PhD
D. A. Tsenov Academy of Economics
Department of Finance and Credit
[email protected]-svishtov.bg
Summary:
The aim of this research is to introduce a methodology for the
optimisation of capital structure of companies, on the basis of
fundamental company indicators and stock exchange rates. A similar
methodology provides the answer to a series of questions and solves
significant problems faced by business practice, related to the realisation
of the main purpose of financial managers of public companies
maximising stock wealth. The achievement of this aim is based on the
effect of financial leverage on the profit of one share and its stock
exchange capitalisation. Therefore within the range of the research, we
identify four separate group of problems in the field of applied capital
optimisation which require precise financial and investment
circumstances and appropriate solutions. The research includes five parts:
First. Technology for modification of the balance sheet positions of the
company; Second; Methodology for construction of the risk adopted
corporate interest rate curve; Third. Technology for maximization of EPS
and technology for evaluation of the company’s risk; Fourth.
Maximization of Value per Share; Fifth. Empirical findings for the blue
chip companies on the Bulgarian capital market.
Key words:
Capital structure, EPS maximization, Business Risk, P/E Ratio,
WACC, CAPM
JEL:
G32, G34
Electronic copy available at: https://ssrn.com/abstract=2966307
Capital structure optimization: theoretical problems and empirical solutions 2
© Prof. Andrey Zahariev, PhD www.finance1952.com
Introduction
The cost of capital is the major theory of the modern financial
theory. The relation between cost financing (the right side of the balance
sheet) and the rate of return (the left side of the balance sheet) is a
milestone of all strategies for the development of the modern financial
management concept. The cost of capital is a mathematical function of the
capital structure, its components and the companies income tax burden.
Therefore the problem of optimizing the capital structure is still a vital
area of scientific research and empirical findings.
The aim of this paper is to introduce and test a methodology for
the optimisation of capital structure of public companies, on the basis of
fundamental company indicators and stock exchange rates. A similar
methodology provides the answer to a series of questions and solves
significant problems faced by business practice, related to the realisation
of the main purpose of financial managers in public companies
maximising stock wealth. The achievement of this aim is based on the
effect of financial leverage on the profit per share and its market
capitalisation. The initial finding of Modigliani and Miler (1958, 1959
and 1963) started a large process of scientific debate where the practical
solutions of empirical problems of the capital structure of the public
companies are often underestimated. Therefore within the range of the
research, we identify various groups of problems in the field of applied
capital optimisation technology which require precise financial and
investment circumstances and appropriate solutions.
The research includes five parts: First. Technology for
modification of the balance sheet positions of the company; Second;
Methodology for construction of the risk adopted corporate interest rate
curve; Third. Technology for maximization of EPS and technology for
evaluation of the company’s risk; Fourth. Maximization of Value per
Share; Fifth. Empirical findings for the blue chip companies on the
Bulgarian capital market.
1. Technology for modification of the balance sheet positions of
the company
The methodology defended by the author for the optimisation of
long-term financing of Bulgarian public companies in the period 2010-
2013 adheres to the theoretical basis and empirical evidence developed in
Electronic copy available at: https://ssrn.com/abstract=2966307
Capital structure optimization: theoretical problems and empirical solutions 3
© Prof. Andrey Zahariev, PhD www.finance1952.com
our earlier researches (See: Zahariev (2011; 2012; 2014a and 2014b)). In
a theoretical and applied aspect, emphasis is placed on the joint-stock
company Sopharma AD using financial data for the period 1 January 2010
31 December 2012. The issue of transposing the accounting data of the
balance of the company for the purposes of capital optimisation requires a
precise overview of the structure of liabilities. On this basis, we defend
the thesis regarding the applicability of three stages of modification of
balance positions for the public joint-stock company for the purposes of
optimizing the capital structure of Bulgarian public companies:
Stage one. The systematization of capital balance (see Table
1);
Stage two. The systematization of the modified balance of
owner’s equity and long-term liabilities (see Table 2);
Stage three. The construction of a modified non-leveraged
capital balance (see Table 3).
The present-day analysis of the evolution of the global financial
and economic post-crisis recovery justifies the importance of the specific
dynamics of the company's capital structure and volume in terms of its
business cycles and market segmentation.
The aim is to approbate a technology for optimization of the
capital structure of Bulgarian companies using empirical data as of 2011.
First we shall analyze the financial data published by Balgarska Roza
Sevastopolis PLC as of 31 Dec. 2010. The area of the research are several
bench mark public companies in terms of their business exposure,
maximum earnings per share, the beta coefficient of their stocks and the
optimality of their capital structure. The model follows the concepts
included in theories of Modigliani and Miler (1958) and is applied to
empirical data with specific technological recommendations by the
author.
The financial profile of the public companies in Bulgaria is
determined by their equity structure, stock price dynamics and economic
sectors they operate in. The subject of this study is Balgarska Roza
Sevastopolis PLC (4BJ/SEVTO) a company that produces and trades in
essential oils, cosmetics, chemical substances and drugs
1
. The company is
a benchmark for its sector, which represents Bulgaria's comparative
advantages on an international scale. The stock of the company is traded
1
http://www.infostock.bg/infostock/control/profile/SEVTO
Capital structure optimization: theoretical problems and empirical solutions 4
© Prof. Andrey Zahariev, PhD www.finance1952.com
on the official stock market in Segment "B". The company’s equity
structure is as follows:
2
Shareholder:
Equity share:
Sopharma AD
49.99%
Other legal entities
23.70%
Telso AD
9.99%
Individuals
9.71%
DOVERIE - United Holding PLC
6.61%
In the period 13 Dec. 2010 12 Dec. 2011 the company's stock
index was negative reaching -7.41% compared to the value of the SOFIX
index of -15.82%. The financial synthesis of the accounting balance sheet
(Table 1) allows us to modify the accounting balance sheet by extracting
the long-term financing elements equity and debt. The capital resources
are used mainly to finance long-term assets and current assets with long-
term debt and equity.
The initial stage of the optimization of the capital structure of
Bulgarian public companies consists of modifying the accounting
balance sheet by transferring the long-term (debt and equity) financing
(Table 1) and retaining the shareholders' equity and retained earnings into
2
Ibid.
Capital structure optimization: theoretical problems and empirical solutions 5
© Prof. Andrey Zahariev, PhD www.finance1952.com
the liabilities part (Table 2) in order to avoid all entries from revaluations
and other accounting revalorization techniques.
Table 1
ASSETS
LIABILITIES
#
Item
Amount in
BGN
#
Item
Amount in
BGN
1.
Non-current assets
19 374 000
1.
Shareholders' equity
12 066 000
2.
Current assets
financed with long-
term liabilities
3 544 000
2.
Reserves
3 273 000
3.
Retained earnings
from previous periods
4 764 000
4.
Long-term liabilities
2 815 000
TOTAL ASSETS
financed with long-
term liabilities and
equity
22 918 000
TOTAL
LIABILITIES:
22 918 000
The essential second stage of the optimization is the synthesis of
the company's income statement (Table 3) for the last three years. Our
aim is to use actual empirical data and estimate the revenues and expenses
in terms of three scenarios pessimistic (25%), realistic (50%) and
optimistic (25%). For the purposes of our optimization model we assume
that the company distributes all earnings as dividends, i.e. EPS=DPS. The
above data show that after the second stage of the modification of the
synthesis of the company's balance sheet the book value exceeds 1.39
times the face value per share.
Table 2
ASSETS
LIABILITIES
#
Item
Amount in
BGN
#
Item
Amount in
BGN
1.
Non-current assets
19 374 000
1.
Shareholders' equity
12 066 000
2.
Current assets
financed with long-
term liabilities
-2 544 000
2.
Reserves
0
3.
Retained earnings
from previous
periods
4 764 000
4.
Long-term liabilities
0
TOTAL ASSETS
16 830 000
TOTAL
LIABILITIES:
16 830 000
Capital structure optimization: theoretical problems and empirical solutions 6
Table 3
Item:
Amount in
BGN thousand
Item:
Amount in
BGN thousand
Expenditures
Depreciation (D)
2010
13210.00
2010
740.00
2009
11971.00
2009
736.00
2008
12518.00
2008
606.00
Average annual
Average annual

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