CAPITAL STRUCTURE AND COMPANY’S PERFORMANCE OF

LISTED COMPANIES IN RWANDA STOCK EXCHANGE,

KIGALI, RWANDA

KADINDA ACHENI EDWARD

MBA/3793/13

A Research Project Submitted in Partial Fulfillment for the Requirement of the Award of the Degree of Master of Business Administration (Finance

and Accounting Option) of Mount Kenya University

OCTOBER 2016

i

DECLARATION

This research project is my original work and has not been presented for a degree in any other University, or for any other award.

Students Name: Kadinda Acheni Edward

MBA/3793/13

Sign ______Date ______

This research project has been submitted with my approval as the Mount Kenya University

Supervisor

Name: Mr. Osiemo Kengere Athanas

Sign ______Date ______

ii

DEDICATION I dedicate this study to my beloved parents, my wife and my children for allowing me to pursue my studies without pressure but rather giving me the much needed support.

iii

ACKNOWLEGEMENT First of all, I give glory to almighty God for his blessing in health, knowledge, determination and wisdom to cover this long journey.

I would like to appreciate all the staff members of Mount Kenya University. Without their support I wouldn’t have produced this research project to the quality it deserves. Special thanks go to my supervisor who instructed and guided me throughout the writing of the research project; their advice has helped me greatly.

Thanks a lot.

iv

ABSTRACT Choice of capital structure affects performance of firm. The general objective of the study was to assess the impact of capital structure on company performance. Specifically, the researcher sought to establish the importance of using capital structure to improve company financial performance, establish the importance of using capital structure to improve company operational performance and it contribution in risk management. This study aims to contribute to Rwanda Stock Exchange by providing vital information regarding the importance of listing companies at Rwanda stock exchange and its importance in terms of market capitalization, to academic researchers by providing more information hence facilitating the continuation of conducting more research in the related field of study and Mount Kenya University by providing a source of learning material to the university since one of the copy of this book will be kept in the school library. The researcher used descriptive research design whereby analytical methods were applied to collect quantitative data. Currently, there five listed companies in RSE, namely the Nation Media Group, Uchumi Holdings, BK, BRALIRWA and KCB. The study targeted three of them which have at least operated for not less than three years in order to obtain their sequence of financial structure. Therefore the study targeted Bank of Kigali, BRALIRWA and KCB Bank Rwanda. These companies are listed in the Rwanda Stock Exchange and therefore the researcher used the three institutions as the target population. The financial records for the four years were used starting from 2010 to 2013. This sample size period was considered enough time to make inference concerning the capital structure of the selected target population. The data was collected using secondary method. For the reliability of this instrument the researcher sought the information from finance and accounting departments of the companies and also downloaded those from the internet as well as audit reports were also used. The data collected was analyzed using common size, trend analysis and calculation of ratios from balance sheet and income statements for the year 2010-2013. Analysis was done using Excel to generate tables and figures. It was observed that the three listed companies have been increasing their assets significantly. This enables them to leverage between their equity and liabilities. It is also observed that proper management of capital structure has enabled these companies understudy to improve their operational performance particularly in the banking sector. The banks have been able to increase their points of service (POS), number of ATM machines, number of employees, number of branches and this means that they are in a position to serve many customers. BRALIRWA also have been able to expand its production capacity in order to meet the demand of their client. In general it is observed that these companies have been able to expand its business activities. Proper monitoring of the capital structure has enabled the companies to mitigating credit risks particularly in banking sector. They regulate the amount of debt and equity in order to avoid the burden of paying a lot of money in repaying the debt. The study recommends that the companies need conduct a lot of investment in order to generate more income. They also need to fully utilize their assets so that it could generate more profits. This is because their profitability ratios such as ROA, ROI and ROE are still less than 50% and if a stronger company comes in the market and offers steep competition, they are likely to be subdued.

v

TABLE OF CONTENTS DECLARATION...... ii

DEDICATION...... iii

ACKNOWLEGEMENT...... iv

ABSTRACT ...... v

TABLE OF CONTENTS ...... vi

LIST OF TABLES ...... ix

LIST OF FIGURES ...... x

LIST OF ACRONYMS AND ABBREVIATIONS ...... xi

OPERATIONAL DEFINITION OF TERMS ...... xii

CHAPTER ONE: INTRODUCTION ...... 1

1.0 Introduction ...... 1

1.1 Background to the Study ...... 1

1.2 Statement of the Problem ...... 3

1.3 Research Objectives ...... 3

1.3.1 General Objective ...... 3

1.3.2 Specific Objectives ...... 4

1.4 Research Questions ...... 4

1.5 Significance of the Study ...... 4

1.6 Limitations of the Study...... 5

1.7 Scope of the Study ...... 5

1.8 Organization of the Study ...... 6

CHAPTER TWO: REVIEW OF RELATED LITERATURE ...... 7

2.0 Introduction ...... 7

vi

2.1 Theoretical Literature...... 7

2.1.1 Components of Capital Structure ...... 10

2.2 Empirical Literature ...... 13

2.2.1 Assessment of the Financial Performance of the Company ...... 18

2.2.3 Challenges to Standard Capital Structure Models ...... 20

2.3 Critical Review ...... 28

2.4 Conceptual Framework ...... 29

CHAPTER THREE: RESEARCH METHODOLOGY ...... 31

3.0 Introduction ...... 31

3.1 Research Design...... 31

3.2 Target Population ...... 31

3.3 Sampling Design ...... 31

3.3.1 Sampling Size ...... 31

3.3.2 Sampling Techniques ...... 32

3.4 Data Collection Methods ...... 32

3.4.1 Data Collection Instruments ...... 32

3.4.2 Reliability ...... 33

3.4.3 Validity ...... 33

3.5 Data Processing and Data Analysis ...... 33

3.6 Ethical Considerations ...... 34

CHAPTER FOUR: RESEARCH FINDINGS AND DISCUSSION ...... 35

4.1 Introduction ...... 35

4.2 Competitive Landscape ...... 35

vii

4.3 Financial ratios of the bank from 2010 to 2013 ...... 37

4.3.1 Profitability ...... 37

4.4 KCB Bank Rwanda Ltd ...... 42

4.4.1 Analysis on income Statement ...... 45

4.5 BRALIRWA on Share Capital...... 48

CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS ...... 54

5.1 Introduction ...... 54

5.2 Summary ...... 54

5.3 Capital structure for KCB Bank Rwanda Ltd ...... 56

5.4 Capital structure for BRALIRWA Company ...... 58

5.5 Conclusion ...... 60

5.6 Recommendations ...... 61

REFERENCES ...... 63

APPENDIX 1: RESEARCH AUTHORIZATION LETTER ...... 67

APPENDIX 2: ACCEPTANCE LETTER FROM RSE...... 68

viii

LIST OF TABLES Table 4.1 Showing the competitiveness of the two selected banks ...... 35

Table 4.2 Bank of Kigali capital structure ...... 36

Table 4.3 Total assets ...... 42

Table 4.4 Total deposits ...... 43

Table 4.5 Net operating income ...... 44

Table 4.6 Analysis of interest Income ...... 46

Table 4.7 Non-funded Income ...... 47

Table 4.8 Total equity ...... 49

Table 4.9 Total assets ...... 49

Table 4.10 Return on Assets (ROA) for BRALIRWA ...... 50

Table 4.11 Comparing the average equity and liability with ROA ...... 51

Table 4.12 Total revenue ...... 51

Table 4.13 Net income ...... 52

Table 4.14 Gross profit ...... 52

ix

LIST OF FIGURES

Figure 2.1 Conceptual framework ...... 29

Figure 4.1 Return on Assets ...... 37

Figure 4.2 Return on Average Equity ...... 39

Figure 4.3 Net Interest Margin ...... 40

Figure 4.4 Loan Yield ...... 41

Figure 4.5 Assets (Rwf ‘Mns’) ...... 42

Table 4.5 Total deposits ...... 43

Figure 4.6 Total deposits (Rwf ‘Mns’) ...... 43

x

LIST OF ACRONYMS AND ABBREVIATIONS BRALIRWA: Brasserie et Limonaderie du Rwanda

CMA : Capital Market Authority.

DSE : Dare Es-Salaam Stock Exchange

ICDC : Industrial Commercial and Development Cooperation.

KNTC : Kenya National Trading Cooperation.

KWAL: Kenya Wine Agencies Limited

NSE : Nairobi Stock Exchange

ROA : Return on Assets.

ROE : Return on Equity

ROI : Return on Investment

RSE : Rwanda Stock Exchange

SPSS : Statistical Package for Social Science

USE : Uganda Securities Exchange

xi

OPERATIONAL DEFINITION OF TERMS Budgeting : is a plan for your future income and expenditures that you can use

as a guideline for spending and saving Strebulaev and Yang

(2012).

Capital structure Capital structure refers to combination of different sources of

funds that firm uses to finance its overall operations and growth.

Capital structure is a financial term and it is a mean to finance

company’s overall assets by selecting the appropriate mixture of

debt (long term and short term) and equity (common equity and

preferred equity) (Myers, 2001).

Financial Management : Financial Management means the efficient and effective

management of money (funds) in such a manner as to accomplish

the objectives of the industry (Maheshwari, 2005)

Profitability : A situation of financial state that are used to assess a business's

ability to generate earnings as compared to its expenses and other

relevant costs incurred (Roberta D. & Donald R, 2003).

Rwanda Stock Exchange (RSE): The Rwanda Stock Exchange Limited was incorporated

on 7th October 2005 with the objective of carrying out stock

market operations. The Stock Exchange was demutualized from

the start as it was registered as a company limited by shares

(Margaritis & Psillaki, 2010)

xii

Stock exchange This refers to an organized and regulated financial market where

securities are bought and sold at prices governed by the forces of

demand and supply. Stock exchanges impose stringent rules,

listing requirements, and statutory requirements that are binding on

all listed and trading parties.

xiii

CHAPTER ONE: INTRODUCTION

1.0 Introduction This chapter is divided into the background to the study, statement of the problem, research objectives, and research questions, significance of the study, scope of the study, the limitation of the research and the organization of the study.

1.1 Background to the Study Capital structure and its influence on the company performance and overall value has remained an issue of great attention amongst financial scholars since the decisive research of

(Modigliani & Miller, 1998) arguing that under perfect market setting capital structure doesn’t influence in valuing the firm. This proposition explains that value of the firm is measured by real assets not, the mode they are financed. Capital structure planning is very important to survive the business in long run. After simple watching the balance sheet of company, you see two sides of balance sheet. One side is liability side and other side is asset side. Liability side is the mixture of finance of company which company has collected from internal and external sources and it has been used or will be used for development of company.

Liability side of balance sheet is made under perfect capital structure planning. Finance manager and other promoters decide which source of fund or funds should be selected after monitoring the factors affecting capital structures. So, capital structure planning makes strong balance sheet. The right capital structure planning also increases the power of company to face the losses and changes in financial markets.

This process has been undertaken by many companies across the world in order to survive in the market for the long run. They do so in order to reduce risks of the company, to do 1

adjustment according to business environment and to develop idea on the new source of funding. Most of the listed companies in the stock markets are advice to undertake such planning in order to improve their performance.

With an objective of assessing the effect of capital structure decision in the performance of the firm the capital structure should add the value of the firm as the financing decisions are not investment decision therefore it should bring the future effect of the company performance due to this reason the company need to employ mix of debt and equity (optimal capital structure) and dividend decision which both have an effect on the Earning per share of the firm.

On the theoretical aspect, the study reviewed the relevancy of four key theories behind the capital structure. These are: The Miller Modigliani theorem, Trade-off theory, Agency Cost theory, Bankruptcy cost Theory, and Market timing theory. These are discussed in detail in the conceptual framework and literature review sections.

Rwanda Stock Exchange (RSE) is among the recently established stock markets in the East

African region. RSE is Rwanda's principal stock exchange. It was founded in 7th October

2005. The RSE is operated under the jurisdiction of Rwanda's Capital Markets Advisory

Council, (CMAC), which in turn reports to National Bank of Rwanda, the country's Central

Bank. Since it was recently started, there are few studies which have been conducted to assess the impact of capital structure on the performance of such listed companies in

Rwanda. Therefore, this study aims to fill this gap by assessing the impact of capital structure on company performance. This was conducted by assessing the performance of three main companies in the stock market.

2

1.2 Statement of the Problem The capital structure of a firm describes the way in which a firm raised capital needed to establish and expand its business activities. It is a mixture of various types of equity and debt capital a firm maintained resulting from the firm’s financing decisions. Rwanda Stock

Exchange has attracted few companies in East African market as compared to other stock exchange like Nairobi Stock market. I the process of ensuring that these companies sustainably operate in the market, considering their relevance to RSE, platform there is a need to assess their capital structure as a way of promoting trade in Rwanda. Eldomiaty

(2007) stated that such sort of market environment results in incomplete financial recessions.

Therefore there is a need to investigate the impact of financial leverage level on financial performance in Rwanda as an example of developing economies. The aim of this study is to empirically investigate the association among debt level and financial performance of firms of top companies listed in Rwanda Stock Exchange from 2010-2014 using financial ratio, and Net profit Margin as performance measures. The significance of this study is that it will help the investors to create such a portfolio that yield them maximum profit. It will also enable them how a choice of capital structure effects the financial performance of the company. This study is a first effort to study the impact of capital structure on firms’ financial performance in Rwanda.

1.3 Research Objectives There are two sets of objectives which were used in this study

1.3.1 General Objective

The general objective of the study is to assess the impact of capital structure on company performance.

3

1.3.2 Specific Objectives

The study aims to;

i. Determine the role of capital structure in improving company financial performance

ii. Assess the contributions of equity and asset management on profitability of the

company iii. Determine the role of capital structure on credit risks management.

1.4 Research Questions The following research questions were used in the study

i. What is the role of capital structure in improving company financial performance?

ii. What are the contributions of equity and asset management on profitability of the

company? iii. What is the role of capital structure on credit risk management in a company?

1.5 Significance of the Study This study aims to contribute significantly to the following groups:

1.5.1 To Rwanda stock exchange

This study of capital structure on company performance can provide vital information regarding the importance of listing companies at Rwanda stock exchange and its importance in terms of market capitalization.

1.5.2 To academic researchers

The study will provides more information hence facilitating the continuation of conducting more research in the related field of study.

4

1.5.3 To Mount Kenya University

This study will provide a source of learning material to the university since one of the copy of this book will be kept in the school library.

1.6 Limitations of the Study Generalization of the research conducted was a limiting factor in this study. The information obtained in this study was limited to companies listed at Rwanda Stock Exchange as a case study to be replica of other companies in Rwanda.

1.7 Scope of the Study Context scope: Various publications such as books, journals and other publications explaining the role of capital structure on organization performance was used to support the discussion in this study. However, the researcher also relied on the information which was sought primarily from the concerned people in our case study area in order to ascertain the role, the effects of capital structure on performance.

Geographical scope: The study was conducted in Rwanda Stock Exchange which is located at Kigali City. It is centrally located at Kigali City Tower. There are two domestic companies listed in the market namely, BRALIRWA and BK. However there are three Kenyan companies in the market as well namely, KCB Bank, Uchumi supermarket and Nation media group.

Time scope: The study was conducted specifically within a time scope of a 4 year period from 2010-2013 in order to assess the effects of capital structure on company performance.

5

1.8 Organization of the Study

Chapter one presents the introduction of the study. In this chapter, the researcher presents the background of the study, the statement of the problem, research objectives, research questions, significance of the study, scope and limitation of the study and finally the organization of the study.

Chapter two presents the literature review of related studies whereby the researcher the topic citing the work of other researchers and it is subdivided into theoretical review, empirical review and conceptual review.

Chapter three presents the research methodology which was used in order to collect and analyze the data.

Chapter four presents the findings whereby tables and charts are adequately utilized in order to facilitate easy understanding.

Chapter five presents the summary of the study and also provides the recommendations of the study.

6

CHAPTER TWO: REVIEW OF RELATED LITERATURE

2.0 Introduction In this chapter the researcher discusses the objectives of the study citing the work that other scholars who have published their evidence relating to the role of financial statement on decision making in an organization. The researcher used journals to develop the theoretical debate, empirical debate and the conceptual framework of this study.

2.1 Theoretical Literature Capital structure policy involves a choice between risk and expected return. The optimal capital structure strikes a balance between these risks and returns and thus examines the price of the stock. There five identified principles of corporate structure. These are:

Cost theory: According to this principle ideal pattern of capital structure is one that tends to minimize cost of financing and maximize the earnings per share. Cost of capital is subject to interest rate at which payments have to be made to suppliers of funds and tax status of such payments (Brealey & Myers, 2001).

Risk theory: This principle suggests that such a pattern should be devised so that the company does not run the risk of brining on a receivership with all its difficulties and losses.

Risk principle places relatively greater reliance on common stock for financing capital requirements of the corporation and forbids as far as possible the use of fixed income bearing securities (Khan & Jain, 1997).

Control theory: While deciding appropriate capital structure the financial manager should also keep in mind that controlling position of residual owners remains undisturbed. The use of preferred stock and also bonds offers a means of raising capital without jeopardizing control (Kishore, 2004).

7

Flexibility theory: According to this principle, the management should strive towards achieving such combinations of securities that the management finds it easier to maneuver sources of funds in response to major changes in needs for funds. Not only several alternatives are open for assembling required funds but also bargaining position of the corporation is strengthened while dealing with the supplier of funds (Maheshwari, 2005).

Timing theory: Timing is always important in financing and more particularly in a growing concern. Maneuverability principle is sought to be adhered to in choosing the types of funds so as to enable the company to seize market opportunities and minimize cost of raising capital and obtain substantial savings. Depending on business cycles, demand of different types of securities oscillates. In times of boom when there is all-round business expansion and economic prosperity and investors have strong desire to invest, it is easier to sell equity shares. But in periods of depression bonds should be issued to attract money because investors are afraid to risk their money in stocks which are more or less speculative

(Maheshwari, 2005).

There are different viewpoints on the impact of the debt-equity mix on the shareholder’s wealth. There is a viewpoint that strongly supports the argument that the financing decision has major impact on the shareholder’s wealth, while according to others, the decision about the financial decision is irrelevant as regards maximization of shareholder’s wealth. A great deal of controversy has developed over whether the capital structure of a firm as determined by its financing decision affects its cost of capital. Traditionalists argue that the firm can lower its cost of capital and increase the market value per share by the judicious use of leverage. Modigliani & Miller, on the other hand, argue that in the absence of taxes and other

8

market imperfections, the total value of the firm and its cost of capital are independent of capital structure.

Modigliani and Miller (1998) argued that the financing mix of debt and equity in the capital structure does not affect the value of a firm under perfect market conditions. This theory is broadly known as “Capital Structure Irrelevance”. This theory states that in a perfect world, where there is no tax and transaction cost associated with issuing debt or going bankrupt, and there is no information asymmetry, capital structure does not affect the market value of a firm. It was criticized since it assumes rational economic behavior and perfect market conditions which are applicable to few firms.

Modigliani and Miller (1963) revised the theory by incorporating the tax benefit as a determinant of capital structure. Debt interest is tax deductible and it is called the tax shield.

M&M stated that a firm can offset part of its interest expense through the tax shield in a form of lower tax payment. Therefore, firms will be able to maximize their value by employing more debt in their capital structure. Miller (1977) stated that the value of a firm depends on the tax bracket that will determine the amount of the tax shield. Although the M&M theory has been criticized by my researchers for its irrelevant assumption of perfect market and lack of information asymmetry, the theory has been considered as the foundation for the upcoming expanded capital structure theories (Ahmad, Abdullah & Roslan, 2012).

Myers and Majluf (1984) suggested that profitable firms will rely more on the internally generated fund more than external debt. In addition to expanding the M&M theory, Jensen

9

and Meckling (1976) developed agency theory. Agency cost is defined as the monitoring cost by the principal and a residual loss. According to their argument, the agency problem exists due to a conflict of interest between shareholders and managers (agency cost of equity) or between shareholders and debt holders (agency cost of debt). Thus, the use of debt capital will minimize the agency cost since the payment of debt interest reduces the surplus cash.

2.1.1 Components of Capital Structure

Equity financing: If a firm doesn’t use debt financing, it’s referred to as an un levered firm

(Brigham 2004). This brings about what is referred to as business risk which is defined as riskiness inherent in the firm’s operations if it doesn’t use debt. If a firm doesn’t use debt then its return on invested capital shall be measured by return on equity which is denoted by net income to common stock holders divided by common equity. ROE = Net income to common stock holders (Common equity). This simply means that the business risk of a leverage free firm will be measured by the standard deviation of its Return on equity

Brigham and Houston, (2007). The question is if a firm’s Return on capital is measured using

Return on equity in the absence of debt will the Efficiency ratios exert a significant effect on leverage?

Debt financing: When a firm decides to use debt financing for its operations it’s faced with a financial risk and it’s referred to as a levered firm. Brigham and Houston, (2007) defined financial risk as that additional risk placed on common stock holders as a result of the decision to finance using debt. Financing risk is the probability that the earnings of the firm will not be as projected because of the method of financing. He also continues by saying that financing risk arises because debt has a fixed financing obligation usually in the form of

10

interest which must be met when the obligation falls due before the shareholders can share in the retained earnings.

Cost of capital: Companies influence their cost of capital through a number of ways because the choice of capital structure affects the cost of capital (Sanford, 2001). He further noted that investors providing equity capital were in a more risky position as opposed to those providing debt since owners are the residual claimants of a company's net cash flows.

Owners of a business receive returns through dividend and increase in the value if the firms' as sets often reflected in stock price appreciation. Debt holders on the other hand obtain interest payment before dividends are paid out. Cost of capital therefore in general summarizes the different costs attached to the different sources of financing obtained by an organization Michael (1992). Michael also noted that for the case of equity financing, the shareholders will not often make explicit the return they will require for their capital contribution unlike the capital raised by way of borrowing which normally has an interest rate attached to it which then forms the basis of an organization's cost of capital. It is therefore imperative to note that a highly levered business depends more on debt for its overall financial capitalization which thereby increasing the risk hath to the debt and shareholders. Another important aspect Sanford (2001) raised in his work was that in both debt and equity financing, both instances required higher returns to bear the risk though the weighted average cost of capital could possibly be reduced up to a point as leverage increased from zero since the cost of debt was less than the cost of equity. Thus the business’s choice of degree of financial gearing was likely to have a bearing on its weighted average cost of capital.

11

Interest (Cost of Debt): Pandey (2006) noted that a company could raise debt in a variety of ways which included borrowing funds from financial institutions or by way of public debt in the form of bonds (debentures) for a specified period of time at a certain interest rate. The before tax cost of debt will therefore become the rate of return required by lenders. Michael

(1992) ,in his scholarly works noted that among the two most popular forms of external financing, debt to most business operations looks cheaper and thus many businesses are easily tempted to utilize debt in preference to other forms of financing. Scholars like

Modigliani and Miller (1958), Michael (1992), and Myers (2002) advanced arguments for utilization of debt in one's capital structures sighting advantages like the effect of tax shields on corporate financing. Myers on the other band warned of the dangers of heavily relying on debt to include financial distress and bankruptcy costs (which can be either direct or indirect) noting that corporate bankruptcies occurred when shareholders exercised their right to default.

Dividends (Cost of Equity): When investors provide equity capital to a firm, they acquire a right to the future dividends of that firm given that they become partial owners of the company and that these dividends cannot be determined from the onset Rao Yahyee, and

Syed (2007). They further stated that businesses have an option of raising capital internally by retaining earnings. The opportunity cost of retained earnings is the rate of return on dividend forgone by equity holders and the cost of external equity is the minimum rate of return which the shareholders require on funds supplied by them by purchasing new shares to prevent a decline in the existing market price of the equity share.

12

Simerly, (2000) further noted that they even had the option of distributing the entire earnings to equity shareholders and raise equity capital externally by issuing new shares. It is sometimes argued that the equity cost of capital is free of cost because it is not legally binding for businesses to pay dividends to ordinary shareholders and that in addition it is not fixed as is the case with interest rates and preference dividend rate (Weill , 2008). Therefore the market value of the shares determined by the demand and supply forces in a well functioning capital market reflects the required rate of return to shareholders.

Loan covenants: One of the key functions of loan covenants is to restrict leverage and that not only does a standard loan agreement limit future debt in absolute dollar terms but also act to limit debt in relationship to cash flows. Loan covenants in general are said to preserve loan terms through mitigating credit risk and the impact of loan rating of companies that financial covenants offer material protection for bank loan investors and that standardization of terms and a shift in the investor mix toward institutional lenders could lead to covenant dilution in the future (Fitch, 1999). Examples of financial covenants include a maximum total debt to earnings before interest, and depreciation; maximum total senior debt to earnings before interest, dividends and tax; a minimum interest coverage, net worth and current ratios. The negative covenants include limitation on indebtedness, liens, contingent liability obligations, limitation on sale of company assets, utilization of leases, issuance of dividends and limitation on capital expenditure among others.

2.2 Empirical Literature Kinsman and Newman (1998) studied the relationship between debt level and firms’ performance by including three measures of debt level. This study suggested an inverse

13

relation between the debt level and firms performance and found that earnings are negatively correlated with short-term debt, but are positive with long-term debt. The same result was found by Majumdar and Chibber (1999) in addition to the size effect to be positively related to firms’ performance.

Gleason (2000) tested the relation between performance and leverage using return on assets as performance proxy. The result from the study indicates a significant negative relation between total debt and firms’ performance. The significant negative influence could infer that retailers use more debt than appropriate. Thus, overleveraging negatively affects firms’ performance. The Gleason study also showed that firm size influences the performance with larger retailers earning higher returns on assets compared to small size retailers. The same results were found by Hammes and Chen (2004) with debt ratio negatively related to return on assets and firm’s size positively related to performance.

Mesquita and Lara (2003) showed that short-term debt is positively related to firms’ performance while long-term debt showed an inverse relationship, but no significant result.

Philips and Sipahioglu (2004) inferred no significant relation between capital structure and firms’ financial performance. Analysis from this study suggests that firms with high leverage do not outperform firms with low level of debt.

Abor (2005) studied the relation between return on equity, firm’s size, sales growth and capital structure in a sample of twenty two firms listed in Ghana. The results showed that short-term debt has a significant and positive relation to ROE while long term debt showed

14

the opposite. Total debt also had significant positive relation to ROE implying that the higher debt will increase the profitability of a firm. This study also emphasized the significant positive relationship between firm’s size and sales growth.

However, on the contrary, Carpentier (2006) found no significant evidence of the relationship between the change in debt and change on firm’s value. However, Carpentier did detect a significant positive coefficient between firm’s size and profitability.

Zeitun and Tian (2007) supported the argument by Myers (1977) indicating that capital structure has a significant impact on firm’s performance as measured by ROA and ROE.

Myers argument is that firms with high short-term debt to total assets have higher growth rates and better performance.

The Zeitun and Tian study showed that the high-performance of a firm is associated with higher tax rates which imply a greater tax benefit from the tax shield.

Cheng (2009) studied the effect of financing mix in capital structure on operating performance. Findings from the study indicate that firms should not solely rely on a single source of financing either debt or equity while firms are advised to incorporate both two sources to raise capital. These findings are consistent with the Ebaid (2009) study where it showed significant

An empirical study made by Kim (1978) showed the choice of capital structure. In the study, he showed moderate debts could increase companies’ value by tax shield. But once debts exceed a limit, the cost of bankruptcy would balance out the tax shield benefits, which would

15

lead to the decreasing of corporate value. Brennan and Schwartz (1978) also made research about this question; they explained that there would be two ways to affect the value of companies by issuing debts. One is by issuing debts could increase the tax savings if the firms survives; another one is reducing the probability of firms’ survival. The optimal capital structure of a company would be when the marginal bankrupt cost is equal to marginal revenue of tax shield. Trade-off theory indicates two features in debts financing, one is profitability, and the other is the risk. This theory supplies a probability that a firm might get optimal capital structure which is an improvement of capital structure.

When a company did their business well, it always chooses to expand its business or require more capital invest more industries. What is important to expand business is capital. Capital could be divided with debt and equity. Every coin has two sides, it is same with debt. The advantage is with high debt, companies can have tax exemption also the holders of debt could get a fixed revenue, and there is no need for shareholders to take out their profit to pay debt holders. It is a win-win mode. While the disadvantage of high debt is the higher debt a firm have, the higher risk a firm has to face to, which means the higher odds the firm is going to bankrupt then there is an economy hard time happens.

According to MM theory, a powerful company should have a high ratio of debt. However, in the real world, most powerful companies don’t have high rates of debt.

Myers and Majluf (1984) tried to explain this problem, they proposed Pecking order theory based on many researches’ conclusions in 1984.When firms decide to do a new investment, firms tend to internal financing. Because if a firm decides to issue equity to finance, the outsider investor would choose to believe that this company has lack of capital, which would

16

result in a negative situation that the stock price dropping. Furthermore, the cost of external financing is relatively high, so firms are more likely to keep assets like internal financing, less risky debts and risky equity as a sequentially selection.

Harris and Raviv (1991) and Myers (2003) published two surveys based on MM theory, which are the famous competitive models of capital structure: the static tradeoff model and the pecking order hypothesis. Harris and Raviv (1991) mentioned that the optimal capital structure does exist. If a company set a target debt level and moving towards it, the firm’s optimal capital structure will be considered by managers about personal taxes, bankrupt cost and agency cost and so on. On the other hand, Myer’s pecking order hypothesis (2003) indicates that because there is no strong form of efficient market, which means there must have asymmetric information problem between insider and outsider investors, which lead to the optimal target debt Ratio doesn’t exist.

Jensen and Meckling (1976) expounded the definition of agency cost in 1976; they explained the influence to capital structure by agency issues. They think there are two kinds of interest conflicts, one is when outside shareholders exist in a firm, and it would lead to a different goal between principal and agency. Because of the asymmetric information and uncertain of investment environment, principal needs a system to monitor agency to do reasonable decisions in order to fulfill principal’s interest. The other conflict is the principal and agency has different option on a risky investment decision due to inequality of risk and profitability.

In order to prevent this situation, principal would always choose to append additional clause in contract or take measures to monitor agency, which will definitely increase the relevant cost. In this theory, the optimal capital structure is minimizing the agency cost.

17

In conclusion, there is no accurate answer for the optimal capital structure. Tradeoff theory and pecking order theory have a relatively neutral standpoint to debts-level in capital structure comparing with MM theory. They believe debts have advantages and disadvantages, moreover, trade-off theory confirmed the existence of optimal capital structure; agency cost theory thinks a high debts-level will increase monitoring cost which is not good for the firm’s profitability.

2.2.1 Assessment of the Financial Performance of the Company

Profitability: The concept of profitability is based on the comparison of the cash outflows required for implementing a strategic alternative with the cash inflows that this alternative is expected to generate. Profitability measured as determined by Holz (2002) included profitability in relation to sales and profitability in relation to investment. The profitability in relation to sales is measured by;

Net Profit Margin: This can be obtained when operating expenses, interest and taxes are subtracted from the gross profit. The ratio obtained therefore establishes a relationship between net profits and sales and also indicates management's efficiency in manufacturing, administration and selling of company products. The general rule is for the ratio to turn every cash invested in the business into profits.

Return on Investment and Return on Equity: The return on investment and return on equity are measures of profitability in relation to investment. The return on investment is obtained by dividing the profits after tax by the investment and the return on equity by dividing the profit after tax by the net worth of the business. The return on equity indicates how well management is utilizing the resources of the shareholders and that the ratio of net

18

profits to owners' equity reflects the extent to which management bas achieved proper utilization of shareholders resources.

Liquidity: Pandey, (2006) noted that it was important for a business to meet its obligations as and when they fell due and those liquidity ratios measured the ability of a business to meet current obligations. Liquidity analysis can be clone by the preparation of cash budgets and cash and funds flow statements. The failure of a business to meet its obligations due to insufficient liquidity will result in poor credit worthiness, loss of creditor confidence or at the worst case scenario legal proceedings which if not handled correctly may result into winding up of the business. He also noted the most common ratios which indicate the extent of liquidity or the lack of it to include among others the current ratio and the quick ratio.

Current Ratio: The current ratio is computed by dividing the current assets by the current liabilities. The current assets include cash and all those assets that can be converted into cash within a year to include marketable securities, debtors and inventory. Current liabilities include creditors, payables, accrued expenses, short term bank loans, income tax liabilities and long term debt maturing within one year. As a general rule, King and Santor (2008

)noted that a current ratio of 2:1 or more is considered satisfactory and that a ratio greater than 1 meant that the business had more current assets than current claims against them.

Quick Ratio: The quick ratio on the other band establishes the relationship between quick or liquid assets and current liabilities. It is computed by subtracting inventory from current assets thereby dividing it by the current liabilities. Inventory or stocks are normally deducted since they are considered to be less liquid and they require more time before being turned

19

into cash. A ratio of 1:1 is considered to represent a satisfactory financial performance

(Margaritis & Psillaki, 2010).

2.2.3 Challenges to Standard Capital Structure Models

The development of the static tradeoff, pecking order and market timing hypotheses has greatly enhanced our understanding of the factors that contribute to determining capital structure choices. Nonetheless, a large body of more recent evidence implies that these models all have significant shortcomings as stand-alone models of capital structure.

Primary Challenges to the Pecking Order and Market Timing Hypotheses

Perhaps the most significant challenge to the pecking order hypothesis is the large number of firms who behave in a manner that is inconsistent with the most basic predictions of the pecking order theory. Recall that under the pecking order theory, firms issue equity only as a last resort. In practice, however, a strikingly large number of firms show a strong preference forequity financing over debt financing.

Strebulaev and Yang (2012) find that more than 10% of Compustat firms use no debt at all and more than 20% of Compustat firms have leverage ratios of less than 5%. Many firms use equity financing when they appear to have available debt capacity. Moreover, these are often precisely the firms for which the adverse selection costs of issuing equity should be the highest - e.g. young, higher growth firms. It is difficult to reconcile this behavior with the pecking order hypothesis being a stand-alone model of capital structure.

Similarly, the market timing hypothesis has been challenged as a stand-alone capital structure model on two primary grounds. First, it does a relatively poor job of predicting marginal equity issuance decisions even for those firms for which the theory is most likely to hold.

20

DeAngelo, and Stulz (2010) report that most firms that have “quintessential market timer characteristics” – i.e. high market-to-book ratios and high excess stock returns – do not issue common stock. Second, the fact that most firms do not stockpile the proceeds of equity issues in their cash account when they do issue is inconsistent with the strongsupply effect in equity financing that is implied by the market timing hypothesis.

Primary Challenges to Traditional Static Tradeoff Models

Corporate finance scholars have also identified several pieces of evidence that are inconsistent with standard tradeoff models. First, since more profitable firms should have a lower probability of distress, tradeoff models predict a positive association between leverage and profitability. In contrast to this prediction, however, one of the most robust findings in cross sectional studies is the negative association between leverage and profitability. Second, although tradeoff models emphasize the primary role of the interest tax shield associated with debt financing, evidence in support of this role is tenuous.

Strebulaev and Yang (2012) report a strikingly high proportion of firms that appear to forego the tax advantages of debt financing by choosing to have zero leverage. More generally, the evidence in Graham (2000) implies that firms underutilize the tax shield associated with debt financing. The importance of the interest tax shield in explaining observed leverage ratios is further undermined by the observation that firms used a substantial amount of debt financing prior to the existence of any corporate taxes.

21

Third, another one of the most robust findings in the empirical literature is that firms tend to issue equity following large run-ups in their stock price. Because such run-ups lower the firm’s leverage ratio, trade-off models would predict that, if anything, these firms should issue debt in order to rebalance their leverage ratios back towards their estimated targets.

Fourth, recent studies that analyze the dynamics of capital structure adjustments report that, while firms do adjust their leverage ratios towards estimated targets, on average, the speed of adjustment is much slower than what would be predicted if the factors contained in trade-off models were first order determinants of capital structure.

The bottom line, therefore, is that the capital structure literature has identified significant challenges to the static tradeoff, pecking order, and market timing hypotheses as stand-alone models of capital structure choice. This is not meant to imply that these models are of little value. On the contrary, each of these models has contributed substantially to our understanding of various aspects of capital structure choice. Unfortunately, in my view, none of them individually appears capable of providing an overall description that is completely consistent with observed capital structure choices.

Dynamic Models with Adjustment Costs

Dynamic tradeoff models attempt to reconcile slow speeds of adjustment with tradeoff models by modifying the M-M assumption of zero transaction and issuance costs. These models show that, in the presence of significant costs to adjusting capital structure, leverage ratios can deviate substantially from estimated targets. Subsequent rebalancing to the target

22

will not necessarily be rapid since firms will weigh the benefits of rebalancing against the costs of adjusting capital structure.

Leary and Roberts (2005) point out several implications of such process for capital structure studies. First, persistent shocks to leverage ratios are not necessarily inconsistent with the existence of target leverage ratios. Firms may stray from their optimal leverage ratio for long periods of time, and therefore exhibit slow speeds of adjustment, simply because adjustment costs outweigh rebalancing benefits. Second, the size and frequency of adjustments to target leverage will depend on the nature of adjustment costs, with adjustments being large and infrequent under fixed adjustment costs, and smaller and more frequent under proportional costs of adjustment. Third, temporal and cross-sectional variation in leverage ratios will be misleading for characterizing financing behavior. Two otherwise identical firms might exhibit very different leverage ratios at a point in time, and very different subsequent financing patterns simply because of different random shocks to their leverage ratio.

In addition to providing an explanation for slow speeds of adjustment and ‘lumpy’ issuance behavior, dynamic tradeoff models have gained traction within the profession because they provide plausible explanations for other capital structure phenomena that would otherwise be puzzling.

Strebulaev (2008) points out that in the presence of adjustment costs, the negative association between leverage and profitability is no longer as puzzling. As profitability increases, leverage mechanically decreases due to the positive association between profitability and the value of total capital. If adjustment costs lead to delayed rebalancing, firms will exhibit a

23

negative association between leverage and profitability even if they are following an optimizing strategy in which target leverage is positively related to profitability.

Adjustment costs are consistent with the observed long-run persistence in capital structures observed in Lemmon, Roberts, and Zender (2009). It is difficult to explain such persistence unless firms were managing capital structures towards a target leverage ratio. Third, the intuition of dynamic capital structure models with adjustment costs is consistent with the survey evidence in Graham and Harvey (2001). In their study, CFOs state that in managing their capital structures, they typically have an optimal range of leverage ratios in mind.

Finally, the predictions of dynamic tradeoff models with adjustment costs are consistent with evidence from studies that analyze how firms actually adjust their leverage ratios.

Adjustment Costs are just not Very Large

Dynamic tradeoff models rely on the existence of adjustment costs that are large enough to delay firms from rebalancing their leverage ratios towards their target. But what are these adjustment costs and is it likely that they are large enough to outweigh the benefits of rebalancing? Several recent empirical observations imply that adjustment costs are actually quite small.

The evidence in Sufi’s (2009) study of lines of credit, reports that over 80% of the firms in his sample have access to a line of credit, and the majority of that line of credit is unused at any one point in time. Because it is virtually costless to draw down on an existing line of credit, it is difficult to rationalize substantial adjustment costs if a firm wishes to rebalance its

24

capital structure by increasing its debt. Similarly, commercial paper represents a relatively low-cost source of debt financing that is accessible to a wide set of larger firms. Again, the availability of such debt financing with minimal market frictions suggests that many firms can rebalance their capital structure towards higher leverage at relatively low direct cost.

Finally, even if a firm experiences a shock that pushes its leverage above its target, there are relatively low-cost ways in which firms can rebalance towards a lower leverage ratio.

Fama and French (2005) report that, although seasoned equity offerings (SEOs) are relatively rare, firms frequently issue equity through mergers and acquisitions, private placements, convertible debt, warrants, direct purchase plans, rights issues, and employee options, grants and benefit plans. In fact, McKeon (2012) finds that investor-initiated equity issuances

(primarily the exercise of employee options) have been greater than the combined proceeds of all management-initiated issuances (i.e., IPOs, SEOs, and private placements) over the past decade.

As Fama and French (2005) note, firms can always offset such investor-initiated equity issuance with share repurchases. Nonetheless, the decision to compensate employees with options, and the subsequent decision of whether or not to repurchase shares to offset the resulting stock issues with repurchases constitute a capital structure decision by the firm. The important point is that such a decision involves the choice of a number of different ways of reducing the company’s leverage at relatively low cost.

25

Challenges from observed capital structure dynamics

Even if one believes that the costs of adjusting capital structure at any one point in time are substantial, a number of other related stylized facts from capital structure research appear to be direct contradictions of the predictions from tradeoff models that are based on adjustment costs. Although most dynamic tradeoff models imply that adjustment costs prevent frequent rebalancing, the reality is that firms issue securities (mostly debt) all the time.

Iliev and Welch (2009) report that the average non-stock-return caused change in leverage is

9% per year. This is driven largely by debt issuing activity. Importantly, however, managers do not appear to use these frequent issuances to adjust their capital structure towards a target.

Such evidence seriously undermines the view that it is adjustment costs that cause firms to exhibit slow speeds of adjustment towards target leverage ratios.

Rauh and Sufi (2010) find that firms frequently refinance existing debt claims, again undermining the view that firms are reluctant to issue securities because of large adjustment costs. Second, when firms do issue securities, they frequently do so in a way that moves the firm away from estimated leverage targets. Hovakimian (2004) finds that, on average, debt issues tend to increase the deviation of the firm’s debt ratio from its estimated target. More generally, Welch (2010) finds that when firms experience exogenous shocks (either positive or negative) to their leverage ratio, the number of firms that then actively decrease their leverage ratio is virtually identical to the number that actively increase their leverage regardless of the direction of the initial shock. Even in the presence of adjustment costs or other frictions, these models generally predict that management-initiated debt issues will

26

decrease the firm’s deviation from its target leverage ratio. Third, following such management-initiated deviations from target leverage ratios, subsequent rebalancing back towards target leverage ratios is incredibly slow even when firms appear to have low-cost means of adjusting leverage.

Denis and McKeon (2012) analyze a sample of firms in which firms initiate substantial new borrowings that deliberately increase their leverage well beyond estimated long-run targets.

Although Denis and McKeonfind that these firms subsequently rebalance towards estimated leverage targets, the speed of adjustment is sufficiently slow and the adjustment process sufficiently passive so as to suggest that movement toward the estimated target leverage ratio is not a first-order consideration for their sample firms. More importantly, even when these firms generate a surplus (i.e. cash flow in excess of investment and dividends), many of the firms use the surpluses to increase equity payouts (repurchases and dividend increases).

In other words, the sample firms could have adjusted their capital structure toward long-run targets without incurring any significant transaction cost, but instead chose to do otherwise. De Angelo and Roll (2011) document pervasive instability in the leverage ratios of publicly held firms over horizons as short as five years. Among firms that are listed for twenty or more years, the leverage ratios of over 60% of them move outside a band width of

+/- 0.10relative to their leverage at the beginning of the measurement period. By the time ten years have elapsed, nearly 50% of the firms see their leverage move outside of a band of width 0.40 (i.e. +/-0.20).

27

De Angelo and Roll (2011) conclude that capital structure stability is the exception rather than the rule among publicly-held industrial firms in the U.S. The bottom line, therefore, is that models that rely on stationary target leverage ratios and adjustment costs are inconsistent with simple observed dynamics in capital structure. Not only do they do a poor job of explaining observed capital structures, but they do poorly in explaining subsequent adjustments to capital structure as well.

2.3 Critical Review In as much as a lot of researches have been done on the impact of capital structure on the performance of the organization, most of these studies have actually tend to have extensively discussed a lot of variables which are basically the indicators of performance and left alone the indicators of the capital structure (Kinsman & Nawman, 1998; Majundar & Chibber,

1999; Gleason 2000; Hemms & Chen, 2004; Mesquitta & Lara, 2003). The studies did not establish a clear relationship between capital structure and organization performance.

Therefore, after reviewing the empirical literature of other scholars, it was realized that none of the previous researchers have attempted to address the impact of capital structure on the organization performance in Rwanda. Hence the researcher was eager to bring a new impute to our local stock of knowledge of this era.

28

2.4 Conceptual Framework Dependent Variable Independent Variable

Company performance Capital structure

 Role of capital structure in Shareholder’s funds improving company financial Equity capital

performance Preference capital Retained earnings  Contributions of equity and asset management on profitability Borrowed Fund  Role of capital structure on Debentures credit risks management Term loans Public deposits

 Government policies

 Demand and supply  Globalization

 Policy

 Dividends

Figure 2.1 Conceptual framework

Source: Literature Review by Researcher

The study identifies two sets of variables. In components of capital structure, shareholder's

funds (owned capital) means funds provided or contributed by the owners. It is also known as

owned capital or ownership capital. In components of Capital structure, equity share capital

represents the ownership capital of the company. It is the permanent capital and cannot be

withdrawn during the lifetime of the company. They are the real risk bearers, but they also

enjoy rewards. Their liability is restricted to their capital contributed. Preference shareholders

29

are also owners of the firm, and they get preference regarding payment of dividends and repayment of Capital. They are cautious investors. Preference Shares carry a stipulated dividend. For Retained earnings, instead of distributing all the profits to shareholders by way of a dividend, the firm retains / keeps / saves a part of the profit for self-financing. Retained earnings constitute the sum total of those profits which have been realized over the years and have been reinvested in the business. Thus, it is also known as self-financing or ploughing back of profits.

The others are in form of loans of money raised using different means other than deducting from the operations of the business. The researcher seeks to link whether the capital structure of the company may affect its performance in terms of return on assets, return on equity and return on capital employed. Of course there are other factors which may affect this process such as the government policies, market demand and supply, globalization and the state of economy.

30

CHAPTER THREE: RESEARCH METHODOLOGY

3.0 Introduction This chapter provides detail regarding the overall approach which was used in the research process. The chapter explains why the researcher was collect the data, the nature of the data collected, where data was collected, how it was collected and how it was analysed.

3.1 Research Design Research design is the roadmap according to which the research intends to achieve the goals and objectives. The researcher used descriptive research design whereby analytical methods were applied to collect quantitative data. Quantitative data was collected in numeric terms.

3.2 Target Population The study targeted the financial and accounts departments for Bank of Kigali, BRALIRWA and

KCB bank Rwanda. These companies are listed in the Rwanda Stock Exchange and therefore the researcher used the three institutions as the target population.

3.3 Sampling Design

3.3.1 Sampling Size

This refers to the number of items to be selected from the universe to constitute a sample.

The size of sample should neither be excessively large, nor too small. It should be optimum

(Kothari, 2004). The financial records for the four years were used starting from 2010 to

2013. This sample size period was considered enough time to make inference concerning the capital structure of the selected target population.

31

3.3.2 Sampling Techniques The researcher applied analytical method in assessing the data collected from financial reports. Financial reports for the four the past four consecutive years formed the sample. The researcher prefers this technique because it gives systematic trend on the capital structure of the listed companies in RSE and how they manage them each year in order to generate more profits.

3.4 Data Collection Methods Data collection Procedures included the activity of gathering information about a subject under the review. After identifying the ideal data collection tool, the researcher applied to manages of selected areas of study to express his interest of conducting academic research in their institutions. A cover letter explaining the purpose of the study was attached to the research instruments in which it was served as a clarification that the researcher is indeed the benefited student at the Mount Kenya University and the study conducted is purely for the academic purpose.

3.4.1 Data Collection Instruments

The data was collected using secondary method. The secondary is the data which is already available and data that has been previously gathered by some other researcher. This was obtained from the already prepared consolidated available financial statements of BK, KCB and BRALIRWA companies for the period of 2010-2013. The purpose was to collect the information which could enable the researcher to analyze the financial performance on the past four years.

32

3.4.2 Reliability

Reliability is a measure of how consistent the results from a test are. Reliability is quantified if you administer a test to a subject twice and get the same score on the second administration as on the first. For the reliability of this instrument the researcher sought the information from finance and accounting departments of the companies and also downloaded them from the internet. All the audit reports were used and therefore it implies that the materials used for this study was reliable.

3.4.3 Validity

It is more concerned in the question on whether the research method actually measures the intended purpose. The validity of the instruments used was done by ensuring that all the financial statement used in this study are audited.

3.5 Data Processing and Data Analysis The data collected were analyzed using documentary analysis by using several techniques such as common size, trend analysis and calculation of ratios from balance sheet and income statements for the year 2010-2013.

The common-size financial statement analysis refers to the analysis and interpretation of financial statement”. This consists of applying analytical tools and techniques to financial statements and other relevant data to obtain useful information.

Here expenses are expressed as percentages to sales in case of income statement, and total assets side and total liabilities side is taken as in percentage in case of balance sheet.

Trend analysis: In this technique the change from year to year and every item in income statement and balance sheet is analyzed using statistical graphs.

33

Ratio analysis: Prasana Chandra (2011) defined ratio as “an arithmetical relationship between two figures. Financial ratio analysis is a study of ratio between various items or groups of items in the financial statements”

A ratio is a mathematical and fixed relationship in degree or number between two quantities or numbers. Ratios can be found out by dividing one number by another number. Ratios show how one number is related to another. It may be expressed in the form of co-efficient, percentage, proportion, or rate.

The objective in using the ratio when analyzing financial information is simply standardize the information being analyzed so that comparison can be made between ratios of a company at different points in time.

3.6 Ethical Considerations The researcher maintained the anonymity of the information sought by avoiding the questions which requires the respondents to provide their name particularly the finance department who provided the financial records. However, this study will be conducted for the purpose of academics and no part of this study shall be reproduces without the consent from the school.

34

CHAPTER FOUR: RESEARCH FINDINGS AND DISCUSSION

4.1 Introduction This chapter presents the presentation and analysis of the data. Interpretation will be made

appropriately in order to facilitate understandability of the research. The study assessed the

information in the financial books from all the listed companies.

4.2 Competitive Landscape There are five listed companies in Rwanda stock market. However, three of them were

reelected for this study because they have operated for more than three years in the market

and therefore their statistics can be easily compared. According to KCB financial reports

2010-2013, it indicated that the bank was rated at position seven out of the total 8

commercial banks in Rwanda by then.

Table 4.1 Showing the competitiveness of the two selected banks

Market share/Total Market Market Market Assets share/Number share/Number of share/Number of of Customers* ATMs Branches

BK 35% 27% 3 (6.1%) 24 (10.8%)

KCB RWANDA 5% 2% 14 (28.5%) 9 (4%)

(KCB strategic plan, 2011)

The table shows that BK maintains the leading position among all other banks in Rwanda

with a market share of 35%, dominating with the number of clients with 27% leading in the

number of branches with 10.8%. However, KCB Rwanda dominates BK with the number of

ATMs with 28.5%. BRALIRWA on the other hand is one of the leading in brewery in the

35

country. All these three companies are listed in the Rwanda stock market. The Rwanda Stock

Exchange (RSE), is Rwanda's principal stock exchange. It was founded in January 2011. The

RSE is operated under the jurisdiction of Rwanda's Capital Market Authority (CMA). The exchange's doors opened for trading on 31 January 2011. That day coincided with the first day of trading in the stock of Rwanda's only brewery, BRALIRWA, which trades under the symbol: BLR.

Table 4.2 Bank of Kigali capital structure 2013 2012 2011 2010

Rwf’000 Rwf’000 Rwf’000 Rwf’000

Total assets 422,360,073 322,794,214 287,899,874 197,676,646

Total liabilities 351,596,389 259,686,921 226,315,542 165,806,759

Total equity 70,763,684 63,107,293 61,584,332 31,869,887

Total liabilities and equity 422,360,073 322,794,214 287,899,874 197,676,646

Source: BK Financial Reports from (2010 to 2013)

The study reveals that BK’s financial performance has been improving over the years from

2010 to 2013. It was observed that the assets of the bank in 2010 were 197,676,646 FRW and there have been consistently increasing to 422,360,073 FRW in 2014. Total liability has also showed a constant increase from 2010 in 165,806,759 FRW to a figure of 351,596,389 FRW

2013. Increase in liabilities is as a result of increase in assets and this can simply mean that the bank operations have constantly increased therefore incurs a lot of liabilities as well.

Total equity was 31,869,887 and the trend has been consistently growing to a total of

70,763,684 FRW in 2013. Similarly, total liabilities and equity was 197,676,646 FRW in

36

2010 and in 2013 it had increased up to 422,360,073 FRW. This implies that the financial performance of the bank have been performing well.

4.3 Financial ratios of the bank from 2010 to 2013

4.3.1 Profitability

The following table summarizes the financial performance of the bank based on its profitability trend from 2010 to 2013. This financial reporting was done with the consideration of IFRS.

Therefore, from the above table, following the subsequent year’s financial performance, the following trends were observed.

Figure 4.1 Return on Assets (Source: Secondary data, Bank of Kigali financial statement 2013)

Return on Assets expresses the net income earned by a company as a percentage of the total assets available for use by that company. ROA suggests that companies with higher amounts

37

of assets should be able to earn higher levels of income. ROA measures management’s ability to earn a return on the firm’s resources (assets). The income amount used in this computation is income before the deduction of interest expense, since interest is the return to creditors for the resources that they provide t the firm. The resulting adjusted income amount is thereby the income before any distribution to those who provided funds to the company.

ROA is computed by dividing net income plus interest expense by the company’s average investment in asset during the year.

The study found out that there has been a consistent increase in the return on average assets from 2010 to 2013. In 2010, the ROA was recorded at 3.5%, in 2011, it increased to 3.6%, in

2012 it also increased further to 3.9% and by 2013 it was recorded at 4.0%. this means that there have been a progressive growth on the ROA which shows a good sign of performance in terms of profitability. There are many factors which might have led to the above observed trends and one of the main thing which might have triggered this is the change in accounting policy disclosure. Issued in May 2008, IFRS 5 Non-current Assets Held for Sale and

Discontinued Operations: clarifies that when a subsidiary is classified as held for sale, all its assets and liabilities are classified as held for sale, even when the entity remains a non- controlling interest after the sale transaction. The amendment is applied prospectively and has no impact on the financial position nor financial performance of the Bank.

Issued in April 2009, IFRS 8 Operating Segments: clarifies that segment assets and liabilities need only be reported when those assets and liabilities are included in measures that are used by the chief operating decision maker. As the Bank’s chief operating decision maker does review segment assets and liabilities, the Bank has continued to disclose this information.

38

Figure 4.2 Return on Average Equity (Source: Secondary data, Bank of Kigali financial statement 2013)

Common or ordinary shareholders are entitled to the residue profits. The rate of dividend is not fixed; the earnings may be distributed to shareholders or retained in the business.

Nevertheless, the net profit after tax represents their return. A return on shareholder’s equity is calculated to see the profitability of owners’ investment. The shareholders’’ equity or net worth will include paid up share capital, share premium and reserves and surplus less accumulated losses.

According to the international financial reporting, the ROAE is considered to be inadequate and therefore the performance of the bank is not good. The continued viability of a bank depends on its ability to earn an adequate return on its assets and capital. Good earnings performance enables a bank to fund its expansion, remain competitive in the market and replenish and /or increase its capital. A number of authors have argued that, banks that must

39

survive need: Higher Return on Assets (ROA)., better return on net worth/Equity (ROE), sound capital base i.e. the Capital Adequacy Ratio (CAR), adoption of corporate governance ensuring transparency to stakeholders that is equity holders, regulators and the public.

The study found out that the ROAE of the bank since 2010 to 2013 was had a decline trend.

In 2010 the ROAE was rated at 24.5%, in 2011 the figure dropped to 18.6% but it later increased to 18.9% in 2012 and further made an increase to 22.1% in 2013. This implies that although there was a decline in 2011 and, the trend seems to be showing an improvement on the values which the shareholders get at the end of the year as the return.

Figure 4.3 Net Interest Margin (Source: Secondary data, Bank of Kigali financial statement 2013)

The study established that there was an increase on the net interest margin since 2010 to

2013. In 2010 the figure showed that it was rated at 8.3%, in 2011, it was rated at 8.4%, in

2012, it increased to 9.6% and in 2013 it went up to 11.1%. This means that there is high chance to increase in the subsequent years. It therefore implies that the financial institution

40

have been receiving a lot of clients who borrow loans which eventually return them with an interest charges.

Figure 4.4 Loan Yield (Source: Secondary data, Bank of Kigali financial statement 2013)

Loan yield is derived from the net loans taken by the bank clients. Over the bank has recorded an increase in the net loans and therefore this might have informed the behavior in which there is an increase in loan yield since 2010 to 2013. The statistics generated from the financial statement indicates that in 2010 the loan yield contributed up to 15.8% of the bank profits, in 2011 it yielded 16.9%, in 2012 it yielded 17% and in 2013 it yielded 20.5%. This shows the significance of loans in financial institutions.

41

4.4 KCB Bank Rwanda Ltd Table 4.3 Total assets Years Assets in Rwf’000

2010 54,306,000

2011 65,052,000

2012 71,228,000

2013 80,340,000

(Source: Secondary data, KCB Rwanda financial statement 2013)

Figure 4.5 Assets (Rwf ‘Mns’) (Source: Secondary data, KCB Rwanda financial statement 2013)

The balance sheet showed the bank’s total assets was projected to increase by an average

24% annually from Rwf from Rwf 34,146,110 million in 2011 to Rwf 58,980,283 million,

80,741,741 million in 2012 and 108,095,920 in 2013. In actual statements it indicated that in

2010 the total assets were 54,306 million in 2011 it went up to 65,052 million, in 2012 it also

42

went up to 71,228 million and in 2013 it was 80,340 million. It is observed that the initial projections were lower than the actual amount realized but subsequently the growth was not steady at 36% as it was projected because we can see that at the end of 2013, the amount realized were lower than the amount projected.

Table 4.4 Total deposits Years Deposits in Rwf’000

2010 32,258,000

2011 47,889,000

2012 54,284,000

2013 52,025,000

(Source: Secondary data, KCB Rwanda financial statement 2013)

Figure 4.6 Total deposits (Rwf ‘Mns’) (Source: Secondary data, KCB Rwanda financial statement 2013)

43

Customer deposits grew from a forecast of Rwf 26,039 million in 2010 to Rwf 43,099 million in 2011 and Rwf 134,794 million in 2013 representing 39% average annual growth underpinned by growth in customer numbers and deposit mobilization through the retail branch network. Proper marketing facilitated a right platform to grow customer base to

50,000 in 2011, increase retail deposits and reduce the cost of funds. Hence net advances increased in tandem by an average 44% from Rwf 15,978 million in 2010 to Rwf 31,870 million in 2011 and Rwf 99,273 million by 2013.

But according to the real financial statements of the bank, it is observed that in 2010 the total customer deposit were 32,258 million which were actually higher than the forecasted in the strategic plan. Similarly in subsequent years, there was a constant rise such that in 2013, the amount customer deposit was 99,273 million.

Table 4.5 Net operating income Years Net operating income in Rwf’000

2010 2,736,000

2011 6,643,000

2012 8,483,000

2013 8,985,000

(Source: Secondary data, KCB Rwanda financial statement 2013)

44

Figure 4.7 Net operating income

(Source: Secondary data, KCB Rwanda financial statement 2013)

4.4.1 Analysis on income Statement

Profits are projected to rise from a forecast loss of Rwf 2,302 million in 2010 to a profit of

Rwf 250 million in 2011 and accelerate to reach Rwf 6,750 million in 2013. This represents a relatively aggressive growth consistent with the banks’ overarching objective of doubling profits every three years. The bottom-line is underpinned by gains in market share and better management of the cost base. All the strategic projects aimed at improving customer service/experience, attracting more customers to the banking halls and other service points and improving efficiencies might have been considered critical and the implementation was done effectively in a timely manner.

45

Table 4.6 Analysis of interest Income Amounts in RWF mn Yield 2010 2011 2012 2013

Personal loans 18% 528 1,353 1,932 2,807

SME banking 18% 228 729 1,113 1,603

Mortgages 18% 153 614 930 1306

Corporate 17% 731 1,293 1,789 2,399

Treasury 7% 369 430 609 809

Staff accounts 7% 26 50 60 72

Total 2,035 4,468 6,433 8,995

(Source: Secondary data, KCB Rwanda financial statement 2013)

Total interest income increased from Rwf 2,035 million in 2010 to Rwf 14,900 million in

2013. This represents a 49% annual increase cutting across all business segments. Though the basket of personal loan and corporate products continue to be the cash cows, the Micro- banking and SME products are expected to contribute increasingly to the asset portfolio considering the immense untapped potential in these sectors. Interest from lending activities constituted about 90% of total interest income and it increasd from Rwf 4,039 million in

2010 to Rwf 13,500 million in 2013. On the other hand, interest income from Government securities and other money market assets grew from Rwf 326 million in 2010 to Rwf 954 million in 2013. Interest from placements also increased from Rwf 104 million in 2010 to

Rwf 445 million in 2013. The segmental contribution to top-line revenues is shown below.

The retail segment contributes an average 47% while corporate, treasury and mortgages contribute 29%, 14% and 9% respectively. The balance of 1% comes from staff accounts.

46

Table 4.7 Non-funded Income Description 2010 2011 2012 2013 CORPORATE SEGMENT Interest from Customers 731 1,293 1,789 2,399 Interest paid to Customers 529 806 1,187 1,584 Net interest income 202 487 603 815 Commission and fees 442 928 1,114 1,337 Total Income 644 1,415 1,717 2,152 RETAIL (PERSONAL/SME/MIC)

Interest from Customers 909 2,696 3,974 5,715 Interest paid to Customers 74 107 165 223 Net interest income 835 2,588 3,810 5,492 Commission and fees 663 1,393 1,671 2,005 Total Income 1,498 3,981 5,481 7,497 TREASURY Interest from Govt Securities 80 326 415 551 Interest from placements with 289 104 194 257 banks Interest paid money market 47 91 131 180 Net interest income 322 339 479 629 Foreign Earnings 545 1,144 1,601 2,082 Total Income 867 1,483 2,080 2,711 OTHER HEAD OFFICE DEPTS Interest income staff loans 26 50 60 72 Total Income 26 50 60 72 Total Operating Income 3,035 6,928 9,337 12,432 (Source: Secondary data, KCB Rwanda financial statement 2013)

Commissions, fees and other non-funds based income will contribute an average of 44% of the bank’s operating incomes and will increase from Rwf 3,465 million in 2011 to Rwf 8,130

47

million in 2013. This is an income stream driven by business volumes and highly sensitive to service quality. The bank targets to grow the customer base to 50,000 from the current

27,000 during 2011 to drive volumes. Specific marketing and promotional programs will be rolled out to attract customers and sensitize them on the range of services available in the bank.

4.5 BRALIRWA on Share Capital BRALIRWA Ltd is a public company limited by shares since 9 June, 2010. The company is a subsidiary of Heineken N.V of Netherlands which owns 75% of the total shareholding while the remaining 25% is owned by the public. The company has a capital of Rwf

514,285,000 divided into 514,285,000 ordinary shares with a value of 1 Rwf. The number of the shareholders is 2,594 as per 25 March, 2014.

The annual meeting of shareholders considers the recommendation of the Directors to increase the share capital from Rwf 514.285.000 to Rwf 5.142.850.000 and decided by special resolution to increase share capital to Rwf 5.142.850.000 of 1,028,570,000 shares of

Rwf5.00 per share through incorporation of Rwf 4,628,565,000 from retained earnings

(reserves) by increasing the par value of our shares from Rwf1.00 per share to Rwf5.00 per share and issue one new share for every one share held as at 23 May, 2014, all the shares ranking pari passu thereafter and that the new shares will not qualify for dividends paid in respect of 2013.

48

Table 4.8 Total equity Years Rwf’000 Percentage change

2010 16,094,000 15.93916393

2011 19,677,880 19.48856438

2012 30,013,151 29.72440251

2013 35,186,388 34.84786918

Total 100,971,419 100

(Source: Secondary data, BRALIRWA financial statement 2013)

The study shows that the equity of BRALIRWA in 2010 was 16,094,000 rwf and it grew by

15.9% to reach at 19,677,880 rwf in 2011. It then grew by 19.5% from that year and it stopped at 30,013,151 rwf in 2012. Finally, in 2013 the company registered a growth of

34.8% on its equity. This shows that company is showing a sign of growth on its equity.

Table 4.9 Total assets Years Rwf’000 Percentage

2010 38,685,000 15.19212

2011 49,889,793 19.59239

2012 74,526,830 29.26768

2013 91,537,000 35.94781

Total 254,638,623 100

(Source: Secondary data, BRALIRWA financial statement 2013)

The study indicates that BRALIRWA Company an increasing growth for the 4 years observed. In the first year of our analysis scope, it is indicated that there was a growth rate of

15.2% in 2010, followed by 19.6% in 2011, then 29.3% in 2012 and finally 35.5% in 2013.

49

This implies that the company continuously managed their capital structure such that they can be in a position to grow their assets.

Table 4.10 Return on Assets (ROA) for BRALIRWA Year Total assets in Rwf’000 Net profit Rwf’000 ROA

2010 38,685,000 10,331,000 27%

2011 49,889,793 20,178,000 40%

2012 74,526,830 25,266,000 34%

2013 91,536,816 15,459,000 17%

(Source: Secondary data, BRALIRWA financial statement 2013)

Return on assets is significant in this analysis because it gives idea as to how effective management is using its assets to generate earnings. In 2010 assets worth Rwf 38,685,000 was able to generate a ROA of 27% which means that the company produces 1Rwf of profit for every Rwf 4 it has invested in its assets. In 2013 assets worth Rwf 91,536,816 was able to generate a ROA of 17%. It indicates that although the there was a consistent increase in total assets over the period under study, ROA kept changing. The operating environment was challenging in 2012. Nevertheless, BRALIRWA Ltd maintained its leadership position in the market and delivered strong performance during the year. Revenue growth of 16.9% was due to increased pricing, volume growth of 4.6% and improved brand mix in the market. Results from operating activities (EBIT) grew by 25.2% and was driven by higher revenue and effective cost management and controls in 2012.

50

Table 4.11 Comparing the average equity and liability with ROA 2010 2011 2012 2013

Total liabilities 71% 72% 71% 72%

Total equity 29% 29% 29% 29%

ROA 27% 40% 34% 17%

(Source: Secondary data, BRALIRWA financial statement 2013)

In 2010 the average assets and liability was divided such that the liability maintained a higher percentage of 71% and the equity was 29%. The ROA was found to be 27%. Subsequently, there was an increase in liabilities in 2011 to 72% and the total average assets reduced to

29%. The slight change made an increase on its ROA to 40% during that year. In 2012, the ratios between total liability and the total assets were also altered and the ROA dropped by

7% to 34% during the same year. In 2013, the ratio between total liabilities and total assets was 72% and 28% respectively. The ROA was observed to have changed to 17%.

Table 4.12 Total revenue Years RWF’000 Percentage 2010 52,798,554 19.32321641 2011 64,958,343 23.77345636 2012 76,978,563 28.17261684 2013 78,503,492 28.7307104 Total 273,238,952 100 (Source: Secondary data, BRALIRWA financial statement 2013)

In 2010 the company registered an average growth of 19.3 on its revenue, 23.8% in 2011,

28.2% in 2012 and 28.7% in 2013. This is also an indication that the capital structure of the company also supports the growth of revenue which the company collects.

51

Table 4.13 Net income Years RWF’000 Percentage

2010 10,330,543 17.3697124

2011 14,657,709 24.64538309

2012 19,027,272 31.99233984

2013 15,458,938 25.99256467

Total 59,474,462 100

(Source: Secondary data, BRALIRWA financial statement 2013)

The table indicates that in 2010 the company registered an average growth on its net income at 17.4% then followed by another increase of 24.6% in 2011, followed by 32.0% in 2012 but eventually dropped to 26.0% in 2013. The legal reserve is based on a Government decree of

12 February 1998 which required an appropriation of 5% of net income for the prior year until a maximum level of 10% of the issued share capital. The legal reserve is not distributable to shareholders.

Table 4.14 Gross profit Years RWF’000 Percentage

2010 25,684,000 20.33345472

2011 34,251,000 27.11575914

2012 34,541,000 27.34534573

2013 31,838,000 25.20544041

126,314,000 100

(Source: Secondary data, BRALIRWA financial statement 2013)

52

The statistics on this table shows that the average growth of the gross profit in 2010 was 20.3 on its revenue, 27.1% in 2011, and 27.3% in 2012 and then it dropped to 25.2% in 2013. It is observed that the gross profit declined by 2% to Rwf 31.8 billion as increased costs were absorbed within the business.

53

CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 Introduction In this chapter the researcher presents a brief summary which reflects what was covered in chapter four and also presents the conclusion which sums the study. Recommendations are also presented in this chapter aimed at addressing the identified gap.

5.2 Summary Competitiveness of the two selected banks

It was observed that BK maintains the leading position among all other banks in Rwanda with a market share of 35%, dominating with the number of clients with 27% leading in the number of branches with 10.8%. However, KCB Rwanda dominates BK with the number of

ATMs with 28.5%. BRALIRWAr on the other hand is one of the leading in brewery in the country. All these three companies are listed in the Rwanda stock market. The Rwanda Stock

Exchange (RSE), is Rwanda's principal stock exchange. It was founded in January 2011. The

RSE was operated under the jurisdiction of Rwanda's Capital Market Authority (CMA). The exchange's doors opened for trading in 2011.

Bank of Kigali capital structure

In most studies of bank Profitability determinants, the total asset is used a measure for bank size. Bank size is usually used to account for potential economies or diseconomies of scale in the banking sector. Additionally, bank size is associated with diversification which may impact favorably on risk and product portfolio.

54

The study established that there has been a steady Compound Annual Growth Rate (CAGR) of 27.9% on total assets in the banks since 2010 to 2013. In 2010 the total assets of the bank was valued at 197.7 billion francs, in 2011 it shoot to 287.9 billion francs, in 2012 the figure stood at 322.8 billion francs and in 2013 the bank recorded a total assets of 422.4 billion francs. This statistics shows that the bank can project the performance of the bank even for the future if for instance the CAGR remain constant. Such projections can be approved by international financial reporting and therefore it leads to improvement in performance of the bank.

Total liability has also showed a constant increase from 2010 in 165,806,759 FRW to a figure of 351,596,389 FRW 2013. Increase in liabilities is as a result of increase in assets and this can simply mean that the bank operations have constantly increased therefore incurs a lot of liabilities as well.

Total equity was 31,869,887 and the trend has been consistently growing to a total of

70,763,684 FRW in 2013. Similarly, total liabilities and equity was 197,676,646 FRW in

2010 and in 2013 it had increased up to 422,360,073 FRW. This implies that the financial performance of the bank have been performing well.

Return on Assets expresses the net income earned by a company as a percentage of the total assets available for use by that company. ROA suggests that companies with higher amounts of assets should be able to earn higher levels of income. The study found out that there has been a consistent increase in the return on average assets from 2010 to 2013. In 2010, the

ROA was recorded at 3.5%, in 2011, it increased to 3.6%, in 2012 it also increased further to

3.9% and by 2013 it was recorded at 4.0%. This means that there has been a progressive

55

growth on the ROA which shows a good sign of performance in terms of profitability. There are many factors which might have led to the above observed trends and one of the main things which might have triggered this is the change in accounting policy disclosure.

The study found out that the ROAE of the bank since 2010 to 2013 had a declining trend. In

2010 the ROAE was rated at 24.5%, in 2011 the figure dropped to 18.6% but it later increased to 18.9% in 2012 and further made an increase to 22.1% in 2013. This implies that although there was a decline in 2011 and, the trend seems to be showing an improvement on the values which the shareholders get at the end of the year as the return.

5.3 Capital structure for KCB Bank Rwanda Ltd The balance sheet showed the bank’s total assets was projected to increase by an average

24% annually from Rwf from Rwf 34,146,110 million in 2011 to Rwf 58,980,283 million,

80,741,741 million in 2012 and 108,095,920 in 2013. In actual statements it indicated that in

2010 the total assets were 54,306 million in 2011 it went up to 65,052 million, in 2012 it also went up to 71,228 million and in 2013 it was 80,340 million. It is observed that the initial projections were lower than the actual amount realized but subsequently the growth was not steady at 36% as it was projected because we can see that at the end of 2013, the amount realized were lower than the amount projected.

Customer deposits grew from Rwf 26,039 million in 2010 to Rwf 43,099 million in 2011 and

Rwf 134,794 million in 2013 representing 39% average annual growth underpinned by growth in customer numbers and deposit mobilization through the retail branch network. The

T24 system should provide the right platform to grow customer base to 50,000 in 2011, increase retail deposits and reduce the cost of funds. Hence net advances will increase in

56

tandem by an average 44% from a forecast of Rwf 15,978 million in 2010 to Rwf 31,870 million in 2011 and Rwf 99,273 million by 2013.

But according to the financial statements of the bank, it is observed that in 2010 the total customer deposit were 32,258 million which were actually higher than the forecasted in the strategic plan. Similarly in subsequent years, there is a constant rise which shows that even in

2013, the amount can be higher than 99,273 million as earlier predicted.

Profits rose from Rwf 2,302 million in 2010 to a profit of Rwf 250 million in 2011 and accelerate to reach Rwf 6,750 million in 2013. This represents a relatively aggressive growth consistent with the banks’ overarching objective of doubling profits every three years. The bottom-line is underpinned by gains in market share and better management of the cost base.

All the strategic projects aimed at improving customer service/experience, attracting more customers to the banking halls and other service points and improving efficiencies might have been considered critical and the implementation was done effectively in a timely manner.

Total interest income increased from Rwf 2,035 million in 2010 to Rwf 14,900 million in

2013. This represents a 49% annual increase cutting across all business segments. Though the basket of personal loan and corporate products continue to be the cash cows, the Micro- banking and SME products are expected to contribute increasingly to the asset portfolio considering the immense untapped potential in these sectors. Interest from lending activities constituted about 90% of total interest income and it increased from Rwf 4,039 million in

2010 to Rwf 13,500 million in 2013. On the other hand, interest income from Government securities and other money market assets grew from Rwf 326 million in 2010 to Rwf 954

57

million in 2013. Interest from placements also increased from Rwf 104 million in 2010 to

Rwf 445 million in 2013. The segmental contribution to top-line revenues is shown below.

The retail segment contributes an average 47% while corporate, treasury and mortgages contribute 29%, 14% and 9% respectively. The balance of 1% comes from staff accounts.

5.4 Capital structure for BRALIRWA Company BRALIRWA Ltd is a public company limited by shares since 9 June, 2010. The company is a subsidiary of Heineken N.V of Netherlands which owns 75% of the total shareholding while the remaining 25% is owned by the public. The company has a capital of Rwf

514,285,000 divided into 514,285,000 ordinary shares with a value of 1 Rwf. The number of the shareholders is 2,594 as per 25 March, 2014.

The annual meeting of shareholders considers the recommendation of the Directors to increase the share capital from Rwf 514.285.000 to Rwf 5.142.850.000 and decided by special resolution to increase share capital to Rwf 5.142.850.000 of

1,028,570,000 shares of Rwf5.00 per share through incorporation of Rwf 4,628,565,000 from retained earnings (reserves) by increasing the par value of our shares from Rwf1.00 per share to Rwf5.00 per share and issue one new share for every one share held as at 23 May, 2014, all the shares ranking pari passu thereafter and that the new shares will not qualify for dividends paid in respect of 2013 and to amend the articles of association adopted on 9 June,

2010 completed by the special meeting of shareholders of 11 November, 2010 accordingly whereby they agreed that the share capital of the company shall be held by the following shareholders: Heineken International B.V., owner of ordinary shares; Limba B.V., owner of 359,950,000 ordinary shares and Others shareholders, owner of 257,140,000 ordinary shares. 58

The study shows that the equity of BRALIRWA in 2010 was 16,094,000 rwf and it grew by

15.9% to reach at 19,677,880 rwf in 2011. It then grew by 19.5% from that year and it stopped at 30,013,151 rwf in 2012. Finally, in 2013 the company registered a growth of

34.8% on its equity.

The study indicates that BRALIRWA Company an increasing growth for the 4 years observed. In the first year of our analysis scope, it is indicated that there was a growth rate of

15.2% in 2010, followed by 19.6% in 2011, then 29.3% in 2012 and finally 35.5% in 2013.

This implies that the company continuously managed their capital structure such that they can be in a position to grow their assets.

Return on Assets (ROA)

Return on assets is significant in this analysis because it gives idea as to how effective management is using its assets to generate earnings. In 2010 assets worth Rwf 38,685,000 was able to generate a ROA of 27% which means that the company produces 1Rwf of profit for every Rwf 4 it has invested in its assets. In 2013 assets worth Rwf 91,536,816 was able to generate a ROA of 17%. It indicates that although the there was a consistent increase in total assets over the period under study, ROA kept changing. The operating environment was challenging in 2012. Nevertheless, BRALIRWA Ltd maintained its leadership position in the market and delivered strong performance during the year. Revenue growth of 16.9% was due to increased pricing, volume growth of 4.6% and improved brand mix in the market. Results from operating activities (EBIT) grew by 25.2% and was driven by higher revenue and effective cost management and controls in 2012.

59

In 2010 the average assets and liability was divided such that the liability maintained a higher percentage of 71% and the equity was 29%. The ROA was found to be 27%. Subsequently, there was an increase in liabilities in 2011 to 72% and the total average assets reduced to

29%. The slight change made an increase on its ROA to 40% during that year. In 2012, the ratios between total liability and the total assets were also altered and the ROA dropped by

7% to 34% during the same year. In 2013, the ratio between total liabilities and total assets was 72% and 28% respectively. The ROA was observed to have changed to 17%.

In 2010 the company registered an average growth of 19.3 on its revenue, 23.8% in 2011,

28.2% in 2012 and 28.7% in 2013. This is also an indication that the capital structure of the company also supports the growth of revenue which the company collects.

In 2010 the company registered an average growth on its net income at 17.4% then followed by another increase of 24.6% in 2011, followed by 32.0% in 2012 but eventually dropped to

26.0% in 2013. The legal reserve is based on a Government decree of 12 February 1998 which required an appropriation of 5% of net income for the prior year until a maximum level of 10% of the issued share capital. The legal reserve is not distributable to shareholders.

The statistics on this table shows that the average growth of the gross profit in 2010 was 20.3 on its revenue, 27.1% in 2011, and 27.3% in 2012 and then it dropped to 25.2% in 2013. It is observed that the gross profit declined by 2% to Rwf 31.8 billion as increased costs were absorbed within the business.

5.5 Conclusion It is observed that the three companies under study have been able to manage their capital structure for the period observed in order to improve their financial performance. It was observed that the three listed companies have been increasing their assets significantly. This

60

enables them to leverage between their equity and liabilities. By so doing these, they are able to increase their ROA through profitable investment. However, the ROI has also improved especially for the banking sector.

It is also observed that proper management of capital structure has enabled these companies understudy to improve their operational performance particularly in the banking sector. The banks have been able to increase their points of service (POS), number of ATM machines, number of employees, number of branches and this means that they are in a position to serve many customers. BRALIRWA also have been able to expand its production capacity in order to meet the demand of their client. In general it is observed that these companies have been able to expand its business activities.

Proper monitoring of the capital structure has enabled the companies to mitigating credit risks particularly in banking sector. They regulate the amount of debt and equity in order to avoid the burden of paying a lot of money in repaying the debt. This has been done by constantly increasing their capital base as well the amount of equity.

5.6 Recommendations Having observed the relevance of leveraging the company’s debts and equity the researcher recommends that although these listed company’s shows a sign of progressive growth their capital structure is still weak such that if a stronger company comes in the market and offers steep competition, they are likely to be subdued. This is because their profitability ratios such as ROA, ROI and ROE are still less than 50%. The study recommends that the companies need conduct a lot of investment in order to generate more income. They also need to fully utilize their assets so that it could generate more profits.

61

The study also realized that there are few listed companies in RSE and therefore it raises concern to assess the capital structure of companies in Rwanda. However, there might be an existence of knowledge gap between companies and RSE which needs to be addressed. Many companies do not have the knowledge base information about stock market whereas on the other hand, RSE staff seems to do little to advice them attract and therefore few companies are currently listed in the market. RSE has to come out strongly to sensitize the importance of

Stock Market in order to attract more companies.

Additionally, taxes pose another challenge in Rwanda. The taxes are very high and tend to discourage foreign companies to come to Rwanda. The government needs to come up with a way of harmonizing tax policies to attract more companies in the country.

62

REFERENCES Abor, J. (2005).The Effect of Capital Structure on Profitability: Empirical Analysis of Listed

Firms in Ghana, Journal of Risk Finance, 6(5):438-45.

Agarawal R. & Zhao X. (2007).The Leverage–Value Relationship Puzzle: An Industry

Effects Resolution, Journal of Economics and Business, 59:286-297.

Brealey R., A. & Myers S.,C. (2001)“Principles of Corporate Finance” (6th Edition), Tata

McGraw-Hill Publishing Company Limited, New Delhi. pp.524. 3.

Cheng ,Y., Liu ,Y. & Chien ,C. (2010). Capital Structure and Firm Value in China Panel

Threshold Regression Analysis, African Journal of Business Management, 4(12) :

2500-2507.

Ghosh, S. (2007). Leverage, Managerial Monitoring and Firm Valuation: A Simultaneous

Equation Approach, Research in Economics, 61: 84–98.

Gleason, K. C., L. K Mathur, & I. Mathur. (2000).The Interrelationship between Culture,

Capital Structure, and Performance: Evidence from European Retailers, Journal of

Business Research, 50:185-191.

Grossman, S. J. & Hart, O. (1982).Corporate Financial Structure and Management

Incentives”, In: The Economics of Information and Uncertainty,:107–140. University

of Chicago Press,Chicago.

Harris, M., & Raviv, A. (1991). The Theory of Capital Structure, The Journal of Finance,

46:297-355.

Holz, Carsten A. (2002). The Impact of The Liability-Asset Ratio on Profitability in China's

Industrial State-Owned Enterprises , China Economic Review,13: 1-26.

Hovakimain, A., Opler, T. & Titman, S. (2001), The Debt-Equity Choice, Journal of

Financial and Quantitative Analysis, 36(1):PP.1-24.

63

Hurdle, G. (1973). Leverage, Risk, Market Structure and Profitability, The Review of

Economics and Statistics: 478-485.

Jensen, M. & Meckling, W. (1976). Theory of the Firm: Managerial Behavior, Agency Costs

and Ownership Structure, Journal of Financial Economics, 3:305-60.

Khan R. & Jain G. (1997) “Financial Management” (2nd edition), Tata McGraw-Hill

Publishing Company Limited, New Delhi. pp.473, 517-518.

King,M. & Santor,E.(2008). Family Values: Ownership Structure, Performance and Capital

Structure of Canadian Firms, Journal of Banking and Finance, 32:2423-2432.

Kishore.R.M (2004) “Financial Management” (5th edition) (Taxman), pp.454.

Krishnan,V. & Moyer,R.(1997). Performance, Capital Structure and Home Country: An

Analysis of Asian Corporation, Global Finance Journal, 8 (1):130-143.

Li,H. ,Meng,L., Wang,Q. & Zhou, L.(2008). Political Connections, Financing and Firm

Performance: Evidence from Chinese Private Firms, Journal of Development

Economics, 87:283–299.

Maheshwari.S.N. (2005) “Management Accounting & Financial Control” Sultan Chand &

Sons. Delhi, pp. D.63.

Majumdar, S.K., Chhibber, P. (1999). Capital Structure and Performance: Evidence from a

Transition Economy on an Aspect of Corporate Governance, Public Choice,98:287-

305.

Margaritis, D. & Psillaki, M. (2007). Capital Structure and Firm Efficiency, Journal of

Business Finance & Accounting, 34: 1447–1469.

Margaritis, D. & Psillaki, M. (2010). Capital Structure, Equity Ownership and Firm

Performance, Journal of Banking and Finance, 34:621-632.

64

McConnell, J., & Servaes, H. (1995). Equity Ownership and the Two Faces of Debt. Journal

of Financial Economics, 39: 131–157.

Miller M., H. (1977). Debt and Taxes, Journal of Finance, 32(2): 261-275.

Modigliani, F. & Miller, M. (1963). Corporate income taxes and the cost of capital: a

correction, The American Economic Review,53:443-53.

Modigliani, F., Miller, M.(1998).The Cost of Capital, Corporation Finance and The Theory

of Investment, The American Economic Review,48 (3) :261-97.

Myers .S. C.(2001).Capital Structure, Journal of Economic perspectives, 15(2):81-102.

Myers, S. (1977).Determinants of Corporate Borrowing, Journal of Financial Economics, 5:

147-176.

Myers, S.C.(1984).The Capital Structure Puzzle, Journal of Finance, 39 :575-92.

Onaolapo, A. & Kajola,O.(2010). Capital Structure and Firm Performance: Evidence from

Nigeria, European Journal of Economics, Finance and Administrative Sciences,

25:70-82.

Rao N,V.,Al-Yahyee, K & Syed.L.(2007). Capital Structure and Financial Performance:

Evidence from Oman, Indian Journal of Economics and Business,:1-23.

Roberta D. & Donald R. (2003). Debt, Incentives and Performance: Evidence from UK Panel

Data ,Economic Journal, Royal Economic Society, 113(490):903-91.

Ross, S.(1977).The Determination of Financial Structure: The Incentive Signaling Approach,

Bell Journal of Economics, 8:23-40.

Simerly, R. & Li,M.(2000).Environmental Dynamism ,Capital Structure and Performance: A

Theoretical Integration and an Empirical Test, Strategic Management Journal, 21:31–

49.

65

Weill ,L.(2008). Leverage and Corporate Performance: Does Institutional Environment

Matter? Small Business Economics, 30:.251–265.

66

APPENDIX 1: RESEARCH AUTHORIZATION LETTER

KIGALI CAMPUS SCHOOL OF POST GRADUATE STUDIES RESEARCH AUTHORIZATION

2nd July, 2015 TO WHOM IT MAY CONCERN

Dear Sir/Madam MR. KADINDA ACHENI EDWARD MBA/3793/13 This is to confirm that the above named person is a bona fide student of Mount Kenya University (Kigali campus). He is currently caring out research work to enable him complete Master of Business Administration (Accounting and Finance Option) degree program. The title of his research is: CAPITAL STRUCTURE AND COMPANY’S PERFORMANCE: A CASE OF LISTED COMPANIES RWANDA STOCK EXCHANGE The information received will be confidential and for academic purpose only. Any assistance accorded him to complete this study will be highly appreciated.

67

APPENDIX 2: ACCEPTANCE LETTER FROM RSE

November 17th, 2015

Dear Sir/Madam,

RE : ACCEPTANCE LETTER

Reference is made to the letter requesting to collect data at Rwanda Stock Exchange, this is to confirm that KADINDA ACHENI EDWARD a Master’s student at Mt. Kenya University can collect data for his research project entitled “CAPITAL STRUCTURE AND COMPANY’S PERFORMANCE: A CASE OF LISTED COMPANIES RWANDA STOCK EXCHANGE”.

I wish you a great time during data collection at Rwanda Stock Exchange

RSEKCT Building, 1st Floor, Avenue du Commerce, PO Box 5337 Kigali Rwanda

68