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Page 1: Dhofar Power Company

Examination of the Corporate

Finance Practices in

Dhofar Power Company

(S.A.O.G)

Course: MBASHR-BF-100204-1

Instructor: Susanne Trimbath

Student: Latifa Said Bait Saleem

ID: 15374639

Submission date: March 31,2010

Word Count (5,367)

Page 2: Dhofar Power Company

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TABLE OF CONTENT

EXECUTIVE SUMMARY ......... ERROR! BOOKMARK NOT DEFINED.

1.0 COMPANY BACKGROUND ............................................................. 5

1.1 COMPANY BACKGROUND ............................................................... 5

1.2 CORPORATE OBJECTIVES .............................................................. 5

1.3 ORGANIZATION OF FINANCE DIVISION .................................... 6

1.4 SHAREHOLDERS ANALYSIS ............................................................ 6

1.5 SOURCES OF FINANCE ...................................................................... 6

1.6 AGENCY PROBLEMS AND CONTROL .......................................... 7

2.0 RISK ......................................................................................................... 7

2.0.1 RISK FACING DPC ............................................................................ 7

2.0.1.1 DPC SYSTEMATIC RISK .............................................................. 8

2.0.1.2 DPC UNSYSTEMATIC RISK ........................................................ 8

2.1 RETURN AND COST OF CAPITAL .................................................. 9

2.1.1 MEASURING DPC RETURN ........................................................... 9

2.1.2 DPC RETURN TREND ...................................................................... 9

2.1.3 DPC WACC.......................................................................................... 9

3. CAPITAL STRUCTURE ....................................................................... 10

3.1.1 DPC CAPITAL STRUCTURE ........................................................ 10

3.1.2. EQUITY HISTORY ......................................................................... 10

3.1.3 DPC LEVERAGE .............................................................................. 11

3.1.4 IMPLICATIONS FOR EQUITY SHAREHOLDERS .................. 11

3.1.5 RIVALS CAPITAL STRUCTURE ................................................. 12

3.2 DIVIDENDS .......................................................................................... 13

3.2.1 DIVIDENDS POLICY ...................................................................... 13

3.2.2 COMPARISON WITH RIVAL DIVIDENDS ................................ 14

4. WORKING CAPITAL ........................................................................ 14

4.1. WORKING CAPITAL DEFINITION .............................................. 14

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4.2 DPC WORKING CAPITAL COMPONENT .................................... 14

4.2.1 CURRENT ASSETS .......................................................................... 14

4.2.2 CURRENT LIABILITIES ................................................................ 15

4.3 DPC WORKING CAPITAL TREND AND INTERPRETATION . 15

4.4 CASH CYCLE ...................................................................................... 16

4.5 DPC AND RIVALS .............................................................................. 17

4.6 MONEY MARKET .............................................................................. 17

5. CONCLUSION ....................................................................................... 17

5.1 AGENCY THEORY AND CORPORATE GOVERNANCE .......... 17

5.1.1 AGENCY THEORY .......................................................................... 17

5.1.2 CORPORATE GOVERNANCE ...................................................... 18

5.2 THEORY OF CAPITAL STRUCTURE AND COST OF CAPITAL

....................................................................................................................... 18

5.3 THEORY OF DIVIDEND POLICY................................................... 19

5.4 EFFECTIVE WORKING CAPITAL MANAGEMENT ................. 19

5.5 CAPITAL MARKET EFFICIENCY AND IMPACT ON SHARE

PRICE OF THE COMPANY .................................................................... 19

APPENDIXES ............................................................................................. 21

APPENDIX D .............................................................................................. 24

APPENDIX E .............................................................................................. 25

APPENDIX F .............................................................................................. 26

APPENDIX G .............................................................................................. 27

APPENDIX H .............................................................................................. 28

APPENDIX I ............................................................................................... 29

APPENDIX J ............................................................................................... 30

APPENDIX K .............................................................................................. 31

APPENDIX L .............................................................................................. 32

APPENDIX M: ............................................................................................ 33

APPENDIX O: ............................................................................................ 34

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Executive Summary

This report between your hands have been written to examine the corporate finance

practices in Dhofar power company –DPC- (SAOG). DPC is listed in the stock market in

which initiate a more efficient financial practice, which compose a good environment for

studying financial theories.

This reports will shed the light on the financial performance of Dhofar Power Company

(SAOG) . The report will move forward to cover several aspect of the corporate finance

in DPC, industry and its rivals which have been presented in the coming five chapters.

The first chapter of this report takes chance to depict the company background, objectives

and highlights some important points about the company source of finance and the

corporate governance practiced in the company. In addition the report presents the

possible agency problem that DPC might face and best method to avoid such clashed and

problems.

The second chapter of this paper highlight the type of risk that might face the company

internally and externally and hazard its well being. In addition the second chapter give a

clear picture about the company cost of capital and return which will present a key for the

following sections of the report.

In the subsequent chapters – chapter three- the report introduces a clear presentation of

the company’s Capital structure in which the report shows the company’s WACC and its

interpretation along with the findings. Since DPC is leveraged company the report study

its history and Cost of capital in as its shows the full picture of the funding process in the

company. Additionally the report mentioned the Dividend policy that DPC used to satisfy

its shareholders.

Chapter four of this report have summarized the company working capital and other

ratios that highlight the company operational status. Through this chapter some problems

and recommendation have been raised due to the analysis of the company operational

working capital and other calculated ratios.

The last chapter of this report create a comprehensive conclusion and recommendation in

which the company can get use of to improve its performance among its rivals in the

market. Moreover, its depict the capital market efficiency and its impact of the company

share price.

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1.0 Company Background

1.1 Company background

Dhofar Power Company DPC (SAOG) started its operation as closed joint company on

Feb 25, 2001 on the power and utilities industry. DPC have been converted to (SAOG)

which is a company subsequent to initial public offering in May8, 2005. On May1, 2003

DPC become a parent company to Dhofar generating company (SAOG) which is the

subsidiary company (Anon, 2009). The group DPC and Dhofar generating company start

commencing its commercial operation since the day of its inception May1, 2003, with a

generation capacity of 242 megawatts and high voltage transmission. The group major

owners are the Electricity holding company (SAOG) with 82.92% of the company

preference share. The Company board of directors consist of Mr. Hamoud Bin Ibrahim

Bin Soomar Al Zadjali (Chairman) and Habib Hussein (Vice Chairmail) to see the full

hierarchy of the owner checks [Appendix A] (Zawaya, 2010a). The company has one

branch that is located in Salalah city south the sultanate. The company maintains 45.5%

of Omani staff out of 109 total staff –Omani and non Omani- which is a compatible

percentage with what have been requested by the Ministry of Manpower in the Sultanate

(Zawaya, 2005b).The major business line of the company is the fossil fuel generation,

transmission and distribution of electricity in Salalah city. The group granted a

concession agreement by the Omani government. The main purpose of the grant is to

support the group to generate, transmit distribute and supply electricity in the region

through building and taking over the exited assets. Under the term of the government

agreement the group is eligible to sell natural gas as the company is leading its business

from its power station that contain six gas turbines (Anon,2010a).

1.2 Corporate Objectives

The company is working with clear standard to ensure the highest safety in the provided

services. The company main concern is the stakeholders as the company objective is

designed to direct the company vision towards providing the customer and the

environment with top of range service. The company is dumping a lot of funds as will be

illustrated in the coming section of this report and that’s funds are used to improve and

upgrade the provided service. Although, the company is concerning about its

stakeholders but its satisfying its shareholders with gaining high profit and distributing

dividend of RO 1,576,160 at the rate of 8% per share which increase the shareholder

satisfaction. The company is yielding high return to its owner which creates a balance

atmosphere in the company environment between its stakeholders and stockholders.

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1.3 Organization of Finance Division

The finance department is directly observed by the chief financial officer that is

supervised by the accounts director. The chief financial officer and the account director

are having totally different but aligned duties that support enhancing the workflow in the

department. The hierarchy is needed to extend to achieve the main target of the company.

The Finance department hierarchy as depicted in [Appendix B] are consist of chief

financial officer who is managing several accountants. In order to create sort of specialty

in the services provided the company should divided the finance department to sections

such as account payable, budgeting, account receivables and general accounts. The

purpose of the added division is to help the financial officer to utilize the maximum of the

staff experience in the different financial fields to achieve the management requirement.

1.4 Shareholders Analysis

The company preference share have a right of two vote per share at any general meeting

while the ordinary share have the right to one vote in the meeting. As per the financial

statement issued on September 2009 Electricity holding Co. own 82.92% of the company

preference stock after acquiring the 70.77% that have been owned by Salalah power

holding prior to 19 July 2009 as illustrated in the below table.

Major Stockholder 30 Sep 2009 30 Sep 2008

No of Shares held

(Preference)

% No of Shares

held

(Preference)

%

Electricity Holding Co SAOC

(Oman) 10,619,378 82.92 - -

Salalah Power Holding Ltd-

(Bermuda) - - 9,062,920 70.77

Electricity holding Co dominate the major shares of the company and the remaining

shares are owned by individuals and other companies.

1.5 Sources of finance

The company had a concession agreement with the sultanate of Oman government that

give the company the right to run the electrical supply project in the region. When the

concession agreement will be expired after 20 years the government will transfer the

project assets ownership to the Ministry of Housing, Electricity and Water (MHEW) and

reimburse the company with R.O 5.2m for the taken assets. Under the umbrella of this

agreement the government is paying the company a fixed amount of money as allowance

for running the project which considers a source of finance to the company operation. In

addition to the government grant the company is financing it project through having long

term loan from Calyon Credit Agricole CIB which was about R.O 8.2 m with 6.72%

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interest rate. In addition the company is financing its operation through having overdraft

from commercial bank which was about R.O 3 m with 6% interest rate.

The company has 26,000,000 shares that have been authorized and 19,702,000 shares

issued and fully paid-up capital. There is no share premium or any financing leases in

DPC.

1.6 Agency Problems and Control

In order to keep the whole matter within the right track that company is following strict

corporate governance rules. The first step was to ensure that the whole board director’s

members are independent person who have reasonable power. In addition the directors

have good technical experience and are satisfied with the offered scheme. The executive

committee builds guidance to the executive manger to protect the utilization of the

company authority and resources. In addition the audit committee is playing a major

internal role to control the whole process. Moreover, Price Water House as external

auditor is creating an external power that ensures the quality and transparency of the

company operation. This internal and external control is controlling any conflict that may

rise between the management and board of directors which represent the agency problem

(Zawaya, 2005b).

2.0 Risk

The risk measurement, management and control become a major topic in the world of

finance and regulation. The importance of risk has been increased since the collapse of

the Long term capital management in 1998. Frank H. Knight developed the famous

economics definition for risk and differentiates it for uncertainty in his book. He defines

the risk as outcomes that can be insured against and uncertainty to outcomes that cannot

be insured against “(Brooke, 2007). Based on the famous definition of Knight there were

several definition and theories have been built about the term “risk”. Risk is known as

external and internal threat of probability of having negative occurrence that will affect

the company return and investment. This probability of having risk can be controlled or

avoid through taking well designed action. The financial risk is the probability of having

low return for the company investment.

The major type of risk is the systematic and unsystematic. The systematic risk is type of

risk that affect the whole economic such as the serious dieses like swine flu and inflation

while the unsystematic is mainly risk usually hit part of the economic such as political

situation in certain country

2.0.1 Risk facing DPC

DPC is facing several risks that are either systematic or unsystematic. Most of those risks

have been managed by the company management. The coming few sentences will depicts

most of the risk that DPC faced during its operation in the market.

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2.0.1.1 DPC Systematic Risk

DPC face some of the risk that is not just hitting the electricity industry but its affect the

whole Omani and international world of economic. This type of risk is what have been

defined as systematic risk as its spread all over the economic world and affect all

industries in the market. The following are the systematic risk that DPC are exposing too

(Al Khalili et al.,2005):

DPC is exposing to the inflation risk. This macro economic risk had affected the

whole Omani market. The inflation rate in Oman jumped dramatically from –

0.5% in 2003 till 12.5% in 2009 [Appendix C] (CIA, 2009). This leads to a

fluctuation in the Omani company demand and supply.

DPC expose to exchange rate risk.

DPC expose to interest rate risk

The un-availability of gas and fuel oil might hamper DPC operation since the gas

and fuel oil is the main tool for DPC operation.

2.0.1.2 DPC Unsystematic Risk

There are a lot of unsystematic risk which is listed in the points below:

DPC is exposes to construction risk which consider a prime risk for the power

plant. Generally the power plants are facing construction challenge that creates a

risk on the running business. The company manages this risk through supplying

the construction project with the full requirement and sources of human capital

and material which lead in finalizing the project on time and avoid any

construction risk. DPC project delivered the power on the time agreed on, on its

contract with government.

Revenue risk that is originally divided to three risks which are the demand risk,

price and payment risk. (1) DPC will receive a fixed allowance from the

government based on the availability of the running system which represents the

demand risk. (2) DPC the allowance will be paid to the company by the

government for 20 year which creates a price risk. (3) At the end of the DPC

contract with the government the company should receive a payment from the

Ministry of Housing, Electricity and Water (MHEW) which will be a payment

risk for DPC.

DPC might face a risk of being penalized for power outages. Those should be

considering by the company to treat the matter carefully and avoid any risk. It

happened before that there was an outage on the DPC system. In order to avoid

this risk the company maintains specific outage provision in its contact with

government to avoid future penalties.

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2.1 Return and Cost of Capital

Generally speaking the Cost of capital is stand for the cost of financing the company debt

and equity. Adversely, return on capital is measuring the cash flow that the company will

generate from its capital. To have worthwhile project or investment the return should be

greater than the cost of capital.

2.1.1 Measuring DPC return

Referring to section 1.5 in the previous chapter the company source of finance which is a

combination of debt and equity as following:

1. Long term loan of R.O 78,843 m with 6.72%. Which have a cost of capital of

6.72% [Appendix D]

2. Preference shares 12,806,300 share, R.O 1. DPC preference shares have a cost of

capital of 10% Appendix E]

3. Ordinary shares 6,895,700 share , R.O 1. The ordinary share have a cost of

capital of 8.5% [Appendix E]

2.1.2 DPC return trend

DPC shares are performing well in the market. Especially with the good effort that the

company spending to improve and develop its service on the electricity market. Appendix

E shows the trend of the company shares form 2007 till 2009. The share price is

fluctuated up and down in the presented period. In results the company return is

fluctuated up and down till the price per share reach 1.42 per share. As mentioned in

section 2.0.1 DPC is facing several risks which cause either material affect or immaterial

affect to the company return and share price. The fluctuation in the return is raised

because of several risks and condition that face DPC business.

Return on Equity (for three year as accessible by the stock market)

Year 2006 2007 2008

Net Income 3,208,956.00 3,535,595.00 2,949,612.00

SHE 18,152,824.00 18,857,540.00 18,689,657.00

ROE 0.18 0.19 0.16

2.1.3 DPC WACC

DPC (Weighted average Cost of Capital) WACC is equal to 8.846% [Appendix G] which

is considered the weighted average for the company source of finance. This percentage is

the minimum return that the company has to earn in its assets to be able to satisfy its

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DPC Capital Structure

23%

77%

1

2

creditors. Appendix G shows table that is used to predict the (company return, return on

equity and check for the periodic maintenance). The table showed the return on equity

that will be received for 15 years. Tariff electricity table, are build for the purpose

showing the Concession Agreement that the government is paying fixed allowance

accordingly for it.

When comparing the WACC with the return we would find that DPC is returning around

10% while it’s costing 8.846% which depict the good performance of the company.

3. Capital Structure

3.1.1 DPC capital structure

Section 1.5 from this report has drawn the exact picture

of the company source of finance that was mainly a

combination between the incurred debt and equity. As

per June 2009 presented balance sheet DPC has equity

of 23% and 77% debt. This shows that the majority of

DPC assets are financed by debt which incurred an

amount of interest which is equal to 2118361 R.O out of

the total loan of 67,024,729 R.O. the companies might

be driven close to the optimal structure if they manage

to maintain a low cost of capital and enjoy high return.

As have been highlighted in section 2.1.3 DPC WACC

is 8.846%. With the given WACC if we calculate the

company value that might give a clear picture about the

probability of the optimal structure existence. With the

current used WACC of 8.846% the company value will be about R.O 11,330,545

[Appendix J]. In the current situation the company can be considered on moderate

optimal structure which is leading to high return. It’s known that the optimal structure

can be achieved through driving the cost of capital down and increase the incurred return

which still needs to be achieved by the company as the debt is high compared to the

equity. This doesn’t mean that financially DPC is in good financial shape but that doesn’t

necessarily mean that it reach the optimum. In addition having 77% of debt turn on the

risk alert, in which DPC should be careful about in the future.

3.1.2. Equity History

Based on the DPC financial statement – statement of change in equity- the company

didn’t issue new share since its inceptions. The total equity (ordinary and preferred stock)

is 19,702,000 R.O which have been incurred as 19,702,000 shares @ rate of 1 R.O per

share. The break down of the issued share is as the following:

Ordinary shares 6,895,700

Preferred shares 12,806,300

Total Equity 19,702,000

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3.1.3 DPC leverage

With 77% debt DPC considered to be Leverage Company because most of its assets are

financed by debt. The DPC debit to equity ratio [Appendix K] is measuring the company

financial leverage which can be computed by dividing the company long term debt by the

equity. The debit/equity ratio is measuring the company ability to borrow and repay the

money. The debit to equity ratio table below depict that the company ability to borrow

and repay its loans is decreasing from 2003 till 2009. This resulted from the huge

percentage of debt that the company is taken. With the existence of 77% debt in the

company capital structure that’s mean that the company is facing risk, as the borrower

has right on the company assets in case of shortage in liquidity.

Table 3.1 (Change is Capital structure)

2009 2008 2007 2006

Equity 19,702,000 19,702,000 19,702,000 19,702,000

Debit 67,024,729 62,735,117 59,718,879 63,408,857

Total 86,726,729 82,437,117 79,420,879 83,110,857

Equity % 23% 24% 25% 24%

Debit % 77% 76% 75% 76%

Table 3.1 reflects the changes that face the company capital structure. The trend shows

that there were no change in the company equity and the whole change have been done in

the debt slice which is increasing by taking more debt to finance the company operation

and assets. The finding states that the company is becoming more leverage due to

increase in its debt from 2006 to 2009 by 3,615,872 R.O. This increase in debt will lead

to increase in the gearing as gearing and risk have positive relation with the debt.

3.1.4 Implications for equity shareholders

Stock holders and bondholders are always having an interesting relation. This relation

caused a lot of theory and practices that reflect the reality of the relation. When the

bondholders are enjoying receiving their interest and having priority to their money in the

liquidity stage the shareholders will be suffering from facing the risk alone. Although

increasing the debt portion help in enjoying high firm value due to tax shield but the

company might face risk of bankruptcy that may result from shortage of meeting

obligation. The agency cost conflicts have been resulted between the bondholders and

shareholders which the latest use to be able to enjoy some of the privilege that the

bondholders have. The all equity company is facing lesser headache than the leverage

company as stated in the in Miller and Modigliani’s theory about capital structure.

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3.1.5 Rivals capital structure

Dhofar Power Company has many rivals in the market that are working in different

region but in the same field who are “AES Barka, Al Kamil Power Co and United Power

and Sohar Power Company”(Bankmuscat,2008) [Appendix L].

Figure 3.1

Rival Comparison

0%

20%

40%

60%

80%

100%

AES Barka

SAOG

Al Kamil

SAOG

United

Power

SAOG

Sohar

Power

SAOG

DPC SAOG

Series1

Series2

* Equity

* Debit

Figure 3.1 compare DPC capital structure with its rivals in the same industry all of them

are leverage companies but the only one that still dominant more equity than debt is

United power SAOG other than that most of the companies in the field are financed

through high percentage of debt.

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3.2 Dividends

3.2.1 Dividends policy

The dividends are paid to the shareholders from the company earning after covering the

company obligation. Usually after issuing the financial report the board of director in

their ordinary meeting is taken decision of the percentage, amount and period for the

dividends to be paid. DPC is paying yearly dividends –starting 2005- to its investors

(Figure 3.2) which is shown the amount of dividends that the company was paying for

five years.

Figure 3.2

(Corporate information,2010)

The reason behind distributing dividends is to satisfy the stockholders. The company is

applying the policy of paying “little dividends or no” and consider it to be the more

favorable policy. The company is distributing few dividends to the investor to incur

privilege to the investor and to motivate other investors to invest in the company. I think

that the dividends policy is irrelevant as the investor can create their own dividends that

tight the company to spend the incur obligation.

Figure 3.3

(Al Khalili et al.,2005)

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3.2.2 Comparison with rival dividends

(Al Khalili et al., 2005)

The major competitor for DPC is United power comparatively to DPC is paying the

highest rate of dividends compared to its rivals as per 2009 presented data.

4. Working Capital

4.1. Working capital definition

The working capital term represent the company operating liquidity that is available from

running the company operation. The working capital can be derived through the

following formula:

Working capital = Current assets – Current Liabilities

The purpose of computing the work in capital is to ensure that the companies have

sufficient liquidity to fund its operation activities. Companies with positive working

capital have the privilege to enjoy reasonable amount of liquidity to finance its operation

transactions. The working capital can be monitor through controlling the company

inventories, account receivables, account payable and cash.

4.2 DPC Working capital component

4.2.1 Current assets

* Inventories; The company have total inventory of R.O 4,579,142 as of Dec.09. The

company inventories are recorded based on lowest cost and net realizable value. The

company inventories cost is based on the weighted average method, the total inventories

cost includes the expenditure that incur to acquire the inventories and delivering it’s to

the desired location.

* Receivables; the balance sheet shows total receivables of R.O 9,680,936 as of Dec.09.

The companies have two sole receivables that share the company receivables. Those

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Working Caital trend

-4000000

-2000000

0

2000000

4000000

6000000

8000000

1 2 3 4

Years

Wo

rkin

g C

ap

ita

l

Series1

Series2

companies are OPWP and ONEIC in where the latest have R.O 3,156,855 and the reset

should be covered by OPWP.

* Advance and prepayments; the company advances and prepayment shows a total of

R.O 387,186 as of Dec.09.

* Cash and bank balance; the company cash and bank balance of R.O 1,030,651 as of

Dec.09. The bank deposits form 99% from the whole part of the cash and bank balance.

The deposits held in the bank with interest rate ranging from 0.25% to 2.5% per annum.

4.2.2 Current liabilities

* Bank Overdraft; the company have an amount of overdraft with approximately R.O

456,116. The company takes an overdraft of 3 million from the bank with interest rate

that are ranging from 6% to 8.5% per annum.

* Current maturities of the term loans; the company record R.O 6,254,155 as current

maturity of the term loan.

* Amount due to related parties; R.O 60,000 have been recorded as a related parties that

the company should paid the amount to.

* Payables; R.O 6,452,514 have been recorded as payables. This amount incurred to be

paid to the Ministry of Oil and Gaze for supplying fuel to the company

* Other payables and accruals; The company have total payables of R.O3,760,844.

4.3 DPC working capital trend and interpretation

As per data presented on [Appendix M] the

company have a dramatically decrease in its

working capital especially at the end of 2008.

As per [Figure A] the company current assets

have been slashed starting 2008 which indicate

that the company increases its reliance on the

payables source of funding starting 2008 which

affect the company liquidity. Since the working

capital is the amount that the company in need for

to stay in business then DPC is facing critical

problem as its working capital is negative which

is mean that the company is durable to bankruptcy

if its need to paid immediate and quick amount

money. As result to the negative working capital

the company might goes to financial pressure which might lead to one of the following

financial interferes:

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- Increase on borrowing to finance the operational activities and to help the

business moving forwards.

- Late payment to creditors which might affect the company reputation or might

lead to series defect on the operation since the company had two initial suppliers

(creditors) who are mainly supplying the initial base for the company operation.

Failure to meet obligation might lead to the collapse in the company main

business activities which is supplying the region with electricity. Another

consequence to this is that creditors might not be gentle with DPC and take the

issue to the court which might resulted in bankruptcy.

Generally working capital is designed to fund the sales attraction process. If there were

less funding spent to increase and attract the company sales then this will lead to less

return on investment. When company achieve high profit margin that mean there is less

working capital are freeze in the selling process (Smith, 2000).

DPC profit margin = Net income/Net Sales

= 3,092,699/5,398,882

= 57%

The profit margin is testing the effacing in the operating cycle as its measure the

generated earning in relation to particular sales level. This is another indication that the

company is not in prefect and effective operation condition which affect its financial

health. The moderate profit margin level that DPC have indicates that most of DPC

working capital is tied in the operational selling process as clarify by Smith Chris. In the

last two years the company starts to be more over trading than before. The company have

the sign of the over trading companies as its have higher creditor and debtor with slashed

cash all over the five presented years [Appendix O] (Tatum, 2010).

Due to lack of funding the company is mainly financing its working capital through its

long term liability which creates link between the company long and short term cycle.

4.4 Cash cycle

The company is experience an increase in its cash cycle which means that the company is

having a stretched time between purchasing its products and generating its receivables

from its debaters [Appendix O]. The company should place a wise decision to manage

its working capital, operating cycle and cash cycle. The improvement in those three will

help the company enjoy less stress financial opposition, Form the whole finding in the

working capital and cash section DPC recommended to rearrange its working capital

management.

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4.5 DPC and Rivals

AES Barka

SAOG Al Kamil SAOG

United Power SAOG

Sohar Power SAOG

Current assets 12,698,608 4,218,000 2,947,000 17,711,000

Current liabilities 14,543,597 4,516,000 4,309,000 13,744,000

Working Capital -1,844,989 -298,000 -1,362,000 3,967,000

(MSM,2009)

The above table shows that most of the companies in the electrical industry are having

negative working capital. Moving to the initial competitor of DPC which is Sohar power

we can finds that its performing well as it manage to maintain positive working capital.

4.6 Money market

The only used money market instrument in Oman is the certificate of deposits

(CBO,2010). The certificate of deposit have newly presented to the Omani market and

still doesn’t practiced by many companies in the Omani different industries and its also

not affecting DPC as its clear from its financial statement.

5. Conclusion

The following chapters will draw a conclusion for the previous presented chapter’s

thoughts and ideas. Through this chapter I will introduce few recommendations to the

company in which give room for improvement in the below topics.

5.1 Agency theory and Corporate Governance

5.1.1 Agency theory

Chapter 1.6 from this paper mentioned the dilemma of the agency cost between the DPC

management and shareholders. The Agency cost is simply an economic concept that is

raised in the publicly traded company. In such companies there are costs that are incurred

from the inefficiency relation between the shareholders and the management. The agency

cost or risk existed because the management might take independent action from

shareholders for their own interest. The company shareholders can prevent them selves

from being fall in the agency cost trap through offering the management with satisfactory

package of salary and allowances to keep their eye away from the shareholders wealth

pie. To apply those thought in DPC, the DPC management are enjoying a satisfactory

package that keep them in the right track. It’s also recommended that the boards of

directors can declare a bonus to the management during the revenue peak time or in

dividends distribution period to keep the management satisfied and motivated. There are

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other external factors that keep the company a way from falling in the agency cost which

will be covered under the corporate governance below.

5.1.2 Corporate Governance

The agency cost can be avoided through making the management happy and through

setting clear legal path for the company management to follow. This legal path can be

created through having the following factors:

- Internal Audit unit

The company has an internal audit unit that is taking care of checking and monitoring the

posted data in daily bases which minimize the possibility of error and fraud. The internal

audit unit present a quarterly repot to the board audit committee in which it’s highlight

the whole findings of discrepancies and biases if existed (Annual report, 2005).

- External Audit company

DPC have been audited by KPMG Company which is considered one of the big names in

the auditing field. KPMG take care of DPC for four years. Recently DPC is under the microscope of Price water house which is also one of the famous names in the audit

world. Dealing with such names keeps the company far from falling in any fraud,

manipulation, corruption…etc. The company is issuing one audit financial report out of

the whole four issued report during the year. Instead being restricted to one yearly visit

Price water house is applying an interim visit audit in which it can test a sample without

giving the company management time to arrange for having this audit visit which

increases the control over the company management creditability.

- Set a clear internal guidelines and policy

The board of director creates a full manual of structure, guidelines and policy that should

guide the management and staff to the right track to reach the planned goal easily. The

audit firms and the internal auditor are taking those rules and regulation as base for

testing the honesty and creditability of the presented data by the company management

and staff.

- Follow the guidelines of the country exchange market

DPC is working in compliance with the code of corporate governance that has been

created by the Capital market Authority. This guidelines control the company

transparency with the public.

5.2 Theory of capital structure and cost of capital

Section 3.1.1 of this report shows the different theories about the capital structure and its

implication of DPC. As mentioned before that DPC assets are mostly covered by debt

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which forms around 77% of the company total capital structure. Seeking the optimal

capital structure we can found that the company has WACC of 8.846%. With this cost

and this capital structure DPC considered to be in its way towards reaching an optimal

capital structure which will support the wealth maximization purpose. The company

management should target its goal towards driving the cost down and increasing the

return which can be achieve through applying difference policy and method to drive the

WACC below the return and gain benefit of that, which will keep the shareholders

satisfied (Brigham,Houston,2007).

5.3 Theory of dividend policy

As what have been discussed in section 3.2.1 the company is applying the policy of

dividends that stated “little dividends or no”. The company boards declared the dividends

yearly in order to keep the investors stratified and gain the attention of other investor’s.

Since DPC have a working capital of -2,000,294 as mention in section 3.2.1 which mean

that DPC is having insufficient liquidity to cover its liability to run its operation. This

information drives us to ask an important question is it wise to pay dividends with such

case of scarcity of the available fund. I would recommend DPC to stop paying dividends

till it’s maintaining acceptable level of liquidity.

5.4 Effective working capital management

Section 4.3 provides a presentation about the company working capital. It have been

highlighted that the company is having a negative working capital for two years. This can

be interpreted as insufficient fund to finance the operating liabilities which is a very

crucial matter that most of the time leads to bankruptcy. With high rate of debt DPC can

be considered that it’s increasing its debt to move the operational cycle. Failing to meet

the short term liability will drive DPC to situation were it might face its vendors in court

or having their operation cycle stopped due to vendor action of stop supplying till their

dues covered by DPC. I do recommended that DPC should analysis the situation and

create a plan for improving its working capital and maintain better rate of liquidity to

cover its operational needs (Bhattacharya, 2006).

DPC need to speed up it receivables collection process to be able to magnify its liquidity,

to create clear picture about this we will found that DPC have Days in payable of 144.87

in 2009 compared to 556.23 receivables days in the same year. This mean that DPC is

outsourcing the fund to run its operations while its much easier to create mutual benefit

by collecting the current receivables and fund the current liability.

5.5 Capital Market efficiency and impact on share price of the company

Evaluating Muscat security market (MSM) we found that it was very volatile in relation

to more stable underlying fundamentals. Without a clear data about the stock market the

investor can’t really beat MSM as the market is going in rally that consistent of a lot of

undervaluation and overvaluation. The investor can’t predict the next move of the market,

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the correlation and the consequence which is considered risky to invest in without solid

ground (Pattanaik, Ali, 2006).

(MSM,2010)

Due to instability of the stock market DPC closing share price is having a fluctuated

movement with peak increase between the year 2007 and 2008. With this fluctuation the

investor can’t predict the future data which make the investment contrary and risky.

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Appendixes

Appendix A

Dhofar Power Company (Board of Directors)

Hamoud Bin Ibrahim Bin Soomar Al

Zadjali

Chairman

Abbas Amiri

Director

Mosabbah Saif Al Mutairy

Director

Salim Tamman Al Maashany

Director

Habib Hussein

Vice Chairman

Glen F De Silva

Director Simon Morgan

Director

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Appendix B

Dhofar Power Company (Management/Finance Department )

G Loganathan

Chief Executive Officer

S Vishawanath

Accounts Director Sorinda Ruwi

Transmission and Distribution

Director

Abdulrahman Hussein

Generation Director

Saeed Al Hadry Corporate

Services Director

Said Al Kathiri Chief Financial

officer

Accountant

Accountant

Accountant

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Appendix C

Inflation Rate movement in Oman from 2003 till 2009

(CIA, 2009)

(CIA, 2009)

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Appendix D

The debit cost of capital is computed as the following formula:

Cost of debit (after corporate tax) = RB * (1-tc)

* tc is zero, the contract signed with the movement exempted the

company from paying tax.

Cost of debit (after corporate tax) = 6.72* (1-0)

= 6.72 %

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Appendix E

(Al Khalili et al.,2005)

The costs of capital for preferred shares are calculated as following:

Cost of capital of preferred shares = Dividends/Shares market value

= (**14.3% *12,806,300)/(***1.42*12,806,300)

= (1,831,301/18,184,946) = 10%

** Dividend rate derived from table A.

*** Market price derive from (Al Khalili et al.,2005)

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Appendix F

(Authority of electricity regulation,Oman,2005)

The company ordinary share cost of capital can be achieved by computing

Capital assets pricing model (CAPM) = **Rf + Risk premium

= 3.5% + 5% = 8.5%

Rates have been taken from Table C as the central based.

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Appendix G

DPC Share price trends

(MSM,2010)

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Appendix H

WACC Calculation:

Capital Source

Market Value

R.O

Proportion

Market

Value

Cost of

Capital

Contribution

to WACC

Ordinary Shares 6,895,700 .35 6.72% 2.352%

Preferred Shares 12,806,300 .646 10% 6.46%

Debt 78,843 0.004 8.5% 0.034%

19,780,843 100 8.846%

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Appendix I

Tariff for electricity

(Al Khalili et al.,2005)

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Appendix J EBIT x (1 – corporate tax) 1,002,300* x (1-0)** ---------------------------------- = ---------------------------------- = R.O 11,330,545 WACC 8.846%

*(Business week, 2010)

**As per the Concession Agreement the company is exempted from paying tax for a

period of five years. For the period ended on June 2009 the company was obliged to pay

an amount of tax 259,198 R.O which have been covered by third party “OPWP” as per

the government contract.

Debt % Equity

% Geared b Cost of Debt

(pre Tax) CAPM(Eq) WACC Firm Value

77% 23% 0.9 8.5% 0.0850 0.08846 R.O

11,330,545

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Appendix K

(Al Khalili et al.,2005)

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Appendix L

AES Barka

SAOG Al Kamil SAOG

United Power SAOG

Sohar Power SAOG

DPC SAOG

Equity 16,000,000.0 9625 19178 27800 19,702,000

Debit 83,173,298.0 23160 2000 153231 67,024,729

Total 99,173,298.0 32,785.0 21,178.0 181,031.0 86,726,729

Equity % 16% 29% 91% 15% 23%

Debit % 84% 71% 9% 85% 77%

(MSM,2009)

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Appendix M:

Elements 2006 2007 2008 2009

Current assets 16,035,300 14,758,885 13,517,696 15,677,915

Current Liabilities 9,308,943 9,920,399 16,512,682 17,678,209

Working capital 6,726,357 4,838,486 -2,994,986 -2,000,294

(MSM,2009)

Figure A

Current Liability and Current assets

0

5000000

10000000

15000000

20000000

1 2 3 4 5

Years

Fig

ure

s

Series1

Series2

Series3

Current assets

* Current liabilities

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Appendix O:

Elements 2006 2007 2008 2009

Average inventory - 2,603,827.00 3,446,094.50 4,215,336.00

Inventory turnover - 5.50 4.71 4.03

Days in inventory - 66.42 77.46 90.47

Average Account Receivables - 4,448,205.50 5,935,201.00 8,227,389.50

Average Receivables Turnover - 2.22 1.52 0.66

Days Receivables - 164.43 240.54 556.23

Average Payables - 2,665,000.50 4,940,354.00 6,750,266.00

Account Payable Deferral

Period - 5.37 3.29 2.52

Days in Payables - 67.98 111.05 144.87

Operating Cycle - 230.85 318.01 646.70

Cash Cycle - 162.87 206.95 501.82

Calculation bases

2006 2007 2008 2009

Inventory 2,166,995 3,040,659 3,851,530 4,579,142

COGS 15,484,177 14,308,924 16,237,338 17,006,714

AR 3,799,852 5,096,559 6,773,843 9,680,936

Credit Sales 9,454,651 9,873,854 9,006,138 5,398,882

Payables 2,497,311 2,832,690 7,048,018 6,452,514

Cash 9,497,440 6,102,420 1,724,577 1,030,651

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