INTRODUCTION:
Cost of Capital is
vital for an organization’s expansion and effective large-scale operations, involving
decisions on debt management, application of retained earnings, capital budgeting
selection, and asset utilization. Financial executives try to minimize the capital
expenditure which is lower than investment return thereby maximizing shareholder
profits and enhancing company value (Sattar, 2015; Mohamad and Saad, 2012; Razak
et al., 2023).
Debt and equity, as
principal financing forms, require a balance for effective leverage, a key inquiry
in corporate governance and financial management (Chadha and Sharma, 2015; Rao and Madhav, 2015; Donaldson, 1978).
Modigliani and Miller's (1958) foundational theory proposed that financing decisions
do not impact a firm's market value, a view supported by Purswani and Raj (2018).
However, later research has indicated that higher levels of debt can influence market
value due to market imperfections, as noted by Salim and Yadav (2012) and Ugwuanui
(2012). Despite its critical influence, empirical evidence from Bangladesh on the
cost of capital's impact remains inconclusive, with conflicting findings in the
literature showing both positive and negative relationships (Chowdhury and Chowdhury,
2010; Lusy et al., 2018; Laila, 2017; Pratheepkanth, 2011; Salehi et al., 2020).
This inconsistency makes it difficult for Bangladeshi companies to determine the
ideal capital structure (Demirgüneş, 2017; Franc-Dąbrowska, 2021). Hence,
the main purpose of this research is to investigate how uses a firms cost capital
makes it influences on its value and profitability regarding manufacturing sector
in Bangladesh.
LITERATURE REVIEW:
Efficiency in resource
management is reflected in a firm's perceived value, often indicated by stock prices
(Sugianto et al., 2020; Khan et al., 2021; Utami and Hasan, 2021). According to
Brealey et al. (2012), business exists in the market place for one primary goal,
and that is to maximize value of its shareholders by minimizing cost of capital.
Chowdhury and Chowdhury (2010) contend that a decreasing WACC can improve firm value.
However, the literature reveals inconsistent findings regarding the connection between
cost of capital and profitability. Rizki et al. (2018) report a negative relationship,
whereas Lusy et al. (2018) observe a positive correlation. Typically, profitable
businesses maintain low debt levels (Balaji,
et al., 2013), while unprofitable
ones have high debt levels (Laila, 2017), although Hossain (2016) suggests managerial
ownership has little influence on ROA.
Hussain and Chakraborty
in 2010 collected data from Bangladeshi commercial banks, where they found that
the cost of fund exerted a significant negative effect on market returns. Similarly,
Farhana and Rahman (2022) found inverse relation between WACC and performance in
Bangladesh's Food and Allied Industry, indicating that higher cost of funds results
in lower profitability. Hasan, Uddin and Khan (2024) however, in contrast to expectations
found no correlation between cost of capital profitability or value the firm. On
the other hand, this study discovers that profitability has a negative relationship
with firm value while leverage exerts positive effect on the same. The existing
body of literature presents divergent findings regarding the relationship between
the cost of capital, profitability, and firm value (Mohapatra, 2012). While some studies suggest positive
connections (Chowdhury and Chowdhury, 2010; Lusy et al., 2018; Mohamad and Saad,
2012), others suggest negative or negligible effects (Laila et al., 2017; Pratheepkanth,
2011; Salehi et al., 2020; Kurniasih and Rustam, 2022).
These discrepancies
stem from differences in the methodologies employed, the specific variables analyzed,
the outcomes achieved, and the inferences made. Therefore, these results cannot
be broadly applied as conclusive for Bangladesh. Therefore, it is crucial to reconcile
these differences to gain a comprehensive understanding of how cost of fund affect
the profitability and value of manufacturing companies in Bangladesh. Based on the
review of existing literature, the following conceptual framework is developed:
Figure 1: Conceptual
Framework
Drawing upon a comprehensive
analysis of existing literature, the subsequent research endeavors are delineated
for in-depth investigation:
H1: There is
a relationship between the cost of capital and profitability.
H2: The cost
of capital is associated with the firm's valuation.
MATERIALS AND METHODS:
This study focuses
on manufacturing companies listed on the Dhaka Stock Exchange (DSE). Data were primarily
collected from secondary sources, including annual reports, the World Bank database,
and the DSE database, spanning the years 2017 to 2023. Newly listed firms were excluded
due to limited data availability, resulting in a final sample size of 120 companies.
Researchers conducted a thorough review of diverse published literature, both domestic
and international, to identify the research variables (Table 2).
Table 2 Variables description
|
Variables
|
Label
|
Source
|
|
Dependent Variables
|
|
Return on Assets
|
ROA
|
Annual Reports
|
|
Value of the Firm
(Tobin Q)
|
TQ
|
Annual Reports, DSE
Data Base
|
|
Independent Variables
|
|
Cost of Capital
|
Weighted Average Cost
of Capital (WACC)
|
Annual Reports
|
|
Total Debt Ratio
|
TDR
|
Annual Reports
|
|
Firm Size
|
SIZE
(Natural Logarithm
of Total Assets)
|
Annual Reports
|
|
Control variables
|
|
Gross Domestic Product Growth
Rate
|
GDPGR
|
World Bank
|
|
Inflation
|
IF
|
World Bank
|
This research employed
Ordinary Least Squares (OLS) regression equations to examine the influence of capital
costs on the value and profitability of manufacturing firms based in Bangladesh.
Two distinct functional equations were utilized in the study, outlined as follows:
Equation-1:
ROAit 
Equation-2:
TQit
Where: a is the
constant term; b
is the coefficient estimates of explanatory variables; eit signifies
the standard error of the
companies
over the years.
RESULT AND DISCUSSIONS:
The descriptive statistics, displayed in Table 2, reveal
key insights about the dataset. For instance, the mean value of ROA indicates that
firms generate a 3.8 percent profit from their assets, with variability 0.095. The
average Tobin's Q (TQ) of 3.828 indicates that the market generally values firms'
assets at 3.828 times their replacement cost. This comes with a considerable variation
of 13.122. Additionally, the mean WACC is 20.2 percent, with considerable variation
among firms. The total debt ratio shows that, more than 50 percent of firms' assets
are financed through leverage, while the average firm size, measured logarithmically,
reflects moderate variability. Economic growth, indicated by the GDP growth rate
(GDPGR), averages 6.5 percent annually, with low variability, and inflation (IF)
averages 6.014 percent, with some fluctuation.
The correlation matrix
in Table 3 shows a significant negative correlation at the 0.01 level between ROA
and total TDR. This suggests that higher debt ratios are linked to lower returns
on assets, which is in line with the findings of Azarberahman and Azarberahman (2011),
Rakesh and Souza (2018), Mekha, et
al., (2019) and Balasubramaniyam
and Ramasubbian (2019). Conversely, ROA has significant positive correlations with
TQ, GDPGR, and firm size (SIZE), suggesting that higher market valuations, larger
firm size, and GDP growth are linked to increased profitability. WACC and inflation
do not show significant correlations with ROA, implying they do not significantly
impact profitability in this context. Furthermore, there is a notable inverse relationship
between TQ and SIZE, indicating that larger companies generally exhibit lower market
valuations in proportion to their assets. The matrix also shows significant relationships,
such as a positive link between GDP growth and capital costs, and a negative correlation
between inflation and WACC, highlighting important dynamics in financial performance
and economic conditions.
Table
02: Descriptive Statistics Results
|
Variable
|
Mean
|
Std. Deviation
|
|
ROA
|
0.038
|
0.095
|
|
TQ
|
3.828
|
13.122
|
|
WACC
|
0.202
|
0.202
|
|
TDR
|
0.5161
|
0.360
|
|
SIZE
|
22.272
|
1.753
|
|
GDPGR
|
0.065
|
0.015
|
|
IF
|
6.014
|
0.845
|
All assumptions were
thoroughly evaluated prior to conducting the regression analysis, confirming compliance
with all prerequisites for the multivariate regression methodology. In tables 4
and 5 exhibit Durbin-Watson statistic values near 2, indicating no significant first-order
autocorrelation in the residuals.
Table 4
shows minimal multicollinearity among the independent variables, with tolerance
values exceeding 0.1 and VIF values below 5. The regression model illustrates
that 59% of the variance in Return on Assets (ROA) can be accounted for by the
explanatory variables, as evidenced by a substantial F-statistic of 10.49 (p =
0.000). A higher Total Debt Ratio (TDR) is associated with a lower Return on
Assets (ROA), aligning with the findings of Rakesh and Souza (2018) and Soni, (2017). Conversely, larger
firm size and higher GDP growth rates are related to higher ROA, which is
consistent with earlier research by Kaur and Kaur (2015) and Hasan et al.
(2024). However, WACC and IF do not significantly affect ROA, aligning with
findings from Hasan et al. (2014) and Hasan et al. (2024).
The coefficient of
1.697 indicates a potential positive but statistically insignificant relationship
between WACC and TQ, consistent with Hasan et al. (2024). Conversely, the significant
coefficient of 5.753 for TDR suggests that higher debt levels enhance a company's
perceived value, supported by existing literature (Hasan et al., 2024; Hongjie,
2023; and Jannati, et al., 2023), while the negative coefficient of -0.660 indicates
larger firms tend to have lower TQ, highlighting a size-related disadvantage in
perceived value. Overall, the regression results partially support hypothesis 2,
identifying a significant link between debt and firm value, while other variables
exhibit weaker or non-significant effects.
CONCLUSION:
The study investigated
the correlation among the cost of fund, profitability, and firm value using data
from 120 listed manufacturing firms on DSE from 2017 to 2023. The findings have
significant implications for the manufacturing industry in Bangladesh. The study
reveals that WACC does not significantly impact firm value and profitability, suggesting
that improving business performance in Bangladeshi manufacturing firms is not dependent
on the cost of capital. It also establishes that firm size and TDR affect both ROA
and Tobin's Q, indicating the need for firms to manage their capital costs while
striving to grow. The study's findings suggest that both the leverage ratio and
company size have an influence on the financial outcomes. In addition, a connection
is established between the expansion of the economy and the profitability of assets,
while no such association is found with Tobin's Q. This highlights the importance
for management to strategically utilize growth prospects and economic indicators
to optimize returns and profitability. Regulators might consider policies encouraging
firms to maintain a healthy debt balance to enhance profitability. Investors should
evaluate factors beyond cost when assessing potential investment opportunities.
Future research could explore alternative performance metrics, sector-specific studies,
longer analysis periods, and comparative studies across countries. Additionally,
examining other influencing variables, regulatory policy impacts, and investor behavior
could provide deeper insights into managing cost of capital in the manufacturing
sector.
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