Human Resource Management (HRM) in a Multinational Enterprise

Comparison between Domestic and International HRM The practices of international HRM and domestic HRM involve a number of commonalities. For instance, personnel planning, staffing, recruitment, selection, evaluation and development as well as remuneration are practices carried out by both domestic and international HRM. However, the operations of domestic HRM involve employees within the border of a single nation whereas international HRM encompasses three categories of nationals (Farndale Paauwe, 2005).Advertising We will write a custom essay sample on Human Resource Management (HRM) in a Multinational Enterprise specifically for you for only $16.05 $11/page Learn More In other words, international HRM utilizes the services of personnel from the parent nation where the corporation is headquartered. Additionally, global HRM deals with employees from host countries where the corporation’s subsidiary offices are located. Moreover, international HRM utilizes other third countries’ personnel as sources of labor, research as well as development. Despite the commonalities in the practices of domestic and international HRM, two main differences exist in their practices. The differences arise from the complications in operations of international HRM and the employment procedures of personnel from different nations. Considering the complexities of operations in different countries, Multinational Enterprises (MNE) must identify and comprehend the best ways of managing the geographically dispersed personnel within foreign subsidiaries in order to have control of both domestic and foreign employees as well as gain international competitive edge (Farndale Paauwe, 2005). In other words, international HRM practices are more complex compared to domestic HRM due to a number of reasons. First, the international HRM tackles international taxation, coordinates foreign currencies and exchange rates. Further, the HR of an MNE manages the concerns of workers from different cultures as opposed domestic HR managers who only manage employees of a single country. Moreover, international HRM practices must adhere to external concerns in its foreign subsidiaries including local codes of conduct, religious beliefs and providing employment opportunity to the natives. Regarding the employment of diverse national groups of employees, international HRM must follow the set regulations concerning the recruitment of personnel. For instance, employees who work abroad and are United States nationals must remit annual income taxes to the government. In addition, the HR manager of MNE must incorporate the diverse cultures of employees in the operations. Standardization of HRM Practices The integration of international HRM practices through the imposition of parent practices to the subsidiaries of the MNEs is driven by two main factors. First, strategic aspects are invaluable drivers of standardizing HRM practices of MNEs. In other wo rds, the international corporations have to function within the framework of global circumstances.Advertising Looking for essay on business economics? Let's see if we can help you! Get your first paper with 15% OFF Learn More For instance, the MNEs carry out operations within the peripheral perspectives of the industry as well as inter-organizational connections and agreements. Such aspects influence the practices of international HRM and the aims of the multinational enterprise (Harzing Ruysseveldt, 2004). Second, the organizational context is another important driver for standardization of HRM practices. In essence, the unique and diverse culture of MNEs and the institutional environment of the firms are widely thought-out to determine the explicit HRM practices in different states. Additionally, the organizational structures including exports and sales of subsidiaries affect HRM practices. The adoption of a worldwide corporate culture by an MNE has numerous advant ages. For example, in situations where high capital ventures are to be remunerated, the HR executives are supposed to utilize the business culture and lingo of the host nation. Additionally, the adoption of the international corporate culture for each subsidiary prevents the elimination of the corporation’s protected market niche due to changing regulations of the host countries. The Role of Subsidiary For multinational enterprises to gain competitive edge in operations, the coordination and integration of the firms’ dispersed organizational units is critical. As such, the subsidiary is capable of achieving local receptiveness as well as international incorporation (Dowling et al., 2013). In other words, a subsidiary is critical in the operations of MNE because it function together with the firm’s headquarters to achieve optimal output. The subsidiary performs a number of roles. In fact, the subsidiary acts as integrated player, implementer, local innovator as w ell as global pacesetter. As an integrated player, the subsidiary is tasked with the responsibility of coming up with useful information that can be utilized by the organization to realize optimal performance. Regarding the role of an implementer, the subsidiary undertakes the creation of individual knowledge and depends heavily on the data from sister ancillaries in performing the directives of the parent firm (Caldwell, 2003). The role of global innovator is where the subsidiary acts as the source of information and knowledge for other auxiliaries. Regarding the local innovator, the subsidiary has the full responsibility of developing appropriate expertise and proficiency in the important functional sections. In general, the subsidiary provides the coordination mechanisms and location competencies that enable the parent firm to achieve the overall strategic roles.Advertising We will write a custom essay sample on Human Resource Management (HRM) in a Multinational Enterprise s pecifically for you for only $16.05 $11/page Learn More Factors that Drive Localization of HRM Practices for MNE Adjusting HRM activities according to the norms and values of a host nation is significant for the success of MNEs (Farndale Paauwe, 2005). The major factors that drive localization of HRM practices for a multinational enterprise are the cultural and institutional environments. To begin with, the cultural environment of an organization affects the way in which the employees of the firm share diverse ways of life including common values, attitudes and behaviors transmitted through a gradual dynamic process over time (Dowling et al., 2013). In other words, culture influences work and HRM practices in a number of ways. For example, culture affects the remunerations conduct including the diverse anticipations of the executive and junior staff relations as well as performance. Additionally, in an organizational culture in which performance is based on incorporated personal social relations, equilibrium of inherent and extrinsic remunerations is often valued. On the contrary, a MNE whose work culture is based on individual autonomy and segregation, extrinsic rewards are normally emphasized. Institutional culture also ensures humane orientation of employees, collectivism in the organization as well as gender egalitarianism to minimize discrimination based on sex. Generally, the HRM practices of the MNE are invaluable in enhancing cohesion between subsidiaries through the adoption of the local norms and values (Dowling et al., 2013). Second, the institutional environment is significant in determining the performance as well as anticipations in subsidiaries. In other words, institutional norms and values such as attributes of education system and industrial relations are important HRM practices. For instance, in recruitment and selection processes, education qualifications are always considered. Further, the scope of labor legislati on and its regency of codification, which is another important institutional factor influences HRM practices through creating codes of conducts that are concerned with equal payment for equivalent job and the determination of minimum wages (Harzing Ruysseveldt, 2004). In general, the institutional environment affects the staffing decisions of MNE. Localization of HRM practices has a number of advantages. First, localization saves on expert costs in terms of salaries and other benefits. The costs of hiring experts are high since the firm has to cater for the expenses of international assignments. As such, the firm utilizes local personnel whose packages are less considered to expert salaries and benefits. Second, localization of HRM practices also utilizes the talents of the local people through recruitment and selection into various work positions.Advertising Looking for essay on business economics? Let's see if we can help you! Get your first paper with 15% OFF Learn More Impact of Culture and Institutional Environment Cultural as well as institutional aspects dictate the manner in which the management of human resources within multinational enterprises is conducted. As such, the MNE operating in the international market must recognize and comprehend the social outline entrenched in international culture to overcome the bottlenecks associated with the customs (Harzing Ruysseveldt, 2004). Recruitment and Selection Recruitment refers to the process of attracting individuals with suitable qualifications to apply for jobs whereas selection is picking the best-suited individuals for positions within an organization from the list of applicants. Culture and institutional environment influences the recruitment and selection of employees within an organization in a number of ways. As such, the firm must consider external and internal aspects in such process. Therefore, several steps must be adhered to in the recruitment and selection process to meet the requ irements of the organization’s culture as well as the institutional environment. For instance, transparency, fairness and qualification requirement must be considered in the process. Additionally, organizations must eliminate the stereotypes of disrespect and lack of recognition during the process. Further, the comprehensive structured screening method allows the interviewees to elucidate the comprehension of job specifications and how to deal with the obstacles that may be encountered in the execution of their functions (Farndale Paauwe, 2005). Training and Development Training and development are important aspects of HRM. The cultural and institutional environments greatly influence training and development of employees in a number of ways. First, development and training must incorporate the norms and values of employees. In addition, MNEs must undertake the institutional management aspects such as formulating policies, offering funds for execution as well as putting up v arious governing bodies to attain the required strategic goals (Dowling et al., 2013). The management of multinational enterprises believes that future growth and development depends largely on quality training and education system. Therefore, all subsidiaries must rely on the trained personnel from the local public training institutions. As such, nations must ensure that training and education of personnel are geared towards the needs of the industry. Further, MNE should adhere to the institutional requirements of quality training and appropriate education system as an integral part of labor force during the process of production. Therefore, human resource development programs such as training and career development form the foundation of enhancement and mobilization of human capabilities to meet the demands of the labor market (Farndale Paauwe, 2005). Compensation Culture and institutional frameworks have greater impact on compensation. Compensation and reward system of an organi zation remains to be one of the important factors that contribute to the improved work performances among employees. Compensation directly affects performances of employees and remains critical in the attainment of the organization’s goals. Therefore, cultural and institutional aspects have to be considered when deciding on the best compensation strategy (Dowling et al., 2013). In other words, employees have diverse values and norms that organizations have to put into consideration while determining effective rewards. Essentially, employees will consider compensation as effective when the types of rewards meet their primary objectives. Often, the central argument is that fair rewards system satisfies the needs of employees, motivates and improves performances. Moreover, the most excellent compensation practices take into account internal institutional processes such employees’ performance management practices as well as competitiveness. Internal balance in the compensa tion practices and design implies the organization’s activities and practices that ensure the attainment of goals. On the other hand, external institutional aspects such as competitiveness encompass compensation practices in relation to industrial standards or regulatory framework. In most cases, compensation practices follow the regulatory frameworks set by the industry or legal authority. However, the MNE must ensure that its compensation practices are geared towards enhancing employee’s motivation and attaining set institutional goals as well as norms and values in order to gain competitive advantage (Caldwell, 2003). In other words, compensation practices must be aligned with the employee’s general productivity as well as motivation. Task Distribution Within the workplace, variation in the workforce may arise from cultural orientations including race, religion and intellectual heritage. Moreover, diversity in the workplace may result from institutional chara cteristics that include education background of the personnel. In essence, variations found within the personnel emphasizes structure component of the organization. Therefore, HRM managers should be capable of understanding the effects of these dimensions on the work performance, success as well as motivation when distributing tasks. Most importantly, the HRM managers should comprehend how cultural and institutional dimensions bring about diversity in the workplace and the way they affect interactions of workers in the process of task distribution (Caldwell, 2003). Further, culture and institutional environments initiate structures that take into consideration all the dimensions of diversity in the workforce during task distribution. Conclusion In summary, the practices of international HRM and domestic HRM involve a number of commonalities include personnel planning, staffing, recruitment, selection, evaluation and development as well as remuneration. Despite the commonalities in t he practices of domestic and international HRM, two main differences exist in their practices. The differences arise from the complications in operations of international HRM and the employment procedures of personnel from different nations. Additionally, localization and standardization of HRM are practices are critical in the management of MNE. Further, for multinational enterprises to gain competitive edge in operations, the coordination and integration of the firms’ dispersed organizational units is significant. Moreover, Culture and institutional frameworks have greater impact on compensation and reward system of an organization remains to be one of the important factors that contribute to the improved work performances among employees. References Caldwell, R. (2003). The changing roles of personnel managers: old ambiguities, new uncertainties. Journal of Management Studies, 40(4), 983-1004. Dowling, P. J., Festing, M. Engle, A. D. (2013). International human resource m anagement: managing people in a multinational context. North Way, UK: Cengage Learning EMEA. Farndale, E. Paauwe, J. (2005). The role of corporate HR functions in multinational corporations: The interplay between corporate, regional/national and plant level. Center for Advanced Human Resource Studies, 5(10), 8-25. Harzing, A. Ruysseveldt, J. (2004). International human resource management. London:Sage. This essay on Human Resource Management (HRM) in a Multinational Enterprise was written and submitted by user Jude Boyer to help you with your own studies. You are free to use it for research and reference purposes in order to write your own paper; however, you must cite it accordingly. You can donate your paper here.

Answers to Questions About Articles

Answers to Questions About Articles Answers to Questions About Articles Answers to Questions About Articles By Mark Nichol 1. I found the follow information about the indefinite article a in The Oxford Advanced Learner’s Dictionary: â€Å"used before uncountable nouns when these have an adjective in front of them, or phrase following them. For example, â€Å"a good knowledge of French†; â€Å"a sadness that won’t go away.† I dont understand the information. The dictionary says that the a is used before uncountable nouns when these have an adjective in front of them. But, as far as I know, the indefinite article a cannot be used in front of uncountable nouns. Does the information mean that we can always use the indefinite article a in front of uncountable nouns that have an adjective in front of them? Is it a rule? Mass, or noncount, nouns can be preceded by the indefinite article a when they are modified by a preceding adjective or a subsequent phrase: For example, though you would refer to bravery as courage, not â€Å"a courage,† you can write of â€Å"an uncommon courage† and â€Å"a courage like no other.† However, the passage from the resource you mentioned refers only to the possibility of the former type of usage, not to its ubiquity; it is rare. 2. Something I would like some clarification on is the use of a or an before the word holistic. I have been taught an, but this doesn’t seem to make sense to me, as there are many instances when a word beginning with h is preceded by a rather than an. Are you able to shed some light on this? Use a or an before a word that begins with the letter h depending on whether the h is pronounced: â€Å"a historic occasion,† but â€Å"an honest mistake.† 3. I don’t know what to do with the names of institutions when they call themselves a name with the in the title for example, â€Å"the Open Door.† In the middle of a sentence, do you have to capitalize the? Would you say, â€Å"We met at The Open Door†? The direct article should be lowercase even when it is integral to an entity’s name (as in â€Å"the American Automobile Association,† when it would not be referred to, minus the, as American Automobile Association†), but many entities insist on capitalizing it as part of a branding identity. (And it’s best to do so for indirect articles, as in, for example, the name of a community center called A Place for Teens.) If you work for the Open Door or it’s giving your organization money or other consideration and management at the Open Door wants the name treated as â€Å"The Open Door,† treat it as â€Å"The Open Door.† Otherwise, style it â€Å"the Open Door.† Want to improve your English in five minutes a day? Get a subscription and start receiving our writing tips and exercises daily! Keep learning! Browse the Grammar category, check our popular posts, or choose a related post below:Useful Stock Phrases for Your Business EmailsRules for Capitalization in TitlesComment, Suggestion, and Feedback

Critical Thinking 2 Speech or Presentation Example | Topics and Well Written Essays - 1000 words

Critical Thinking 2 - Speech or Presentation Example All the sectors are related and affect each other. a) For each unit change of an independent variable, the change in the quantity of Chevys sold or demanded is equivalent to the coefficient of the variable. Therefore; a unitary change in the following independent variables will cause a corresponding change in quantity demanded by; The increase in the price of tickets resulted into increased profits in the short-run. However, in the long-run, profits declined owing to the fact that in the long-run, the customer is not willing to purchase the ticket at an increased price. a) These goods conform to the law of demand. This is because the law of demand states that an increase in the price of a commodity would lead to decrease in its demand as consumers would be less willing to purchase the commodity at a higher price, thus leading to a negative price elasticity of demand. On the other hand, an increase in consumer’s income would lead to an increase in demand of the commodity as consumers are able to consume more of the commodity, thus leading to a positive income elasticity of

Starbucks Case Study Example | Topics and Well Written Essays - 4750 words

Starbucks - Case Study Example The first Starbucks store was established in the 1971 in Seattle by three friends Jerry Baldwin, Gordon Bowker and Zev Siegl. These three individuals were high school teachers of English and History. They got their inspiration to open their own coffee shop from a Dutch business man named Alfred Peet (Coffee, 2014). The Starbucks as we know today is quite different from what it was during the time of its inception. At first the store only sold raw coffee beans and coffee machines and equipments, which changed over a decade as the company also started to sell coffee drinks. A decade later the company appointed Howard Schultz as the head of retail operations. He was overwhelmed by the idea of espresso bars in Italy and asked the owners to apply the concept of coffee house in Seattle. This experiment was quite successful and it marked the beginning of the famous Starbucks coffee beverages. Howard found a company named Il Giornale, which later on acquired Starbucks (Starbucks, 2011). The acquisition of Starbuck was financially supported by a lot of local investors and the name of the company was officially changed to Starbuck Corporation. The company decided to make geographical diversification and opened up stores in Vancouver and Chicago. By 1987, the total number of Starbucks outlet was 17, which increased to 55 by 1989 and 84 in the next year. In the year 1992, the company went public and it was able to expand its business from the $27 million gathered from the stock prices (Grant, 2013).

One of the major characteristics that Beowulf and Hamlet Essay Example for Free

One of the major characteristics that Beowulf and Hamlet Essay One of the major characteristics that Beowulf and Hamlet share is the fact that they both rid Denmark of a treacherous monster who poses a serious threat to the land. Beowulf uses his warrior-like skills to fight and conquer a physical monster who literally haunts the swamps outside the state and plagues it with murderous acts. Hamlet’s monster is also one who commits murderous acts, though this is in the form of his uncle Claudius who kills the King (Hamlet’s father) and usurps the Danish throne. The two men, Hamlet and Beowulf, are thrown into these battles as youth, and both take on the challenge willingly. In fact, Beowulf travels from Geatland specifically to meet the challenge of fighting Grendel. Hamlet too takes it upon himself to kill Claudius as soon as he finds out that this man has been the agent of his father’s death. Another characteristic that both Hamlet and Beowulf share is their death and the method in which this occurs. Both are defeated in their final efforts at ridding their homelands of the evil that had infiltrated. In fact, both die though their efforts are successful. Beowulf dies at the hand of the final monster (the dragon) whom he succeeds in slaying, but who also deals Beowulf a deathly blow that eventually kills him. Hamlet also has a similar experience in that, while he is able to slay Claudius by the end of the play, he is caught with a poisoned sword and eventually expires after all his enemies have died. The two characters die by peripheral (yet fatal) blows given them during the melee. Both show bravery by continuing to fight even while they are mortally wounded. Eventually, both succumb to the serious wounds they have acquired, yet they die in the victory of knowing they have defeated their enemies. Beowulf and Hamlet also differ in many ways, one of which is the character that they show throughout the play. While Beowulf displays a warrior-like character, Hamlet shows himself to be fearful and awkward in acting out the desires of his heart. Beowulf is eager to come to the aid of the King of Denmark, and he pauses only to partake of the feast given in his honor before he sets out to kill Grendel. When he encounters the monster, he loses no time in indecision but immediately performs the actions necessary to kill the beast. In fact, Beowulf fights three ferocious beasts throughout the story with the same vivacity and fierceness. Hamlet differs from Beowulf in his character, and he displays the tendency to employ a much more subdued and stealthy course of action. Though he too determines to defend the honor of Denmark’s (former) king by killing his murderer, he demonstrates a greater portion of dalliance and indecision than does Beowulf. When he gets his first chance to kill Claudius, his idle thoughts concerning the condition of Claudius’ heart (while praying) leads him to forfeit that chance and allow Claudius to live. He fails in his pursuits far more than Beowulf does too, because in his second attempt to kill Claudius, he ends up killing Polonius instead. In these ways, Hamlet shows himself to lack self confidence in a manner that is vastly different from Beowulf the ready warrior. Beowulf and Hamlet show differences in the tenure of their lives and the fulfilment of their royal destinies. Hamlet, unlike Beowulf, fails to ascend to the throne to which he is heir. He dies before the throne falls vacant and also fails to prove King Claudius a usurper in any effort to gain his rightful place on the throne. Beowulf, on the other hand, is able to spend fifty years as ruler of his Geat kingdom. In addition to this, Beowulf differs from Hamlet in his ability to live out his live and to attain old age. He is able to demonstrate his strength as a ruler for many years and to gain the respect of his subjects. Hamlet, who dies young, is unable to do any of this. He is never able to command the subjects over whom he was destined to rule precisely because of the fact that his life ends tragically in his youth. Therefore, while both men perform in the role of princes during their youth, Beowulf becomes promoted to the level of king while Hamlet dies with all his potential. Works Cited Beowulf. The Harvard Classics, Volume 49. Frances B. Grummere (Trans. ) 1910. P. F. Collier Son, 1993. Shakespeare, William. Hamlet. London: Penguin, 1994.

Michelangelo :: Essays Papers

Michelangelo2 Michelangelo was pessimistic in his poetry and an optimist in his artwork. Michelangelo's artwork consisted of paintings and sculptures that showed humanity in it's natural state. Michelangelo's poetry was pessimistic in his response to Strazzi even though he was complementing him. Michelangelo's sculpture brought out his optimism. Michelangelo was optimistic in completing The Tomb of Pope Julius II and persevered through it's many revisions trying to complete his vision. Sculpture was Michelangelo's main goal and the love of his life. Since his art portrayed both optimism and pessimism, Michelangelo was in touch with his positive and negative sides, showing that he had a great and stable personality. Michelangelo's artwork consisted of paintings and sculptures that showed humanity in it's natural state. Michelangelo Buonarroti was called to Rome in 1505 by Pope Julius II to create for him a monumental tomb. We have no clear sense of what the tomb was to look like, since over the years it went through at least five conceptual revisions. The tomb was to have three levels; the bottom level was to have sculpted figures representing Victory and bond slaves. The second level was to have statues of Moses and Saint Paul as well as symbolic figures of the active and contemplative life-representative of the human striving for, and reception of, knowledge. The third level, it is assumed, was to have an effigy of the deceased pope. The tomb of Pope Julius II was never finished. What was finished of the tomb represents a twenty-year span of frustrating delays and revised schemes. Michelangelo had hardly begun work on the pope's tomb when Julius commanded him to fresco the ceiling of the Sisti ne Chapel to complete the work done in the previous century under Sixtus IV. The overall organization consists of four large triangles at the corner; a series of eight triangular spaces on the outer border; an intermediate series of figures; and nine central panels, all bound together with architectural motifs and nude male figures. The corner triangles depict heroic action in the Old Testament, while the other eight triangles depict the biblical ancestors of Jesus Christ. Michelangelo conceived and executed this huge work as a single unit. It's overall meaning is a problem. The issue has engaged historians of art for generations without satisfactory resolution. The paintings that were done by Michelangelo had been painted with the brightest colors that just bloomed the whole ceiling as one entered to look.

Revisiting Cost of Capital in Commercial Banks

CHAPTER 1: INTRODUCTION 2 Background Capital Structure decision remains one of the corporate strategies to corporate managers because it affects firm’s value. This research is conducted within the commercial banks. In many research journals and articles the cost of capital is the expected rate of return of capital in investor’s investment. Weighted average cost of capital is considered as required rate of return in the company. Component of cost of capital are; long-term debt, preferred stock, and common stock. Each must have minimum return.We analyze from previous research articles that the banks should not focus on historical cost but on new cost, because in order to invest and rise, new cost of capital is used to make decisions. Level of interest rates, tax rates are two of the factors that affects cost of capital in the commercial banks. Interest rates apply on debt and equity. It is the most important factor for investors. Cost of debt affects by the level of inter est rates and also the cost of equity. As described in many articles, if interest rates increases the cost of debt increases, which increases the cost of capital.So, the raising of capital delayed till interest rate become favorable. This shows how the interest rate can be a source effective measure of the cost of capital. Similarly, if the tax rates increases, the cost of debt decreases, which decrease the cost of capital as it affects the after tax cost. The cost of capital directly and totally linked with capital structure. Capital structure influence the value of the banks, firm, company potentially by reflects the financing strategy. And capital structure should consider tax strategies.We found from different articles that the most important capital structure decisions are when the expected tax rates goes higher. The basic function of capital structure is to minimize the cost of capital and risk. Interest is tax deductable. The deductibility of interest payments provides influe nce for value. Higher the tax rate, the greater impact of deductibility of interest potentially on the after-tax cost of debt. These are the proved facts that are evaluated in previous researches. According to this research we are trying to find what role these factors play in commercial bank’s capital structure.It is necessary for top management of any business institutions to ascertain the banks or firms relevant cost of capital. From the banks’ perspective, the cost of each source of capital reflects the level of return because it is affected by certain factors like tax rates, interest rates, dividends etc. as the time period changes, the level of return also changes. In its simplest form, the capital structure decision is the selection by firm management of debt-to-equity ratio for the firm. Cost of Capital is perhaps the most fundamental and widely used concepts in financial economies.Managers of banks or corporation and also regulators employ the weighted average cost of capital for investment decisions. The WACC and the tax rates are endogenous to the firm’s debt policy. The interest rates affect the cost of debt as increasing debt increasing interest payments. We also derive the sources of capital structure that which source is better for the commercial banks and how the interest rates, tax rates brings variation in the cost of debt and the dividends and growth rates affects the cost of equity that totally affect the weighted average cost of capital.Our methodology allows us to value the government tax rates and interest rates that affect cost of debt. We specify numerically the affects of the variations in the factor like interest rates, tax rates and dividends, thus providing useful conceptual framework for the tax and interest policy debates that influence cost of capital of debt and equity. Finally we come to analyze that cost of debt increase or decrease by variation in the interest rates and tax rates and that help in the est imation of WACC that show that whenever the WACC decreases, it results in an increase in the profit that is useful for any organization or commercial banks. . Problem statement (Revisiting the cost of capital in the commercial bank) The problem statement of this research proposal includes re-examine the cost of capital in commercial banking sector of Pakistan and also to evaluate the direct and indirect association of the factors that affects weighted average cost of capital and how this variation (increase or decrease) can affect the profit and also the capital structure -debt and equity- of the commercial banks. 2. Research objectives While doing research planning, we analyze that the cost of capital considers the factors affecting decision making.The following object of the research comes into play: ? We will find out the factors which creates the variation (increase or decrease) on cost of capital and their effect on the capital structure decision making. ? To analyze the after effects of these factors on capital structure. ? To examine up to how much extent they are controllable or not from bank’s perspective. 3. Significance The importance of this research paper is that, the relation between the different determinants of the costs of capital creates different impact on the different commercial banks by affecting capital structure of that commercial bank.We know that as the weighted average cost of capital decreases, it increases the profit n the Commercial Banks. Risk associated with cost of capital and capital structure taking needs to b looked at differently in the case of the commercial banking institutes. This research sheds new light on how the cost of capital computed in the case of commercial banks. Also the relationship between the cost of capital and capital structure is investigated. This research has another importance as banking system has a vital role to play in the economic development of a nation. A healthy economy requires a sound banking system.This research states that how banks applies different techniques that enhance their performance and also affect the decision making of the Mangers regarding their capital. In this research, the main finding of the paper suggests that the commercial bank should focus on reducing the cost of capital that maximizes the profit. According to our findings, it is concluded that each banks has its policies of financing. Each bank takes decision of selecting capital structure for minimizing their cost, risk factor differently that occupies good financial position in market.Factors that have impact on cost of capital as well as on capital structure are tax rates, interest rates, dividends payout, risk of default and other like market fluctuation, corporate governance. This research plays a vital role by showing the significant contribution of Commercial Banks while equating debt to equity ratio. It also shows the understanding of the performance of Banks by evaluating weighted average cost of capital. The main findings of the paper suggest that private commercial banks should focus on reducing the cost of capital which can magnify the returns to their stockholders.Finally this research paper would also help the students in academics in understanding the relation between the factors and the cost of capital and also their after affects that create impact on the weighted average cost of capital. 4. Limitation Time constraint of this semester is the issue for this study as we have limited time in this semester as compared to the actual time required for the research. By being in banks we will acquire interviews approximately 15 -30 minutes with questionnaire because of the time given by the Mangers of Finance Division.The information given by the managers is also limited because it difficult for them to provide all necessary information as they are bound by the policies of the commercial bank. 1. 6 Report Structure Chapter 1 represents the introduction of res earch topic its background, problem statement, objectives of research that set, significance of this research and limitations. This chapter gives brief information about the topic pervious information, the scope of research and its benefits, the target of the research. And also provides the basic information that already conducted by different authors researchers.Chapter 2 deals with the literature review and conceptual framework. In this portion you will find the different views of different researchers related to this research topic cost of capital in commercial banks including capital structure importance its link with cost of capital, and factors that affect cost of capital. This portion also gives the direction and relevant information which is very helpful in proceedings the research. Conceptual framework helps in determining the relationships of factors with WACC.Chapter 3 provides the detail of methodology that is adapted to proceedings the research. This portion gives expla nation of research type, method, sample size, instruments that is used in finding and collecting the data. Chapter 4 gives the analysis of data that is collected through the questionnaire, interviews and calculating the WACC of commercial banks that chosen with assumptions, and research findings that proves the hypotheses that is set. Chapter 5 includes the conclusion of research findings and literature review findings.Also gives the recommendations. Finally Appendix attach to our research that contain Questionnaire. CHAPTER 2: LITERATURE REVIEW AND CONCEPTUAL FRAMEWORK 1 Literature Review 2 Capital structure (Khadka 2005) has analyses in his research that the firms meet their operational needs by raising their funds and this can be done through the capital structure that involves the two major sources of debt and equity. There should be an appropriate balance between debt and equity as it has effects on the risk and return of the shareholders of the company.If there are reasonable proportions of debt and equity in the capital structure of the firm, it maximizes the shareholders wealth while minimizing the cost of capital and that could be considered as the optimal capital structure. (John J. Pringle, Jun. , 1974) Since banks are private economic units, it is reasonable to suppose that shareholder interests will influence, if not control, managerial decisions. Capital is an important managerial decision variable and that it plays an important role in the financial management of the individual bank. Groth 1997) said that the selection of capital structure affects the cost of capital. Carefully selection of capital structure is more important. Banks and companies consider more conservative capital structure with sensitivity to cyclical effects of economy. It involves in dividing not in sharing. If payments of dividend are not deductible and if interest is tax deductible on debt then capital structure is important. Barton and Gordon (1987) Financing and capital s tructure choices are among the several key decisions made by firm managers.Yet the study of these questions has been generally neglected by strategy researchers. Several scholars have noted that the issues involved are concerned with fundamental choices ‘which should support and be consistent with the long- term strategy of the firm. Balakrishnan and Fox (1993) said that by selecting suitable financing, a ‘firm's ability to manage its relationship with lenders thus becomes a key source of competitive advantage. Capital is a critical resource for all firms, the supply of which is uncertain. This uncertainty enables the suppliers of finance to exert ontrol over the firm. Stearns (1986) and Mizruchi (1993) estimate the cost of equity capital use a dividend discount model (DDM) methodology and earnings estimates. They find that the cost of equity capital for large U. S publicly traded companies ranged between 10% and 12% during 1979-1995, depending on the assumptions used wi th the DDM approach. Interestingly, Myers and Borucki (1994) obtain the same range of estimates for the cost of equity capital of a limited sample of U. S. utility companies using a DDM-type method.Bruner (1998) and Weaver(2001) surveying large corporation and confirm about WACC methodologies. Both authors find that there is a significant difference exists in estimating the equity capital component of the firm. Some uses CAPM while other uses different methods. 4 Cost of capital Cost of capital is the minimum required rate of return by investors in firm’s securities. It occupies an important role in the theory of financial management and in the investment decision making as it provides criteria for allocation of the capital that what a firm pays for its capital like debt, preferred stock and equity.Cost of Capital is related with the level of risk associate with existing and new assets and investments. (Khadka 2005) Modigliani and Miller (1958) proved that firms cost of capit al is independent of capital structure as it has no effect on the capital structure. The traditional belief of Modigliani and Miller (1963) is that the cost of capital can affect capital structure as in this belief they said that the personal taxes may include that brings variation in the cost of capital and hence affects the capital structure of the company. Khadka 2005) states that there is an empirical relationship between the cost of capital with capital structure, the size of the firm, growth of the firm, dividend payout ratio and liquidity of underdeveloped economy like Nepal but the major focus was the relationship of the leverage with the cost of capital where he conclude that negative beta shows that there is a negative relationship of cost of capital with the leverage as cost of capital decreases with the use of the leverage and this is done by the tax deductibility of the interest charges in the Nepalese firms.Cost of capital is the expected rate of return of capital in i nvestor’s investment. On debt, the amount of interest is paid is called cost of debt. Whereas cost of equity is equivalent to the risk free rate of interest plus risk premium for business risk. (Groth 1997). 5 Factors that affects cost of capital Groth (1997) further said that risk is one of the factors that affect the cost of capital which determines the expected risk of cash flow in the asset side of the bank. Business risk is that when bank and companies cash flow are not able to meet its operating expenses.Risk is linked to economic changes. And it would be at risk to business risk when change in economy occurs and when financing is done by totally with equity. Cost of equity influenced by business risk. Equity holder’s risk has not accepted by the creditors and preferred stock holder if present. If increase in business risk occurs then it decreases the financial risk and the optimal D/E ratio, and increases the cash flow uncertainty of asset side. Financial risk i s that when bank and companies cash flow are not able to meet its financial obligations. If firm finances through debt, then it has financial risk.Tax rates and interest rates are also factors. Interest payment expected deductibility give opportunity for value. If the tax deductibility is realized by the company then stockholders get the expected benefit of the tax deduction. Jorgenson and Landau (1993) or Bond and Devereux (2003) analyses that the government’s choice of the corporate tax rate is an important factor with respect to the investment decision made by shareholders and it is well known that the existence of corporate taxes distort this investment decision away from the social optimum . John J. Pringle, Jun. (1974) said that the traditional function of risk-bearing, capital is important in adjusting the maturity structure of liabilities. Risk is a function of uncertainty regarding future events, e. g. , earnings, losses on loans and securities, fluctuations in depos its, conditions in the financial markets, etc. Cost of equity increases if the financial risk become high. The cost of equity and debt increases with the increase in debt. The deduction of tax and its benefit is an expected benefit, to allow deduction of interest; the pre-tax EBIT income must be large.On after tax cost of debt, there is the greater the impact of interest deductibility, if the tax rate s higher. John R. Graham, (2003) analyze that the appropriate cost of capital in the presence of personal taxes does not depend directly on either the dividend payout rate or the tax on dividends. Equity shares have a market value lower than the difference between the reproduction cost of a firm's assets and the market value of its debt obligations. Because of this capitalization, it need not be true that an economy without risk or uncertainty would have no equity financing.Groth (1997) said that asymmetry of effects is that the expected return to stockholder will goes up, if in place of some equity; some debt is used. The good or bad leveraging effects are asymmetry if interest is tax deductable. The inability to realize the interest deduction result in an asymmetry effect on expected return to stockholder. Weighted average cost of capital become low with the cost of capital high, if the debt capital increase in proportion. Cost of equity increases with the cost of debt.If the cost of components high the weighted average cost of capital increases and reason is that shareholder prefer to use of debt when expected value of tax benefit is attractive as compared to the added financial risk associated with the debt. The Demanded rate of increase in cost of debt and equity, effects on value of the expected increase in tax benefit of using more debt. Interest rate affects the cost of debt. It involves the risk components that have the probability of default on the debt. Meziane (2006) in his article said that a company pays interest which is treated as an expense for t ax purpose and therefore it is tax deductable.Company will be bankrupt, if default on payment of interest to bank present by company. Equity financing cannot create a tax advantage because dividends are paid after interest and tax. Interest is paid on debt before tax deduction, whereas, dividend is paid after tax benefit. So, the cost of equity is high then cost of debt. Debt financing becomes attractive when tax is deductable from interest. Banks use cost of capital for decisions, a weighted average interest on debt. Bank should select D/E ratio for which the cost of capital fluctuate with the degree of debt finance is minimized.The D/E ratio is considered as one of the way of financing. (Alan J. Auerbach, aug. 1979). William F. Coffin and Sean Collin (2006) said that in the mid of 1990, a trend towards higher B/S debt in which low cost interest rate, lending level reduced by commercial banks and increase payback period for borrowers, a stable banking system. Cost of capital become low that could lower by the management in down market through viewing current corporate governance themes, taking action on giving management training with respect to capital market issues of today and advanced planning to identify the potential investors. Cost of capital and Corporate Governance Ramly and Rashid said corporate governance is also the factor that affects the cost of capital. CG directly affects the cost of equity, And indirectly with beta. This means poor performance of manager created through weak rights, thus increase cost of capital. Strong (weak) shareholders right associated with increase (decrease) cost of equity capital. CG generate liquidity problem in which investor high the sell price and decrease the buy price which can high the transaction cost and also affects the COEC.Thus, the CG creates strong mechanism on COEC and provides positive shareholder value for firm. It has also reducing effects on cost of capital. Banks and other financial institutes have negative influence on CG. Hennart, (1994) Both classes of suppliers (debt holders and equity holders) have governance abilities. The level of governance ability varies between the two and the optimal selection of the type of financing depends on the nature of resources of the firm. Seth, (1990) financing choices have the potential to affect performance by changing the level of governance costs. Importance and difficulties of WACC Denis Boudreaux (1995) in his article uses the buildup model for the cost of equity capital by estimating cost of equity capital for capital budgeting analyses. He said that whenever there is a need to determine the value of the firm, the cost of capital must be estimated. He said that the cost of debt of closely held firm is much higher that the publicly traded organization because of the loans or debt borrowed by the closely held firms including the commercial banks.He further said that the public traded firms have the low risk whereas a huge risk factor is involved in the closely held businesses. Experts have recognized that the exploitation of debt and equity can enhance the corporate value in 1940s. Later in the years, five concept developed on this area(1) early gearing leverage model; (2) the model of Modigliani and Miller (MM); (3) Capital Asset Pricing Model(CAPM); (4) Arbitrage Price Theory (APT); and (5) Gordon Model Shubbar and Alzafiri, (2008). Unless a firm can gain in excess of its cost of capital, it will not add value to its investor’s wealth.Company’s cost of capital is expressed by the weighted average of the cost of individual sources of capital employed. Bruner et. al. , (1998). For a firm using common stock (equity) and bond (debt) financing, with re and rd as the cost of equity capital and the cost of debt capital, the WACC is expressed the following equation: WACC = r = wd rd (1 ? t) + we re Where, wd (weight (proportion) of debt) = (value of debt/value of debt and value of equity), we (weight (pr oportion) of equity) = (value of equity/value of debt and value of equity), wd + we = 1, and t = tax rate on corporate income.The component costs, re and rd, as well as the weights are based on market values: re is frequently calculated as the risk free rate plus a risk premium, based on the capital asset pricing model, and rd reflects the market rates on the firm’s outstanding debt and on the rd of similar firms. The standard treatment includes (1? t) in the WACC calculation to reflect the deductibility of interest payments in the calculation of the corporate tax on the firm’s income statement: the interest cost of debt, by this procedure, is reduced.Also, to avoid double counting the tax â€Å"advantage† of debt, the interest payments are not calculated in the prospective cash flows. This is the textbook treatment in calculating a firm’s cost of capital. (Miller2006) Evaluating a firm’s weighted average cost of capital has its importance to the m anagers who estimate investments projects for capital budgeting purposes or to the investor whose desire is to assess the overall riskiness and expected return from a company’s activities for valuation purposes. (Miller 2006).Fama and French (1997, 1999) analyse that few difficulties arise because there is some uncertainty in evaluating a firm’s (or banks) cost of capital. This uncertainty is a sort of risk faced by the firm when projecting a project’s cash flow. Bruner, Eades, Harris, and Higgins, (1998) also analyze that there is wide variation in estimating WAAC by different methods. This is due to the manager’s differences in firms cost’s of equity capital that helps in investment decision making. 8 Conceptual Framework DV= DEPENDENT VARIABLE IV= INDEPENDENT VARIABLE MV=MODERATE VARIABLE 9 Conceptual HypothesisHo: WACC increases with increase in interest rates and decreases with decrease in interest rates. H1: WACC increases with decrease in ta x rates and decreases with increase in interest rates. H3: Cost of debt increases with increases in interest rate and decreases with decrease in interest rates. H4: Cost of debt increases with decrease in tax rates and decreases with increase in interest rates. CHAPTER 3: RESEARCH METHODOLOGY 10 Type of Research Research can be defined as the search for knowledge, or as any systematic investigation, with an open mind and facts, usually using a scientific method.Our research is empirical research, which tests the feasibility of a solution using empirical evidence. This research comprises of both the qualitative and quantitative research method for the data analysis. Firstly we search for the secondary data in order to know and understand the analysis of the previous researcher that how they work and create different perspective for the Weighted Average Cost of Capital than we include the researches of the previous researcher in the literature review of this research in order to creat e relation and direction between the previous researches with our research. 1 Sampling Technique Sampling Technique used in our research is Random Sampling in which we chosen from a population for investigation. In this method we chose from managers in the Commercial Banks and estimates obtained from the random sample in order to solve our queries related to WACC. 12 Sample Size The Sample Size is comprises of 5 Commercial Banks of Karachi. More than the given sample size is not possible because of the time of this semester and also the little difficulty in finding the appointments with the Mangers of Finance Departments. 3 Instruments Questionnaire includes 12 question given to the Managers of the Commercial Banks in order to analyses the perception of the manager that how each individual differs in their perception for the factors that affects the weighted average cost of capital. Most of them include five point likert scales. Other than questionnaire, the balance sheet of 2009 of each bank is used to estimate the WACC for the year and evaluate how the factors like tax rates, interest rates affect WACC. 14 Data CollectionThis research has been carried out to evaluate the correlation between the factors of cost of capital like tax rates, interest rates and the WACC that how these factors affect the WACC in the commercial banks. The selected five banks include: Allied Bank Limited (ABL), Habib Bank Limite(HBL), Muslim Commercial Bank(MCB), Alfalah Bank and Soneri Bank Limited. Descriptive Data Analysis is taken place in order to estimate WACC. This study employs after-tax cost of debt and equity in order to estimate WACC for selected banks. The procedure of calculating after-tax cost of debt and cost of equity has been stated here.The cost of debt measures the cost of borrowing funds of the firm. In calculating the after-tax cost of debt of each bank for the year 2009 by the following formula: After-tax cost of debt = pre-tax cost of debt (1 – tax rate) The cost of equity evaluated through the given formula: Cost of equity = Gordon growth model =(Do (1 + g))/ (market price per share)] + g) Finally the Weighted Average Cost of Capital calculated by WACC = (Weighted average cost of debt) + (weighted average cost of equity) CHAPTER 4: DATA ANALYSIS 15 QUESTIONNAIRE ANALYSIS Banks normally prefer financing through debt plus equity. 1% of the commercial banks use both (debt and equity) as their sources of finance while remaining 29% of the banks prefer debt for their investment. Only exploitation of equity is not preferred by any banks because through debt finances, the banks gain and improves profit. [pic] Equity sources liable bank to pay dividend, 71% of the banks says that the dividend payment increases the cost of capital while the other 14% said that it decrease the cost of capital and the remaining said that dividend payment has no such impact on the cost of capital. [pic] 5% of the commercial banks said that by using tax shield , cost of capital decreases as it decreases cost of debt and also impact interest rates. While 14% said that it has no such impact like some of Islamic bank like Meezan Bank. [pic] 71% of the sample size agreed that the Cost of capital has positive impact on the capital structure by using both sources of finance while 15% disagree and other 14% are highly disagree. That means most of the commercial banks are in the favor of Ho that the using both sources improves the profit of the commercial bank. [pic] 7% agrees and 28% strongly agrees that the risk factor of the default increases as there is an increases liabilities when bank finance through debt while only 10% of the sample size disagree to this fact but still they have profit by increasing their liabilities. [pic] Approximately 86% of the commercial banks agree from the fact that the fluctuation in the interest rate affects Cost of Capital and also the Capital Structure of their banks while other says that there is no as such im pact of the interest rates but from secondary data we analyze that interest rate is the factor that affects the cost of capital and the capital structure. pic] 71% of the managers agrees that as low dividend payout affects the reputation of their bank, similarly high dividend payout and dividend growth also affect the capital structure decision whereas 29% of the managers said that high dividend has no such impact on the cost of capital and on investment decision. [pic] 100% of the sample size agrees that cost of capital highly impact the investment decision in the commercial bank that also affects capital structure decision making and increases the profit if the weighted average cost of capital is low. [pic] 5% of the sample size agrees that the cost of capital has a huge impact on the level of risk because the maximization of the profit in the commercial bank is truly based on cost of capital and its other factors. [pic] 57% of the sample size agree that the taxes bring variation in the cost of capital in commercial bank while the other denied that taxes has no such affects on cost of capital but many researches has proved that taxes highly affects the cost of capital. [pic] 100% of the managers agree that weighted average cost of capital reduces as there is reduction in the net financial debt.It can be explained by the fact that if the cost of debt remains same but there is variation in the weightage of the debt. The lower weightage reduces the WACC of the commercial bank. [pic] While the method used for the cost of equity varies in different banks. 15% uses the CAPM, 42% uses the Gordon Growth Model whereas the remaining percentage uses both the CPM and Gordon Growth Model method when they finances through the equity. [pic] 16 DESCRIPTIVE ANALYSIS 17 Allied Bank Limited WACC = (Weighted average cost of dbt) + (weighted average cost of equity)WACC = (interest (1-tax)) + (Do (1 + g))/ (market price per share)] + g) COST OF EQUITY: |YEAR |2005 |2006 |2007 |20 08 |2009 | |DIVIDEND/SHARE |2. 5 |2. 5 |3 |3. 5 |4 | |GROWTH |0% |0% |20% |16. 66% |(14. 28%) | Average growth=4. 476% Cost of equity = Gordon growth model =(Do (1 + g))/ (market price per share)] + g) Cost of equity =4(1+0. 4476)/59. 11+0. 04476 = 11. 54% | |g |Growth Rate |4. 476% | | |Do |Last Dividend |4 | | |MP |Market Price |59. 11 | | | | | | COST OF DEBT: Interest Rate = 9. 619% Tax rate = 32. 4% Weighted average cost of debt after tax = 0. 09619(1-0. 324)Weighted average cost of debt after tax =6. 503 % WEIGHTED AVERAGE COST OF CAPITAL: | |AMOUNT |%AGE COMPONENT |COST |WACC | | |Thousand |(a) |(b) |(a*b) | | |(000) | | | | |DEBT |39,457,216 |0. 0055 |0. 650 |0. 00036 | |EQUITY |7,110,007,580 |0. 9945 |0. 1154 |0. 11476 | |TOTAL |7,149,464,796 | | |0. 11512 or 11. 51% | ANALYSIS In order to prove our research hypotheses, we find different relation between the interest rates, cost of debt and WACC; we assume different variation in the interest rates as it is the independent v ariable that affects the WACC hich is the dependent variable. In 2009, the interest rate of ABL was 9. 619%, we assume two different rates in which one is greater than 2009 rate i. e. 15% and other is less than 2009 interest rate i. e. 7. 00%. As the interest rates increases, it also increases the cost of debt that results in the increase in the weighted average cost of capital. Hence, hypotheses Ho and H3 of our research has proved by this analysis because as the interest rate decreases to 7. 00%, the cost of debt also declines which result in decreases in the WACC and vice versa. INTEREST |COD |WACC | |7. 00% |4. 73% |11. 50% | |9. 62% |6. 50% |11. 51% | |15. 00% |10. 14% |11. 52% | pic] For the relation between the taxes rates, cost of debt and WACC. We find different variations among them. Tax rates are the independent variable so they create different affects on WACC as it is dependent variable. In 2009, ABL has the tax rate of 32. 40%. Similarly we assume one tax rate greater than 32. 4% and another is less than 32. 4% in order to prove our hypothesis. From the following analysis, we come to know that as the tax rates increases, it decreases the cost of debt that results in the decrease in the weighted average cost of capital.Hence, hypotheses H1 and H4 of our research have proved by this analysis. |TAX RATES |COD |WACC | |30% |6. 73% |11. 84% | |32. 40% |6. 50% |11. 51% | |35% |6. 25% |11. 50% | [pic] 8 Habib Bank Limited (HBL) WACC = (Weighted average cost of debt) + (weighted average cost of equity) WACC = (interest (1-tax)) + (Do (1 + g))/ (market price per share)] + g) COST OF EQUITY: |YEAR |2005 |2006 |2007 |2008 |2009 | |DIVIDEND/SHARE |1. 5 |1. 48 |1. 48 |3. 01 |0. 30 | |GROWTH |0 |-1. 333% |0 |103. 378% |-90. 033% | Average growth=2. 4024%Cost of equity = Gordon growth model =(Do (1 + g))/ (market price per share)] + g) Cost of equity = 0. 03 (1+0. 024)/40. 9+0. 024 = 2. 475% | |g |Growth Rate |2. 4024% | | |Do |Last Dividend |0. 03 | | |MP |Ma rket Price |40. 90 | | | | | | COST OF DEBT: Interest Rate = (LIBOR+1. 75) = 18. 65% Tax rate = 37. 2% Cost of debt after tax = 18. 65 (1 – 0. 3732) Cost of debt after tax = 11. 69% WEIGHTED AVERAGE COST OF CAPITAL: | |AMOUNT |%AGE COMPONENT |COST |WACC | | |Thousand |(a) |(b) |(a*b) | | |(000) | | | | |DEBT |33,536,837 |0. 786 |0. 169 |0. 0912 | |EQUITY |9,108,000 |0. 214 |0. 0246 |0. 0053 | |TOTAL |42644837 | | |0. 0965 or 9. 65% | ANALYSIS We find different relation between the interest rates, cost of debt and WACC in order to prove our research hypothesis. We assume different variation in the interest rates as it is the independent variable that affects the WACC which is the dependent variable.In 2009, the interest rate of HBL was 18. 65%, we assume two different rates in which one is greater than 2009 rate i. e. 20% and other is less than 2009 interest rate i. e. 12. 00%. As the interest rates increases, it also increases the cost of debt that results in the increase in the weighted average cost of capital, this can easily proved by given table and you can also find this relation through the given graph. Hence, hypotheses Ho and H3 of our research has proved by this analysis because as the interest rate decreases to 12%, the cost of debt also declines to from 11. 69% to 7. 2% and which result in decreases in the WACC from 9. 65% to 6. 44% and vice versa. |INTEREST |COD |WACC | |12% |7. 52% |6. 44% | |18. 65% |11. 69% |9. 65% | |20% |12. 536% |10. 38% | pic] Tax rates are the independent variable so they create different affects on WACC as it is dependent variable. In 2009, HBL has the tax rate of 32. 40% that having COD 6. 503% and a WACC of 11. 51%. Similarly we assume one tax rate greater than 32. 4% and another is less than 32. 4% in order to prove our hypothesis. From the following analysis, we come to know that as the tax rates increases, it decreases the cost of debt that results in the decrease in the weighted average cost of capital. Henc e, hypotheses H1 and H4 of our research have proved by this analysis. Tax rates |COD |WACC | |30% |6. 73% |11. 84% | |32. 4% |6. 503% |11. 51% | |35% |6. 25% |11. 50% | [pic] 19 Muslim Commercial Bank (MCB)WACC = (Weighted average cost of debt) + (weighted average cost of equity) WACC = (interest (1-tax)) + (Do (1 + g))/ (market price per share)] + g) COST OF EQUITY: |YEAR |2005 |2006 |2007 |2008 |2009 | |DIVIDEND/SHARE |4. 5 |5. 1 |5. 6 |6 |6. 8 | |GROWTH |0 |13. 33% |9. 8% |7. 14% |13. 33% | Average growth=8. 72%Cost of equity = Gordon growth model = (Do (1 + g))/ (market price per share)] + g) Cost of equity=6. 8(1+0. 0872)/189. 79+0. 0872 =12. 62% | |g |Growth Rate |8. 72% | | |Do |Last Dividend |6. 8 | | |MP |Market Price |189. 79 | | | | | | COST OF DEBT: Interest Rate = 12. 75% Tax rate = 33. 07% Cost of debt after tax = 12. 275 (1 – 0. 3307) Cost of debt after tax = 8. 216% WEIGHTED AVERAGE COST OF CAPITAL: | |AMOUNT |%AGE COMPONENT |COST |WACC | | |Thousand (000) |(a ) |(b) |(a*b) | |DEBT |44,662,088 |0. 0221 |0. 0822 |0. 0018 | |EQUITY |1,972,537,950 |0. 778 |0. 1262 |0. 1234 | |TOTAL |2,017,200,038 | | |0. 1252 or 12. 52% | ANALYSIS From many different previous researches, we find different relation between the interest rates, cost of debt and WACC. We assume different variation in the interest rates as it is the independent variable that affects the WACC which is the dependent variable. In 2009, the interest rate of MCB was 12. 28%, we assume two different rates in which one is greater than 2009 rate i. . 11. 6% and other is less than 2009 interest rate i. e. 14. 90% in order to find the after affects of these changes. Remaining other things constant, as the interest rates increases, it also increases the cost of debt that results in the increase in the weighted average cost of capital, this can easily proved by given table and you can also find this relation through the given graph. Hence, hypotheses Ho and H3 of our research has proved by t his analysis because as the interest rate decreases to 11. 6%, the cost of debt also declines to from 8. 22% to 7. 6% and which result in decreases in the WACC from 12. 52% to 12. 51% and vice versa. |INTERSET RATES |COD |WACC | |11. 60% |7. 76% |12. 51% | |12. 28% |8. 22% |12. 52% | |14. 90% |9. 97% |12. 6% | [pic] For the relation between the tax rates, cost of debt and WACC. We find different variations among them. Tax rates are the independent variable so they create different affects on WACC as it is dependent variable. In 2009, MCB has the tax rate of 33. 07%. Similarly we assume one tax rate greater than 33. 07% and another is less than 33. 07% in order to prove our hypothesis. From the following analysis, we come to know that as the tax rates increases, it decreases the cost of debt that results in the decrease in the weighted average cost of capital.Hence, hypotheses H1 and H4 of our research have proved by this analysis. |TAX RATES |COD |WACC | |30% |8. 59% |12. 53% | |33. 07% |8. 22% |12. 52% | |40% |7. 36% |12. 50% | pic] 20 Al-falah Bank Limited WACC = (Weighted average cost of debt) + (weighted average cost of equity) WACC = (interest (1-tax)) + (Do (1 + g))/ (market price per share)] + g) COST OF EQUITY: |YEAR |2005 |2006 |2007 |2008 |2009 | |DIVIDEND/SHARE |0. 5 |1. 25 |1 |2. 25 |2. 25 | |GROWTH |0 |150% |-20% |125% |0 | Average growth=51%Cost of equity = Gordon growth model =(Do (1 + g))/ (market price per share)] + g) Cost of equity = 2. 25(1+0. 51)/26. 13+0. 51 = 64% | |g |Growth Rate |51% | | |Do |Last Dividend |2. 25 | | |MP |Market Price |26. 13 | | | | | | COST OF DEBT: Weighted average Interest Rate = 6. 406%.Tax rate = 34. 84% Cost of debt after tax = 0. 06406 (1 – 0. 3484) Cost of debt after tax = 4. 174% WEIGHTED AVERAGE COST OF CAPITAL: | |AMOUNT |%AGE COMPONENT |COST |WACC | | |Thousand (000) |(a) |(b) |(a*b) | |DEBT |18,687,600 |0. 00138 |0. 0417 |0. 000057 | |EQUITY |13,491,562,500 |0. 986 |0. 64 |0. 639104 | |TOTAL |13,5 10,250,100 | | |0. 639 or 63. 9% | ANALYSIS Many different researches have concluded that different variation in the interest rates as it is the independent variable that affects the WACC which is the dependent variable. In 2009, the interest rate of Alfalah Bank was 6. 404%, we assume two different rates in which one is greater than 2009 rate i. e. 8. 6% and other is less than 2009 interest rate i. . 4. 6% in order to find the after affects of these changes. Remaining other things constant, as the interest rates increases, it also increases the cost of debt that results in the increase in the weighted average cost of capital, this can easily proved by given table and you can also find this relation through the given graph. Hence, hypotheses Ho and H3 of our research has proved by this analysis because as the interest rate decreases to 4. 6%, the cost of debt also declines to from 4. 174% to 2. 997% and which result in decreases in the WACC from 63. 914% to 63. 0% and vice versa. |I NTEREST RATES |COD |WACC | |4. 6% |2. 997% |63. 90% | |6. 406%. |4. 174% |63. 914% | |8. 6% |5. 604% |63. 918% | [pic] For the relation between the taxes rates, cost of debt and WACC.We find different variations among them. Tax rates are the independent variable so they create different affects on WACC as it is dependent variable. In 2009, Alfalah has the tax rate of 34. 84%. Similarly we assume one tax rate greater than 34. 84% and another is less than 34. 84% in order to prove our hypothesis. From the following analysis, we come to know that as the tax rates increases, it decreases the cost of debt that results in the decrease in the weighted average cost of capital. Hence, hypotheses H1 and H4 of our research have proved by this analysis as they are negatively correlated. TAX RATES |COD |WACC | |25% |4. 805% |63. 917% | |34. 84%. |4. 174% |63. 9% | |40% |3. 844% |63. 915% | [pic] 21 Soneri Bank Limited ANALYSISSoneri Banks has following interest rates and tax rates, which affe ct WACC in the same manner as it affects other commercial Banks. In 2009, it has interest rate of 12. 63% that has the cost of debt 8. 54% and the WACC is of 0. 37%. Variation in the interest rates brings following changes and hence proves our research. |INTEREST RATES |COD |WACC | |11. 60% |7. 84% |0. 35% | |12. 3% |8. 54% |0. 37% | |14. 60% |9. 87% |0. 43% | [pic] Tax rates posses the same affect. As tax rates increases, it has negative relation with the COD and WACC that proves the hypothesis H1 and H4 of our research as in 2009, the tax rate was 32. 34%, when it decrease, the COD increases which also increases WACC and again inversely proportional when Tax rate increase. TAX RATES |COD |WACC | |25% |9. 47% |0. 41% | |32. 34% |8. 54% |0. 37% | |40% |7. 57% |0. 33% | [pic] CHAPTER 5: CONCLUSION AND RECOMMENDATION 1. ConclusionAccording to past related researches, there should be a suitable balance between debt and equity as it has effects on the risk and return of the sharehold ers of the bank. If there are reasonable proportions of debt and equity in the capital structure, it maximizes the shareholders wealth while minimizing the cost of capital and that could be considered as the optimal capital structure. Factors like Interest payment expected deductibility give prospect for value. If the tax deductibility is realized by the bank then stockholders get the expected benefit of the tax deduction.If firm finances through debt, then it has financial risk. And if through equity, then it has business risk. The cost of capital can affect capital structure that the taxes bring variation in the cost of capital and hence affect the capital structure of the banks. Cost of equity increases if the financial risk become high. The cost of equity and debt increases with the increase in debt. On after tax cost of debt, there is the greater the impact of interest deductibility, if the tax rate s higher. Weighted average cost of capital become low with the cost of capital high, if the debt capital increase in proportion.Cost of equity increases with the cost of debt. If the cost of components high the weighted average cost of capital increases and reason is that shareholder prefer to use of debt when expected value of tax benefit is attractive as compared to the added financial risk associated with the debt. The Demanded rate of increase in cost of debt and equity, effects on value of the expected increase in tax benefit of using more debt. Interest rate affects the cost of debt. It involves the risk components that have the probability of default on the debt.In this research, the main finding of the paper suggests that the commercial bank should focus on reducing the cost of capital that maximizes the profit. According to our findings, it is concluded that each banks has its policies of financing. Each bank takes decision of selecting capital structure for minimizing their cost, risk factor differently that occupies good financial position in market . Factors that have impact on cost of capital as well as on capital structure are tax rates, interest rates, dividends payout, risk of default and other like market fluctuation, corporate governance.These factors differently affect the cost of capital and capital structure of each commercial bank. Some banks agree that tax brings variation in the capital structure as the use of taxes decreases the cost of debt but some banks strongly disagree, like Islamic bank Meezan and Alfalah,. These Islamic banks have no such interest rate risk. Tax impacts on cost of capital increases cost of capital agrees by majority of commercial banks, and disagrees by some commercial banks. Dividend impacts on cost of capital increases cost of capital agrees by some banks, and disagrees by some banks.Interest rate brings effects on increase in cost of capital as the interest rate increases the cost of debt also increases but some banks strongly disagreed. Other factors like market fluctuation also influen ce interest rate to increase. And sometimes sudden increase in interest rates influence market. Due to this, all factors differently impact on cost of capital variation (increase and decrease) and capital structure decision making. We have estimated Weighted Average Cost of Capital (WACC) of commercial banks in order to find the effects of cost of capital and their factors on profit and capital structure decision making.We analyze from computing WACC with different assumptions that; †¢ The interest rates increases (decreases), it also increases (decreases) the cost of debt that results in the increase (decreases) in the weighted average cost of capital. Hence, hypotheses Ho and H3 is verify. †¢ The tax rates increases (decreases), it decreases (increases) the cost of debt that results in the decrease (increases) in the weighted average cost of capital. Hence, hypotheses H1 and H4 is verify. The cost of capital improves the profit and capital structure decision making in wh ich other factors also takes part to maximize the profit in the commercial banks. . Recommendations Cost of capital plays a central role in valuation, portfolio selection, and capital budgeting. Therefore, measuring and validating the cost of capital has been the subject of much research. †¢ For reducing cost of capital of bank, we recommend that proportion of debt plus equity financing is better although debt increases risk of default as most of the commercial banks prefer debt financing. Because, debt financing provides tax benefit under suitable market conditions and reduces WACC. †¢ Through equity financing banks give dividend which increases their reputation in market.In short, payment of dividend gives market position. And it is also important because in terms of financial ratios, equity financing shows bank more strong as compared to debt or liabilities. †¢ Adopt an optimal capital structure to improve shareholder value. Capital structure is part of a bank†™s package of financial policies, which include dividend policy and amount of debt and equity claims issued which improves share holder wealth and reduces WACC. Conventional thinking in the area of finance has also assumed that a certain amount of debt in the capital structure is a good thing. Interest rates are high in Pakistan.The following reforms looked-for from the Government of Pakistan (GOP): †¢ Allow and encourage consideration of financial institutions to reduce disintegration in the financial sector. †¢ Strengthen legal and judicial reform laws to allow financial institutions to foreclose on guarantee to reduce risk in the case of unpaid loans without going through lengthy court proceedings. CHAPTER 7: AREA OF FURTHER STUDIES After performing this research we have concluded that the researches on the Weighted Average Cost of Capital in Banks are less or there is no proper research that has taken place for the Commercial Banks.There should be more researches on the factor that are affecting WACC in the commercial banks as its proper estimation maximizes profit. It is found with the help of weightage there is a huge impact on the cost of capital that may be a source of further studies for the commercial bank because proper weightage of debt and equity can improves or enhances the profit of commercial banks. The WACC affects the profit or Capital Structure decision making that has direct affect on the reputation of the commercial banks. CHAPTER 8: REFERENCES †¢ Nadeem A.Sheikh and Zongjun Wang, June 2010, International Journal of Innovation, Management and Technology, Vol. 1, No. 2, Financing Behavior of Textile Firms in Pakistan, pg 130-135 †¢ Khadka, H Bahadur,2006. Leverage and the Cost of Capital. The Journal of Nepalese Business Studies,Vol. III, No1: 85-91 †¢ Modigliani, F. and Miller, M. H. 1963. Corporate Income Taxes and the Cost of Capital: A Correction. American Economic Review: 433-443. †¢ Shubber, K. and Alza firi, E. (2008). â€Å"Cost of capital of Islamic banking institutions: an empirical study of a special case†, International Journal of Islamic and Middle Eastern Finance and Management, Vol. No. 1, pp. 10-19 †¢ Bruner, R. F. , Eades, K. M. , Harris, R. S. , Higgins, R. C. (1998). â€Å"Best practices in estimating the cost of capital: survey and synthesis†, Financial Practice and Education, Spring/Summer, pp. 13-28. †¢ Miller, R. A. (2006). â€Å"The weighted average cost of capital is not quite right†, The Quarterly Review of Economics and Finance, 49 (2009) 128–138 †¢ Jorgenson, Dale W. and Ralph Landau (1993). Tax Reform and the Cost of Capital – An International Comparison. Washington, D. C. : Brookings Institution. †¢ Fama, E. F. , and K.French, 1997, Industry costs of equity, Journal of Financial Economics 43, 153-193. †¢ Fama, E. F. , and K. French, 1999, The corporate cost of capital and the return on corporate inv estment, Journal of Finance 54, 1939-1967. †¢ John J. Pringle, the Capital Decision in Commercial Banks, the Journal of Finance, Vol. 29, No. 3 (Jun. , 1974), pp. 779-795 †¢ Richard Lambert*, Christian Leuz, Robert E. Verrecchia â€Å"Accounting Information, Disclosure, and the Cost of Capital† September 2005, Revised, August 2006 †¢ Barton, S. L. and P. J. Gordon (1987). ‘Corporate strategy: Useful perspective for the study of capital structure? Academy of Management Review, 12, pp. 67-75 †¢ Balakrishnan, S. and I. Fox (1993). ‘Asset specificity, firm heterogeneity, and capital structure', Strategic Management Journal, 14(1), pp. 3-16. †¢ A. Seth (1990). ‘The impact of LBOs on strategic direction', California Management Review, 32(1), pp. 30-43. †¢ Groth John C. , â€Å"Capital structure: Perspectives. † Management Decision 35:7 (1997): 552–561. †¢ John C. Groth, Professor, Texas A University, USA â€Å"Capi tal Structure: Implications†, 1997. †¢ Ross, Stephen A. , Randolph W. Westerfield, and Jeffrey Jaffe. Corporate Finance. 9th ed.Boston, MA: McGraw-Hill, 2010. †¢ Alan J. Auerbach, Wealth Maximization and the Cost of Capital, the Quarterly Journal of Economics, Vol. 93, No. 3 (Aug. , 1979), pp. 433 †¢ John R. Graham, â€Å"Taxes and Corporate Finance: A Review†, the Review of Financial Studies, Vol. 16, No. 4 (Winter, 2003), pp. 1075-1129 †¢ Meziane Lasfer, Professor, Cass Business School, UK â€Å"Optimizing the Capital Structure: Finding the Right Balance between Debt and Equity†. †¢ William F. Coffin and Sean Collin, 2006, Techniques to lower the cost of capital in today’s volatile markets, CCG Investor Relations. Ali Murtaza, manager financial reporting and analysis, finance division, BANK ALFALAH LIMITED. †¢ Amir Ahmed, risk manager, Asst. vice president, Risk Management Unit, MEEZAN BANK. †¢ Aniel Victor, Asst. manag er, Riak management, UBL FUNDS MANAGERS. †¢ Syed Ali Shabar, Branch Manager, MCB BANK LIMITED. †¢ Raza Abbas, Asst. vice president, Portfolio Management, HABIB BANK LIMITED. †¢ Aamir Maysorewala, customer service manager, ALLIED BANK LIMITED. †¢ Riazullah Khan, Assistant Vice President & Manager, SONERI BANK. APPENDIX A Questionnaire NAME_________________________DESIGNATION_________________ BANK__________________________ BRANCH_______________________ 1. Debt and equity are the sources of finance, through which source your bank finances their investment? a) Debt b) Equity c) Both 2. What is the impact of dividend payment on cost of capital as using equity is source of finance that will liable bank to pay dividend? a) Increase cost of capital b) Decrease cost of capital c) No impact on cost of capital 3. Tax shield also has an important factor in cost of capital, how tax impact on cost of capital? a) Increase cost of capital b) Decrease cost of capital ) No impact on cost of capital 4. Cost of capital has positive impact by using both sources of finance. [pic] 5. When bank finance through debt, it increase liabilities that also increase the risk factor of default. [pic] 6. Fluctuation in the interest rate affects Cost of Capital and also the Capital Structure of your banks. [pic] 7. As low dividend payout will affect the reputation of your bank, is high dividend payout and dividend growth affect the capital structure decision? [pic] 8. Cost of capital occupies an important role in the financial management and in investment decision making in commercial banks. [pic] . Cost of capital affects the level of risk in commercial bank. [pic] 10. Taxes bring variation in the capital structure of commercial banks. [pic] 11. Reducti