Identification Of The Optimal Capital Structure
Introduction
This chapter will explain the research background as well as the problem that the author wants to resolve. Also, it will explain the research objectives, the research limitations, and the contribution given by the research.
Background
Based on Undang-Undang Republik Indonesia Nomor 20 Tahun 2008 about Micro, Small, and Medium Enterprises, Small Enterprise is an independent and productive economic business performed by individual(s) or business entity that is not a subsidiary nor a branch of specific company that is owned, controlled, or is a direct or indirect part of Medium Enterprise nor Large Enterprise that meets the criteria of Small Enterprise as intended in this particular Undang-Undang. The criteria of Small Enterprise as mentioned in Chapter 4 Article 6 are:
- has a net worth of more than IDR 50,000,000. 00 (fifty million rupiahs) up to IDR 500,000,000. 00 (five hundred million rupiahs) not including land and building of business premises; or
- has annual sales results of more than 300,000,000. 00 (three hundred million rupiahs) up to IDR 2,500,000,000. 00 (two billion five hundred million rupiahs).
Small Enterprise also has workforce of 5 to 19 people, regarding to the definition from Badan Pusat Statistik (BPS) Indonesia based on labor quantity, and is a set of small-scale economic activities of people that fulfills net assets or annual sales as well as the ownership regulated in the Undang-Undang (Tohar, 2001: 1). The net worth of Small Enterprise is required to fund its operational activities or growing its business. They might take advantage of their internal sources such as retained earnings and initial equity balance (internal equity capital), as well as external sources such as debt capital, equity capital, and crowdfunding. (Triraharjo, 2018)
Earnings retention is the activity of retaining cumulative net earnings (profit) of the firm after accounting dividends, meanwhile initial equity capital is the amount of capital provided by the owners to finance the initial operating activities. Debt financing is when a firm raises money for working capital through sales of debt instruments to individuals or institutional investors and the borrower company should pay back the principal of debt along with agreed interest at a specific time period stated in an agreement. It could be an instant way of gaining capital, but the risk is bigger compared to other financing resources since it requires collateral and debt lenders is the priority of payback. External equity financing is when a firm raises capital through issuance and sale of shares to individuals or institutional investors. It has extensive benefits other than the funding itself, the small business could gain insights and experience about business from the venture capital investor or angel investor. Still, equity financing means sharing the ownership of the business and the new owner(s) might insist of different plan.
Crowdfunding is the pooling of small amounts of capital from a large number of individuals and it’s possible when the business has a loyal network of customers who support the expansion plan or convincing plan to the public crowdfunding investors. Also, the financial technology has developed and becomes more advanced in bridging surplus and deficit economic agents through internet-based crowdfunding. (Hecht, 2015)Rumah Bermain Jejakecil is a growing small enterprise that conducts informal educational institution based in Dago, Bandung established three years ago. The business is owned by four owners, with equal proportion of ownership, who also take the role as general managers. Jejakecil, as familiar to the customers, is providing regular Monday to Thursday pre-school classes, Tuesday-Wednesday and Saturday-Sunday exploratory classes, Thursday and Saturday Karate extracurricular program, as well as workshop classes for children from 1 to 6 years old. The current capital structure of Jejakecil only consist of initial equity balance donated by the current owners in the beginning of business initiation, and the average profit margin since the beginning of the year is 34%.
Problem Identification
In the previous years, Rumah Bermain Jejakecil has always been a company that implements Cost Focus business strategy in which the “focus” strategy was aiming competitive advantage in a narrower market segment since they believed that the market size was proper to be exploited and had a good growth potential, also there were not many of accountable competitors. Meanwhile, Jejakecil integrated the focus strategy with low-cost (generic) strategy where aiming low production cost is the key to the operation activities since the “niche” market was still price sensitive from the lack of references to similar business type. (David, 1998)
However, Rumah Bermain Jejakecil recognized market development in the recent year. The development was indicated by the growth of demand which caused supply deficit since the average increase of demand had reached 22. 37% in comparison of year 2017 and 2018. Jejakecil immediately responds to the market transformation through business expansion in a form of new operating branches in Padalarang and Jakarta, after executing series of business planning. Rumah Bermain Jejakecil is currently experiencing a transition process of business strategy, from Cost Focus to Cost Leadership strategy. The shifting occurs from the change of strategic target (scope) from narrow or “niche” to a broader target.
When the transition process is fully accomplished, the new business strategy will allow Jejakecil to have bigger opportunity of market acquisition and become a market leader, which would lead to bigger advantages such as setting market price as well as executing aggressive strategies to achieve effectiveness and efficiency of business process. (David, 1998; Fournier and Deighton, 1997; Pass and Lowes, 1997; Porter, 1980 and 1985)However, Rumah Bermain Jejakecil’s current capital structure does not suit the new expansive business model. In order to expand the business, Jejakecil requires optimal capital structure for more effective business process and to lessen risk in case there occurs issue within the operating activities. Therefore, it is necessary for the company to determine its source of funding through business valuation, measurement of Cost of Capital (COC), and Capital Asset Pricing Model (CAPM) calculation of alternative solutions to achieve the goal. This research would like to resolve the financing strategy, more specifically the optimal capital structure, of Rumah Bermain Jejakecil in order to achieve higher business valuation.
Research Question
Based on the problem identification described above, this study would like to assess the financial performance to make financial strategy recommendations for Rumah Bermain Jejakecil. The research questions are as follows,
- What are the capital structure alternatives that could possibly be implemented to Jejakecil’s current business strategy?
- How does the projection of capital structure alternatives affect Jejakecil’s business value?
Research Objective
This study paper is organized to achieve these following objectives
- To identify alternatives of capital structure strategy that could be implemented to Jejakecil’s current business strategy
- To determine the optimal capital structure that would increase Jejakecil’s business value
Scope and Problem Limitation
Primary financial reports of Rumah Bermain Jejakecil of year 2017 to 2018 would be used for this research study and would be valuated using Free Cash Flow for the Firm (FCFF) method because it is more suitable for private and small enterprise compared to Free Cash flow to Equity (FCFE) nor Dividend Discounted Model (DDM). (Triraharjo, 2018) Capital Asset Pricing Model (CAPM) will be used to measure the risk as one of the consideration to define which alternative is the best.
Research Contribution
The author has the faith that this research paper would be beneficial for Rumah Bermain Jejakecil to consider the result for financial decision and the readers who would like to learn the method of business valuation, specifically for small enterprise. Also, this would give insight to the financial managers of relevant businesses to make the right decision when similar issue appears. Most importantly, this research would be useful for further research in the upcoming future as reference.
Writing Structure
The study paper would consist of these following chapters
Chapter 1: Introduction
First chapter will contain explanation of research background and the problem identification, as well as research objectives, research limitations, and the contribution of the research to related party.
Chapter 2: Literature Review
Second chapter will contain relevant theories and past research paper, also formulas to help the author complete the research. Research variables, framework, and key definitions of relevant topics will be ascribed in this chapter.
Chapter 3: Methodology
Third chapter will contain methodology that the author uses throughout the research process to accomplish research objectives.
Chapter 4: Data Analysis
Fourth chapter will contain research data processing (analysis) and the results. This will be the chapter to state the answer to research questions.
Chapter 5: Conclusion and Recommendation
Fifth chapter will contain research summary, answer to the research questions, and final recommendation that can be implemented by Rumah Bermain Jejakecil.
