Leverage Analysis Project

Chapte
1
por bottom. Use the Text Box Tools tab to change the formatting of the sidebar text box.]
INTRODUCTION
One of the tough challenges that firms face is to determine the right amount of leverage.
Leveraging decision is important because it affects the financial performance of the firm.
The capital structure of a firm is defined as specific mix of debt and equity that a firm uses
to finance its operations. Firms can choose among many alternative capital structures. For
example, firms can issue a large amount of debt or very little debt. Firms have options of
arranging lease financing, use warrants, issue convertible bonds, sign forward contracts or
trade bond swaps. They can also issue dozens of distinct securities in countless
combinations.
When a firm considers its financing options, for example debt vs. equity, it must ensure
that the amount of leverage does not impose an excess burden on the firm. This means that
the firm should be able to meet its financial obligations during both good and bad times.
The two important points to be considered while making financing decisions are:
First, debt implies fixed financial obligations for the firm. After the firm breaks even,
meaning its earnings cover its debt obligations, any additional earnings will be distributed
among shareholders. Thus, when times are good and the firm’s earnings are high, debt
financing results in higher EPS. However, when times are bad and the firm’s earnings
barely cover its debt obligations, there is little left for shareholders and, thus, EPS is low
under debt financing. This relationship also shows that EPS exhibits a greater variation
under debt as opposed to equity financing in the two scenarios as can be seen from the
results shown in the last table.
Second, stock financing does not dilute the shares of current owners. Therefore, in the
boom scenario, existing shareholders benefit from a higher EPS, but, in the bust scenario,
they bear the whole burden of the firm’s poor performance.
To the entrepreneur and corporate Liberalization, Globalization and Privatization are the
important issues threatening the existence of a firm. In such a complex corporate
environment, it is a challenge to the Finance Manager to survive the firm in long run
perspective with the objective of maximizing the owner's wealth. With a view to achieve
2
this objective finance manager is required to pay his due attention on investment decision,
financing decision and dividend decision.
Assuming that a sound investment policy and opportunity are in place, it is the intention
of this dissertation to optimize the financing decision and dividend decision in the context
of achieving the stated objective. Financing decision refers to the selection of appropriate
financing mix and so it relates to the capital structure or leverage.
Leverage is used to describe the firm's ability to use fixed cost to increase the return to its
owners. It is a tool for measuring Business Risk, Financial Risk and Overall Risk. A
company's long term debt in relation to equity is its capital structure. The larger the long
term debt, the higher the leverage. There are 3 types of leverages that are financial
leverage and combined leverage and operating leverage.
Financial Leverage* Operating Leverage= Combined Leverage.
Capital structure refers to proportion of long-term debt capital and equity capital required
to finance investment proposal. There should be an optimum capital structure, which can
be attained by the judicious exercise of financial leverage.
In order to run and manage a company, funds are needed. Right from the promotional
stage, finance plays an important role in a company’s life. If funds are inadequate and not
properly managed the entire organization suffers, it is therefore necessary that correct
estimation of the current and future need of capital be made to have an optimal capital
structure which shall help the organization to run smoothly.
The capital structure is made up of debt and equity securities and refers to permanent
financing of a firm.
On the other hand a general dictionary meaning of the term Leverage refers to an increase
of accomplishing some purpose. In Financial Management the term leverage is used to
describe the firm’s ability to use fixed cost assets or funds to increase the returns to its
owners.
This dissertation mainly concentrates on the study of effects of leverage on Manufacturing
and service sector firms.
3
Chapt
er
4
RESEARCH METHODOLOGY
The objectives for which study has been undertaken are:
1) To study the methods of raising finance and financial leverages used by the companies.
2) To examine the dividend policy of the company.
3) To assess the inter relationship between degree of financial leverage (DFL), earning per
share (EPS) and dividend per share (DPS).
4) To examine the relationship between leverage and the value of the firm
NEED FOR THE PROJECT
Leverage is an important technique which helps the management to take sound, prudent,
financial and investment decisions. It also helps to evaluate business, financial, total risk of
any organization. The task of choosing most suitable combination of different techniques in
the light of the firm’s anticipated securities for financing fund requirements earnings is
facilitated by it. In matters relating to investment also leverage technique is immensely
helpful. It acts as a useful guideline in setting the maximum limits by which the business of
the firm should be expanded. For example, the management is advised to stop expanding
business the moment anticipated return on additional investment falls short of fixed charge
of debt.
Collection of data
This project is totally based on the Secondary Data, So all the data used in the project have
been collected from
1) The annual reports of the companies.

2) The Web sites of companies.
3) The study material.
The data collected from this source have been used and complied with due care as per
requirement of the study.
5
Period of study
The present study covers a period of two years from 2008-2010.
Techniques of analysis
For analyzing the degree of association between DFL, EPS and DPS. The study has been
made by converting the collected data into relative measure such as ratios, percentage rather
than absolute one.
Limitation of study:
1. The study is limited to five years only. Generally twenty years data is ideal to form trend
analysis.
2. This is based on secondary data collected from the annual report of the company. It was
not possible to collect the primary data from the company's office.
Scope of the project
Capital structure employed by the companies and its effect on the EPS has been studied
previously and also the different financial constraints of both the industries have been
compared. Particularly, it is in the scope of this project to analyze the differences in the
effect of leverage on the profitability of the firms in manufacturing and service industries
6
Chapte
r
7
Leverage
Leverage is using given resources in such a way that the potential positive or negative
outcome is magnified in finance, this generally refers to borrowing. If the firm's Return On
Assets (ROA) is higher than the interest on the loan, then its Return On Equity (ROE) will
be higher than if it did not borrow. On the other hand, if the firm's ROA is lower than the
interest rate, then its ROE will be lower than if it did not borrow.
In other words, may be defined as, the employment of an asset or sources of fund has to pay
fixed cost or fixed return.
Types of leverage
There are three type of leverage:
1. Financial Leverage.
2. Operating Leverage.
3. Combined or composite leverage.
Financial leverage
Financial leverage is primarily concerned with the financial activities which involve raising
of funds from the sources from which a firm has to bear fixed charges. These sources
include long-term debt (e.g.: bonds, debentures, etc) & preferential shares etc. Long-term
debt carries a contractual fixed rate of interest & obligatory. As the debt providers have
Prior claim on income & assets of a firm over equity shareholders. Their rate of interest is
generally lower than the expected return of the equity shareholders. Further, interest on debt
capital is tax-deductible expenses. These two-phenomenon lead to magnification of rate of
return on equity capital & hence E.P.S goes without saying that effects of changes in EBIT
(Earnings Before Interest & taxes) on the earning per share are shown by the financial
leverage. Financial leverage can best be described as the ability of a firm to use fixed
financial charges in EBIT on the firm earning per share.
Financial leverage helps to know the responsiveness of E.P.S. to change in the EBIT. It
involves use of funds obtained at fixed cost in the capital structure in such a way that it
increases the return for common shareholders.
8
It is referred to a state at which a firm has to bear fixed financing cost arising from the use
of debt capital. The firm with high financial leverage will have a relatively high fixed
financing cost compared with low financial leverage. Financial leverage occurs when a
company employ the fixed cost of funds debt or preference share capital with a view to
maximizing earning available to equity shareholder by a way of a higher income of funds.
This technique also called ‘Trade on equity’. Financial leverage influence the financial risk
as long as the company’s earning are greater than its fixed cost it will enjoy a favorable
financial leverage position and make earning available to equity shareholders.
Financial leverage can measure with the help of the following formula:-
EBIT
Financial leverage =
PBT
Financial leverage will have a favorable impact on earning per share a return of equity only.
When the firm’s return on investment exceeds the interest cost of debt it is favorable. The
impact will be unfavorable if the return on investment is less than interest.
The financial leverage measures the relationship between the EBIT & E.P.S. and it reflect
the effect of change in EBIT on the level of E.P.S. The financial leverage measures the
responsiveness of the E.P.S. to charge in EBIT If defined as degree of financial leverage-
% Change in EPS
Degree of financial leverage =
% Change in EBIT
9
Operating leverage
10
Operating leverage associated with investment activities (Assets acquisition). It occurs
anytime when firm has fixed costs that must be met regardless of volume in
operating leverage, when fixed cost remains constant the percentage
change in profit accompanying a change in volume is greater than the
percentage change in volume. A firm with high operating leverage will
have a relatively high fixed cost in comparison with a firm with low
operating leverage. If a company employs operating leverage then its
operating profit will increase at a faster rate for any given increase in sale.
However, if sales fall the firm with high operating leverage will suffer more
loss than the firm with the no or low operating leverage. Therefore operating
leverage called “2-edged sword”. It can be ascertained by the help of
following formula
Contribution
Operating leverage =
EBIT
Degree of operating leverage
A high degree of operating leverage shows the greater impact on the operating
income of the company due to variability in its sales, which is also responsible for
variability in its operating profit. It is an important determinant of operation risk.It can be
measured by % change in E.B.I.T. due to percentage change in sale.
% Change in EBIT
Degree of operating leverage =
% Change in sales
Favorable leverage is said to occur when the firm earns more on the assets purchased with
the funds than their opportunity use. It is unfavorable when firm doesn’t earn equivalent to
the cost of funds
11
Composite Leverage or Combined Leverage or Total Leverage
12
When financial leverage is combined with operating leverage the effect of change in
revenues or earning per share is magnified. Composite/combined leverage refers to extent
to which firm has fixed operating cost as well as financial cost.
The degree of operating and financial leverage can be combined to show the effect of total
leverage on E.P.S associated with given change in sales.
Operating and financial leverage together cause wide fluctuation in E.P.S. For given change
in sales if company employs high level of operating leverage and financial leverage even a
small change in level of sales will have a dramatic effects on earning per share
It can be calculated using the following formula;-
Contribution
Combined leverage =
PBT
Significance
A proper combination of both financial & operating leverage is blessing for the firm’s
growth, while improper combination of both leverages may prove curse for the growth of
company. So company should try to achieve balance of both leverages.
13
14
Chapt
er
INTRODUCTION
15
Financial leverage is primarily concerned with the financial activities, which involve raising
of funds from the sources for which a firm has to bear a fixed charge. These sources include
long-term debts (e.g. bonds, debenture etc.) and preference share capital. Long-term debt
capital carries a contractual fixed rate of interest and its payment is obligatory. As the debt
providers have prior claim on income and assets of a firm over equity shareholders, their
rate of interest is generally lower than the expected return on equity shareholders.
Further interest on debt capital is a tax-deductible expense. These two phenomenon’s lead
to the magnification of rate of return on equity capital and hence EPS. It goes without
saying that the effects of changes in EBIT on the earnings per share are shown by the
financial leverage. Financial leverage can best be described as “the ability of a firm to use
fixed financial charges to magnify the effect of changes in EBIT on the firm’s earnings per
share.
Financial leverage helps to know the responsiveness of the earnings per share (EPS) to the
changes in earnings before interest and taxes (EBIT). It involves the use of funds obtained
at a fixed cost in the hope of increasing the return to common shareholders.
Financial leverage refers to the extent to which a firm has fixed financing cost arising from
the use of debt capital. The firm with financial leverage will have a relatively high fixed
financing cost compared to the firm with a low financial leverage.
Financial leverage will occur when a company employs the fixed cost of funds, debt or
preference share capital with a view to maximizing earnings available to equity
shareholders by way of a higher income than the cost of funds.
These techniques also called “trading on equity”. Financial leverage influences the financial
risk of a company. If the earnings are insufficient for covering the fixed cost burden then
the company has to face financial risk. As long as the company’s earnings are greater than
its fixed costs, It will enjoy a favorable financial leverage position and a make use of the
earnings available to equity shareholders.
Financial leverage can be measured with the help of the following formula:
Financial leverage = EBIT / PBT
16
Financial leverage will have a favorable impact on earnings per share and return on equity
only when the firms return on investment exceeds the interest cost of debt. The impact will
be unfavorable if the return on investment is less than the interest cost.
The financial leverage measures the relationship between the EBIT and EPS and it reflects
the effects of change in EBIT on the level of EPS. The financial leverage measures the
responsiveness of the EPS to a change in EBIT and is defined as a % change in EPS divided
by the % change in EBIT. Symbolically,
Financial leverage = % Change in EPS / % Change in EBIT
The behaviors of DFL reveals that :-
1. Each level of EBIT has distinct DFL.
2. DFL is undefined at financial BEP.

3. DFL will be negative when the EBIT level goes below the financial BEP.
4. DFL will be positive for all values of EBIT that are above the financial Break even
point. This will however starts to decline as EBIT increases and will reach to a limit of one
(1).
By assembling DFL one can understand the impact of a change in EBIT on the EPS of the
company. It helps in assessing the financial risk of the company. It also explains the impact
of market risk on financial risk.Greater the financial leverage, wider the fluctuation in
return on equity and greater is the financial risk.
IMPLICATIONS
1. High operating leverage combined with high financial leverage will consolidate
risky situation.
2. Normal situation is one should be high and another should be low. If a company
has a low operating leverage, financial leverage can be higher and vice – versa.
3. Ideal situation is when both the leverages are low.
17
APPLICATION AND UTILITY OF LEVERAGE
To understand the applications and utility of leverage in financial analysis it is important to

understand the behavior of degree of operating leverage. It is to be noted that:
1. For each level of output there is a distinct DOL.

2. At BEP, DOL is undefined.
3. If quantity is less than BEP, the DOL will be negative.(but there is no such direct
relationship that less quantity leads to decrease in EBIT no such connection to be formed.)
4. If quantity is greater than BEP the DOL will be positive (but there is no such direct
relationship. DOL may start declining after ancreasing quantity beyond certain level and
will limit to one (1).
5. A large DOL indicates that small fluctuation in the level of operation will produce
large fluctuation in the level of operating income.
18
Chapte
r
PROFITABILITY
19
Profitability is the ability of a company to generate profit. It is an overall measure, which
depicts the efficiency and effectiveness at which the company has been operating. It
indicates the overall result of the management's decision. Further, it reflects how best the
company has put to use its scarce resources to generate a higher rate of profitability.
Profitability is also taken as a criterion to measure and assess the relative efficiency of the
management of a company to generate profit. A company, which generates a higher rate of
profitability, is considered to be more efficient than other companies. Profitability is
represented by the return on investment (ROI). It is the overall measure of a company's
performance.
According to Du-Pont control chart, variability in profitability is explained by taking into

consideration its two components viz profit margin and asset turnover. As per this part, an
overall control is exercised on the various resources of a company and necessary corrective
action for further improvement in profitability is suggested.
Profitability is ascertained from the income statement. The various components of an

income statement and their inter-relationship embrace the profitability status of the firm.
This can be shown from the following table –
INCOME STATEMENT
Total Revenue
- Variable cost
- Fixed Expenses
= EBIT
- Interest on Debt
= Profit before Tax
- Tax
= Profit after tax
- Preference Dividend
= Equity Earnings
EBIT = Total revenue – Total cost} Total cost = V+F
Now total revenue = Quantity produced * unit selling price
Therefore EBIT = Q * S – Q * V – F = Q (S - V) – F
Where:-
20
Q = Quantity produced and sold.
S = Unit selling price
V = Variable cost per unit
F = Total fixed cost.
EPS = PAT / N and EPS per equity = PAT – DP / N
Now PAT = EBIT – I – Tax on (EBIT - I)
Therefore EPS for equity = [ (EBIT – I )(1 - T) – DP] / N

Thus we can see that EBIT is related S, Q.V, and F and EPS is related to EBIT. This
relationship can be used to understand movement in related items with reference movement
in certain items.
The relationship between quantity of production sold and earning capacity established
operating leverage. The operating hints that when we change the level of operation it results
in the change In earning capacity.
The relationship between organizations total earning capacity and earning by the individual
investors establish financial leverage. The financial leverage hints that when earning
capacity changes it results in the corresponding change the earning by the individual
investor.
The relationship between the two leverage brings out the total leverage. The total leverage
hints that when there is a change in level of operation it results in the corresponding change
in the earnings by the individual investor.
Thus this relationship can be shown as:
21
QUANTITY EBIT EPS
Levels of operation Earning capacity Earnings per share
Op. leverage Fin. leverage
Total Leverage
Ref: “Lecture Notes on Financial Management” by JCS Ravikant S Wawge, DBAR,

SSGMCE, Shegaon
22
Chapte
r
Capital Structure
One of the tough challenges that firms face is the choice of capital structure. Capital
structure decision is important because it affects the financial performance of the firm. The
23
capital structure of a firm is defined as specific mix of debt and equity that a firm uses to
finance its operations. Firms can choose among many alternative capital structures. For
example, firms can issue a large amount of debt or very little debt. Firms have options of
arranging lease financing, use warrants, issue convertible bonds, sign forward contracts or
trade bond swaps. They can also issue dozens of distinct securities in countless
combinations
Capital Structure theories
Mainly there are two different views regarding capital structure of the firm. One view states
that capital structure is relevant for any given firm. It emphasizes the determination of the
optimum capital structure of a firm at which over all concept of capital for a firm is
minimum they are increasing the total value of the firm.
The second view states that there is no optimal capital structure for any firm. The market
value of the firm is same for any capital structure (any debt/equity ratio) thus capital
structure of the firm is irrelevant.
There are four theories /approaches of expanding the relationship between capital structure
and cost of capital and value of the firm. These are as follows-
1. NI approach
2. NOI approach
3. MM approach
4. Traditional approach.
Assumptions
1. The firm employs only two types of capital ie debt and equity. there are also no
preference share.
2. There is no corporate tax. This assumption has been removed later.
3. The firm pays 100 % of its earning as dividend. Thus there is no returned.
4. The firm’s total assets are given and they do not change, in other words the
investment decisions are assumed constants.
5. The firms total financing remain constant. the firm can change its capital structure
either by redeeming the debentures by issue of share or by raising debt and reduce equity
share capital
24
6. The operating earning (EBIT) is not expanded to grow.
7. The business risk remain constant is independent of capital structure and financing
risk.
8. All investors are assumed to have same subjectivity of distribution of future
expanded EBIT of firm.
Perpetual life of the firm.
Uses of some symbols in our analysis of capital structure theories
S = Total market value of equity debt.
B = Total market value of debt.
V = Total market value of firm.
I = Interest payment.
NI = Net income available on equity share.
Ko = Overall cost of capital.
Ke = Equity capitalization rate.
NI Approach
Durand has suggested NI Approach. According to this approach capital structure decision is
relevant to the valuation of the firm. In other words a change in the capital structure causes
a corresponding change in the overall cost of capital as well as the total value of the firm.
According to this approach, a higher debt content in the capital structure (ie high financial
leverage) will result in decline in the overall or WACC this will cause increase in the value
of equity shares of the company, and vice versa.
This approach is based on following assumptions:
1. The cost of debt is less than cost of equity capitalization rate.
25
2. The debt content does not change he risk perception of the investor.
3. There is no corporate tax.
On the basis of NI Approach Total value of the firm as –
V=S+B Where S = Ni/Ke.
NOI Approach
Durand has also suggested this approach. This approach is just opposite of NI Approach.
According do this approach the market value of firm is not at all affected by capital
structure changes. The market value of the firm ascertained by capitalizing the NOI at
overall cost of capital (Ko) which is considered to be constant. The market value of equity
is ascertained by deducting the market value of debt from market value of firm.
This approach is based on following assumptions-
1. The overall cost of capital (Ko) remains constant for all degrees of debt equity of
leverage.
2. The marked capitalization value of the firm as a whole and the spilt between debt
and equity is no relevant.
3. The use of debt having low cost increase in equity capitalization rate (Ke) Thus the
advantage of debt is set off exactly by increase in capitalization rate (Ke).
4. There is no corporate tax.
The following formula can ascertain according to this approach the value of the firm:-
V = EBIT/Ko
And value of equity (S) = V-B
M-M Approach
26
This is Modigliani and Miller approach. According to this approach the value of the firm is
independence of its capital structure however there is basic difference between the two. The
NOI approach is purely definitional and conceptual. It does not provide operational
justification for relevance of capital structure in valuation of the firm. While MM approach
support the NOI approach providing behavioral justification for irrelevance of total
valuation and cost of capital of the firm from its capital structure, in other words MM
approach maintaining that the average cost of capital does not change with the change in
the debt weighed equity mix or capital structure of the firm.
Basic Propositions
Following are the basic propositions of the MM Approach.
 The overall cost of capital (Ko) and value of firm (V) are constant for all level of
debt equity mix. The total market value of the firm is given by capitalizing expected net
operating income (NOI) by the rate appropriate for risk classes.
 The cost of equity (Ke) is equal to capitalization rate of pure equity steam plus premium of
financial risk. The financial risk increases with more debt content in capital structure, as a
result cost of equity (Ke) increase in manner to off set greatly the use of less expensive
source of funds represented by debt.
 The cost of rate of investment purpose is completely independent of the way in

which investment is financed.
Assumptions
1. Investors are rational. They evaluate risk and return of each investment proposal
rationally before investing. They are able to maximize their return at minimum cost.
2. Capital market is 100% competitive.
3. The firm pay no any income tax thus loses its tax advantages.
4. Expected earnings are definite and constant so future earning of firm are known and
definite.
Traditional Approach
27
The traditional approach also known as intermediate approach is a compromise between
two extreme of NI & NOI approach. According to this approach the value of firm can be
increase initially or using more debt as debt is cheaper source of fund than equity. Thus
optimal capital structure can be reached by debt and equity mix. Beyond the certain level
equity increases because increase in debt (financial leverage) increases the financial risk of
equity shareholder. The advantage of cheaper debt at this point capital structure is offset by
increase cost of equity. After there comes a stage when the increase cost of equity cannot be
offset by the advantage of the low cost debt. Thus overall cost of capital (Ko) according to
this certain point remain more or less constant.
According to above discussion it can conclude that the traditional theory support
that the cost of capital and value of the firm are dependent upon capital structure of firm.
28
Chapte
r
Earning per share is the reward of an investor for making his investment and it is the best
measure of performance of a firm. "The bottom line of income statement is an indictor of
29
performance of "think-tank" or "top-level" of the company. Ordinary investors lacking in-
depth knowledge and inside information mainly depend on EPS to make their investment
decision. So it should be the objective of financial management to maximize the EPS from
the viewpoint of both the investor and investee.
Again the objective of financial management is maximization of value measure in terms of

market price of equity share of a corporate entity. Given the objective of the firm to
maximize the value of equity share, a firm should select a desired combination of financing
mix or capital structure to achieve the goal. Theoretically, optimum capital structure implies
that combination of debt and equity at which overall cost of capital is Minimum and value
of the firms is Maximum. The prevailing view is that the value maximization criterion as a
criterion of optimal capital structure is measured in terms of market price of equity share
i.e. the value of the firms is maximized when the market price of equity share is maximized.
So according to this view maximization of market price of equity share leading to the
maximization of value of the firm is a criterion of optimum capital structure.
In this context an example of a firm may be drawn which is running with optimum debt
equity combination. Now due to the influence of some external factors i.e. sudden political
change or something like this the market price of its equity shares started decreasing and as
a result value of the firm went on decreasing. Due to the downward movement of the value
of firm. Its capital structure will not become optimum further and will need restructuring to
become optimum again.
In practice, change in market price of equity share may occur very rapidly and hence it is
very difficult to change the composition of capital structure accordingly.
Capital structure decision is an internal decision of the firm. So increase in market price of
equity share due to the influence of external factors leading to the maximization of the
value of the firm should not be a criterion of optimum capital structure. Rather EPS may be
a better substitute, as a criterion of value maximizing EPS should be the main slogan or
mul-mantra of a firm in order to realize the objective of maintaining an appropriate capital
structure.
Dividend policy decision
Dividend decision is the major decision area of financial management. A firm is to decide
what portion of earning would be distributed to the shareholders by way of dividend and
30
what portion of the same would be retained in the firm for its future growth. Both dividend
and retention are desirable but they are conflicting are desirable but they are conflicting to
each other. A finance manager should be able to formulate a suitable dividend policy,
which will satisfy the shareholder without hampering future progress of the firm. It is
common that higher the earnings, higher will be the amount of dividend and vice-versa.
The firms with a history of taking on good project and the potential for more good projects
in the future acquire much more control over their dividend policy. In particular, these firms
can pay much less in dividend than they have available as cash profits and hold on to the
surplus cash because the shareholder trusts them to reinvest these profits wisely In contrast,
shareholders of firms having history of poor projects wish to have less retention of profits
because of the fear that the profits will be invested in poor projects.
The dividend policy of a firm affects the market price of the share. In general, the stability
of dividend seems to increase the marker price of the share. However the dividend policy
may affect the market price indirectly by affecting the investor’s expectations of growth
and risk associated with the stream of dividend. The dividend policy of a firm determines
the amount of retained earnings, which can be reinvested by the firm to ultimately result in
growth of the firm and subsequent increase in dividends in later years.
31
Chapte
r
32
Use of fixed cost bearing capital in the capital structure is termed as financial leverage.
Such capital especially debt is cheaper than the equity as the cost of debt is generally lower
than that of equity and a tax advantage is attached with its use. In these circumstances, if
total capital employed remains constant, increase in the financial leverage or use of debt
implies that relatively cheaper source of fund replaces a source of fund having relatively
higher cost. Now if a company follows this practice its net return will be attributable to the
low base of equity shareholders (lower base being due to the increase in financial
leverage).
As a result it will lead to the magnification of return to the equity and thus EPS. But one
should keep in mind that the same holds well in favorable business environment where the
company is able to earn a rate of return on investment being higher than its cost of
financing. So long this situation continues the return on equity or EPS will increase with the
increase in financial leverage.
The excess of the rate of return on investment over the fixed rate of interest and preference
dividend will go to the equity shareholders. However during the period adversity when the
company is not in a position to earn greater (at least equal) rate of return than the cost of
debt and preference share, its return on equity and EPS, instead of increase, will actually
decrease, with the increase in the financial leverage.
As higher earnings would result in higher dividend, the above discussion follows that
increase in use of financial leverage increases the Earning per share and thus Dividend per
share. Conversely decrease in the Earning and Dividend per Share.
Keeping this theoretical background in view, the efforts are made to its applicability in it
real corporate practice.
1. FIXED ASSETS
Fixed assets are those assets owned by a company that contributes to the company's income
but are not consumed in the income generating process and are not held for cash conversion
purposes. Fixed assets are tangible items usually requiring significant cash outlay and
lasting for an extended period of time.
Buildings, real estate, equipment and furniture are good examples of fixed assets. Fixed
assets are sometimes collectively referred to as 'plant'.Generally intangible long-term assets,
33
such as trademarks and patents, are not categorized as fixed assets but more specifically
referred to as 'fixed intangible assets'
2. CURRENT ASSETS
It's the current assets that provide the fuel for the engine of growth in a company. Inventory
is a good example of the importance of current assets. Inventory represents assets being
held by the company for sale, and the speed of the movement of the inventory through the
company is of significant importance to the operating success of the company.
3.DEBT/EQUITY RATIO
Indicates the proportion of equity and debt that the company is using to finance its assets.
Sometimes investors only use long term debt instead of total liabilities for a more stringent
test.A ratio greater than one means assets are mainly financed with debt, less than one
means equity provides a majority of the financing.
If the ratio is high (financed more with debt) then the company is in a risky position -
especially if interest rates are on the rise.
Debt vs. Equity -- Advantages and Disadvantages
In order to expand, it is necessary for business owners to tap financial resources. Business
owners can utilize a variety of financing resources, initially broken into two categories, debt
and equity. "Debt" involves borrowing money to be repaid, plus interest. "Equity" involves
raising money by selling interests in the company. The following table discusses the
advantages and disadvantages of debt financing as compared to equity financing.
ADVANTAGES OF DEBT COMPARED TO EQUITY
Because the lender does not have a claim to equity in the business, debt does not dilute the
owner's ownership interest in the company.
• A lender is entitled only to repayment of the agreed-upon principal of the loan plus
interest, and has no direct claim on future profits of the business. If the company is
34
successful, the owners reap a larger portion of the rewards than they would if they had sold
stock in the company to investors in order to finance the growth.
• Except in the case of variable rate loans, principal and interest obligations are
known amounts which can be forecasted and planned for.
• Interest on the debt can be deducted on the company's tax return, lowering the
actual cost of the loan to the company.
• Raising debt capital is less complicated because the company is not required to
comply with state and federal securities laws and regulations.
• The company is not required to send periodic mailings to large numbers of
investors, hold periodic meetings of shareholders, and seek the vote of shareholders before
taking certain actions.
DISADVANTAGES OF DEBT COMPARED TO EQUITY
• Unlike equity, debt must at some point be repaid.

• Interest is a fixed cost which raises the company's break-even point. High interest
costs during difficult financial periods can increase the risk of insolvency. Companies that
are too highly leveraged (that have large amounts of debt as compared to equity) often find
it difficult to grow because of the high cost of servicing the debt.
• Cash flow is required for both principal and interest payments and must be
budgeted for. Most loans are not repayable in varying amounts over time based on the
business cycles of the company.
• Debt instruments often contain restrictions on the company's activities, preventing
management from pursuing alternative financing options and non-core business
opportunities.
• The larger a company's debt-equity ratio, the more risky the company is considered
by lenders and investors. Accordingly, a business is limited as to the amount of debt it can
carry.
• The company is usually required to pledge assets of the company to the lender as
collateral, and owners of the company are in some cases required to personally guarantee
repayment of the loan.
35
4.FIXED-ASSET TURNOVER RATIO
The fixed-asset turnover ratio measures a company's ability to generate net sales from
fixed-asset investments - specifically property, plant and equipment (PP&E) - net of
depreciation. A higher fixed-asset turnover ratio shows that the company has been more
effective in using the investment in fixed assets to generate revenues.
The fixed-asset turnover ratio is calculated as:
This ratio is often used as a measure in manufacturing industries, where major purchases
are made for PP&E to help increase output. When companies make these large purchases,
prudent investors watch this ratio in following years to see how effective the investment in
the fixed assets was.
5. COST OF EQUITY AND COST OF DEBT
When the company issues debt, for example in the form of bonds, it to pay bondholders the
interest. This interest is tax deductible.
On the other hand, when the company issues equity, i.e. stocks, it pays dividends. This
dividend is taxed as corporate income.
Because of the ability of debt to escape taxation vis-a-vis equity, cost of debt is lower than
cost of equity. This is called a debt tax shield.
6. DIVIDENT PAYOUT RATIO
The dividend payout ratio is the percentage of a company's annual earnings paid out as
cash dividends. Dividend payout ratios vary by industry and are affected by market
conditions and tax law. Moreover, both a low dividend payout ratio and a high dividend
payout ratio can have good or bad implications. A low dividend payout ratio can indicate a
fast-growing company whose shareholders willingly forego cash dividends, because the
company uses the extra money to generate higher returns and, in turn, a high stock price.
36
But a low dividend payout ratio can also point to a company that simply can't afford to pay
dividends. Similarly, a high dividend payout ratio can indicate a blue-chip that pays high
dividends and whose stock price is temporarily depressed. But a high dividend payout ratio
can also point to a mature company with few growth opportunities.
7.RETENTION RATIO
Percentage of the earnings of a firm that are not paid out to stockholders
(shareholders) as dividends but are either reinvested in the firm or are kept as
reserve for specified purposes (such as to pay off a debt or purchase a capital
asset).
Calculated as:
8.FIRM VALUE
Enterprise value, or the value of capital employed, corresponds to the market value of the
enterprise’s machines and commercial activities. Enterprise value is equal to the market
value of the shareholders’ equity (stock market capitalisation if a company is quoted) plus
the market value of the net financial debt. Also called firm value.
9.GROSS PROFIT RATIO
Gross Profit Ratio shows the relationship between Gross Profit of the concern and its Net
Sales. Gross Profit Ratio can be calculated in the following manner: -
Gross Profit Ratio = Gross Profit/Net Sales x 100
Where Gross Profit = Net Sales – Cost of Goods Sold
Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses – Closing Stock
And Net Sales = Total Sales – Sales Return
Objective and Significance: Gross Profit Ratio provides guidelines to the concern
whether it is earning sufficient profit to cover administration and marketing expenses and
is able to cover its fixed expenses. The gross profit ratio of current year is compared to
previous years’ ratios or it is compared with the ratios of the other concerns. The minor
change in the ratio from year to year may be ignored but in case there is big change, it
must be investigated. This investigation will be helpful to know about any departure from
37
the standard mark-up and would indicate losses on account of theft, damage, bad stock
system, bad sales policies and other such reasons.
However it is desirable that this ratio must be high and steady because any fall in it would
put the management in difficulty in the realisation of fixed expenses of the business.
10.NET PROFIT RATIO

Net Profit Ratio shows the relationship between Net Profit of the concern and Its Net
Sales. Net Profit Ratio can be calculated in the following manner: -
Net Profit Ratio = Net Profit/Net Sales x 100
Where Net Profit = Gross Profit – Selling and Distribution Expenses – Office and
Administration Expenses – Financial Expenses – Non Operating Expenses + Non
Operating Incomes.
And Net Sales = Total Sales – Sales Return
Objective and Significance: In order to work out overall efficiency of the concern Net
Profit ratio is calculated. This ratio is helpful to determine the operational ability of the
concern. While comparing the ratio to previous years’ ratios, the increment shows the
efficiency of the concern.
38
PHARMA INDUSTRY
39
INDIAN PHARMA INDUSTRY
The pharmaceutical industry in India is among the most highly organized sectors. This
industry plays an important role in promoting and sustaining development in the field of
global medicine. Due to the presence of low cost manufacturing facilities, educated and
skilled manpower and cheap labor force among others, the industry is set to scale new
heights in the fields of production, development, manufacturing and research. In 2008, the
domestic pharma market in India was expected to be US$ 10.76 billion and this is likely to
increase at a compound annual growth rate of 9.9 per cent until 2010 and subsequently at
9.5 per cent till the year 2015.
Industry Trends
• The pharma industry generally grows at about 1.5-1.6 times the Gross Domestic
Product growth. Globally, India ranks third in terms of manufacturing pharma
products by volume
• The Indian pharmaceutical industry is expected to grow at a rate of 9.9 % till 2010
and after that 9.5 % till 2015
• In 2007-08, India exported drugs worth US$7.2 billion in to the US and Europe
followed by Central and Eastern Europe, Africa and Latin America
• The Indian vaccine market which was worth US$665 million in 2007-08 is growing
at a rate of more than 20%
• The retail pharmaceutical market in India is expected to cross US$ 12-13 billion by
2012
• The Indian drug and pharmaceuticals segment received foreign direct investment to
the tune of US$ 1.43 billion from April 2000 to December 2008
Challenges
Every industry has its own sets of advantages and disadvantages under which they have to
work; the pharmaceutical industry is no exception to this. Some of the challenges the
industry faces are:
40
• Regulatory obstacles
• Lack of proper infrastructure
• Lack of qualified professionals
• Expensive research equipments
• Lack of academic collaboration
• Underdeveloped molecular discovery program
• Divide between the industry and study curriculum
• Government InitiativesThe government of India has undertaken several including policy
initiatives and tax breaks for the growth of the pharmaceutical business in India. Some
of the measures adopted are:
• Pharmaceutical units are eligible for weighted tax reduction at 150% for the research
and development expenditure obtained.
• Two new schemes namely, New Millennium Indian Technology Leadership Initiative
and the Drugs and Pharmaceuticals Research Program have been launched by the
Government.
• The Government is contemplating the creation of SRV or special purpose vehicles with
an insurance cover to be used for funding new drug research
• The Department of Pharmaceuticals is mulling the creation of drug research facilities
which can be used by private companies for research work on rent
PharmaExport
In the recent years, despite the slowdown witnessed in the global economy, exports from
the pharmaceutical industry in India have shown good buoyancy in growth. Export has
become an important driving force for growth in this industry with more than 50 % revenue
coming from the overseas markets. For the financial year 2008-09 the export of drugs is
estimated to be $8.25 billion as per the Pharmaceutical Export Council of India, which is an
organization, set up by the Government of India. A survey undertaken by FICCI, the oldest
industry chamber in India has predicted 16% growth in the export of India's pharmaceutical
growth during 2009-2010.
41
Key players in Indian Pharmaceutical Industry
There are several national and international pharmaceutical companies that operate in India.
Most of the country's requirements for pharmaceutical products are met by these
companies. Some of them are briefly described below:
Ranbaxy Laboratories Limited is the biggest pharmaceutical manufacturing company in

India. The company is ranked at the 8th position among the global generic pharmaceutical
companies and has presence in 48 countries including world class manufacturing facilities
in 10 countries and serves to customers from over 125 countries. Ranbaxy Laboratories
2009-2010 Q3 Net Profit Results showed a profit of Rs 116.6 crore as compared to Rs
394.5 crore deficit, recorded during the corresponding period last fiscal.
Dr. Reddy's Laboratories manufactures and markets a wide range of pharmaceuticals both
in India and abroad. The company has 60 active pharmaceutical ingredients to manufacture
drugs, critical care products, diagnostic kits and biotechnology products. The company has
6 FDA plants that produce active pharma ingredients and 7 FDA inspected and ISO 9001
and ISO 14001 certified plants. Dr. Reddy's Q1 FY10 result shows the revenues of the
company at Rs. 18,189 million which is up by 21%. During this quarter the company
introduced 24 new generic products, applied for 22 new generic product registrations and
filed 4 DMFs.
Cipla is an Indian pharmaceutical company renowned for the manufacture of low cost anti
AIDS drugs. The company's product range comprises of anthelmintics, oncology, anti-
bacterials, cardiovascular drugs, antibiotics, nutritional supplements, anti-ulcerants, anti-
asthmatics and corticosteroids. Cipla also offers other services like quality control,
engineering, project appraisal, plant supply, consulting, commissioning and know-how
transfer, support. For the financial year 2008-09 the company registered an increase of 22%
in sales and other income over the previous year.
Nicholas Piramal is the second largest pharmaceutical healthcare company in India. The
brands manufactured by the company include Gardenal, Ismo, Stemetil, Rejoint, Supradyn,
Phensedyl and Haemaccel. Nicholas Piramal has entered into join ventures and alliances
with several international corporations like Cheissi, Italy; IVAX Corp; UK, F. Hoffmann-
La Roche Ltd., Allergan Inc., USA etc.
42
Glaxo Smithkline (GSK) is a United Kingdom based pharma company; it is the world's
second largest pharmaceutical company. The company's portfolio of pharma products
consist of central nervous system, respiratory, oncology, vaccines, anti-infectives and
gastro-intestinal/metabolic products among others. On November 2009, the FDA had
announced that the H1N1 vaccine manufactured by GSK would join the list of the four
vaccines approved.
Zydus Cadila also known as Cadila Healthcare is an Indian pharmaceutical company

located in Gujarat. The company's 1QFY2010 results show the net sales at Rs880.3cr which
is higher than the estimated Rs773cr. The net profit was Rs124.8cr which was increase of
39%; the increase was on account of higher sales and improvement in the OPM.
43
DR.REDDYS
44
DR.REDDYS
Established in 1984, Dr. Reddy’s Laboratories is an emerging global pharmaceutical

company. As a fully integrated pharmaceutical company, it provides affordable and
innovative medicines through three core businesses:
Pharmaceutical Services and Active Ingredients, comprising Active Pharmaceuticals and

Custom Pharmaceuticals businesses;
Global Generics, which includes branded and unbranded generics; and
Proprietary Products, which includes New Chemical Entities (NCEs), Differentiated

Formulations, and Generic Biopharmaceuticals.
Its products are marketed globally, with a focus on India, US, Europe and Russia. Dr.
Reddy’s conducts NCE research in the areas of metabolic disorders, cardiovascular and anti
inflamation. Its strong portfolio of businesses, geographies and products gives an edge in an
increasingly competitive global market and allows to provide affordable medication to
people across the world, regardless of geographic and socio-economic barriers.
Dr. Reddy's offers an unparalleled portfolio to customers, who include innovators and
generic formulators worldwide. With a strong product portfolio of more than 140 products,
including niches like oncology and hormones, and our “first in, last out” approach, it is little
wonder we are today the third ranked API player globally. Our goal is always to enable our
customers to be the first to launch a generic product and to provide value added services to
help them remain competitive and profitable for the entire life cycle of the product. We
have built the capabilities to consistently deliver on this promise in scale and across the
largest product range.
A highly skilled global team focuses on timely delivery of products, product development,
technology leadership, cost competitiveness, the highest levels of customer service, and full
compliance with regulatory and quality requirements. Our expertise in organic synthesis
and process development complemented by a controlled supply chain enables us to provide
our customers with high quality Bulk Actives at competitive prices. They are aggressively
building their product portfolio to cater to generic players in the emerging markets and
generic and patent challenge formulators in regulated markets.
45
Its operations capabilities are among its core strengths, with six USFDA approved plants in
India, one in Mexico and our latest addition, a USFDA inspected plant in Mirfield, UK,
having a total capacity of 3300KL.
Its API business is supported by our technologically advanced Product Development

infrastructure, which identifies new products and is engaged every step of the way, from
the conceptual stage to delivery of drugs to the market place. The Product Delivery Teams,
the Centres of Excellence and IP teams help create value through Intellectual Property and
proactive patenting; early development work on certain promising molecules;
breakthrough product delivery; and by delivering cost leadership in API.
All the above advantages make Dr. Reddy's API, an ideal partner in your product
development efforts.
Dr. Reddy’s Board of Directors comprises eminent individuals from diverse fields. The
Board acts with autonomy and independence in exercising strategic supervision,discharging
its fiduciary responsibilities, and in ensuring that the management observes the highest
standards of ethics, transparency and disclosure.
Our directors are experts in the diverse fields of medicine, chemistry and medical research
human resource development, business strategy, finance, and economics. They review all
significant business decisions, including strategic and regulatory matters. Every member of
the Board, including the non-executive directors, has full access to any information related
to our company.
Committees appointed by the Board focus on specific areas, take decisions within the
authority delegated to them and make specific recommendations to the Board on matters in
their areas or purview.
SWOT ANALYSIS
46
Strengths:
• Wholly owned subsidiaries in US and Europe

• Joint ventures in China and South Africa
• Markets pharmaceutical products in 115 countries
• Partnerships with global pharmaceutical companies like Novartis, NOVO Nordisk,
etc.
• Strong product portfolio
• Manufacture and market over 250 medicines targeting a wide range of therapies
• Wide range of anti-cancer drugs developed
• Over 100 APIs developed
• Six New Chemical Entities(NCE
• Low cost base
• Contributes to company’s high profit margin of around 34% of sales
• Partnerships with key players in the market keeps its cost base down
• Research Driven & Global Talent
• Expertise in developing innovative product formulations
• 6120 employees worldwide including 951 scientists in which 323 are dedicated
towards new drug discovery research.
Weaknesses:
• High amount of revenues from overseas

• India - a rich source of Active Pharmaceutical Ingredients (APIs), hence major
source of revenue is exports of APIs. May loose out to western world, especially
Europe, where currency is much more stable than the Indian Rupee
• Over-reliance on partnerships
• In order to compete effectively in global markets, strategic partnerships required to
develop products.
• Lack of resources similar to US and Europe based competitors to develop a drug to
marketing stage
• Generic drugs smallest focus
47
• Smallest portion of revenues from generics at around 20%
• Lack of patent legislation in India harms sales of its products
Opportunities:
• Take a drug all the way to market

• Take a molecule from its pipeline all the way to the market place cost-effectively
market
• Buy back of the integrated drug development company from ICICI Ventures and
Citigroup
• Domestic Generic drugs market
• In another 4-6 years, many product patents obtained after the 2004 legislation will
go off providing an opportunity to the company increase its domestic footprint in
Generics
Threats:.
• Needs to gain FDA approval for all sources and products. Products have to pass
strict FDA trials before going to market, which can be costly and time consuming.
This may delay the company entry to particular markets which affects revenue
• Competition from US and European Companies
• Based in lucrative markets e.g. Novartis, Merck & Co
• Revenues running into billions which dwarfs Reddy’s annual turnover Litigation
charges
• Reddy’s lost the case against Pfizer for the use of generic form of Norvasc drug.
Legal cost $10m and also loss of market opportunity.
• Heightened concerns about profitability of German generics business of Betapharm
All amounts in Indian Rs.Million
48
Year Sales % sales Contribution EBIT % EBIT EBT EPS % EPS
2008-09 68,326 37.47 14,013 9036 41.01 8064 54.48 171.45
2007-08 49,700 -23.68 10,426 6408 -53.98 5450 20.07 -67.055
2006-07 65,125 164.68 17,716 13925 723.98 12399 60.92 535.245
2005-06 24,605 21.91 4,274 2657 577.62 2013 9.59 123.02
2004-05 19,212 -5 1,502 2,46 -90.89 1,38 4.3 -67
YEAR FL DFL OL DOL CL DTL

2009 1.12 1.24 1.55 1.09 1.74 4.58
2008 1.17 1.24 1.63 2.28 1.9 2.83 Interpretation
2007 1.12 0.74 1.27 7.39 1.43 3.25 from DFL
2006 1.32 0.22 1.61 26.36 2.12 5.61
2005 1.78 0.73 6.09 18.17 10.84 13.4 From above, DFL
increased from 0.737 to 1.242 during 2004-09. In the year 2008-09 the variability of EPS is
the highest. For every 1 unit change in operating profit EPS changes by 1.242 units. In the
above case debt increased the variability in EPS as the DFL increased from 0.735 to 1.242.
Thus the financial risk also steadily increased.
Financial Risk is the added variability in earnings per share (EPS) plus the risk of possible
insolvency that is induced by the use of financial leverage. Debt increases the probability of
cash insolvency over an all-equity-financed firm.
Interpretation from DOL
The DOL increased from the year 2004-05 to 2005-06 and then decreased towards 2008-
09.In the year 2008-09 for every 1 unit change in the sales there is 1.094 units change in the
EBIT.
The closer that a firm operates to its break-even point,the higher the absolute value of its
DOL. Thus the sales are closer to break-even in the year 2005-06.
Business Risk is the inherent uncertainty in the physical operations of the firm. Its impact
is shown in the variability of the firm’s operating income (EBIT). DOL magnifies the
variability of operating profits and, hence, business risk. In the above case business risk is
highest in the year 2005-06
49
Interpretation from DTL
The percentage change in a firm’s earnings per share (EPS) resulting from a 1 percent
change in output (sales) is called DTL. Highest DTL is observed in the year 2004-05. For
every 1 unit increase in sales EPS changed by 13.4.
All amounts in Indian Rs.Millio
CoD CoE Dbt/Eq DP

YEAR FA CA ty Ratio
2009 16,220 25392 1.9 1.8 0.9 26.19
2008 12,339 20753 2 1.8 1.12 21.94
2007 38,252 33892 3.4 13.8 0.9 15.52
2006 35,315 21,565 2.1 13.7 0.7 6.25
2005 8,414 16,703 2.3 12.3 0.41 20.71
Fixed Assets and Current assets
 Dr.Reddy’s had maximum fixed assets and current assets in the year 2007.Fixed
assets drastically decreased during 2008 and slightly increased towards 2009.Current assets
also showed a similar trend but the decrease in the current assets is slightly lower compared
to fixed assets
Cost of equity and Cost of debt
 From the table, the CoE is higher during the period 2004-07 and Dr.Reddy’s could
use debt as a cheaper source of capital. During 2007-09 the CoE decreased to 1.8 which is
slightly lower than the CoD which is 1.9. Thus the company enjoyed debt as a cheaper
source of capital during 2004-07.
Debt/equity ratio
 In the above case the ratio is greater than 1 in 2007-08 i.e. 1.12. thus the company
financed its assets using debt and the company is In a risky position.
Year DP Retention ratio GPR NPR EPS

2009 26.19 71.35 19.71 54.48 18.48
2008 21.94 79.43 14.11 20.07 13.21
2007 15.52 82.97 12.58 60.92 13.57 50
2006 6.25 93.9 31.55 9.59 29.01
2005 20.71 78.82 10.26 4.3 10.08
From the table:
 EPS is highest during 2008-09 and in the same year Dr.Reddy’s paid a large
percentage of the earnings to the shareholders.
 In the year 2006 though the company had highest EPS it paid very meager
percentage to the shareholders.it retained 93% of its earnings during that year.
YEAR Dbt/Eqt VALUE WACC

2009 0.9 56151 16.8
2008 1.12 65951 20.2
2007 0.9 65612 15.6
2006 0.7 52639 12.7
2005 0.41 22440 8.3
From the table:
 The debt to equity ratio and value is the firm are highest during the year 2007-08,
thus Dr.Reddy’s could leverage and debt and increase the value of the firm. Also during the
same year the WACC is low compared to previous years.
YEAR FA/CA FA/TA FATR Sales BEP DOL

2009 0.64 0.39 1.86 68,326 24267 1.09
2008 0.59 0.37 1.91 49,700 19153 2.28
2007 1.13 0.53 1.97 65,125 13935 7.39
2006 1.64 0.62 4.95 24,605 9308 18.17
2005 0.5 0.33 3.31 19,212 16065 26.36
From the table:
 FATR decreased continuously from the year 2006-09.FATR is highest in the year
2006, which implies Dr.Reddy’s is able to use the investment on fixed assets to generate
sales .
51
 An interestion correction berween DOL , sales and BEP can be observed from the
above table i.e. DOL is high in the year 2005 when the company’s sales are closer to BEP
sales.
 From the Fixed assets to total assets ratio it can be noticed that the percentage of
the fixed assets in the total assets of the company is highest in the year 2006 and same is
reflected even in the FA/CA ratio for the year 2006.
52
Fixed assets Vs Current assets
 From the graph, the proportion of fixed assets increased from 2005-07 and
then decreased.The total assets also followed the similar trend
EPS-DFL
From the graph, it can be noticed that as DFL increased slightly and EPS varied drastically
irrespective of the DFL variations.
53
RANBAXY
54
Ranbaxy Laboratories Limited (Ranbaxy), India's largest pharmaceutical company, is an
integrated, research based, international pharmaceutical company, producing a wide range
of quality, affordable generic medicines, trusted by healthcare professionals and patients
across geographies. Ranbaxy today has a presence in 23 of the top 25 pharmaceutical
markets of the world. The Company has a global footprint in 46 countries, world-class
manufacturing facilities in 7 countries and serves customers in over 125 countries.
In June 2008, Ranbaxy entered into an alliance with one of the largest Japanese innovator
companies, Daiichi Sankyo Company Ltd., to create an innovator and generic
pharmaceutical powerhouse. The combined entity now ranks among the top 20
pharmaceutical companies, globally. The transformational deal will place Ranbaxy in a
higher growth trajectory and it will emerge stronger in terms of its global reach and in its
capabilities in drug development and manufacturing.
Mission&Vision
Ranbaxy's mission is ‘To become a Research-based International Pharmaceutical

Company’. The Company is driven by its vision to ‘Achieve significant business in
proprietary prescription products by 2012 with a strong presence in developed markets’.
Financials
Ranbaxy was incorporated in 1961 and went public in 1973.

For the year 2009, the Company recorded Global Sales of US
$ 1519 Mn. The Company has a balanced mix of revenues from emerging and developed
markets that contribute 54% and 39% respectively. In 2009, North America, the
Company's largest market contributed sales of US $ 397 Mn, followed by Europe
garnering US $ 269 Mn and Asia clocking sales of around US $ 441 Mn.
Strategy
Ranbaxy is focused on increasing the momentum in the generics business in its key
markets through organic and inorganic growth routes. Growth is well spread across
55
geographies with focus on developed and emerging markets. It is the Company’s constant
endeavour to provide a wide basket of generic and innovator products, leveraging the
unique Hybrid Business Model with Daiichi Sankyo. The Company will also increasingly
focus in high growth potential segments like Vaccines and Biogenerics. These new areas
will add significant depth to the existing product pipeline.
R&D
Ranbaxy views its R&D capabilities as a vital component of its business strategy that will
provide a sustainable, long-term competitive advantage. Ranbaxy is among the few Indian
pharmaceutical companies in India to have started its research program in the late 70's, in
support of its global ambitions. A first-of-its-kind world class R&D centre was
commissioned in 1994. Today, the Company has multi-disciplinary R&D centers at
Gurgaon, in India, with dedicated facilities for generics research and innovative research.
The R&D environment reflects its commitment to be a leader in the generics space
offering value added formulations and development of NDA/ANDAs, based on its Novel
Drug Delivery System (NDDS) research capability. Ranbaxy’s first significant
international success using the NDDS technology platform came in September 1999, when
the Company out-licensed its first once-a-day formulation to a multinational company.
WorldwideOperations
Global Pharma Companies are experiencing an ever changing landscape ripe with
challenges and opportunities. In this challenging environment Ranbaxy is enhancing its
reach leveraging its competitive advantages to become a top global player.
Driven by innovation and speed to market we focus on delivering world-class generics at

an affordable price. Our unwavering determination to achieve excellence leads us to new
global benchmarks. Our people have consistently risen above all challenges maximized
opportunities and positioned Ranbaxy as a leader in the global generics space.
Ranbaxy’s global footprint extends to 46 countries embracing different locales and

cultures to form a family of 50 nationalities with an intellectual pool of some of the best
minds in the world
56
RANBAXY
Year Sales % chg Contribution EBIT % EBIT EBT EPS % EPS

2009 76117 2.24 11991 10808 183.49 10097 7.05 128.37
2008 74449 6.63 -2626 -12945 -213.58 -15000 -24.85 -219.64
2007 69822 13.87 13580 11397 21.382 9985 20.77 47.4
2006 61315 18.186 9389 7546 311.305 6510 14.09 25.17
2005 51880 -2.351 3727 2282 -76.21 1611 18.83 174

2009 1.07 0.699 1.109 61.915 1.187 57.308
2008 0.86 1.03 0.202 -52.214 0.175 -33.128
2007 1.44 2.22 1.191 1.542 1.36 3.41745
2006 1.24 0.08 1.244 17.118 1.442 1.38403
2005 1.41 2.28 1.633 32.415 2.313 -74.011
Interpretation from DFL
From above we can notice that DFL has been continuously fluctuating. In the year 2004-05
the variability of EPS is the highest. For every 1 unit change in operating profit EPS
changes by 2.283 units.
Debt increases the probability of cash insolvency over an all-equity-financed firm. Debt
also increased the variability in EPS as the DFL decreased from 2.283 to 0.699. Thus the
financial risk also decreased.
The DOL has decreased from the year 2004-05 to 2007-08 and then increased towards
2008-09. In the year 2008-09 for every 1unit change in the sales there will be 61.915 units
change in the EBIT.
The closer that a firm operates to its break-even point, the higher is the absolute value of its
DOL. Thus the sales are closer to break-even in the year 2008-09.
variability of operating profits and, hence, business risk.in the above case business risk is
highest in the year 2008-09.
57
change in output (sales) is called DPS.For 1 unit increase in sales EPS decreased by 74.011
unit.
YEAR FA CA CoD CO.E DBT/EQTY D/P Ratio

2009 51135 51020 1.8 1.9 0.68 …
2008 49607 58664 0.5 6.02 0.79 …
2007 42045 37333 4.9 12.5 0.89 60.06
2006 38953 35761 2.7 13.5 0.93 94.95
2005 20591 28707 2.8 8.9 0.06 170.28
 Ranbaxy could find the debt capital cheaper than equity capital over the period of
6 years from 2004-09. It can be noted that the highest cost of debt is greater than
the lowest cost of equity. Thus the company enjoyed debt as a cheaper source of
capital.
 Ranbaxy had maximum fixed assets in 2009 and maximum current assets in the
year 2008. Fixed assets and current assets of the company has been continuously
increasing from 2005-2009.
 Debt to equity ratio of the company is less than 1. Hence the company financed
most of its assets using equity
Year DP ratio Retn Ratio GPR NPR EPS

2009 … 100 10.52 11.72 7.05
2008 … 2.07 -22.02 -24.85
2007 60.06 -668.18 6.55 14.33 20.77
2006 94.95 16.89 12.61 9.07 14.09
2005 170.28 -259.14 2.22 5.78 18.83
From the table:

58
Ranbaxy could not declare any dividents during 2008 and 2009 because of low profits and
NPR is negative for the year 2007-08 after paying taxes which indicate loss.
Year DBT/EQTY WACC Value of the firm
2009 0.68 14.2 74892
2008 0.79 13 74155
2007 0.89 12.8 62933
2006 0.93 12 56788
2005 0.69 10.7 35186
From the above table:
 Debt to equity ratio is highest during the year 2005-06 and highest WACC during
2006-07.
 The value of the firm is high in the year 2009, when the WACC and debt to equity
ratio are low.
YEAR FA/CA FA/TA FATR Sales BEP DOL

2009 1.00 0.50 2 76117 75090 61.915
74449 - -52.214
29255
2008 0.85 0.46 2.14 1
2007 1.13 0.53 2.71 69822 11223 1.542
0.11 0.52 2.73 61315 12035 17.118

2006
2005 0.72 0.42 2.92 51880 20114 32.415
From the table:
 FATR decreased from the year 2005-09.FATR is highest in the year 2005, which
implies Ranbaxy efficiently used the investment on fixed assets to generate sales in the
year 2005.
 Ranbaxy operated close to BEP IN THE YEAR 2009 and this is indicated by
Highest DOL for the same year.
 FA/CA ratio and FA/TA ratio are highest for the year 2007 and hence it can be
inferred that Ranbaxy invested more in fixed assets during the corresponding year.
59
From the graph, the proportion of current assets and also the total assets increased from 2005-08
and then slightly decreased during 2008-09
EPS -DFL
60
The cash inflows in the year 2007-08 are not enough to meet the fixed costs and therefore
equity share holders could not realize any earnings on the equity share.in the year 2006-07
the earnings per share are maximum i.e. in this year the firm has succesfully leveraged on
the debt to increase the EPS compared to 2005-06
61
AUROBINDO
Aurobindo
Among the largest 'Vertically Integrated' pharmaceutical companies in India, Aurobindo

has robust product portfolio spread over major product areas encompassing CVS, CNS,
Anti-Retroviral, Antibiotics, Gastroenterologicals, Anti-Diabetics and Anti-Allergic with
approved manufacturing facilities by USFDA, UKMHRA, WHO, MCC-SA, ANVISA-
Brazil for both APIs & Formulations and has Global presence with own infrastructure,
strategic alliances, subsidiaries & joint ventures.
Aurobindo’s R & D strengths lie in developing intellectual property in non-infringing

processes and resolving complex chemistry challenges. In the process, Aurobindo
develops new drug delivery systems, dosage formulations and applies new technology for
better processes.
Aurobindo Pharma was born of a vision. Founded in 1986 by Mr. P.V. Ramprasad Reddy,
Mr. K. Nithyananda Reddy and a small, highly committed group of professionals, the
Company became a public venture in 1992. It commenced operations in 1988-1989 with a
single unit manufacturing active pharmaceutical ingredients. Aurobindo Pharma went
62
public in 1995 by listing its shares in various stock exchanges in the country. Over the
years, Aurobindo Pharma has evolved into a knowledge driven company. It is R&D
focused, has a multiproduct portfolio with multi-country manufacturing facilities, and is
becoming a marketing conglomerate across the world. Aurobindo Pharma created a name
for itself in the manufacture of bulk actives, its area of core competence. After ensuring a
firm foundation of cost effective production capabilities and a clutch of loyal customers,
the company has entered the high value speciality generic formulations segment, with a
global marketing network.
Vision
To become Asia’s leading and one among the top 15 generic pharma companies in the
world by 2015.
Mission
To become the most valued pharma partner for the world pharma fraternity by
continuously researching, developing & manufacturing a wide range of products
complying to the highest regulatory standards
Eminent Board
Corporate governance, accountability and protecting shareholder interests have always
guided the Company. There is an eminent board with considerable knowledge and
experience in pharmaceutical and healthcare, administration, teaching, banking and
consulting to guide and supervise the Company. They are adequately supported by a large
team of professional managers
Aurobindo has a global footprint
Scope of operations is large in the U.S. and Europe with considerable presence in Latin
America and emerging markets. Developmental activity is on-going in Japan and
Australia. Domestic market remains an area of strength.
Products
The Company has one of the widest product portfolio of 300+ products
Major therapeutic segments covered:
• Cardio vascular
• Neuroscience
• Anti-retroviral
63
• Gastro-intestinal
• Anti-infective
• Pain management
• Osteoporosis
Capacities
There are large capacities for manufacturing formulations. This is supported by huge
manufacturing capacity for intermediates and active ingredients. There is considerable
head room even as formulations sales have been
showing secular rise quarter-on-quarter.
Performance track record
For over two decades, Aurobindo has successfully sought and worked for leadership
position in its product category.
Product knowledge, manufacturing capabilities, sensitivity to the market and relationship
with customers are the bedrock for the healthy momentum in the business. The Company
has reported profits every year and is a consistent dividend paying company. More
important, shareholder value has been increased while meeting customer needs.
This high energy pharmaceutical company has a passion to succeed in the most
competitive markets. Aurobindo’s commitment to create good health acts as a constant
driver for improvement. The Company straddles key strategies from fermentation to
formulation and is one of the most cost effective producers in the world. Vertically
integrated manufacturing process and captive raw material source makes an impact in end
product marketing. Ability to control quality and power to price has helped Aurobindo to
offer quality pharmaceuticals at affordable prices. All projects are completed within
budgeted time without cost overruns. Value creation and cost effectiveness start early at
Aurobindo. There is an excitement across the organization driving the change to become a
global resource in the pharmaceutical industry. In this journey, as in the past, care is taken
to create value for all stakeholders, and in particular to the customers and investors.
64
AUROBINDO
Year Sales % sales Contribution EBIT % EBIT EBT EPS % EPS

2008- 28852.5 19.755 2945.1 2121.1 41.243 1570.4 23.9 -55.912
09
2007- 24092.8 21.698 4356 3610 44.463 3448.4 54.21 26.128
08
2006- 19797.2 34.47 3217.3 2498.9 62.752 2311.6 42.98 225.11
07
2005- 14722.1 27 246.6 1535.4 85.188 929 13.22 91.316
06
2004- 11591.7 -13.563 1234 829.1 -60.097 429.2 6.91 -73.963
05

2009 1.35 1.355 1.388 2.087 1.875 1.45
2008 1.047 0.585 1.206 2.049 1.263 0.28
2007 1.081 3.587 1.287 1.82 1.392 0.34
2006 1.653 1.072 1.333 3.155 2.203 1.97
2005 1.932 1.23 1.489 4.431 2.875 0.28
2004 1.186 1.386 1.167 0.956 1.384 0.65
65
From above we can notice that DFL has been continuously fluctuating. In the year 2006-
07 the variability of EPS is the highest. For every 1 unit change in operating profit EPS
changes by 3.587 units.
Debt increases the probability of cash insolvency over an all-equity-financed firm. Debt
also increased the variability in EPS as the DFL increases.Thus financial risk is highest in
the year 2006-07
The DOL has decreased from the year 2004-05 to 2008-09 .in the year 2004-05 for every
1unit change in the sales there will be 4.434 units change in the EBIT.
The closer that a firm operates to its break-even point, the higher is the absolute value of
its DOL. Thus the sales are closer to break-even in the year 2004-05.
variability of operating profits and, hence, business risk.in the above case business risk is
highest in the year 2004-05
change in output (sales) is called DPS.For 1 unit increase in sales EPS decreased by unit.
CoD debt/equit
YEAR FA CA COE DP ratio y
2009 11579 19455 1.40 22.02 0.85
2008 9507 17219 1.14 7.06 0.93
2007 13713 18630 0.83 6.81 1.45
2006 12334 12560 0.81 13.37 0.72
2005 11108 8883 0.41 6.16 0.43
66
 Aurobindo had maximum fixed assets in 2007 and maximum current
assets in the year 2009. Fixed assets and current assets of the company
has been continuously increasing from 2005-2007 and then decreased
towards 2008.
 Debt to equity ratio of the company is greater than 1 during 2006-07. Hence the
company financed most of its assets using debt in 2007.
year DP ratio Rtn ratio GPR NPR EPS

2009 22.02 92.47 20.35 16.09 23.9
2008 7.06 91.88 15.54 4.54 54.21
2007 6.81 91.34 10.87 12.41 42.98
2006 13.37 92.37 11.02 11.74 13.22
2005 6.16 87.56 9.25 4.89 6.91
From the table:
 During the year 2007-08 EPS is highest but the company paid only 7% of the earnings to
the shareholders and retained
Year Debt/equity WACC Value of the
firm 92% of the earnings
2009 0.85 13.85 35139
2008 0.93 16.13 30487
2007 1.45 13.6 29728
2006 0.72 12.9 21825
2005 0.43 10.3 17086
From the table:
The value of the firm has been continuously increasing while the debt to equity ratio
increased till 2006-07 and decreased during 2007-08.
67
FA/CA FA/TA FATR Sales BEP
YEAR DOL
2009 0.60 0.74 0.63 102228.4 70022 2.087
2008 0.55 0.74 0.75 85377.6 59798 2.049
2007 0.74 0.77 0.91 88566.1 53380 1.82
2006 0.98 0.75 1.26 40097.2 12654 3.155
2005 1.25 0.6 1.31 34105.2 9487 4.431
From the table:
FATR decreased from the year 2005-09.FATR is highest in the year 2005, which implies
Aurobindo efficiently used the investment on fixed assets to generate sales in the year
2005.
From the graph, it can be noticed that as DFL decreased, EPS also decreased in the corresponding
year and increased as the DFL increased. So, it can be said that DFL and EPS are positively
correlated.
68
From the graph, we can notice that proportion of current assets is increased from
2005-09 and the proportion of fixed assets decreased. Also the total assets of the
company increased
TELECOM INDUSTRY
69
The Indian Telecommunications network with 203 million connections is the third largest
in the world and the second largest among the emerging economies of Asia.Today, it is the
fastest growing market in the world. The telecommunication sector continued to register
significant success during the year and has emerged as one of the key sectors responsible
for India’s resurgent India’s economic growth.
Telecom sector accounts for 1 percent of India’s GDP. Likely to double in 2-

3 years
• Telecom services contribute 30 percent to India’s total service tax revenue
• The Indian telecom sector gives direct employment to more than 4,00,000 people, compared to
about 6,00,000 people in China
• Not just the enabler of software, BPO and ITeS companies, it is also the lifeline of a fast
growing E-commerce space
• State-of-the-art telecom infrastructure has led to the rise of cities like Mysore, Mangalore,
Jaipur, Ahmedabad, Kochi on the software services map
• This has helped spread the benefits of a booming Indian economy to beyond metros and
large cities, and wealth creation is happening in tier-2 cities
70
Growth
The sector, which was growing in the range of 20 to 25 per cent up to the year 2002-03, has
moved to a higher growth path of an average rate of 40-45 per cent during the last two
years.This rapid growth has been possible due to various proactive and positive decisions of
the Government and contribution of both by the public and the private sector. The rapid
strides in the telecom sector have been facilitated by liberal policies of the Government that
provide easy market access for telecom equipment and a fair regulatory
framework for offering telecom services to the Indian consumers at affordable prices.
Major Players
There are three types of players in telecom services:
• State owned companies (BSNL and MTNL)
• Private Indian owned companies (Reliance Infocomm, Tata Teleservices,)
• Foreign invested companies (Hutchison-Essar, Bharti Tele-Ventures, Escotel, Idea
Cellular, BPL Mobile, Spice Communications)
• Fastest Growing Sector – CAGR 22% (2002-07)

• Second Largest Telecom Market
– Lowest tariff charges in the world
– Wireless Subscribers – 315.3 Mn
– Wireline Subscribers – 38.4 Mn
– Teledensity – 30.6
– 23 Circles - 4 Categories ( Metro, A, B & C)
• Bharti Airtel – Largest player with presence in 23 Circles
71
Year Sales %change Contributio EBIT %change EBT EPS %change
In sales n in EBIT in EPS
2009 29356.1 47.86 8108.2 3787.1

-8.48
2740.1 0.98
180
2008 -49.19 -84.02

19853.1 -54.36 6735.1 4138.2 2932.1 0.35
2007 43500.1 47.47 14861.8 8143.6
51.67
5092.5 2.19
508.33
2006 38.69 -72.09

29496.1 30.08 10864.3 5369.2 2198.1 0.36
2005 22674.5 72.9 8293.1 3871.2
48.98
682.7 1.29
106.76
YEAR FL DFL
2009 1.38 -21.2
2008 1.41 1.71
2007 1.6 9.84
2006 2.44 -1.86
2005 0.67 2.18
From the above table, DFL has been continuously fluctuating. In the year 2006-07 the
variability of EPS is the highest. For every 1 unit change in operating profit EPS changes
by 9.84 units. In the above case as the DFL decreased and the financial risk also decreased.
Dbt/Eqt D/P
YEAR FA CA CoD CoE y Ratio
6147 404 7
2009 8.3 67 1.1 .1 0.53 …
72
5821 346
2008 3.4 67 1.1 8.60 1.54 …
6098 206
2007 9.4 58 1.5 14.54 1.62 …
2006 38768.9 35928 1.2 18.87 2.85 …
2005 35974.9 39752 7.1 28.38 2.58 …
Fixed Assets and Current assets
IDEA Cellular had maximum fixed assets and current assets in the year 2009.
Fixed assets decreased during 2008 and in turn increased towards 2009.
Current assets decreased from 2005-07 and then increased towards the year 2009.
Cost of equity and Cost of debt
From the table, the CoE is higher during the period 2004-05 and the company could use
debt as a cheaper source of capital. During 2007-09 the CoE decreased to 7.1 which is
higherer than the CoD which is 1.1. Thus the company enjoyed debt as a cheaper source of
capital during 2004-09
Debt/equity ratio
In the above case the ratio is greater than 1 during the four years period ( from 2004-2008)
Thus the company financed its assets using debt and the company is In a risky position in
case the interest rate increases.
Year Rtn Ratio GPR NPR EPS

2009 100 15.84 8.71 0.98
2008 100 20.51 9.91 0.35
2007 100 25.81 15.33 2.19
2006 100 24.05 11.44 0.36
2005 100 25.29 6.24 1.29
 IDEA retained 100% of its earning during all the 5 years under study and hence the
company did not pay dividents to its shareholders.
 Though the GPR is high in the year 2004-05, the NPR is very low.
 In the year 2006-07 the NPR is high and hence the EPS is also high.
Dbt/Eq
Year ty WACC Value
73
21666
2009 0.53 14.8 9
10060
2008 1.54 13.4 0
2007 1.62 12.8 64303
2006 2.85 11.2 44192
2005 2.58 9.9 40633
From the table, it is interesting to observe that the value of the company is the highes in
the year 2008-09 when it financed most of its assets using equity i.e. debt/ equity ratio is
the low.Also the company has comparitively low value during the year 2004-05 when it
financed most of its assets using debt.Hence IDEACellular could not use debt as a cheaper
source of finance.
YEAR FA/CA FA/TA FATR Sales Indiff. Pnt EBIT
2009 1.52 0.6 0.62 29356.1 2333 3787.1

2008 1.68 0.63 0.74 19853.1 2560 4138.2
2007 2.95 0.75 0.61 43500.1 5240 8143.6
2006 1.08 0.52 1.24 29496.1 3384 5369.2
2005 0.9 0.48 1.01 22674.5 2593 3871.2
implies IDEA Cellular efficiently used the investment on fixed assets to generate
sales in the year 2005.
 FA/CA ratio and FA/TA ratio are highest for the year 2007.
74
75
From the graph, the proportion of fixed assets increased and the total assets of the
company also increased from 2005-09
EPS-DFL
From the graph it can be observed that the company leveraged properly and used
debt component successfully. EPS and DFL are positively correlated in the case
of IDEA CELLULAR Ltd.
76
BHARTI AIRTEL
77
Airtel comes to you from Bharti Airtel Limited, one of Asia’s leading integrated telecom
services providers with operations in 19 countries across Asia and Africa. Bharti Airtel
since its inception, has been at the forefront of technology and has pioneered several
innovations in the telecom sector.
The company is structured into four strategic business units - Mobile, Telemedia,
Enterprise and Digital TV. The mobile business offers services in India, Sri Lanka and
Bangladesh. The Telemedia business provides broadband, IPTV and telephone services in
89 Indian cities. The Digital TV business provides Direct-to-Home TV services across
India. The Enterprise business provides end-to-end telecom solutions to corporate
customers and national and international long distance services to telcos.
Airtel was born free, a force unleashed into the market with a relentless and unwavering
determination to succeed. A spirit charged with energy, creativity and a team driven “to
seize the day” with an ambition to become the most globally admired telecom service.
Airtel, in just ten years of operations, rose to the pinnacle to achivement and continues to
lead.
As India's leading telecommunications company Airtel brand has played the role as a
major catalyst in India's reforms, contributing to its economic resurgence.
Today they touch peoples lives with their Mobile services, Telemedia services, to
connecting India's leading 1000+ corporates. They also connect Indians living in USA, UK
and Canada with callhome service.
• Largest Private Integrated Telecom Company in India
• 3rd Largest Wireless Operator in the World
• Largest & Fastest Growing Wireless Operator in India
• Largest Telecom Company listed on Indian Stock Exchange
78
VISION 2020
• To build India's finest business conglomerate by 2020
• Supporting education of underprivileged children through Bharti Foundation
Strategic Intent:
– To create a conglomerate of the future by bringing about “Big

Transformations through Brave Actions.”
MISSION
• “ We at Airtel always think in fresh and innovative ways about the needs of our
customers and how we want them to feel. We deliver what we promise and go out
of our way to delight the customer with a little bit more”
CORE VALUES
• Empowering People - to do their best
• Being Flexible - to adapt to the changing environment and evolving customer

needs
• Making it Happen - by striving to change the status quo, innovate and energize
new ideas with a strong passion and entrepreneurial spirit
OBJECTIVES AND VALUES
• To undertake transformational projects that have a positive impact on the society

and contribute to the nation building process.
• To Diversify into new businesses in agriculture, financial services and retail

business with world-class partners
• To lay the foundation for building a “conglomerate” of future
• Openness and transparency - with an innate desire to do good
79
• Creating Positive Impact – with a desire to create a meaningful difference in
society.
SWOT ANALYSIS
Strengths
• Bharti Airtel has more than 65 million customers (July 2008). It is the largest
cellular provider in India, and also supplies broadband and telephone services - as
well as many other telecommunications services to both domestic and corporate
customers.
• Other stakeholders in Bharti Airtel include Sony-Ericsson, Nokia - and Sing Tel,
with whom they hold a strategic alliance. This means that the business has access
to knowledge and technology from other parts of the telecommunications world.
• The company has covered the entire Indian nation with its network. This has
underpinned its large and rising customer base.
Weaknesses
• An often cited original weakness is that when the business was started by Sunil
Bharti Mittal over 15 years ago, the business has little knowledge and experience
of how a cellular telephone system actually worked. So the start-up business had to
outsource to industry experts in the field.
• Until recently Airtel did not own its own towers, which was a particular strength of
some of its competitors such as Hutchison Essar. Towers are important if your
company wishes to provide wide coverage nationally.
• The fact that the Airtel has not pulled off a deal with South Africa's MTN could
signal the lack of any real emerging market investment opportunity for the business
once the Indian market has become mature.
Opportunities
• The company possesses a customized version of the Google search engine which
will enhance broadband services to customers. The tie-up with Google can only
enhance the Airtel brand, and also provides advertising opportunities in Indian for
Google.
80
• Global telecommunications and new technology brands see Airtel as a key strategic
player in the Indian market. The new iPhone will be launched in India via an Airtel
distributorship. Another strategic partnership is held with BlackBerry Wireless
Solutions.
• Despite being forced to outsource much of its technical operations in the early
days, this allowed Airtel to work from its own blank sheet of paper, and to question
industry approaches and practices - for example replacing the Revenue-Per-
Customer model with a Revenue-Per-Minute model which is better suited to India,
as the company moved into small and remote villages and towns.
• The company is investing in its operation in 120,000 to 160,000 small villages
every year. It sees that less well-off consumers may only be able to afford a few
tens of Rupees per call, and also so that the business benefits are scalable - using its
'Matchbox' strategy.
• Bharti Airtel is embarking on another joint venture with Vodafone Essar and Idea
Cellular to create a new independent tower company called Indus Towers. This
new business will control more than 60% of India's network towers. IPTV is
another potential new service that could underpin the company's long-term
strategy.
Threats
• Airtel and Vodafone seem to be having an on/off relationship. Vodafone which

owned a 5.6% stake in the Airtel business sold it back to Airtel, and instead
invested in its rival Hutchison Essar. Knowledge and technology previously
available to Airtel now moves into the hands of one of its competitors.
• The quickly changing pace of the global telecommunications industry could tempt
Airtel to go along the acquisition trail which may make it vulnerable if the world
goes into recession. Perhaps this was an impact upon the decision not to proceed
with talks about the potential purchase of South Africa's MTN in May 2008. This
opened the door for talks between Reliance Communication's Anil Ambani and
MTN, allowing a competing Inidan industrialist to invest in the new emerging
African telecommunications market.
• Bharti Airtel could also be the target for the takeover vision of other global
telecommunications players that wish to move into the Indian market.
81
Airtel comes to you from Bharti Airtel Limited, India's largest integrated and the first
private telecom services provider with a footprint in all the 23 telecom circles. Bharti
Airtel since its inception has been at the forefront of technology and has steered the course
of the telecom sector in the country with its world class products and services. The
businesses at Bharti Airtel have been structured into three individual strategic business
units (SBU's) - Mobile Services, Airtel Telemedia Services & Enterprise Services
AIRTEL
82
Year Sales % Contribution EBIT % EBIT EBT EPS % EPS
Year FL sales DFL
2009
2008-09 372328 38.55
1.21 191128
0.63 104523 33.33 85910.1 41.4 20.9
2008 268728 46.45 140918 78394.1 59.1 73115.4 34.23 59.7
2007-08 1.07 1.01
2007 183492 59.01 91359.5 49272.3 91.72 46783.8 21.43 98.8
2006-07
2006 115393 1.05
44.1 1.08
53386.5 25698.9 40.65 23454.8 10.776 65
2005
2005-06 80076.6 68.06
1.09 38447.4
1.60 18271.1 121.03 15831.9 6.528 136.5
2004-05 1.15 1.13
From above ,we can notice that DFL has decreased from the year 2004-05 towards 2008-
09. In the year 2005-06 the variability of EPS is the highest. For every 1 unit change in
operating profit EPS changes by 1.6 units. DFL decreased from 1.6 to 0.627. Thus the
financial risk also decreased
CoE CoD Dbt/eqt D/P

YEAR FA CA y Ratio
480922. 8.8
2009 9 59172.3 9.50 0.13 5.73
361194. 10.8
2008 0 37579.4 3.26 0.25 …
216814. 11.2
2007 4 44454.7 2.82 0.3 …
153481. 23.8
2006 2 29542.9 2.67 0.43 …
107594. 2.8
2005 4 21990.7 4.39 0.61 …
Fixed Assets and Current asset
 Airtel had maximum fixed assets and current assets in the year 2009.Current assets
increased from the year 2005-09.
83
YEAR DP RATIO Ret ratio GPR NPR
2009 5.73 94.78 28.15 26.36
2008 … 95.22 29.33 22.58
2007 … 100 29.08 23.99
2006 … 100 27.47 22.46
2005 … 100 23.14 17.8
 Airtel retained 100% of its earnings during 2005-07 and hence could not pay any
dividends to its shareholders during that period.
 Its Gross Profit Ratios and Net Profit Ratios increased gradually during the given period.
Year Dbt/Eqty WACC Value

2009 0.13 15.2 375301
2008 0.25 13.4 258130
2007 0.3 12.3 157751
2006 0.43 12 115362
2005 0.61 8.3 94371
 Airtel financed most of its assets using equity and debt/ equity ratios are unusually low.
 A gradual increase in the value of the company can be observed.
 FATR increased from the year 2005-07 and decreased towards 2009.FATR is
FATR Sales Indf. Pnt EBIT
YEAR FA/CA FA/TA
372328 67165 104523
2009 8.13 0.89 0.88
268728 49956 78394.1
2008 9.61 0.91 1
183492 31298 49272.3
2007 4.88 0.83 1.03
115393 15706 25698.9
2006 5.20 0.84 0.75
80076.6 10594 18271.1
2005 4.89 0.83 0.72
84
 FA/CA ratio and FA/TA ratio are highest for the year 2008.
From the graph, the proportion of fixed assets is very high compared to
current assets and the total assets of the company increased from 2005-09
EPS-DFL
Airtel used debt to a sufficient extent to give more returns to the shareholders. Because
the EPS is continuosly increasing and DFL and EPS are positively correlated in this case.
85
TATA COMMUNICATIONS
\
86
Tata Communications is a leading global provider of a new world of communications.
With a leadership position in emerging markets, Tata Communications leverages its
advanced solutions capabilities and domain expertise across its global and pan-India
network to deliver managed solutions to multi-national enterprises, service providers and
Indian consumers.
The Tata Global Network includes one of the most advanced and largest submarine cable
networks, a Tier-1 IP network, with connectivity to more than 200 countries across 400
PoPs, and nearly 1 million square feet of data center and colocation space worldwide.
Tata Communications' depth and breadth of reach in emerging markets includes

leadership in Indian enterprise data services, leadership in global international voice, and
strategic investments in operators in South Africa (Neotel), Sri Lanka (Tata
Communications Lanka Limited), and Nepal (United Telecom Limited).
Tata Communications Limited is listed on the Bombay Stock Exchange and the National
Stock Exchange of India and its ADRs are listed on the New York Stock Exchange.
(NYSE: TCL)
Vision
Deliver a new world of communications to advance the reach and leadership of our
customers.
Commitment
Invest in building long-lasting relationships with customers and partners and lead the
industry in responsiveness and flexibility.
Tata Group Profile
Tata is a rapidly growing business group based in India with significant international
operations. Revenues in 2007-08 are estimated at $70.8 billion USD , of which 61 per
cent is from business outside India. The Group employs around 350,000 people
87
worldwide. The Tata name has been respected in India for 140 years for its adherence to
strong values and business ethics.
The business operations of the Tata Group currently encompass seven business sectors:
communications and information technology, engineering, materials, services, energy,
consumer products and chemicals. The Group's 27 publicly listed enterprises have a
combined market capitalisation of some $60 billion, among the highest among Indian
business houses, and a shareholder base of 3.2 million. The major companies in the Group
include Tata Steel, Tata Motors, Tata Consultancy Services (TCS), Tata Power, Tata
Chemicals, Tata Tea, Indian Hotels and Tata Communications.
The Group's major companies are beginning to be counted globally. Tata Steel became
the sixth largest steel maker in the world after it acquired Corus. Tata Motors is among
the top five commercial vehicle manufacturers in the world and has recently acquired
Jaguar and Land Rover. TCS is a leading global software company, with delivery centres
in the US, UK, Hungary, Brazil, Uruguay and China, besides India. Tata Tea is the
second largest branded tea company in the world, through its UK-based subsidiary Tetley.
Tata Chemicals is the world's second largest manufacturer of soda ash. Tata
Communications is one of the world's largest wholesale voice carriers.
In tandem with the increasing international footprint of its companies, the Group is also
gaining international recognition. Brand Finance, a UK-based consultancy firm, recently
valued the Tata brand at $11.4 billion and ranked it 57th amongst the Top 100 brands in
the world. Businessweek ranked the Group sixth amongst the "World's Most Innovative
Companies" and the Reputation Institute, USA, recently rated it as the "World's Sixth
Most Reputed Firm."
Founded by Jamsetji Tata in 1868, the Tata Group's early years were inspired by the spirit
of nationalism. The Group pioneered several industries of national importance in India:
steel, power, hospitality and airlines. In more recent times, the Tata Group's pioneering
spirit has been showcased by companies like Tata Consultancy Services, India's first
software company, which pioneered the international delivery model, and Tata Motors,
which made India's first indigenously developed car, the Indica, in 1998 and recently
unveiled the world's lowest-cost car, the Tata Nano, for commercial launch by end of
2008.
88
The Tata Group has always believed in returning wealth to the society it serves. Two-
thirds of the equity of Tata Sons, the Tata Group's promoter company, is held by
philanthropic trusts which have created national institutions in science and technology,
medical research, social studies and the performing arts. The trusts also provide aid and
assistance to NGOs in the areas of education, healthcare and livelihoods. Tata companies
also extend social welfare activities to communities around their industrial units. The
combined development-related expenditure of the Trusts and the companies amounts to
around 4 per cent of the Group's net profits.
Going forward, the Group is focusing on new technologies and innovation to drive its
business in India and internationally. The Nano car is one example, as is the Eka
supercomputer (developed by another Tata company), which in 2008 is ranked the world's
fourth fastest. The Group aims to build a series of world class, world scale businesses in
select sectors. Anchored in India and wedded to its traditional values and strong ethics,
the Group is building a multinational business which will achieve growth through
excellence and innovation, while balancing the interests of its shareholders, its employees
and wider society.
SWOT ANALYSIS
Strengths
• Scale. By combining the assets of Teleglobe and TGN, VSNLI has achieved the
traffic volumes necessary to be a credible low-cost provider in the international
wholesale market.
• Geographic footprint. VSNLI’s extensive network includes undersea cable,
terrestrial fibre and satellite capacity – essential for an international wholesale
provider wishing to provide end-to-end connectivity without becoming overreliant
on partners to fill the geographic gaps.
• Commanding presence in international wholesale voice market. The company
is now carrying over 16 billion international voice minutes per year, a position built
on its extensive bilateral relationships.
89
• Tier 1 ISP. VSNLI can obtain enhanced global peering capability and redundancy
as a tier-one ISP. The company has over 345Gbit/s of peering capacity with other
carriers.
• Full portfolio of services. VSNLI can offer a comprehensive suite of voice, data
and mobile services, provided through a variety of network options including
submarine cable, switching gateways, IP points of presence (PoPs) and earth
stations.
• Strength in signalling conversion market. VSNLI is an international provider of
mobile signalling conversion services, based on Teleglobe’s strong position in this
market.
• Access to intellectual property and proprietary (VoIP) technology. Based on
Teleglobe/ITXC’s capability, VoIP enables better control of least-cost routing,
supplementing the traditional voice product portfolio with the VoIP network and
services, and innovative value-added services. This will allow more flexible
services for existing customers and the targeting of new customer segments.
• Home base in Indian market. VSNLI has direct connections to the fast growing
Indian market via VSNL, which was the first ISP in India and now offers hosting
and co-location services out of its data centres in Mumbai, Delhi, Chennai and
Bangalore. VSNL also provides IP VPN services in over 115 locations in India and
has started offering national long-distance services in some Indian towns. The
operator has rolled out its metro Ethernet services in six major cities in India and
another 18 cities globally.
• Reputation. Based on Teleglobe’s long history in international wholesale, and its
existing bilateral relationships, VSNLI can claim established status in the sector.
• Customer base. VSNLI has acquired a strong presence in the wholesale market,
with a multitude of blue-chip fixed and mobile customers for its voice and data
services.
• Backing of the Tata Group. The Tata Group, which held 45.15% of VSNL as of
31 March 2006, has activities in business sectors from information systems and
communications to engineering, materials, services, energy, consumer products and
chemicals. It is one of India's largest business conglomerates, with revenues of
$21.9 billion in 2005/2006.
90
Weaknesses
• Wholesale/retail conflict. As with any erstwhile wholesale provider attempting to

serve the enterprise market, VSNLI will need to reassure its wholesale customers
that its retail activities are not in direct competition with theirs.
• Image. VSNLI is still not incredibly well known as a provider of corporate
communications solutions to global enterprises. The company is increasing its
profile in the marketplace, but there is some way to go before it becomes as well
known as some of its competitors.
• Lack of access networks. Access is key to serving the enterprise market, and
while VSNLI now has an impressive roster of long-distance assets, it is still under-
represented as an access provider. Last mile will prove to be a challenge in
delivering services to its targeted corporate customer base.
Opportunities
• Leverage Tata Group. With Tata Group now being VSNL’s major shareholder,
VSNLI can leverage the group’s strengths in IT and network solutions to drive its
presence in the corporate marketplace.
• Build applications into the network. One way in which VSNLI wants to move up
the value chain is by building applications into the network. Tata Group ownership
will help to achieve this by providing the necessary skills and resources needed to
become a credible network-based IT services provider.
• Growth in mobile services. Teleglobe was one of the leading providers of

signalling services to the mobile sector, and VSNLI is doing its best to capitalise
on this. The central role this plays in mobile operators’ businesses gives VSNLI the
scope to sell other types of mobile-oriented service, and to take advantage of
expected growth in end-user mobile voice and data traffic.
• Leapfrog to VoIP. With the ITXC expertise on board, VSNLI gains a boost in
moving from TDM to VoIP technology, a process that was already moving apace
and is becoming increasingly important in the international wholesale voice
market.
91
• Reaching new voice market segments. The acquisition of ITXC meant that
Teleglobe, and now VSNLI, can expand its service portfolio to target a wider
market for voice services. VSNLI states that it is the world’s leading wholesale
VoIP carrier, and has the world’s largest VoIP network.
Threats
• Competition for mobile business. With a large number of wholesale operators
focused on winning business and launching new products specifically for mobile
operators, VSNLI should not be complacent about its current standing in the sector.
• Wholesale voice commoditisation. Voice prices are continuing to fall,
undermining margins and revenues in the sector.
• Slump in bandwidth sales. If data growth in India runs out of steam, this will
undermine VSNLI’s core international bandwidth business, producing problems
for the company in supporting the opex costs of its significant bandwidth assets.
92
TATA communication
Year Sales %change Contribution EBIT %change EBT EPS %change
2009 102228. 51.09 417.7

4 19.7 16092.4 5069.7 4227.6 3.21
2008 85377.6 -37.2 11199.4 3355.3 -34.9 1489.2 0.62 -78.5
2007 88566.1 120.8 12991.1 5161.1 -31.7 3725.3 2.89 -84.3
2006 40097.2 17.56 11048.2 7561.5 19.5 6867.17 18.4 28.31
2005 34105.2 8764.8 6326.7 10539.8 14.34
YEAR FL DFL
2009 1.19 8.17
2008 2.25 2.24
2007 1.38 2.65
2006 1.10 1.45
2005 0.60 1.42
From above we can notice that DFL increased from the year 2005-09. In the year 2008-09
the variability of EPS is the highest. For every 1 unit change in operating profit EPS
changes by 8.17 units. DFL increased from 1.42 to 8.17. Thus the financial risk also
increased
YEAR FA CA CoE CoD Dbt/eqty DP ratio

1
2009 116058.7 41484.1 6.2 1.2 0.36 29.08
2008 82963.3 29893.7 5.8 10.3 0.34 49.28
2007 68401.4 20617.6 4.2 10.1 0.11 32.02
2006 63454.7 21161 3.4 9.2 0.03 30.49
2005 30973 20236.7 3.3 6 0.01
From the table:
93
 TATA invested more in fixed assets and the company fixed assets increased from 2005-09
 TATA invested most of its assets using equity
 TATA paid more dividends compared to IDEA and Airtel telecom
Year DP ratio Retention Ratio GPR NPR EPS

2009 29.08 75.02 11.36 13.25 3.21
2008 49.28 74.56 10.14 8.87 0.62
2007 32.02 81.37 13.71 11.25 2.89
2006 30.49 82.77 14.02 12.1 18.4
2005 28.23 100 5.46 14.47 14.34
From the table:
 DP Ratio increased from 2005-08 and decreased to almost half during 2008-09
 TATA retained nearly 80% of its earnings for further investments
 GPR and NPR decreased from 2005-08
Year Dbt/eqty VALUE WACC

2009 0.36 119763.3 14.6
2008 0.34 86438.9 13.3
2007 0.11 79015.9 12
2006 0.03 75182.2 11.7
2005 0.01 55911.1 8.7
 Debt/ Equity increased suddenly from 2007-08 i.e. TATA increased the proportion of debt
during this period
 Value of the company gradually increased from 2005-09
Year FA/CA FA/TA FATR Sales Indff. Pnt EBIT

2009 2.80 0.74 0.63 102228.4 70022 5069.7
2008 2.78 0.74 0.75 85377.6 59798 3355.3
2007 3.32 0.77 0.91 88566.1 53380 5161.1
2006 3 0.75 1.26 40097.2 12654 7561.5
2005 1.53 0.6 1.31 34105.2 9487 6326.7
94
TATA Telecommunications used the investment on fixed assets to generate sales
in the year 2005.
 FA/CA ratio and FA/TA ratio are highest for the year 2007
FA Vs CA
From the graph, the proportion is fixed assets is very high and also amount of total
assets increased fro 2005-09.
DFL Vs EPS
95
From the graph. DFL and EPS moved together and seems to be correlated because
as DFL decreased during 2007-08 EPS also decreased and during 2008-09 as DFL
increased EPS also increased.
96
Chapte
r
SUMMARY, FINDINGS AND
CONCLUSION
9
PHARMA INDUSTRY
DR.REDDYS
 Dr.Reddys used both financial leverage and operating leverage to increase its
profitability and hence both financial risk and operating risk is high. Companies with
97
high operating leverage are vulnerable to sharp economic and business cycle swings.
Hence, Dr.Reddys reduced its business risk gradually from 2005-2009.
 WACC is high and debt to equity ratio is also high and hence the financial risk
is high
 Sales exceeded the BEP sales in 2005. It retained on 80% of its earnings on an
average
 and paid dividends to its shareholders during all the five years under study.
 It maintained more of current assets and is able to generate sales from the
investments on fixed assets.
RANBAXY
 High DOL and comparatively low DFL and hence high business risk is higher
than financial risk.
 WACC is lower compared to Dr.Reddys but Ranbaxy financed most of its

assets using equity.
 Ranbaxy’s sales are close to its BEP sales in the year 2009. The firm did not
pay dividends for the past 2 years and retained all its earnings for further investments.
 Ranbaxy’s investment in fixed assets increased during the given period and its
FATR decreased.
AUROBINDO
 Aurobindo used both financial and operating leverage. But the DOL is higher
than DFL . Hence business risk is higher than financial risk.
 WACC is comparable to that of Ranbaxy’s.The firm used both debt and equity
to an equal extent to finance its assets
 Its sales were higher than BEP sales during the five year period under study. It
retained nearly 90% of its earnings and paid dividends with the remaining earnings.
98
 It maintained more of fixed assets and its FATR is also high.
SERVICE INDUSTRY
IDEA CELLULAR
 DFL is negative during 2008-09 .It implies that EBIT during this year is less
than the BEP.
 IDEA financed most of it assets using debt and hence high financial risk exists.
 Low earnings per share and IDEA did not pay any dividends during the period
under study. The firm retained all its earnings for further investment.
 IDEA invested more on fixed assets than on current assets.
AIRTEL
 EPS is high compared to other 2 firms and Airtel retained 100% of its earnings
during 2005-07 and hence could not pay any dividends to its shareholders during that
period.
 Airtel financed most of its assets using equity
 Value of the company is high
TATA
 EPS is low until 2006-07 and increased suddenly almost 9 times for the year
2007-08.
 Low debt/ equity ratios compared to others two companies under study. Hence
we can say that TATA financed most of its assets using equity.
 Value of the company doubled in the past five years.
99
SUMMARY AND FINDINGS:
An empirical study is conducted to analyze the differences in leveraging practices within

and between Pharmaceutical industry (manufacturing) and Telecommunications industry
(service).
Key players in both the industries are chosen for study. Dr.Reddys, Aurobindo and
Ranbaxy are chosen from pharmaceutical industry and Idea Cellular, Airtel, TATA
Telecommunications from Telecommunications industry.
The degree of financial, operating leverage and combined leverage are calculated using
the information published in the annual reports of the companies.
Service and manufacturing firms differ fundamentally in overall structure and growth
dynamics. In service firms relative to manufacturing firms entry costs and capital
requirements lower because investment in machinery and equipment is almost non-
existent. If service firms lease their facilities (buildings), then their total capital invested is
mainly working capital. They rely less on physical infrastructure and machines but more on
human capital. Hence they cannot leverage on fixed costs.
Financial leverage has a positive effect on the firm's profitability but the use of excessive
debt creates agency problems among shareholders and creditors, which in turn, lead to
negative relationship between leverage and profitability.
The existence of agency costs of debt may cause firms to take riskier investment after the
issuance of debt to expropriate wealth from the firm’s bondholders because the firm equity
is effectively a stock option.
The degree of financial, operating leverage and combined leverage are calculated using the
information published in the annual reports of the companies.
DFL, DOL,DCL,EBIT and EPS are calculated for the companies chosen and the trend is
observed for a period of 5 years. Effect of degree of leverage on the EPS and EBIT is
analyzed.An important observation is that DOL will be maximum when the firm operates
100
close to the break even. This is proved by calculating BEP sales and comparing with the
actual sales.
Since service firms cannot use operating leverage to increase the profitabililty as most of
the capital is predominantly working capital. So, only DFL leverage is calculated and its
effect on EPS during the given time period is analysed.So, companies in service industry
are expected to use high degree of financial leverage to increase the profitability.
But from the empirical study it is found that Debt to Equity ratio is comparatively lower for
companies in service industry. Two out of three firms (TATA and AIRTEL) chosen for
study financed most of their assets using equity and hence did not use financial leverage to
increase the profitability. On the other hand IDEA used financial leverage and pooled high
financial risk. During 2008-09 when the world suffered from recession IDEA ended up
with negative DFL i.e. EBIT is lower than BEP.
An interesting phenomenon is observed in case of firms in manufacturing industry,
operating leverage decreases as a company’s sales increases and shifts away from the
break-even point of sales.( Dr.Reddys, Ranbaxy). Also, shareholders of the firms that
financed most of their assets using equity could benefit from high EPS.
There are many factors that affect the enterprise value or the firm value. One of the
important factor which not only effects the value of the firm but also acts an indicator of
nature of financing is debt to equity ratio. So, debt to equity ratio and value of the
companies are calculated and analyzed.
Ranbaxy with comparatively low debt to equity ratio has high value of the firm. Value of
the firm can be calculated by subtracting Interest cost from Earnings before interest and
tax. It implies that the enterprise value is inversely proportional to interest cost which is in
turn directly proportional to debt to equity ratio and thus Ranbaxy which financed most of
its assets using equity has more Firm value. In simple words degree of financial leverage
affects the firm value.
Firm’s asset structure affects its leverage in both positive and negative ways. Ability of
Assets to Support Debt also effects the leveraging decisions. Lower risk assets with more
stable market values provide better collateral for debt. With better collateral, the firm’s
ability to borrow increases.
Firms with high level of assets that can be used as collateral tend to use more debt rather
than issue new equity because costs associated with issuing equity rise due to the
101
asymmetry of information possessed by insiders and outsider suggests a positive
relationship between debt ratios and the firm capacity of collateralized assets.
Since service firms do not have high level of assets like manufacturing firms. Therefore,
the costs associated with this agency problem would be higher for the service firms
because of the lower level of collateralized assets.
This is clearly evident from the companies chosen for study. While Dr.Reddys, Ranbaxy
and Aurobindo has debt to equity ratios comparatively more than that of Airtel and Tata.
Theoretical research predicts positive relationship between collateralized asset and
leverage. Prior empirical studies use fixed assets as its proxy and the findings are consistent
with theoretical predictions. The findings of this paper show opposite result: leverage
decreases as the proportion of fixed asset in the total assets of the firm increases. The
service industry is usually characterized by a relatively low level of fixed assets. Current
assets can more easily be converted to cash and thus have more liquid capacity than fixed
asset. Lending institutions generally attribute more significance to the capacity to convert
borrowers’ assets into cash and we conjecture that in the service industry the importance of
current rather than fixed assets plays an important role in their decision to offer loans to
firms with high ratio of current to total assets, or a low ratio of fixed to total assets. This
supply-side argument might explain why firms who own relatively low ratios of fixed to
total assets may have higher leverage (IDEA Cellular).
Idea Cellular maintained low fixed to total assets ratio and thus could use more debt by
using current assets as collateral. Airtel and TATA maintained more of fixed assets and so
could not use them as collateral. This is proved by very low debt to equity ratios.
Fixed asset turnover ratio of the companies is also studied. Manufacturing and other
industries requiring major-investments will often spend heavily on properties,
manufacturing plants, and equipment to push themselves ahead of the competition. A large
capital investment purchases may not immediately yield higher sales. It may take a year or
more for the company to fully utilize those investments. If a company invested in major
improvements heavily one year, it would be wise to watch the Fixed Asset Turnover
closely over the next year to see if those investments actually helped the company.
The higher the Fixed Asset Turnover ratio, the more effective the company's investments in
Net Property Plant and Equipment have become.
102
It is desirable that Gross Profit ratio must be high and steady because any fall in it would
put the management in difficulty in the realization of fixed expenses of the business. Net
Profit ratio is helpful to determine the operational ability of the concern.
NPR and GPR are stable in case of Airtel and halved during Idea Cellular.NPR is
abnormally low in case of Dr.Reddys during 2005 and abnormally high during 2007.
Abnormal decrease may be attributed to low sales.
Income tax, nondebt tax shield, firm size, and growth opportunities are the other factors
that determine capital structure choices of the firm which are not studied in this project.
The relationship between leverage and growth opportunities can be positive or negative,
depending on the nature of the growth opportunity.
Leverage has a significant negative effect on investment because of an agency problem

between shareholders and bondholders. If managers work in the interest of shareholders,
they may give up some positive net present value projects due to debt overhang. The other
argument is based on agency conflicts between managers and shareholders. They argue that
firms with free cash flow but low (or no) growth opportunities may nevertheless invest
(overinvest) in that the manager may take on projects with negative net present value.
However, such a strategy is costly to the manager, if the capital market takes into account
such potential opportunism, or there is a takeover of the firm by another company;
managers have an incentive, therefore, to recommit and increase leverage and pay out cash
as interest and principal. These theories suggest a negative relationship between leverage
and investment but only for firms with no or little growth opportunities.
Corporate income tax has important impact on debt-equity choices. Modigliani-Miller

proposition – the corporate tax case - suggests that firms that face higher marginal tax rates
should use more debt to take advantage of tax shield.
In conclusion, financing choice is not a simple one-period decision but a dynamic

occurrence. Firms issue equity when their market valuations are high. Service firms and
manufacturing firms follow different leverage practices. One major difference observed is
that service firms use more of equity than manufacturing firms. This may be partly
attributed to differences in the asset structure of the firms.
SUGGESTIONS :-
103
1. High interest costs during difficult financial periods can increase the risk of
insolvency. So, the companies must not use large amount of debt.
2. Airtel and TATA should invest more on current assets so that they can obtain
debt and thus can use financial leverage.
3. Debt instruments often contain restrictions on the company's activities,
preventing management from pursuing alternative financing options and non-
core business opportunities.
4. The larger a company's debt-equity ratio, the more risky the company is
considered by lenders and investors. Accordingly, a business is limited as to the
amount of debt it can carry.
5. The company is usually required to pledge assets of the company to the lender
as collateral, and owners of the company are in some cases required to
personally guarantee repayment of the loan.
6. Growth opportunities in the economy and of the industry have to be studied
before making financing decisions.
7. Acquisition of new assets of heavy costs should be done with proper capital
budgeting supported by payback period.
8. The process of asset securitization is a new and innovative financing method
used for funding and risk management purposes.
9. the increased use of debt causes both the costs of debt and equity to increase.
10. Signaling theory suggests firms should use less debt than MM suggest.This
unused debt capacity helps avoid stock sales, which depress stock price because
of signaling effects.
11. Managers have better information about a firm’s long-run value than outside
investors.Managers act in the best interests of current stockholders. Issue stock
if they think stock is overvalued.Issue debt if they think stock is undervalued.
As a result, investors view a common stock offering as a negative signal--
managers think stock is overvalued.
BIBLIOGRAPHY:
 Maheswari S.N.: Financial Management 5th Edition

104
 Annual reports of companies
 Notes on leverage by Alex Tajirian
 Paper on Financial Statement Analysis of Leverage and How It Informs
About Profitability and Price-to-Book Ratios
 Paper on the effect of leverage increases on real earnings management by Irina Zagers-
Mamedova
 A journal on The Determinants of Capital Structure in the Service Industry: Evidence
from United States by Amarjit Gill, Nahum Biger, Chenping Pai and Smita Bhutani
 A report on telecom industry by Corporate Catalyst India
 A reading on Financial Ratio Analysis prepared by Pamela Peterson Drake
 Is There Room For Growth? Debt, Growth Opportunities and The Deregulation of U.S.
Electric Utilities by Laarni from IBS.
 Asset Securitization and Optimal Asset Structure of the Firm by Jure Skarabot.
WEBLIOGRAPHY
 www.wikiwealth.com
 www.wikianswers.com
 www.investopedia.com
 http://www.pdf-searcher.com/pdf/leverage-analysis.html
105

Leverage Analysis Project

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Leverage Analysis Project

Uploaded by

Copyright:

Available Formats

Chapte

The objectives for which study has been undertaken are:

2) To examine the dividend policy of the company.

NEED FOR THE PROJECT

1) The annual reports of the companies.

The present study covers a period of two years from 2008-2010.

Scope of the project

There are three type of leverage:

Degree of operating leverage

It can be calculated using the following formula;-

Financial leverage = EBIT / PBT

Financial leverage = % Change in EPS / % Change in EBIT

The behaviors of DFL reveals that :-

1. Each level of EBIT has distinct DFL.

2. DFL is undefined at financial BEP.

3. Ideal situation is when both the leverages are low.

To understand the applications and utility of leverage in financial analysis it is important to

1. For each level of output there is a distinct DOL.

According to Du-Pont control chart, variability in profitability is explained by taking into

Profitability is ascertained from the income statement. The various components of an

EPS = PAT / N and EPS per equity = PAT – DP / N

Now PAT = EBIT – I – Tax on (EBIT - I)

Therefore EPS for equity = [ (EBIT – I )(1 - T) – DP] / N

Levels of operation Earning capacity Earnings per share

Op. leverage Fin. leverage

Ref: “Lecture Notes on Financial Management” by JCS Ravikant S Wawge, DBAR,

Capital Structure theories

S = Total market value of equity debt.

B = Total market value of debt.

V = Total market value of firm.

NI = Net income available on equity share.

Ko = Overall cost of capital.

Ke = Equity capitalization rate.

This approach is based on following assumptions:

1. The cost of debt is less than cost of equity capitalization rate.

V=S+B Where S = Ni/Ke.

This approach is based on following assumptions-

And value of equity (S) = V-B

Following are the basic propositions of the MM Approach.

 The cost of rate of investment purpose is completely independent of the way in

2. Capital market is 100% competitive.

Again the objective of financial management is maximization of value measure in terms of

Dividend policy decision

Debt vs. Equity -- Advantages and Disadvantages

ADVANTAGES OF DEBT COMPARED TO EQUITY

DISADVANTAGES OF DEBT COMPARED TO EQUITY

• Unlike equity, debt must at some point be repaid.

The fixed-asset turnover ratio is calculated as:

5. COST OF EQUITY AND COST OF DEBT

6. DIVIDENT PAYOUT RATIO

9.GROSS PROFIT RATIO

Gross Profit Ratio = Gross Profit/Net Sales x 100

Where Gross Profit = Net Sales – Cost of Goods Sold

And Net Sales = Total Sales – Sales Return

10.NET PROFIT RATIO

Net Profit Ratio = Net Profit/Net Sales x 100

And Net Sales = Total Sales – Sales Return

Ranbaxy Laboratories Limited is the biggest pharmaceutical manufacturing company in

Zydus Cadila also known as Cadila Healthcare is an Indian pharmaceutical company

Established in 1984, Dr. Reddy’s Laboratories is an emerging global pharmaceutical

Pharmaceutical Services and Active Ingredients, comprising Active Pharmaceuticals and

Global Generics, which includes branded and unbranded generics; and