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THESIS ON: IMPACT OF FINANACIAL LEAVEREAGE ON INVESTMENT

“CASE STUDY OF PAKISTAN TELECOMMUNICATION

COMPANY LIMITED”

[FINANCE THESIS]

[B.S(P.A)-IV]

SUPERVISED TO : SIR GHULAM SHBIR SHAIKH

SUPERVISED BY: JAWED LUND (2K12/PAE/23)
ZOHAIB BHAMBHRO (2K12/PAE/62)
MUHAMMAD JUMAN (2K12/PAE/34)
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Turnitin Originality Report

“Impact of Financial Leverage in Investment, in case of PTCL”
By
Jawed Lund, B.s (PA)

Processed on 15-Aug-2015
Word Count: 13,568
Study Consist: 2005 to 2014
Similarity Index: 2%
Similarity by Source
Internet Sources: 2%
Publications:1%
Student Papers:1%
Sources:1

G. Shabir Shaikh
Thesis Supervisor
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Faculty of Social Science

PUBLIC ADMINISTRATION
UNIVERSITY OF SINDH
JAMSHORO

CERTIFICATE
I am pleased to certify that Mr. Jawed Lund S/o Ali Akbar has
satisfactorily carried out a research work, under my supervision on the topic
of “impact of inflation on economic growth: in case study of Pakistan
Telecommunication company limited ”.

I further certify that his distinctive original research and his thesis is
worthy of presentation to the faculty of Social sciences, UNIVERSITY OF
SINDH, JAMSHORO for the degree of BS.P.A (FINANCE).

SUPERVISOR: _________________________
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ACKNOWLEDGEMENT

We would like to thank Mr. Ghulam Shabir Shaikh– supervisor who has
given Many useful comments related to my topic. After his guidance we are able to
complete thesis through his step by step support for research work. Also we would
like to thanks to Mr. Ghulam Shabir Shaikh who checked work on short term
notice and appreciate thesis work by both of persons also a lot of detailed and
valuable comments on this thesis work. The same appreciation s will be for
members from thesis group and for the teacher and members from groupies
course.
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DEDICATION
This thesis is dedicated to my parents who introduced me to the joy of reading from birth enabling such
a study to take place today. And dedicate to my close friends who connivance and suggest me about my
education and my carrier in future.
Also to my teachers of my departments and from primarily level respected teachers who understand
my mind approach and thanks-full to all of respected teachers they gave chance to learn from them and they
converted theirs knowledge and information about study, they always helps me in time of need to ask about any
difficulty about study. In last I would like to say that ALLAH make them happy in their life.
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Table of Contents
Abstract ------------------------------------------------------------------------------------------------------------------------------------------ 09
Chapter # 01 --------------------------------------------------------------------------------------------------------- 09
Analysis of research problem
1 .1. Introduction to Financial Leverage ----------------------------------------------------------------- 09
1.1.1. Total debt to asset ratio or debt ratio ------------------------------------------------------------ 10
1.1.2. Total debt to equities ratio -------------------------------------------------------------------------- 10
1.1.3. Long term debt to equities ratio ------------------------------------------------------------------- 11
1.1.4. Equity to assets ratio ---------------------------------------------------------------------------------- 11
1.1.5. Times interest earned --------------------------------------------------------------------------------- 11
1.2. Concept of financial leverage in Pakistan ---------------------------------------------------------- 12
1.3. Companies in Pakistan ---------------------------------------------------------------------------------- 13
1.4. Growth of Telecom Sector in Pakistan after Deregulation ----------------------- 14
1.5. Impact of Deregulation on Mobile Sector ----------------------------------------- 14
1.6. OPERATING & FINANCIAL HIGHLIGHTS of PTCL ----------------------------------------------- 16
1.7. Financial Performance of PTCL ----------------------------------------------------------------------- 18
1.7.1. Dividends and Appropriations --------------------------------------------------------------------- 18
1.7.2. Profitability --------------------------------------------------------------------------------------------- 18
1.7.3. Revenues ------------------------------------------------------------------------------------------------- 18
1.7.4. Operating Costs ----------------------------------------------------------------------------------------- 19
1.8. Graphical Presentation of PTCL ---------------------------------------------------------------------- 19
1.8.1. Profit Before and After Tax -------------------------------------------------------------------------- 19
1.8.2. Return on Operating Assets and Equity (%) ----------------------------------------------------- 20
1.9. Introduction of leverage in PTCL ------------------------------------------------------------------------------------------ 22
1.10. Leverage Position --------------------------------------------------------------------------------------- 24
1.11. Introduction of PTCL --------------------------------------------------------------------------------------------------------- 26
1.12. History of PTCL ------------------------------------------------------------------------------------------------------------------ 28
1.13. Introduction of Etisalat ------------------------------------------------------------------------------- 28
1.14. Objectives of study ---------------------------------------------------------------------------------------- 29
Chapter # 02
Literature review and Research methodology ---------------------------------------------------- 30
2.1. Summary -------------------------------------------------------------------------------------------------------- 30
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2.2. Summary ------------------------------------------------------------------------------------------------------- 31

2.3. Summary -------------------------------------------------------------------------------------------------------- 32
2.4. Summary ---------------------------------------------------------- --------------------------------------------- 32
2.5. Summary ------------------------------------------------------------------------------------------------------- 33
2.6. Research Methodology ------------------------------------------------------------------------------------- 34
2.7. Theoretical Framework ------------------------------------------------------------------------------------ 34
2.7.1. Variables ----------------------------------------------------------------------------------------------------- 35
2.7.2. Research Hypothesis ------------------------------------------------------------------------------------- 35
2.7.2. a) Hypothesis - H1 ---------------------------------------------------------------------------------------- 35
Table No. 1 ------------------------------------------------------------------------------------------------ 35
Table No. 2 ------------------------------------------------------------------------------------------------ 36
Table No. 3 ------------------------------------------------------------------------------------------------ 36
Table No. 4 ------------------------------------------------------------------------------------------------ 36
2.7.2. b) Hypothesis – H2 -------------------------------------------------------------------------------------- 37
Table No. 1 ----------------------------------------------------------------------------------------------- 37
Table No. 2 ----------------------------------------------------------------------------------------------- 37
Table No. 3 ---------------------------------------------------------------------------------------------------- 38
Table No. 4 ---------------------------------------------------------------------------------------------------- 38
Table No. 5 ---------------------------------------------------------------------------------------------------- 38
CHAPTER # 03
DATA ANALSIS, CONCLUSION, RECOMMENDATION AND REFERRENCES ------------------ 40
3.1. Sample Size -------------------------------------------------------------------------------------------------- 40
3.2. Data Analysis & Discussion ----------------------------------------------------------------------------- 40
3.3. The findings ------------------------------------------------------------------------------------------------- 40
3.3.1. APPENDEX: Companies List
3.4. Conclusion --------------------------------------------------------------------------------------------------- 42
3.5. Recommendation & Limitation ---------------------------------------------------------------------------- 42
3.6. References ------------------------------------------------------------------------------------------------------- 43
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ABSTRACT
Regardless of the size and nature, largely all businesses are dependent on leverage. This
research called for analyzing the impact of leverage on equity elements like the earnings to price ratio,
Market value of equity and book to market ratio. Later on we also tested to identify the relationship
between leverage and on expected stock returns. Financial data for different companies ranging in their
own sectors was collected and then financial data from 2002 to 2012 was used to run pooled regression
in order to find out any existing relationship The results were pretty astonishing as it was proved that
leverage had no impact on either of the equity elements. Nevertheless, a relationship could be identified
between leverage and expected stock returns. Hence it will be safe to conclude that Pakistan’s economy
is shortsighted and consumption oriented and that profits and earnings of companies in Pakistan are
highly financed by their respective revenues. But nevertheless judgments about a particular sector
couldn’t be made as this report has various business sectors of Pakistan.
Keywords: Leverage, Equity, Degree of Operating Leverage (DOL), Degree of Financial Leverage
(DFL), Degree of Total Leverage (DTL), Market Value of Equity, Book to Market Value Ratio.
 Page |9

Chapter # 01
Analysis of Research problem
(Financial Leverage And Its Impact On Investment)
1.1. Introduction to Financial Leverage
Financial leverage is the degree to which a company uses fixed-income securities such as debt
degree of financial leverage means high interest payments, which negatively affect the company's
bottom-line earnings per share.

“Use of debt to increase the expected return on equity. Financial leverage is measured by
the ratio of debt to debt plus equity”. By Campbell R. Harvey.
The amount of debt that has been used to finance activities. A company with much more debt tha
n equity is generally called "highlyleveraged." Too much leverage is often thought to be unhealthy, but
many firms use leverage in order to expand operations. By Farlex Financial Dictionary.

The more debt financing a company uses, the higher its financial leverage. A high degree of financial
leverage means high interest payments, which negatively affect the company's bottom-line earnings per
share. Financial risk is the risk to the stockholders that is caused by an increase in debt and preferred
equities in a company's capital structure. As a company increases debt and preferred equities, interest
payments increase, reducing EPS. As a result, risk to stockholder return is increased. A company should
keep its optimal capital structure in mind when making financing decisions to ensure any increases in
debt and preferred equity increase the value of the company.

Leverage helps both the investor and the firm to invest or operate. However, it comes with
greater risk. If an investor uses leverage to make an investment and the investment moves against the
investor, his or her loss is much greater than it would've been if the investment had not been leveraged -
leverage magnifies both gains and losses. In the business world, a company can use leverage to try to
generate shareholder wealth, but if it fails to do so, the interest expense and credit risk of default
destroys shareholder value.

Financial leverage metrics compare the funds supplied to a company by creditors to the funds
supplied by the company's owners. Risks of the enterprise are borne both by creditors and owners, but in
proportion to their share of the funding. If creditors have provided most of the funding, they have more
to lose than the owners if the business fails.
 P a g e | 10

This article illustrates four of the most commonly used financial leverage metrics, including the
total debt to asset ratio (or debt ratio), total debt to equities ratio, long term debt to equities ratio, and
times interest earned. Companies borrow funds through bank loans and bond issues so as to
create leverage. Leverage metrics compare a company's creditor-supplied funds to owner-supplied
funds. Owners and creditors share risks and rewards in proportion to their share of the funding.

According to Reilly and Brown (2003), investment is the current commitment of funds for a
period of time in order to derive future payments that will compensate the investor for, the time the
funds are committed, the expected rate of inflation and the uncertainty of the future payments. But a
very important question rises here that how such fund will be generated.

1.1.1. Total debt to asset ratio or debt ratio

What proportion of the company's total funding is provided by creditors? The total debt to assets
ratio metric addresses this question. This metric compares two balance sheet entries, total liabilities
(i.e., total debt) and total assets.

Total debt to asset ratio, or Debt ratio = Total liabilities / Total Assets

1.1.2 Total debt to equities ratio

Debt to equity ratios measure the extent to which owner's equities can protect creditors' claims,
should the business fail. The first of these debt to equity ratios, total debt to stockholders' equities, is the
strongest of these measures, that is, it provides the most conservative view of creditor protection. This
ratio compares two balance sheet entries, Total stockholders equities and Total liabilities.

Equity financing means rising funds for company activities or operations by issuing stocks to
individual and institutional investors. These individual and institutional investors become creditors and
receive ownership interest in exchange for their funds. On the other hand, when a company raises fund
through the issuance of bonds or borrowing from banks or other financial institution, it is called debt
financing. In return, these individuals and institutions receive promise that they will receive interest
periodically and principal amount at maturity. When a company uses mix of these sources, it is called
capital structure.

According to Odit and Chittoo (2008) in 1930 and 1940s, the inclusion of debt in capital
structure were considered as evil. And it was considered as taboo and the basic source of bankruptcy
 P a g e | 11

and financial distress. But the concepts were changed by Modigliani and Miller (1958). They claimed
that the value of a firm is independent of its capital structure in a frictionless or complete world, where
there is no transaction cost, no default risk, asymmetric information and no taxes.

Total debt to equities ratio = Total liabilities / Total stockholders equities

1.1.3. Long term debt to equities ratio

The second debt to equities ratio, long term debt to stockholders equities (or more simply long
term debt to equities) is more properly a measure of leverage, because the debt figure contains only
debt to lenders, or long term debt, (as opposed to total debt, which includes debt to vendors, employees,
and tax authorities as well as debt to lenders). It is appropriate to view the long term debt to
equities ratio as a measure of what is called the company's capital structure—a comparison of the
company's debt funding to its equities funding. "Funding" in this sense has in mind funds used to acquire
income-earning assets, which are likely to include long term debt but not short term debt. (Short term
debt usually represents obligations such as "Employee salaries owed," "Accounts Payable," and "Taxes
due.").

Long term debt to equities ratio = Total long term liabilities / Total stockholders equities

1.1.4. Equity to assets ratio

The Equity to assets ratio (along with the total debt to total equity ratio described above) is one
of the most direct measures of leverage. The ratio and its complement (1 - Equity/Assets) must total 1.0.
The ratio shows what proportion of total assets are funded by equities.

Equities to assets ratio = Total equities / Total assets

1.1.5. Times interest earned

Can the company still meet interest charges if earnings decrease? The times interest earned
metric addresses this question. This is considered a measure of the credit worthiness of the company.
Times interest earned is based on income statement terms: the company's earnings before
extraordinary items, interest and taxes are compared to the company's interest expenses.

Times Interest Earned = Earnings before tax and extraordinary items + interest expense) / interest
expense
 P a g e | 12

1.2. Concept of financial leverage in Pakistan

Corporations play a vital role in contributing to the economic growth. In today‟s dynamic
environment, firms generally face intense competition and should therefore need to act in response. To
respond to global competition, firms need to make huge investment in modern technology,
infrastructure, land, building, machinery, quality management, innovation and product development
etc. Such factors will help organization to promote efficiency and effectiveness and gain competitive
advantage. A firm needs cash or money to invest in land, building, machinery and to take care of day to
day operations. The money which firms or businesses invest in purchasing land, machinery or other
fixed assets is called capital investment. In other words, investment can define as spending on capital
goods by firms which ultimately amplified production of consumer goods.
The objective of this study is to find either financial leverage is good or bad in the context of
Pakistani firms? Financial leverage, in the context of this study, is defined as the degree to which a firm
employs borrowed money. Capital structure choices are challenging decision because using higher
leverage can take a firm to risk of bankruptcy. But this cannot lead to decide that debt is always bad.
Financial leverage is good in a sense that it raises stockowners’ return on their investment due to the
fact of tax benefit related with borrowing. focuses on Pakistani manufacturing and service firms,
while only limited research has been conducted on such firms in that context recently Abdulaziz
Istaitieh (2005 ) starting with the basics, once one begins thinking about fixed non-state-contingent
obligations like bonds, loans and the like things get very complicated very fast.

This paper is focusing on the effect of the profitability of the firm and its financial leverage on
the capital structure of the textile sector companies in Pakistan. Capital structure refers to the different
options used by a firm in financing its assets. Generally, a firm can run for different levels of debts,
equity, or other financial arrangements. It can combine bonds and lease financing, bank loans or many
other options with equity in an overall attempt to boost the market value of the firm. In this attempt to
maximize the overall value, firms differ with respect to capital structures. This paper attempts to
answer the question that how profitability and capital impact capital structure of listed Pakistani firms
belonging to the textile industry sector. As Pakistan is one of the major producers of cotton, the
country has a sound textile industry. It is apparent from the fact that the textile exports double to $10.5
billion in 2007 from $5.2 in1999. Pakistan accounts for 3% of the United States textile
imports. The country’s textile exports are expected to reach $14 billion while employing approximately
6.2 million people indirectly as well as directly. Pakistan’s textile and apparel manufacturing industry
 P a g e | 13

provides employment to 40% of the country’s labor force to proceed with this, the capital structure of
10 listed firms has been analyzed by adopting an econometric framework over a period of 6 years.
Hence, the study is unable to establish any significant relation between profitability and financial
leverage effect on the capital structure of a firm. Pakistan is a developing country with three stock
exchanges, KSE, LSE and ISE the Karachi Stock Exchange (KSE) being the largest one. More than 700
companies are listed on KSE. Like other developing economies, the area of capital structure is relatively
unexplored in Pakistan. In previous researches, capital structure has never been taken as a dependent
variable but would be discussed in this new way here.

1.3. COMPANIES INFORMATION

In order to have a comprehensive analysis, financial data of ten companies from

diversified industries were collected. Following is the background to respective companies:
Byco:

Pakistan’s emerging energy companies engaged in the businesses of oil refini ng,
petroleum marketing, chemicals manufacturing and petroleum logistics. They have their
head quarters in Karachi but the mission continues to fulfill the energy demand globally
as well.

Atlas Honda Limited (ATLH):

is a joint venture between the Atlas Group and Honda Motor Co. Ltd., Japan. AHL
manufactures and markets Honda motorcycles in collaboration with Honda Motor
Company. Honda motorcycles are by far the largest selling motorcycles in the country with
an unmatched reputation for high quality, relia bility and after-sales-service.

Engro Corporation (ENGRO):

Engro Corp is one of Pakistan’s largest conglomerates with businesses ranging from
fertilizers to power generation. Currently, Engro Corp’s portfolio consists of seven
businesses, which include chemical fertilizers, PVC resin, a bulk liquid chemical terminal,
industrial automation, foods, power generation and commodity trade. From its existence,
Engro has come a long way in its vision of becoming a premier Pakistani company with a
global reach.
 P a g e | 14

Pakistan Telecommunication Company Ltd (PTCLA):

PTCLA has redefined the boundaries of the telecommunication market and is

shifting the productivity frontier to new heights globally. Today, for millions of people,
PTCLA has been the prime source for instan t access to new products and ideas. More
importantly it allowed better living standards for people with increased values in this
ever-shrinking globe. They are setting free the spirit of innovation. 
 PTCLA is going to be
your first choice in the future as well, just as it has been over the past six decades.

1.4. Growth of Telecom Sector in Pakistan after Deregulation

Although tremendous growth has taken place in the Pakistan telecom sector but
most of it can be attributed to the cellular growth. Fixed line is still awaiting a take off.
Similarly Value Added Services have grown but are still a drop in the bucket. Now that the
competition has been introduced in the telecom sector some very positive impact have
been observed on the growth of the sector in a short sp an of time which is expected to
continue to grow for at least next years. A brief account of the growth after deregulation
in telecom sector is given below.

1.5. Impact of Deregulation on Mobile Sector

Driven by lowest tariffs, maximum coverage, and relatively better quality the
Pakistan mobile market maintained rapid growth during2007. The newly deregulated
mobile market is now working on sustaining the mobile boom that hit Pakistan 2 years
back and on the brink of adding Value Added along with customer satisfa ctions. Steady
growth saw addition of more than two million mobile subscribers every month throughout
the last year. Network coverage of almost 90% of the total population of Pakistan has
made mobile industry even more attractive for foreign investment. Pa kistan has emerged
as one of the fastest growing mobile markets among the developing nations. This year the
sector grew by 80% whereas average growth rate in last 4 years has been more than
100%. Today total subscribers have reached 76.9 million (Dec 2007) whereas it was
34.5million in 2006 and 12.7million in 2005. Figure -1 shows the subscribers growth of
different Cellular Mobile Operators. In Pakistan’s competitive and heated mobile market
operator’s survival lies in getting into new areas exploring new V alue Added products, and
providing better quality of services. This is only possible by rolling out networks and be
 P a g e | 15

The first to reach untapped population of the country .Out of 376 tehsils across Pakistan,
almost 77 % are covered with mobile networks, bringing the figure to 290.

In 2004 there were less than 2000 cell sites erected by all mobile operators all together
for provision of mobile services. Today total cell sites of all mobile operators are more than
17,500. In 2007 the share of each company in mobile market exhibited a change, except for
Ufone whose subscriber share remained more or less the same. Mobilink kept on loosing its
share for another year in favors of Telenor and Warid despite its secure subscriber base ,where
as Paktel and Insta phone share in the market also dropped as both companies are struggling
with transitional phase. Figure-2 depicts the Cellular mobile operators share in the
telecommunication market.
 P a g e | 16

1.6. OPERATING & FINANCIAL HIGHLIGHTS of PTCL

Financial Years Year ended Year ended

Dec 31, 2014 Dec 31, 2013

KEY INDICATORS
Operating
Pre tax margin (EBIT margin) % 10.19 24.90
Net margin % 6.39 15.66
Performance
Fixed assets turnover times 0.99 1.06
Debtor’s turnover Times 4.75 4.77
Return on equity % 5.40 12.85
Return on capital employed % 3.38 8.92
Retention % (144.84) 19.66
Leverage
Debt Equity Ratio 30:70 28:72
Leverage % 47.91 43.38
Time interest earned Times 28.14 58.26
Liqudity
Current Times 1.57 1.94
Quick Times 1.51 1.85
--------------------------------------------------------------------------------------------------------------------------------
Valuation
Earnings per share Rs 1.02 2.49 1
Breakup value per share Rs 18.07 19.78
Dividend payout ratio % 244.84 80.34
Price earnings ratio Times 22.55 11.42
Market price to breakup value Times 1.27 1.44
Dividend per share Rs 2.50 2.00
Dividend yield % 10.86 7.03
 P a g e | 17

Dividend cover ratio Times 0.41 1.24

Market value per share Rs 23.03 28.44
(as on Dec 31 & June 30)
HISTORICAL TRENDS
Operating Results
Revenue Rs (m) 81,513 81,061
Profit / (loss) before tax Rs (m) 8,012 19,838
Profit / (loss) after tax Rs (m) 5,207 12,696
Dividend Rs (m) 12,750 10,200
_______________________________________________________________________________________________________________________
Financial Position
Share Capital Rs (m) 51,000 51,000
Reserves Rs (m) 40,815 49,782
Shareholders’ equity Rs (m) 92,144 100,872
EBITDA Rs (m) 17,825 28,311
Working Capital Rs (m) 25,280 36,335
Current assets Rs (m) 69,625 74,918
Total assets Rs (m) 179,574 181,908
Non current liabilities Rs (m) 43,085 42,453
Operational*
ALIS as on Dec 31 & June 30 No (000) 4,323 4,014
Average ALIS per employee No 207 183

2014 was quite challenging and exciting year for the telecom sector of Pakistan. The launch of 3G/4G
wireless broadband services marked a significant change in the telecom landscape of the country. PTCL
greeted it as an opportunity of tremendous growth, given the strategic initiatives embarked long before.
Ufone considered as a strong competitor in the auction process and was the first to launch 3G in
Pakistan, due to its advanced planning and network readiness. Being the market leader in wireless
broadband, PTCL launched ‘CharJi EVO’, providing our EVO community an opportunity to experience
high-speed internet. The total tele-density stands at an impressive 77% with broadband penetration at
4% only, including 3G/4G subscribers. The growth in traditional revenue streams like voice and text
messaging is reaching to maturity, as the data poised to be the next wave of revenue progression.
 P a g e | 18

Total telecom services revenue is now approaching US $5 billion mark per annum, with a large
untapped potential. Industry growth, despite lower ARPUs (Average Revenue per User) and issues like
the energy crisis, suggests a resilient telecom sector.
1.7. Financial Performance of PTCL
Company performed well during 2014. With 34% increase in the subscriber
base of broadband segment, both wireline and wireless, corresponding revenues also
increased by 34%. Subscriber base of fixed voice segment also witnessed growth during
the year. Besides, revenue from Corporate Services also increased as compared to last
year. tools consumed were the main constituents of the operating expenses.
1.7.1. Dividends and Appropriations
For the year under review, the Directors have recommended a final cash dividend of 15% (Rs.
1.5 per share) which is in addition to the interim cash dividend of 10% (Re. 1.0 per share). The total
dividends for the year thus stood at 25% (Rs. 2.5 per share) as compared to dividends of 20% (Rs. 2.0
per share) for 2013. For the loss of assets due to fire and floods incurred during the year, an amount of
Rs. 1.0 billion was utilized from the insurance reserve. Also, the income of Rs. 0.3 billion earned on
insurance reserve funds was transferred from unappropriated profits to the insurance reserve.

1.7.2. Profitability
The Company’s profitability remained stable in spite of extraordinary expenses on account of a
successfully completed voluntary separation scheme as well as losses due to fire and floods. PTCL’s net
profit for the year was Rs. 5.2 billion mainly contributed by revenue growth as well as effective cost
optimization measures, despite the exceptional expenses of Rs. 8.2 billion and Rs. 0.9 billion on account
of voluntary separation scheme and loss of assets due to fire incident respectively. PTCL’s Group profit
after tax for the year was about Rs. 4 billion. The PTCL Group profitability during the year remained
subdued mainly due to amortization of 3G license acquired by Ufone (the 100% owned subsidiary of
PTCL). PTCL’s earnings per share (EPS) for the year was Rs. 1.02 whereas for PTCL Group the EPS was
Rs. 0.78.

1.7.3. Revenues

During the year, PTCL Group revenues stood at Rs. 129.9 billion. PTCL’s revenues of Rs. 81.5
billion for the year registered increase mainly on account of robust performance of broadband segment
 P a g e | 19

as well as sustaining the fixed line voice revenues in spite of decline in revenues from international
incoming calls.

1.7.4. Operating Costs

Through effective cost optimization measures implemented during the year, the total
operating cost for PTCL Group increased by 6% thus withstanding the inflationary pressures. Similarly,
the increase in PTCL’s operating expenses was 6% per annum as well. Of these, the cost of services of Rs.
55.7 billion increased by 5%, administrative and general expenses of Rs. 9.9 billion increased by 8% and
selling and marketing expenses of Rs. 3.3 billion increased by 13% as compared to last year. Salaries,
allowances and other benefits; foreign operators’ cost and satellite charges; depreciation on property,
plant and equipment; amortization of intangible assets; fuel and power and store, spares and loose as
related revenues. Company improved its touch points with customers, offering ease to do business. The
sections below share an overview of different segments of your Company’s rich products and services in
2014.

1.8. GRAPHICAL PRESENTATION OF PTCL

1.8.1. PROFIT BEFORE TAX AND PROFIT AFTER TAX (RUPEES IN BILLION)

25

20

15

10

0
2010 2011 2012 J 2012 D 2013 2014

-5
 P a g e | 20

PTCL leveraged its dominance in the fixed line sector to transition to data by aggressively
converting voice subscribers to double and triple play. This strategy was highly successful to restrain
fixed-to-mobile substitution and maintain organic growth. In wireless broadband, EVDO (Evolution-
Data Optimized) maintained pressure on other wireless technologies like WiMAX, which appear to be
stalled in terms of market expansion. Ministry of Information and Telecommunication Technology is
working diligently on articulating a new telecom policy to respond to emerging challenges of dynamic
industry incorporating inputs from various stakeholders. The new policy is expected to stimulate the
industry and to yield even more dividends for the nation.
The Company’s profitability remained stable in spite of extraordinary expenses on account of a
successfully completed voluntary separation scheme as well as losses due to fire and floods. PTCL’s net
profit for the year was Rs. 5.2 billion mainly contributed by revenue growth as well as effective cost
optimization measures, despite the exceptional expenses of Rs. 8.2 billion and Rs. 0.9 billion on account
of voluntary separation scheme and loss of assets due to fire incident respectively. PTCL’s Group profit
after tax for the year was about Rs. 4 billion. The PTCL Group profitability during the year remained
subdued mainly due to amortization of 3G license acquired by Ufone (the 100% owned subsidiary of
PTCL). PTCL’s earnings per share (EPS) for the year was Rs. 1.02 whereas for PTCL Group the EPS was
Rs. 0.78.

1.8.2. RETURN ON OPERATING ASSETS & EQUITY (PERCENTAGE)

18

16

14

12

10

0
2010 2011 2012 J 2012 D 2013 2014
-2
Return on Operating Assets Return on Equity
 P a g e | 21

The growth in traditional revenue streams like voice and text messaging is reaching to maturity,
as the data poised to be the next wave of revenue progression. Envisaging enormous wireless data
growth potential in Pakistan, several new players entered the smart phone market, targeting all income
groups with high end data features in services marked the year 2014. The flux of data-enabled devices
will stimulate the evolution of the whole ecosystem to a new level and we are about to witness rapid
growth in content consumption. To ride this wave, PTCL launched Wifi enabled high-speed
broadband dongles ‘CharJi EVO’, which connects several handheld devicesto
ultra-speed wireless internet on-the-go. Total telecom services revenue is now approaching US $5 billion
mark per annum, with a large untapped potential. Industry growth, despite lower ARPUs (Average
Revenue per User) and issues like the energy crisis, suggests a resilient telecom sector. Pakistan telecom
sector is now diversifying through solutions such as MFS (Mobile Financial Services), E-Governance and
E-Health. There are nine major players competing in mobile financial services and branchless banking,
from the telecom and banking sector. Intersection of large unbanked population, impressive mobile tele-
density along with countrywide sale and distribution channels are the key success factors behind
phenomenal growth. With several players entering the market, margins are declining, which will be
offset by tremendous volume growth.

1.8.3. REVENUE AND TRADE DEBTS (RUPEES IN BILLION)

 P a g e | 22

90

80

70

60

50

40

30

20

10

0
2010 2011 2012 J 2012D 2013 2014

During the year, PTCL Group revenues stood at Rs. 129.9 billion. PTCL’s revenues of Rs. 81.5
billion for the year registered increase mainly on account of robust performance of broadband segment
as well as sustaining the fixed line voice revenues in spite of decline in revenues from international
incoming calls. Through effective cost optimization measures implemented during the year, the total
operating cost for PTCL Group increased by 6% thus withstanding the inflationary pressures. Similarly,
the increase in PTCL’s operating expenses was 6% per annum as well. Of these, the cost of services of Rs.
55.7 billion increased by 5%, administrative and general expenses of Rs. 9.9 billion increased by 8% and
selling and marketing expenses of Rs. 3.3 billion increased by 13% as compared to last year. Salaries,
allowances and other benefits; foreign operators’ cost and satellite charges; depreciation on property,
plant and equipment; amortization of intangible assets; fuel and power and store, spares and loose as
related revenues. Company improved its touch points with customers, offering ease to do business. The
sections below share an overview of different segments of Company’s rich products and services in 2014.
Your attention is drawn to note 12.10 of PTCL’s financial statements as well as note 17.10 of the
consolidated financial statements for the year, which contains the information and explanation
regarding certain litigation cases as highlighted by external auditors in their audit reports.

1.9. INTRODUCTION OF LEAVEARGE IN PTCL

Pakistan Telecommunications Company Limited was incorporated in Pakistan on
December 31, 1995 and commenced business on January 1, 1996.
It is listed on all the three stock exchanges of the country. It was established to undertake the
 P a g e | 23

telecommunication business formerly carried by Pakistan Telecommunication Corporation

(PTC). The business was transferred to PTCL on January 1, 1996 under the Pakistan
Telecommunication (Reorganization) Act, 1996 and the company took over all the properties,
rights, assets, obligations and liabilities of the PTC except those transferred to National
Telecommunication Corporation (NTC), Frequency Allocation Board (FAB), Pakistan
Telecommunication Authority (PTA) and Pakistan.
PTCL made several investments in infrastructure development and added network
capacity to enhance services and expand its reach across the country. The market in Pakistan is
extremely competitive and PTCL has the largest nationwide installed network infrastructure
capability including switching, transmission, fiber optic backbone, co-location and international
capacity. This gives PTCL a unique position in terms of providing to carriers and individual
consumers alike. With the introduction of Vfone, the new CDMA-based WLL platform of PTCL, is
poised to become the largest fixed wireless telephony network in Pakistan. On the wireless
broadband front, a major upgrade of the WLL CDMA network was rolled out in order to provide
wireless broad and services in 17 major cities. Broadband Pakistan offers DSL services with
unmatched reliability, affordability and connectivity. Customers have the option to packages
with varying speeds from 512Kb to 2Mbwith unlimited downloads. Broadband customer service
is available twenty-four hours a day, seven days a week at 1236 with highly trained and
professional representatives.
Telecommunication Employees Trust (PTET). The registered office of PTCL is in
Islamabad. PTCL provides telecommunication services in Pakistan. It owns and operates
telecommunication facilities and provides domestic and international telephone services and
other communication facilities throughout Pakistan. It has also been licenced to provide such
services to territories in Azad Jammu and Kashmir and Northern Areas.
PTCL has invested in the capacity of two SEA-ME-WE submarine cables to meet the
increasing demand of international traffic. Additionally, PTCL is also part of a consortium that
will put in place a high-capacity fiber-optic submarine cable that stretches from India to Italy
and France via the Middle East, named I-ME-WE, to provide effective resilience to the existing
cable systems (SMW3 & SMW4).PTCL has also signed an agreement with Huawei Technologies
Pakistan and Hewlett Packard (HP) to jointly launch the Network Operation Centeral project
which has state-of-the-art fault detection and resolution technology.
The telecom industry posted its highest-ever revenue in the fiscal year 2013. Total
investment in the sector — at $472 million — was a major improvement from the $240.3
million invested in the prior year. And consolidation is also taking place in the cellular industry.
The industry posted cumulative revenue of Rs440.2 billion in FY13, up seven per cent from FY12,
according to the recently released annual report of the Pakistan Telecommunication Authority
(PTA). And the fortunes of the country’s largest telecom company — Pakistan
Telecommunication Company Limited (PTCL) — mirrored that of the overall industry.
In the January-September 2013 period (9MCY13), the company posted an unconsolidated
after-tax profit of Rs 9.3 billion, against a loss of Rs742.6 million in the same period last year.
Revenues jumped by an impressive 63.4 per cent to Rs60.7 billion. Mean while, the company’s
 P a g e | 24

stock has ranged between a low of Rs17 and a high of Rs31.2 in the year-to-date period. It ended
last Thursday at around Rs28.4 per share.
During F Y09, the PTCL achieved various milestones. Broadband Pakistan became the
largest broadband service in Pakistan with over 200,000 subscribers spread over 170 cities. EVO
was launched which made the company the first 3G Wireless broadband service provider in
Pakistan. It is the sole integrated telecom service provider offering Bundled Voice Data, Internet
and TV services at compelling and competitive rates to a wide audience. This year PTCL also
underwent ERP implementation. Now PTCL is the first organisation in Pakistan which,
successfully implemented SAP new dimension products such as Supplier Relationship
Management (SRM), E-Recruitment, Employee/Manager Self Service (ESS/MSS) and Business
Intelligence (BI). Recent results 3Q10.
The company's revenue of Rs 73.6 billion for the period under review was 7% higher as
compared to the corresponding period last year. The revenue earned by PTML (Ufone), the
wholly-owned subsidiary of PTCL, was higher by 22%, while PTCL's revenue decreased by 4%.
PTCL's domestic voice revenue declined by 7% whereas International revenue registered an
increase of 23%. Net profit of Rs 6.7 billion showed a 12% growth as compared to the same
period last year. PTCL's profit after tax at Rs 7.9 billion was 9% higher than the same period
last year. Due to better cost controls, there was a decrease in Administrative and General
Expenses by 17%. Other operating income increased by 32% due to improved realization of
receivables as well as prudent utilization of available funds. Finance cost decreased by 62%
because of relative stabilization of rupee during the period.
The decline in the profits of the company due to the above-cited reason has led to a
decrease in the gross margin percentage also. The gross margin or operating profit margin of
PTCL declined in FY09 to 18.15% from 24.67% in FY08 and 26.33% in FY07. The reason for the
decline in the operating profits has been increasing in the cost of selling, and marketing and
selling expenses. This increase is attributable to the introduction of new services and packages
and launching of campaigns to increase awareness of multimedia and broadband. The foreign
operators cost and satellite charges increased to a level of Rs 6,053 million in FY09 from Rs
3,541 million in FY08. Vigorous efforts were exerted during the year to collect overdue
receivables culminating in reduced level of provision required for doubtful debts and thus
decreasing Administrative and General Expenses to Rs 8.935 billion compared to Rs 10.824
billion last year, ie a saving of 17.45% on this account. Also, the net margin of PTCL has shown
a declining trend over the last 5 years. It declined from 30.46% in FY05 to 15.45% in FY09. The
declining income after tax has been the prime reason for the decline in net margin. Moreover,
the declining net income has also led a decline in the return on operating assets and return on
equity over the past years. The return on operating assets stands at 10.96% in FY09 as
compared to -3.34% in FY08, 18.76% in FY07, 25.53% in FY06 and 34.83% in FY05. Similarly
the return on equity stands at 9.28% in FY09 as compared to -2.71% in FY08, 14.45% in FY07,
20.22% in FY06 and 25.45% in FY05.

1.10. Leverage Position

 P a g e | 25

The debt ratios showed a decreasing trend in the FY07. The debt to asset ratio of the
company had declined considerably in FY05 but the trend reversed in FY06, declining again in
FY07. It is important to note that the company maintains a largely unleveraged capital
structure, with the current trend in debt ratios bought about largely by changes in current
liabilities of the company. This was brought about mostly due to a decline in current liabilities
of the company in FY05 and an increase in the same in FY06. The absence of the dividends
payable portion of current liabilities in FY05 and its coming back online in FY06was an
important contributor to the trend. Further, the FY06 also sawan increase in short term
borrowings of the company, complemented by increases in other components of current
liabilities. Increases in assets, mainly arising from higher cash and bank balances, could not
prevent the trend of the debt ratios.
The financial strength of PTCL is evident from the healthy TIE ratio of the company. The
TIE ratio of the company continued to rise in FY06despite lower profits during the period.
However, it declined in FY07, as a result of decrease in profits as discussed before. This reflects
the little ability of the company to pay off its liabilities as they become due. The major portion of
debt arises from current liabilities.

Mergers: PTCL — owned by UAE-based Etisalat — has submitted a binding offer to

acquire Warid Telecom, the cellular company with the lowest local market share. Given that
PTCL already owns Ufone — which has the third highest market share — it would pass
Mobilink as the largest cellular company. It is also bidding in the 3G spectrum auction, which is
expected to be completed this year. Sector watchers pointed out some of the possible effects of
the two transactions on the company’s balance sheet. “In addition to the need to finance for 3G
[auction], we believe PTCL’s balance sheet will be leveraged further if it opts to be the sole
owner of Warid,” said a Top line Securities research report.

Sana Abdullah of Global Securities wrote in a recent research note that in case PTCL acquires
Warid, “the transaction is likely to mean a cash outflow of about Rs 26 billion (total transaction
size of $950 million) for PTCL, even if the transaction is financed by 75 per cent debt.”

“Hence, we estimate PTCL’s payout ratio to be lower in CY13. However, if the company decides
to go for a higher equity proportion, we cannot rule out PTCL holding back its final dividend,”
said Abdullah.

The company had a huge 173.9 billion in total assets, of which about Rs20 billion were in cash
and short-term investments, by end-September 2013. Cellular industry: The number of cell
phone subscribers touched nearly 128.93 million in FY13, up 6.74 per cent YoY. But, this was
lower than the 10.23 per cent growth recorded in FY12. By end-September 2013, total
subscribers had reached over 129.58 million. In a sign of the intensifying competition, a key
metric for the industry — average revenue per user (ARPU) — declined to Rs211 per month in
FY13, from Rs217 in FY12. However, during the same period, national cellular outgoing traffic
to cellular networks grew by a sizable 52.51 per cent to 294.2 billion minutes. The PTA
attributed this to the increase in the subscriber base and the attractive call packages offered by
cellular companies. But international incoming calls fell by 10.2 per cent to about 9.71 billion
 P a g e | 26

minutes in FY13. Some analysts blamed this on the increase in calling rates after the formation
of the International Clearing House (ICH).

“Telecom industry witnessed 550 million average monthly long-distance international

(LDI) incoming minutes [in CY13]. This is much lower than the pre-ICH levels [of 1.2-1.8 billion
minutes]. But revenues grew handsomely due to 41 per cent increase in international rates,
from 6.25-cents per minute to 8.8-cents,” said Muhammad Tahir Saeed of Top line Securities.
Mean while, a look at the financial statements of parent companies of cellular companies for
9MCY13 indicates their growth has slowed down. Telenor group — the parent company of
Telenor Pakistan, which has the second highest number of cellular customers in the country —
said in its 3QCY13 report that its revenues from Pakistan inched up by five per cent YoY in local
currency. But revenues declined by about four per cent YoY in Norwegian krone terms, to 4.065
billion krone. “We had expected a higher growth rate, but we see continued pressure on taxes,
regulations and weak macroeconomic development. We also see continued fierce on-net
competition,” Telenor Group CEO Jon Fredrik Baksa as said in a call with analysts last year.

Issues: One of the major issues impacting the sector’s revenues is the so-called ‘grey traffic,’
which essentially refers to calls that are routed illegally either to or from the country. According
to the PTA, Pakistan loses an estimated $1 billion annually due to this. To reduce the problem,
the government partnered with LDI operators to form the ICH. However, the revenue-sharing
mechanism under ICH rules has also upset some telecom companies. Telenor LDI
Communications (Pvt) Ltd, a subsidiary of Telenor Pakistan, decided to withdraw from the ICH
on January 25. “Telenor enterprise has faced financial losses of more than Rs2.2 billion since the
establishment of ICH,” the company said.
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PTCL is a revenue spinner and the only company with ground lines in each nook and
corner of the country. PTCL has privatized by the government twice. Firstly in 1994 12% shares
are issued to general public and then in 2005 26% of PTCL has privatized, but this time these
shares are not offered to the general public. This time foreign companies are invited for the bid,
and government also had a plan to hand over the management for the improvement of PTCL.
Among these 26% shares 10% are offered to PTCL workers at discount rate.
The fall of corporate giants like ENRON and WORLD COM left many learning impressions
for both public and private sector enterprises besides stakeholders including
governments, employees, Board of Directors and strategic partners. In both of the above
mentioned historical cases, the core reason was fraudulent conduct by the corporate level
management. The top officers consistently kept hiding the true financial facts and figures
bearing losses and public reports kept
displaying healthy financial results andprofitability, which strengthened the trust of shareholde
rs and partners tokeep investing besides helping the share price to grow further in the stock
market. Unfortunately, we might have another big financial scandal in Pakistan about
privatization of PTCL. PTCL no doubt is one of the strongest corporate enterprises not only in
Pakistan but also in the continent known as Asia.
Pakistan’s Telecom market, Economy and Pakistan’s political stability. Pakistan’s image,
 P a g e | 27

which already is in crisis, will be hurt further. Supreme Court of Pakistan has already given
decision against the privatization of PSO and Pakistan Steel and if PTCL’s privatization gets
challenged on true facts, it will bring horrifying results. Now this brings another example to
Corporate Governance books and poses immense need to improve upon corporate governance
practices. Corporate Governance is the set of policies, procedures, practices, processes, customs,
laws and institutions affecting the way in which a corporation or enterprise is controlled or
administered.

1.11. Introduction of PTCL

Pakistan Telecommunication Company Limited (PTCL) is proud to be Pakistan’s most
reliable and largest converged services carrier providing all telecommunications services from
basic voice telephony to data, internet, video-conferencing and carrier services to consumers
and businesses all over the country. Whether it is an office in the largest city of Pakistan or a
home in a small village, we are present in every corner of Pakistan to serve our customers.
PTCL is all set to redefine the established boundaries of the telecommunication market and is
shifting the productivity frontier to new heights. Today, for millions of people, we demand
instant access to new products and ideas. More importantly we want them for their better living
standards with increased values in this ever-shrinking globe of ours. We are setting free the
spirit of innovation. PTCL is going to be your first choice in the future as well, just as it has been
over the past six decades.
Product and Services Business & Corporate Users. For clear communication the first
choice of business circles is PTCL telephone for local, nationwide and
international calling. Today businesses can have 10-100 lines with modern day services to meet
their needs. Now you get options like Caller-ID, call-forwarding, call-waiting, Call Barring, to
name a few.
Pakistan Telecommunication Company Limited (PTCL) is the leading
telecommunication authority in Pakistan. The corporation provides telephonic and Internet
services nationwide and is the backbone for the country's telecommunication infrastructure
despite the arrival of a dozen other telecommunication corporations, including Telenor Corps
and China Mobile Ltd. The corporation manages and operates around 2000 telephone
exchanges across the country, providing the largest fixed-line network. Data and backbone
services such as GSM, CDMA, broadband Internet.
 P a g e | 28

The details of the share holding in the company is till now is as given from 100% shares
of the company 62% is owned by the government while 26% was sold to Etisalat
Telecommunications under the privatization program run by Shaukat Aziz in 2006 the
remaining 12% are sold to General Public in the same year. Further, with the technological
advancement, more and more telecom services were becoming available but there was not
enough money available with the corporation to install new telecom systems for the provision of
modern services. Resultantly, a digital divide prevailed in Pakistan keeping it behind its
neighbors and other comparable countries in terms of telecom access. Cellular mobile services
in Pakistan commenced in 90s when two cellular mobile telephone licenses were awarded to
Paktel and Pak.Com (Instaphone) for provision of cellular mobile telephony in Pakistan.
Currently there are six cellular players in the market. The Telecom Sector has contributed2
percent towards the overall GDP growth with revenues of over PKR 235bn.

1.12. History of PTCL

When Pakistan came into being then it start with name of "Pakistan post & telegraph
Department" in 1947. As time passed and new technology developed communication system has
also developed. So in 1962 telephone and telegraph department was established and Pakistan
post was declared as separate department. Telephone & Telegraph department has converted
to Telecommunication Corporation in 1991 under Pakistan Telecommunication Corporation
(PTC) ordinance of 1991. With Pakistan Telecommunication
Corporation Ordinance 1991government open the way for private competition and start
awarding licenses for cellular phone and card operated pay phones. With this liberalization
1991government of Pakistan decided to privatized PTC and use voucher methodin 1994 for
privatization that later were convertible to shares, total number of voucher was six million
that were equal to 600 million shares at the rate Rs.10 per share. The telecom sector was
liberalized but PTCL was still them on opolist of the land line telephone services. In 2003 PTCL
monopoly comes to an end when government decided to completely liberalize the
telecommunication industry.
In 2006 the company was completely privatize when government sold its 26%
management share to Etisalat. Evolution and change are choices we make not for their own
sake but for the sake of progress, growth & better adaptation to a changing world. This is a time
of growing challenges. The pace of technology is changing. Networks of the future will not only
have to be digital and intelligent, but also offer high transmission capacity and flexible band
width. Services provided will be personal and tailored to individual needs. As Etisalat embraces
new technologies and make the world of global communications accessible to more people it
 P a g e | 29

perfects the art of bringing people together. To reflect growth, the firm’s insight for the future
and concern for people, it now has a new Corporate Logo and Identity. The identity has a green
background, which signifies solidity, inspires confidence and denotes Etisalat the mother brand.
The red dot represents technology and the world of communication. The 3 curves featured in
the design not only represent the letter 'E' which stands for Etisalat and the Emirates, but also
signify an entity that is growing outside its boundaries and expanding into strategic businesses
locally and internationally.

1.13. Introduction of Etisalat

Introduction of Etisalat
Etisalat has been the telecommunications service provider in the United Arab Emirates
since 1976 and is the number one mobile operator in the UAE. For three decades, since the birth
of the UAE, it has played a key role in driving and supporting the nation’s prosperity. Famous
for over 30 years for delivering technological excellence, innovation and reliability, Etisalat is
on track to be a top 20 Global Telco by 2010 – pioneering technology for tomorrow’s customers.
Etisalat, which has 33 million subscribers in 14 countries, has made acquisitions and
investments in excess of Dh 30 billion in expanding international operations. The UAE- based
operator operates in Afghanistan, Benin, Burkina Faso, the Central African Republic,
Ivory Coast, Egypt, Gabon, Niger, Saudi Arabia, Sudan, Tanzania, Togo, Pakistan, and the U.A.E.
Etisalat stands 140th among the Financial Times Top 500 Corporations in the world in terms of
market capitalization, and is ranked by The Middle East magazine as the 6th largest company
in the Middle East in terms of capitalization and revenues. The Corporation is the
largest contributor outside the oil sector to development programs of the UAE Federal
Government. Etisalat has also won accolades from across the region for its nationalization
program.
1.14. Objectives
 The main objectives of this project is find the financial position of company.
 Determine the financial performance of the company.
 The objective of the study is to explore the impact on, profitability and long term
financial position. It has to explore the financial ability of the firm by inducing the event.
 The objective of this project to analysis the impact of leverage on shareholder return.
 Theoretical work implemented in practical form which we have learned.
 Achieving the experience through this thesis and to learn about this.
 To knowing about company and collecting the information.
 To present the company’s financial data and information and in project.
 P a g e | 30

 Determining the relationship between the leverage and investment in which company’s
return to shareholders and on their debt paying ability. And also how much company
generate profit within one year.
 The objective of study that how company achieve the goals and targets against
competitors and how company utilize the debts in right way.
 An other objective is that satisfaction, company how make equal balance into the
customers.

CHAPTER # 02
LITERATURE REVIEW AND RESEARCH METHODLOGY
ARTICLES INFORMATION

Profitability

Financial
Firm’s
Growth Leverage

shareholders
return

2.1. Summary
 P a g e | 31

The purpose of the study is to find the factors that influence on financial leverage of Pakistani
firms. The dependent variable is financial leverage and independent variables are profitability, size and
growth of the firms. A sample of 10 Firms is selected from two (02) sectors (Cement Sector and Service
sector). This study used the secondary data from annual reports of companies from 2006 to 2012. The
regression of model and correlation is used to check the factors that influence on the financial leverage.
in manufacturing sector Financial leverage (FL) has a negative relationship with profitability (ROA),
while Size of the firm (FS) and growth of the firm (FG) have no impact on financial leverage. In Services
sector financial leverage (FL) has a positive relation with Size of the firm (FS) while profitability (ROA)
and growth of the firm (FG) have no impact on financial leverage (FL).
Ernst (2002) found short of a monetary map is one of the majority ordinary reason used for
trade breakdown next choose the incorrect site. Monetary preparation is a significant fraction in the
commerce as the eatery commerce has senior fraction of price of auction than other industry. ni firms. A
variety of variables that are potentially responsible for determining leverage decisions in companies.
Riaz (2011) found that Determinants on capital structure, case of Pakistani Government owned and
private firms. . Sample is selected from Pakistani registered companies from ISE. The sample comprised
91 companies out of which 80 companies are private and 11 are government owned companies from
period 1999 to 2006. Variables are Tangibility, Size, Growth rate, Tax provision ROA (return on assets)
and profitability are used as an independent variables and Financial leverage used as a Dependent
variables. They used spearman correlation and regression analysis method. They found the result that
Pakistani owned and private companies used different types of financing patterns, Government owned
companies employ more leverage than private companies.
2.2. Summary:
The study depicts pre and post event effect of merger and acquisition on the service industry in
Pakistan. the impact of financial position ratios and profitability ratios on the bankruptcy score. PTCL, a
service industry, is the focus of study with data ranging from year 2006 to 2015. The finding of the study
has shown a positive significant impact of financial position and profitability ratios on the firm
bankruptcy score. The long term, financial position of the firm remains unaffected. The findings of the
study suggest the decline in performance of PTCL during the observed time period.
Study have been conducted on merger and acquisition, precisely measuring profitability,
leverage impacts, shareholder’s wealth and it is also paid emphasis on efficiency of mergers and
acquisition. Mergers and acquisitions are considered as a strategy to gain profitability, avoid insolvency,
improving asset quality and maximizing return on assets and equity (ARSHAD, 2012)
 P a g e | 32

In 2012, Oleyede & Luqman Adedamola, conducted a study in food, beverages and
manufacturing sector. there was significant impact on profitability but very small impact produced in
manufacturing sector. Financial statement analysis among 10 listed banks in Karachi stock exchange
with 15 financial ratios calculated the performance of pre and post-merger analysis in Pakistan. The
results were compared with the help of sample paired t-test and inferred that there is no significant
impact of merger on financial performance of banks merged between years 2006 to 2011 (Abbas,
Imran, & Saeed, 2014).
The operating performance has significantly declined along with the shareholder wealth after
the transaction of merger has performed. The study tested performance of 3 banks with the help of ratio
analysis between the years 2007 to 2010 (Kayani & Javed, 2013). The cost efficiency increases from
93.83% to 94.15% but profitability declined by 5% after merger and acquisition in banking sector of
Pakistan. The study used stochastic frontier analysis for data analysis to prove the significance of study
(Afza & Yusuf, 2012).
2.3. Summary
This paper aims to investigate Affect of leverage on stock returns and systematic risk in the
corporate sector of Pakistan. This study determines the relation between leverage and systematic risk.
We find out that high level of leverage creating a high level of systematic risk, leading to high volatility
in the stock prices.
Financial leverage results from the difference between the rate of return the company earn on
investment in its own asset and the rate of return the company must pay its creditors (Garrison et al.,
2004). Hamada (1972) and Rubinstein (1973) demonstrate that a firm's beta should increase if the firm
finances more heavily with debt. Hamada and Rubinstein type models is that it utilizes leverage values
based on accounting flow numbers (degree of operating and financial leverage) rather than market
stock numbers (level of operating and financial leverage). In the Hamada model, for example, both the
value of debt and equity are stock measures and, theoretically, should be market values.
Risk management effectiveness combines both the ability to exploit opportunities and avoid
adverse economic impacts, and has a significant positive relationship to performance. This effect is
moderated favorably by investment in innovation and lower financial leverage (Anderson, 2009).
Leverage and the counting beta are directly related to the systematic risk (bowman, 1989). High
Levered and less highly levered firms show a stronger negative relation according to stock returns.
Financial structure’s accounting measurements, Liquidity, performance, firm specific attributes and
operating risk have been shown to capture risk components that potentially impact the durability of
 P a g e | 33

distressed firms (Flagg et al., 1991). The advantage of debt financing those are well defined is mostly
different in return rate earned by optimally unleveled and levered firms net of a return best to
recompense for possible bankruptcy costs (Kane, Marcus, and Mc Donal, 1985). The average rate of
return on their equity funds business enterprises leverage their capitals Leverage will do this if the rate
of return on the invested funds is significantly higher than the interest rate paid on the rented funds. In
different situations the equity capital gives a relatively high rate of return on the equity funds (Shilling
& Duffy, 2003).
2.4. Summary
Chemical industry is one of the most Important and main industry of Pakistan. Many local and
Multinational companies are producing chemical products which not only cater the local needs but also
earn profitable returns as a result of International exports. A general concept exists that financial
leverage has significant impact on the financial performance of the companies. This study is also
conducted to find out the relationship between financial leverage and financial performance of listed
chemical companies of Pakistan.
Syed Shah (2013) employed a sample of 35 listed companies from Food Producer sector of KSE.
The research was conducted to find out the Relationship between financial leverage and financial
performance. Debt to equity ratio was used to measure financial leverage whereas financial
performance is measured using Return on Asset, Earning per share, Net Profit margin, Sales growth and
return on equity. There was positive relation of debt to equity ratio with return on Asset and Sales
growth and negative relationship of debt to equity ratio with Earning per share, Return on equity and
Net profit margin. Hence Sugar Companies listed at Karachi Stock Exchange can enhance their financial
performance by having leverage up to a significant level and can play their part in uplifting the
country’s economy. Rajni Saini (2012) conducted a study on Impact of Financial Leverage on
Shareholders Return and business sector underwriting from the Indian Telecom part organizations.
Study period consisted of years 200405—2010-11.
Akhtar et al. (2012) has observed the Relationship Between financial performance and financial
leverage by taking evidence from Fuel & energy sector of Pakistan. Her study was intended to measure
the effect of financial leverage on financial performance of the fuel and energy companies. Sample size
of her exploration comprised of 20 open constrained organizations from fuel and vitality division
recorded at Karachi Stock Exchange and time period comprise years 2000-2005.
Hasan Ahmed Al-Tally (2014) in his research work on An Investigation of effect of financial
leverage on firms financial performance in Saudi Arabia’s public listed companies has demonstrated
 P a g e | 34

that since the Incorporation of Saudi stock market in the year 2003, corporations have been in the
position to substitute equity for more debt. This research was conducted to further enhance the
understanding of how financial leverage operates in no Interest based financial system of the country &
how it may affect the financial performance.
Asif et al. (2011) in their research finding regarding Impact of financial leverage on dividend
policy evidence from listed companies at Karachi Stock exchange, examines the relationship between
dividend policy & the financial leverage of 403 companies, listed in the Karachi stock exchange during
the period 2002-2008.
2.5. Summary
The purpose of this study was to analyze the relationship between financial leverage and firm’s
investment in the presence of certain control variables such as (Tobin’s Q, cash flow, liquidity, return on
equity and sale. This study found that financial leverage has significant negative impact on firms’
investment. It shows that as leverage increases firm’s investment decreases, we may say that highly
levered firms invest less. The relationship between liquidity and investment is positive but insignificant.
Tobin’s Q has also shown positive but slightly insignificant relationship with investment for the target
samples.
According to Odit and Chittoo (2008) in 1930 and 1940s the inclusion of debt in capital structure
were considered as evil. Similarly, Ahn et al. (2005) found positive relationship between leverage and
firm value but it is weaker for firms with low growth opportunities and stronger for firms with more
growth opportunities. Childs et al. (2005) examined the interactions between the financing and
investment decisions in model of agency conflicts (between shareholder and bond holder). They found in
their study that short term debt is significantly helpful in reducing agency costs on under-investment
and over-investment. Jo et al. (1994) investigated the relationship between financing decisions and
investment opportunities set, and reported a positive relationship between debt ratio and measure of
investment opportunities.
2.6. RESEARCH METHODLOGY
The aim of the study is to knowing about the impact of leverage on investment and also
company’s profit and shareholder return. The study will use certain ratio as independent and leverage
as dependent variable with the help of regression analysis the conclusion will be drawn. The only
company Pakistan Telecommunication Limited is taken one sample study the technique is selective. The
selection is made because the said organization was previously government owned and it has been
privatized. The PTCL privatization is and an acquisition by Etasalat, the telecommunication company of
 P a g e | 35

UAE (United Arab Emirates). This study is conduct on the secondary data and information through the
different sites of Ptcl and other companies Pakistan. Also through articles ant essays of researchers,
which they had been researched on companies of Pakistan.
2.7. Theoretical Framework

Profitability
Independent Variable Dependent
Variables

Financial

Leverage

shareholders
2.7.1. Variables
return
The study takes one independent variable is financial leverage and two dependent variables.
Dependent variables includes profitability and shareholders return, model as dependent variable.
2.7.2. Research Hypothesis
A hypothesis is a statement that shows the inferred relationship among the different variables.
The conjectured relationships among the variables are established on the basis of previous literature
available. These relationships can be verified using certain statistical tests/techniques. These
hypotheses may be substantiated or not, depending upon the results derived from statistical analysis.
The following hypotheses have been proposed in the light of literature review.
2.7.2. a) Hypothesis - H1
H01: There is positive relationship between leverage and profitability
H02: Leverage increases the high risk of profitability
H03: There is negative relationship between leverage and profitability
Total population of study is 10 manufacturing sector companies (cement sector). And in service sector
(telecommunication) 10 companies are taken. Sample size of study is five manufacturing sector
companies and five service sector companies. Our study on the basis of secondary data, used the sample
from Jan 2005 – Dec 2012 of 10 organizations to analyze and interpret our hypotheses as well our
results. We had implemented the co-relational, Regression in our study. The purpose of our research, we
had excluded certain sectors due to type of activity. For example banking sector, financial services and
 P a g e | 36

equity investment sector was excluded. In addition to all of this some other firms were also omitted due
lack of data and information.
H04: Profitability and Financial Leverage ratio are positively related.
Cash flow information gives a strong note of firm’s preconditions to their business challenges and thus
the level of vulnerability is known more specified. Free cash flows are stated to be negatively related to
leverage ratio by Norvaišienė and Stankevičienė (2007) from behalf of Pecking Order Theory. Theoretic
point of view was also confirmed in the paper.

Table No. 1
Model R R Square
1 .153a .023

Table No. 2
Model R R Square Adjusted R Square Std. Error of the Estimate

1 .546 .298 .291 8.72245

The model summary table explains the amount of variability in the dependent variable
explained by the independent variable. The value of r-square is 0.298 that means approximately 29.8%
of the variability of dependent variable “Profitability” is explained by the independent variable
“Financial Leverage” and remaining of the variance is unexplained.
Table No: 3.
Model Sum of Df Mean Square F Sig.
Squares
Regression 3425.324 1 3425.324 45.022 .000a

1 Residual 8064.600 106 76.081

Total 11489.924 107

ANOVA test whether the regression model is valid or not. F-statistics is 45.022 which are very
high and sig. value is highly significant which is less than 5% level of significance this implies that the
test of ANOVA is highly significant and model is valid from the given predictors.

Table No: 4.
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Model Unstandardized Coefficients Standardized Coefficients

B Std. Error Beta t Sig

(Constant)

1 24.002 3.173 -.546 7.564 .000

Financial
Leverage -.348 .052 -6.710 .000

Above table is concerned with the parameters of the regression model. Coefficients’ table shows
the significance of individual independent variable in explaining the dependent variable. The un-
standardized coefficient (B) value shows the magnitude and relationship between dependent variable
“Profitability” and independent variable “Financial Leverage”. If that value is positive that means there
is a positive relationship exist between predictor and dependent variable. If that value is negative, which
is in our case, this means there is a negative relationship exist between predictor and dependent
variable. If there is one unit increase in Financial Leverage of the firm it will decrease the profitability of
the firm by 0.38 units. The t-test statistics is highly significant at 5% level of significance that means
coefficient value differs significantly from zero and predictor is making significant contribution in the
model.
2.7.2. b) Hypothesis – H2
H01: High leverage increases the stock return.
H02: High leverage decreases the stock return.
The statically graphs and techniques are taken from Transport and Communication Industry and
Cotton Textiles companies. And this data adopted as a secondary data of Transport and Communication
Industry and Cotton Textiles companies. Above hypothesis which tested on these tables and financial
data analyzed.
Table No. 1:
Year INDEX Return ∆ in STD Volatility ∆ in ΒX y-bx Lev
PRICE Return Volatility
µ……Y B s.e. ∆δ…..X Α L
2005 72.59 0 0 0 0 0 0 0 4.0730
2006 68.59 -0.0551 -0.0551 0.039 0.1973 0.1973 -0.012 0.2610 0.8600
2007 53.04 -0.2693 -0.21422 0.1515 0.3891 0.1918 -0.050 0.2983 1.2698
2008 58.8 -0.19 0.07935 0.0561 0.2368 -0.1523 0.018 0.2295 2.3332
2009 199.99 1.75506 1.945034 1.3753 1.1727 0.9358 0.456 -0.208 2.3564
AVG 0.24813 0.351013 0.2345 0.1161 2.1785

Interpretations:
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Year 2008 and year 2009 is showing higher leverage ratio i.e. (2.332) & (2.3564) more than the
average leverage ratio (2.1785). In year 2009 there is highest leverage ratio and that leads to high
change in return volatility (0.9385) too.
Table No. 2
In Millions
2005 2006 2007 2008 2009 Average

SHAREHOLDER'S EQUITY 30347.5 40660.3 47063.5 47209.6 55804.5

TOTAL FIXED LIABILTIES 30951.8 31123.7 31911.3 31792.8 30990.1
LEVERAGE 0.980476 1.30641 1.474822 1.484915 1.8007202 1.409469

Interpretation
According to the leverage effect, a reduction in the equity value would raise the debt to fixed
liabilities ratio, hence raising the risk of the firm. In year 2005 the value of equity was the lowest
(30347.5) and the leverage ratio was 0.9804, whereas in year 2009 the leverage ratio is showing the
lowest value (1.800) with highest equity (55804.5) in all the preceding year.

Table No. 3: Statistical Analysis of Financial Leverage Indicator

Mean Maximum Minimum Variance Std. Dev. Observations

Debt Equity -1.68 10.22 -116.26 413.14 20.33 35
Ratio

Table No. 4: Statistical Analysis of Financial Performance Indicator

Mean Maximum Minimum Variance Std. Dev. Observations
EPS 0.92 17.53 -14.85 64.77 8.05 35
NET PROFIT -10.86 12.96 411.91 4921.67 70.15 35
MARGIN
RETURN ON ASSET 3.98 22.72 -8.87 69.27 8.32 35
RETURN ON EQUITY 31.35 498.81 -87.61 9394.81 96.93 35
SALES GROWTH 1.09 4.04 -2.36 1.16 1.08 35

The maximum value of net profit margin is 12.96% and minimum value is -411.91. The
industrial average of net profit margin is -10.86 with the variance from the mean is 4921.67 and
standard deviation of 70.15. The maximum value of return on asset is 22.72 and minimum value is -8.87.
The industrial average of return on asset is 3.98 with the variance from the mean is 69.27 and standard
deviation of 8.32. The return on equity is very high maximum value of return on equity is 498.81 and
minimum value is -87.61. The industrial average of return on equity is 31.35 with the variance from the
 P a g e | 39

mean is 9394.81 and standard deviation of 96.93. The maximum value of sales growth is 4.04 and
minimum value is -2.36. The industrial average of sales growth is 1.09 with the variance from the mean
is 1.16 and standard deviation of 1.08.

Table No.5: Correlations analysis of financial performance indicators with Financial Leverage

D/E EPS NET PROFIT ROA ROE SALES

RATIO MARGIN GROWTH
D/E Ratio 1 -0.00341 -0.019857 0.028485 -0.83433 0.136025
EPS -0.003405 1 0.340107 0.713719 0.005699 0.246167
NET PROFIT -0.019857 0.340107 1 0.279016 0.060038 0.136091
MARGIN
ROA 0.028485 0.713719 0.279016 1 0.036827 0.164832
ROE -0.834333 0.005699 0.060038 0.036827 1 -0.039853
SALES 0.136025 0.246167 0.136091 0.164832 -0.03985 1
GROWTH

Table 5 shows the relationship between debt equity ratio and various performance indicators.
The results show the positive relationship of debt equity ratio with return on asset and sales growth,
and negative relationship of debt equity ratio with earning per share, net profit margin and return on
equity. There is a negative relationship between debt equity ratio and earning per share which support
the fact that as debt increases, the interest payment will also raise, so EPS will decrease.
Net profit margin tells that how much additional dollar earned by the company has effect on
profits. The negative relation between debt equity ratio and net profit margin ratio indicates that as
debt increase, net profits of the company tend to decrease, because most of the revenues are used to pay
off the debts. So, the net profit margin ratio will also decrease.
The positive relationship between debt equity ratio and return on asset indicates that the
assets which are financed by the debt have greater returns. The relationship between debt equity ratio
and ROE is negative as shown in table 3. The large debt will decrease the ROE, because in Pakistan
economic conditions are poor. Using more debt will favor ROE when economic conditions are good but if
economic condition is not good, then increase in debt may hurt ROE. The results show the positive effect
of financial leverage on sales growth of listed sugar companies of Pakistan.
 P a g e | 40

CHAPTER # 03
DATA ANALYSIS, CONCLUSION, RECOMMENDATION AND REFERRENCES
3.1. Sample Size
Sample Size consisted of 18 listed companies from Chemical Sector of Karachi Stock Exchange.
Others from telecommunication companies of Pakistan. This data is secondary of these companies of
Pakistan.
3.2. Data Analysis & Discussion
This data taken as the secondary and data of cement companies of Pakistan. This section
includes the statistical analysis of financial leverage and the financial performance. The common
method to measure financial leverage is to use financial ratio, in which debt to equity ratio is being
calculated and analyzed. Debt to equity ratio is calculated by dividing total liabilities to shareholders'
equity. Debt to equity ratio indicates that how much portion of capital structure is being financed by
debt. . In listed sugar companies of Pakistan, the average debt equity ratio is -1.68%, maximum debt
equity ratio is 10.22%, minimum debt equity ratio is -116.26%. The results show in the table 1 that the
variance from the mean is 413.14% with the standard deviation of 20.33%. The hypothesis of the study
was there is a significant negative relationship exists between financial leverage and profitability of the
firms in cement production sector listed on Karachi Stock Exchange. Following is the hypothesis
assessment on the basis of statistical test results. The sample of eighteen firms of cement industry listed
on Karachi Stock exchange was taken; Simple Linear Regression (SLR) as a statistical technique was
 P a g e | 41

used for this research study. The identified technique was used to examine the impact of studied
independent variable on the dependent variable i.e profitability of firm.
3.3. The findings from this research are as follows:
There is negative significant impact on profitability of the firms on financial leverage which
means that profitability and financial leverage are negatively related to each other. If one unit increases
in financial leverage than the profitability decreases by 0.2 unit. The size of the firm has in-significant
impact on the financial leverage which means that no change or approximately zero change take place
during change in size of the firm on financial leverage. Also growth has in-significant impact on the
financial leverage which means that relationship between them is approximately equal to zero. Also size
of the firms and growth has in-significant and inverse relation with the financial leverage.
There is in-significant impact of financial leverage on profitability which means that firms have
impact of financial leverage on the profitability. The size of the firm has a positive and a significant
impact on the financial leverage which means that by increasing one unit of financial leverage the size
of the firm increases by 0.008 units or very small change take place. The last variable used is growth
which has insignificant impact on the financial leverage. And it also has a negative impact which means
that increase in leverage decrease the growth of the firm.

3.3.1. APPENDEX: Companies List

1 Al-Abbas Cement
2 Attock cement
3 Bestway Cement
4 Cherat Cement
5 D.G Khan Cement
6 Dadabhoy Cement
7 Dandot Cement
8 Dewan Cement
9 Fauji Cement
10 Fecto Cement
11 Gharibwal Cement
12 Javedan Cement
13 Kohat Cement
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14 Lucky Cement
15 Maple Leaf Cement
16 Mustehkam Cement
17 Pioneer Cement
18 Zeal Pak Cement

3.4. Conclusion
The regression model is used to check the factors that influence on the financial leverage. The
results shows that in manufacturing sector Financial leverage (FL) has a negative relationship with
profitability (ROA), while Size of the firm (FS) and growth of the firm (FG) have no impact on financial
leverage. It means that as financial leverage increases profitability decreases. In Services sector
financial leverage (FL) has a positive relation with Size of the firm (FS) while profitability (ROA) and
growth of the firm (FG) have no impact on financial leverage (FL). It means that as size increases
financial leverage also increases. This finding may be useful for financial advisor, investor and financial
managers.
This study investigated the relationship between financial leverage and profitability of the
firms belongs to cement manufacturing sector of Pakistan. It was hypothesized that there is a
significant negative relationship exist between financial leverage and firm profitability. The statistical
test result show that there is a significant negative relationship exists between financial leverage and
the profitability of the firm in cement manufacturing sector of Pakistan. Highly leverage firms have
lower profitability and lower leverage firms have higher profitability. The results of this study are
consistent with the results of previous studies conducted by Titman and Wessels (1988), Wald (1999),
Sheel (1994), Eunju and Soocheong (2005). The results of this study are not matching with the results of
previous studies conducted by Larry and Stulz (1995) in which he found a significant positive
association between leverage and profitability. He conducted the study in Ghana where the cost of debt
is lower than the cost of debt in Pakistan and he took top twenty companies listed on stock exchange of
Ghana. This could be the reason of contradiction in results of both studies.
3.5. Recommendation & Limitation
Future researchers may extend study period and may also take all the companies from food
producer sector of Karachi Stock Exchange. Researcher can also conduct comparative study by taking
data from different sectors to check the relationship between financial leverage and financial
performance. This study is based on secondary data and was limited to the firms belongs to cement
 P a g e | 43

manufacturing sector of Pakistan which are listed on Karachi Stock Exchange. Data was taken from
year 2005 to year 2010. Profitability was used as dependent variable and was measured as the ratio of
net income after tax to total assets and financial leverage was used as the independent variable and
was measured as the ratio of total debt to total assets ratio. Data of eighteen firms listed on Karachi
Stock Exchange were available to conduct this study. This study can also be conducted by taking data of
all firms listed on Karachi Stock Exchange. The cement sector is highly leveraged sector of Pakistan.
Major companies have taken debt for expansion of their units which require them to pay fix cost on debt
which is very high in Pakistan. High fixed cost put adverse impact on firm bottom line which means it
reduces net income of the firm. Economic and political uncertainty and worst law and order situation is
creating adverse situation for this sector
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