CHAPTER I 1.

1 INTRODUCTION OF THE STUDY

CAPITAL STRUCTURE
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example is referred to as the firm's leverage. In reality, capital structure may be highly complex and include tens of sources. Gearing Ratio is the proportion of the capital employed of the firm which come from outside of the business finance, e.g. by taking a long term loan etc. The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, how a firm is financed is irrelevant to its value. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs. These other reasons include bankruptcy costs, agency costs, taxes, information asymmetry, to name some. This analysis can then be extended to look at whether there is in fact an optimal capital structure: the one which maximizes the value of the firm.

CAPITAL STRUCTURE IN A PERFECT MARKET

Assume a perfect capital market (no transaction or bankruptcy costs; perfect information); firms and individuals can borrow at the same interest rate; no taxes; and investment decisions aren't affected by financing decisions. Modigliani and Miller made two findings under these conditions. Their first 'proposition' was that the value of a company is independent of its capital structure. Their second 'proposition' stated that the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged firm, plus an added premium for financial risk. That is, as leverage increases, while the burden of individual risks is shifted between different investor classes, total risk is conserved and hence no extra value created. 1

Their analysis was extended to include the effect of taxes and risky debt. Under a classical tax system, the tax deductibility of interest makes debt financing valuable; that is, the cost of capital decreases as the proportion of debt in the capital structure increases. The optimal structure then would be to have virtually no equity at all.

AGENCY COSTS
There are three types of agency costs which can help explain the relevance of capital structure:

Asset substitution effect: As D/E increases, management has an increased

incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders.

Underinvestment problem: If debt is risky (eg in a growth company), the

gain from the project will accrue to debtholders rather than shareholders. Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value.

Free cash flow: unless free cash flow is given back to investors,

management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management.

OTHER
The neutral mutation hypothesisfirms fall into various habits of financing, which do not impact on value. Market timing hypothesiscapital structure is the outcome of the historical cumulative timing of the market by managers. Accelerated investment effect- even in absence of agency costs, levered firms use to invest faster because of the existence of default risk.

1.2 REVIEW OF LITERATURE

The review of literature helps the researcher to do the study in the correct order and also help by providing results of the previous study. The study shows that there were many studies on financial performance of various industries. The researcher gains a good back ground of the problem by reviewing certain studies. A few related studies are given below:

Title: Effects of Ownership Structure and Control on Corporate Productivity. Author: Charles W. L. Hill and Scott A. Snell Year: 1995 Journal: Academy of Management. Findings: This study developed and tested a model that attempts to describe the influence of ownership structure on productivity differences between firms. We theorized that diversification, investment in R&D, capital intensity, and ownership structure all determine firm productivity. Ownership structure was proposed to affect productivity both directly and indirectly through the mediators of diversification strategy, R&D expenditure, and capital intensity. Results based on data from a cross-sectional set of 122 Fortune 500 firms suggested that ownership affects a firm's posture toward diversification and investment in R&D. Those factors and capital intensity in turn explain differences in productivity between firms.

Title: The Determinants of Capital Structure. Author: Sheridan Titman and Roberto Wessel Year: 1996 Journal: American Finance Association. Findings This paper analyzes the explanatory power of some of the recent theories of optimal capital structure. The study extends empirical work on capital structure theory in three ways. First, it examines a much broader set of capital structure theories, many of which have not previously been analyzed empirically. Second, since the theories have different empirical implications in regard to different types of debt instruments, the authors analyze measures of short-term, long-term, and convertible debt rather than an aggregate measure of total debt. Third, the study uses a factor-analytic technique that mitigates the measurement problems encountered when working with proxy variables.

Title: The Theory of Capital Structure Author: Milton Harris and Artur Raviv Journal: The Journal of Finance Year: 1991 Publishing: Blackwell Publishing

Findings: This paper surveys capital structure theories based on agency costs, asymmetric information, product/input market interactions, and corporate control considerations (but excluding tax-based theories). For each type of model, a brief overview of the papers surveyed and their relation to each other is provided. The central papers are described in some detail, and their results are summarized and followed by a discussion of related extensions. Each section concludes with a summary of the main implications of the models surveyed in the section. Finally, these results are collected and compared to the available evidence. Suggestions for future research are provided.

Title: Entrepreneurship Theory and Practice Author: Chandra S. Mishra, Daniel L. Mcconaughy Journal: The Journal of Finance Year: 1999 Findings: This study tests the hypothesis that FFCFs use less debt because founding family CEOs are more averse to control risk, the risk of losing control. Control risk increases with leverage because of the higher probability of bankruptcy that is associated with higher leverage. We examine a subset of public family-controlled firms in which the founding family plays a strong and direct role: firms whose CEO is the founder or related to the founder. Looking at these firms, therefore, should lead to a better understanding of distinctive financial characteristics of founder (entrepreneur) owned and operated firms, especially in the context of their control incentives and risks. Finally, we show that ignoring the founding family control factor in the analysis of firms' leverage policies omits an important factor common to many firms and may lead to an incomplete or incorrect understanding...

Title: The Impact of Managerial Self-Interest on Corporate Capital Structure Author: Irwin Friend and Larry H. P. Lang Year: 1998 Journal: American Finance Association. Findings: This paper provides a test of whether capital structure decisions are at least in part motivated by managerial self-interest. It is shown that the debt ratio is negatively related to management's shareholding, reflecting the greater non diversifiable risk of debt to management than to public investors for maintaining a low debt ratio. Unless there is a non managerial principal stockholder, no substantial increase of debt can be realized, which may suggest that the existence of large non managerial stockholders might make the interests of managers and public investors coincide.

Title: 7

The Impact of Capital Structure on the performance of microfinance institutions. Author: Anthony Kyereboah- Coleman. Year: 2007 Journal: The journal of risk finance Findings: Most of the microfinance institutions employ high leverage and finance their operations with long term as against short term debt. Also, highly leveraged microfinance institutions perform better by reaching out to more clientele, enjoy scale economies, and therefore are better able to deal with moral hazard and adverse selection, enhancing their ability to deal with risk.

Title: The Impact of Capital Structure on profitability an empirical analysis of listed firms in Ghana. Author: Joshua Abor Year: 2005 Journal: The journal of risk finance Findings: The results reveal a significantly positive relat ion between the ratios of short term Debt to total assets. However, a negative relationship between the ratio of long term debt to total assets and ROE was found. With regard to the relationship between total debt and return rates, the results show a significantly positive association between the ratio of total debt to total assets and return on equity.

1.3 STATEMENT OF THE PROBLEM

The company uses 80% of its funds requirement through borrowed funds. Around 20% of the sales incomes are used to meet the interest cost and the interest covered ratio is too high. Therefore the study is required to test the relationship between the capital structure and cost of capital and profitability.

10

1.4 OBJECTIVES OF THE STUDY:

To analyze the various specified cost of capital. To analyze the capital structure and the overall cost of capital. To study the efficiency in usage of capital during the period of study. To know the impact of cost of capital on the profitability of the firm. To offer valuable suggestions to the company.

11

1.5 RESEARCH METHODOLOGY METHODOLOGY OF THE STUDY PERIOD OF STUDY:

This study covers a period of 5 years from 2003-04 to 2007-08.

RESEARCH DESIGN:
It is analytical and the method used is case study method. The analytical studies are those which determine the frequency with which something occurs or its association with something else.

DATA COLLECTION:
The study is purely based on secondary data. The data have been collected from published annual reports of the company. The annual reports were directly obtained from the discussion with the financial manager of the company.

TOOLS:
Ratio analysis Cost of capital. Weighted Average cost of capital Correlation

1.6 SCOPE OF THE STUDY:

12

 This study will help the firm in making some financial decisions for future years. This study will help the management to decide the optimum capital structure in order to
increase the profitability and the value of the firm.

The study clearly explains about at what areas they have to improve their performance. It helps in making some reference for its past performance.

13

1.7 LIMITATIONS OF THE STUDY

The study is based on the secondary data. So the reliability of the data may not be accurate.

The study limited to 5 years and the time value may affect the findings.

The availability of ratios for the study is also limited.

The study is limited with Sri Karpagam mills India Private Limited and other concerns are not considered

14

1.8 CHAPTER SCHEME OF THE STUDY

CHAPTER -1 Deals with the introduction, design and execution of the study. CHAPTER -2 Deals with the industry and organization profile. CHAPTER -3 Deals with the data analysis and interpretation. CHAPTER-4 Deals with the findings, suggestions and conclusions.

CHAPTER - II
15

INDUSTRY PROFILE
2.1 INTRODUCTION
Spinning mills were introduced to the United States in 1790 by English-born mechanists and businessman Samuel Slater (1768 1835). The twenty-one year old had worked as a textile laborer for more than six years in an English mill, where he learned about the workings of a cotton-spinning machine invented (1783) by Richard Ark Wright (1732 92). The British considered the Ark Wright mill the cornerstone of their booming textile industry and laws prevented anyone with knowledge of the mill from leaving the country. Eager to seek his own fortune, Slater disguised himself in 1789 to evade the authorities and sailed from England to recreate the spinning mill in America.

HISTORY OF SPINNING
No one really knows when the first spun fiber was made. The oldest known fabric is from 6300 BC (Turkey) and already showed great skill. All fabrics were made from yarns spun from animals and plants until the mid 1800s and all yarn colors were made with natural dyes from plants and bugs. Textiles and wool were very important commodities throughout history. Great Britain tried very hard to keep sheep out of America so they could force the colonies to buy textile products from abroad. Sheep did make to the colonies but at first they were so scarce that any person who killed or harmed a sheep was executed even if they were the owner! An industrious housewife was one that spent every spare minute spinning either for her familys own use or as barter for other items. Being a spinner was a symbol of value and thrift. Originally, being a spinster meant that you spun yarn. However, in the 1700s spinster became the legal term for unmarried women past their "prime". This was because the best spinners were always unmarried. Developing the skill necessary to make the finest yarns required more time than any married women with children could afford. Therefore being a spinster of the highest skill also meant you were unmarried!! In the 1600s up to the 1800s young girls made up the spinning labor force (6 to 9 years old) and worked extremely long hours for low wages. But in the 1800s spinning became 16

mechanized and textiles were soon a major player in the industrial revolution. However, even with these dramatic changes in the industry, spinning wheels were still common in households up in to the early 1900s. Today in the United States there has been a renewed interest in hand spinning and demonstrations are found at many festivals and fairs. There are festivals and conferences that are specifically designed for hand spinners held all over the country. In the very beginning, prehistorically, spinning was done without tools. The thread was drawn out of a bundle of fibers and twisted between the palm of the hand and thigh of the leg. The length of the spun or twisted fibers was wound onto a short, straight stick. The process was then repeated. The hand spindle developed from the short straight stick. Over time the stick was notched to hold the thread and a weight was added to give momentum to the stick as it whirled. The weight, known as a "whorl" was made of clay, a round piece of wood, or a flat rock. Thus was born the hand spindle or drop spindle. Much later the wheel was added to the spindle to keep it spinning. It was found that the larger the wheel the faster the spindle would turn. The size of the drive wheel grew to 6 feet and larger. This type of wheel became known as the "Great Wheel" or as the "Walking Wheel". Even later the foot peddle or "treadle" was added to the wheel. This allowed the spinner to sit instead of walking back and forth to wind the spun woolen fiber onto the spindle. With a treadle on the wheel one could also keep the wheel going without using ones hands. With ones hands freed one can spin more smoothly. Until the mid 19th Century, most households kept two wheels: a great wheel for the household woolens and a smaller treadle type for the linens. This was so one would not get the natural grease of the wool on the flax making it more difficult to spin.

HOW TO USE A LOW WHORL DROP SPINDLE

17

Tie the "leader" tightly around the spindle at Point A. (A leader is a length of pre- spun yarn.). Bring the long end of the leader down and under the whorl. Wrap the leader around the pointed short end of the spindle. This acts a tensioning device. Bring the leader up and tie in a half hitch around the hook at the top of the spindle. If you are right handed, Balance the loose fibers on the back of your left Hand. The leader is held between your left thumb and pointer. You twist the spindle with your right hand and then pull the loose fibers through your left thumb and pointer. If you are left handed, reverse these instructions. Hold the wool in your right hand, leaving your left hand free to twist the spindle and draw the loose wool fibers out of the fiber bundle. Lay your loose fibers next to the end of the "leader". Twist the spindle. The leader should spin also. Twisting the spindle in the clockwise direction will give you a "Z" twist yarn. Twisting the spindle in the counter-clockwise direction will give you an "S" twist yarn. Either works, but be consistent. If you are not consistent, you will be unspinning your work. As you twist the spindle the loose fibers should be caught and twisted around the leader. Draw/Pull the fibers out of the fiber bundle. Watch them spin together. Let Go of the twisted fibers. Twist the spindle again. Some people chant: "Twist, Pull, Let Go." as they learn to spin using a drop spindle. When the yarn is long enough to make the spindle drag, untie the half hitch and wrap the spun yarn around the spindle next to the whorl. Re-tie the half hitch and spin your next length of yarn.

HAND SPINNING YARN

18

Hand spinning is the art of creating yarn (or thread) from fibers. A hand spinner creates yarn by twisting fibers together using tools such as drop spindles and spinning wheels. There are many different techniques and types of fiber used to produce a variety of yarns. Fortunately, hand spinning is a chosen art in the United States and no longer a way of life that would make one consider it a chore. However, there are still many older people in our communities that remember spinning yarn and weaving fabric as part of their daily lives. In other parts of the world hand spinning is still as important as it was for us in the 1700s. Women in nomadic cultures carry spindles with them every where they go and prepare yarn with every spare moment. Why would anyone choose to spin their own yarns today when there are thousands of yarn choices out there? For more choices of course! Since most hand spinners use their own yarn to knit, weave, etc., they have control of the entire process from raw material to final product! However, while beginners spin wonderful yarns, it takes a while to achieve this level of "designing" yarns. Fortunately, most spinners dont look at spinning as a "means to an end". They enjoy the process of spinning as well. The fibers are soft and full of character and the yarn winding on the bobbin is always unique. And treadling a spinning wheel is a rhythmic and relaxing process that becomes addictive! Since most of the fibers I use are naturally derived, I feel a connection to the world and the symbiotic relationship we must maintain with the earth. We have lost that connection with the industrialization of our country and the consequences are evident in some of the environmental and political decisions that are made by this country each day!

THE SPINNING OF COTTON INTO YARN

19

How the manufacturer turns the cotton into yarn ready for the weaver. This is called spinning. Perhaps there is some one in your class who has visited a spinning mill and can tell how cotton is cleaned and made ready for weaving. This is what the girls of the Sewing League of Pleasant Valley saw the day they went to visit the mill. The Camp Fire girls went the same day, and Miss Ashly, their guardian, said that what they learned would count as an honor. How cotton is prepared for spinning. The girls went to the lower floor where the cotton is received. They saw the bags and iron bands removed and the cotton pulled apart by a queer machine called a cotton opener, or bale breaker, for you remember the cotton was pressed very hard before being shipped. The cotton is then placed in pickers, or machines which blow it apart and blow out the leaves and dust and dirt. As the cotton leaves this machine, it looks like a big piece (6 ft. wide) of cotton batting rolled in a large roll. It looks soft and clean. Then the girls watched the men place this roll at the back of the next machine, called a carding machine. Here it was cleaned some more; and such a wonderful thing happened. As it left the machine instead of coming out as a lap of the roll of cotton like it went in, it came out in a long thick coil which looked like a rope, and there were tall round cans ready to receive this continuous line of cotton rope. How soft and beautiful it looked! What wonderful machines the manufacturer had. Some one must have made them. Then the girls visited ever so many machines which wound this cotton rope on spools. Each machine made the rope thinner and finer until it was drawn out as thin and round as the manufacturer wished. Barbara Oakes noticed this: that these spinning machines not only drew out the cotton rope and made it thinner, but put in a twist which prevented it from breaking so easily. Do you remember how the cotton fiber looked under the microscope? The twist in the fiber helps in the spinning. Isn't it wonderful to think that such tiny fibers can be made into spinning yarns, and yarns woven into cloth.

2.2 COMPANY PROFILE

20

INTRODUCTION:
SRI KARPAGAM MILLS INDIA PRIVATE LIMITED is a company incorporated under companies act 1956, on 25th January 2005 with authorized capital of Rs.2.5 crores. Later the Authorized Share Capital has been enhanced to 15 crores. The company will carry out main business of manufacturing of cotton yarn and any other type of yarn. In addition, the company is having windmill for power generation. The company at present is having 16,064 spindles capacity. The production capacity will be increased by adding another 12000 spindles of all new modern machineries form the coming month of June 2007 onwards. TIIC has sanctioned fresh machinery term loan of Rs.1750 lakhs for this purpose.

LOCATION:
The company is located at S.F.No.248/2B and 248/4 Udayampalayam, Chinnavedampatti Village, Coimbatore-641 006. It is only about 10km from the center of the city. The total area of the land available is around 6.67 acres. Water required for the process is only about 5000 litres per day including for human consumption which is available in the mill site itself. Secured and well maintained stay and canteen facility for campus labours from outside was established in the mill premises itself.

HISTORY OF EXISTING BUSINESS:

The promoters of this company has formed as partnership concern is the name and style of SRI KARPAGAM SPINNERS with a initial capacity of 1296 spindles in 1994 which started its commercial production from Jan 1995. This unit has growth and increased its spindleage capacity to 8000 spindles with modernization and replacement of machineries. For this purpose, the unit has availed a term loan from TIIC in the year 1997 for LMW Double Scutcher Blow room Machinery. The above was duly repaid and closed in 2004.

21

MERGER:
During the course of merger of the two partnership firms, first Sri Karpagam Textiles was taken over by Sri Karpagam Spinners as a going concern by execution of an instrument of business purchase agreement dated 11th March 2005 to take both assets and liabilities as such and finalized on 10th March 2005. After this takeover, Sri Karpagam Spinners with capacity of 16064 spindles was taken over with all assets and liabilities by the company Sri Karpagam Mills India Private Limited which was established on 25th January 2005 by execution of another instrument of business purchase agreement dated 1st day of April 2005. In respect of consideration of the takeover by the company, the promoters were allotted respective number of shares of Rs.10/- each to match with their capital outstanding in the preceding firm. After the above process of takeover both partnership firms were dissolved and dissolution recorded duly with register of firms, Coimbatore.

ABOUT THE PROMOTERS:

22

The

first

and

permanent

Directors

of

the

company

are

Mr.A.Krishnaswamy, Mr.A.Somasundaram, Mr.A.Shanmughasundaram and Mr.A.Sivamani, all are residing in Coimbatore. All the above are brothers and other major shareholders.

1. Mr. A. Krishnaswamy B.Sc., aged around 50 years, is having more than 25 years experience in steel trading business. He is looking after a partnership concern of Sri Karpagam Steels which is having dealing in MS Plates and Plate Cuttings. The above concern is also their family concern in which all promoters are partners. He is looking after the general administration of the company. 2. Mr. A. Somasundaram B.Sc., F.T.C. aged around 48 years, is having rich experience of 25 years in the field of textile spinning previously he was worked as a factory manager in Rajshree Spinning Mills Ltd. For more than 14 years. His functional responsibilities in the company are planning, production, maintenance and quality control. 3. Mr. A. Shanmughasundaram B.A., aged around 44 years, is having experience of around 17 years in the iron and steel trading business. He is looking after general administration of the company along with other directors. 4. Mr. A. Sivamani B.Sc., C.A. (Intermediate), A.T.A. aged around 42 years, is having rich experience in the field of textile activities around 12 years. Previously he was looking after the yarn manufacturing business of Sri Karpagam Spinners. His functional responsibilities in the above company are finance, accounts, yarn marketing, laisioning, personnel and General administration of the company.

PRODUCTION PROCESS
23

The production process of the company is illustrated by a flowchart as follows:

COTTON MIXING OUTPUT IS COTTON IN SMALL TUFT FROM

BLOW ROOM

Output Is Blow Room Lap

CARDING

Output Carding Silver

DRAW FRAME

Output Is Finisher Draw Frame Silver

SIMPLEX

Output is rove in bobbin

RING SPINNING
24

Output is yarn in cop

CONE WINDING PROCESS WHEN REQIRED TO SELL YARN IN CONE FORM

REELING PROCESS WHEN REQUIRED TO SELL YARN IN SINGLE OF PLAIN OR CROSS REEL

Output is in cone form

CHEESE WINDING WHEN DOUBLE YARN COUNT IS REQUIRED

Output is parallel winded yarn in cheese form

DOUBLING PROCESS

Output is doubled yarn cop

REELING WHEN REQUIRED IN HANK FROM OF PLAN REEL OR CROSS REEL

CONE WINDING PROCESS WHEN REQUIRED TO 25 SELLING CONE FORM

PRODUCTION: RAW MATERIAL:

The various types of Cotton such as Y-1, Jayanthyr, V 797, H4, J34, for 20s count Sankar 6, MUC5, LRA (for 40s count) are being procured directly and through various channels like cotton brokers, Traders, Cotton Corporation of India, etc. and are procured from various parts of Maharastra, Gujarat, Andhra Pradesh, Karnataka and Tamil Nadu. Cotton is also imported for price benefits and quality staples.

LABOUR:
Through modernization of machinery etc, has improved the production and quality, the always a factor to be depended upon. Since the labour force is available in plenty in and around the Coimbatore, the company does not face any problem in shortage of man power. Present Administration Skilled labour Unskilled labour 25 250 60 ------335 ------No. of Shifts No. of working days - 3 Shifts - 29 days/month Future Requirement 10 100 35 --------145 ---------

There is no statutory default by the company in any manner.

26

POWER:
The present Power requirement of the company is 800KVA. The sanctioned load was 850 KVA. In addition to the load by TNEB, stand by generators with capacity of 125 KVA, 225 KVA & 250 KVA are supporting the power requirement in case of power shutdown.

MARKETING:
The end product of these units viz, 30s count and 40s count are the raw material for various textile products in the industries of power loom, knitting, sizing, handlooms, etc. The brand Karpagam has its own demand in the market and well accepted among the end users. Hence the product has stabilized its market share is Karur, Bhavani, Tirupur, Komarapalayam, Tiruchungodu, Sangagiri, Salem and Erode. In addition NEW TIRUPUR which houses the 220 crore NETHAJI KNIT TIDEL PARK recently inaugurated by Finance Minister will add to the existing market facilities of KARPAGAM.

PROPOSED LIMIT:
The Company requires term loan of Rs.777 lakhs towards installation of Wind electric generator of 1.65 MW Capacity.

The Project Cost as follows: 1. Cost of One No. Vestas type V82/1650 Wind Electric Generator (WEG) as per Proforma Invoice 2. Infrastructure development charges and other statutory Charges payable to TNEB 3. Charges for Erection & Commissioning of one No.V82/1650 WEG Service tax & Surcharge on Erection charges Total 27

(Rs. In Lakhs) 1039.34 42.60 25.00 3.06 ___________ 1110.00 ___________

MEANS OF FINANCE:
1. PROMOTORS MARGIN (30%) 2. TERM LOAN SOUGHT FROM IREDA Total 333.00 777.00 1110.00

Note: Holiday period required for the above loan - 3 months Repayment period Interest rate requested - 11 years - 8.5% p.a.

Hence considering the growth of the mill in near future i.e. From May 2007 onwards, we are going to install 12,000 spindles additional capacity within a short span of 3 to 4 months additional requirements power is about 50 lakhs units per annum and the increasing power cost, installing of further wind electric generators of suitable capacity is a must.

CONCLUSION:
The proven track record of the company and its promoters vast experience will pave the way for the flourishing of company. It will be further strengthened by captive power generation.

28

CHAPTER III ANALYSIS AND INTERPRETATION

3.1 RATIO ANALYSIS INTRODUCTION:
Fundamental Analysis has a very broad scope. One aspect looks at the general (qualitative) factors of a company. The other side considers tangible and measurable factors (quantitative). This means crunching and analyzing numbers from the financial statements. If used in conjunction with other methods, quantitative analysis can produce excellent results.

Ratio analysis isn't just comparing different numbers from the balance sheet, income statement, and cash flow statement. It's comparing the number against previous years, other companies, the industry, or even the economy in general. Ratios look at the relationships between individual values and relate them to how a company has performed in the past, and might perform in the future.

MEANING OF RATIO:
A ratio is one figure express in terms of another figure. It is a mathematical yardstick that measures the relationship two figures, which are related to each other and mutually interdependent. Ratio is express by dividing one figure by the other related figure. Thus a ratio is an expression relating one number to another. It is simply the quotient of two numbers. It can be expressed as a fraction or as a decimal or as a pure ratio or in absolute figures as so many times. As accounting ratio is an expression relating two figures or accounts or two sets of account heads or group contain in the financial statements.

29

MEANING OF RATIO ANALYSIS: Ratio analysis is the method or process by which the relationship of items or group of items in the financial statement are computed, determined and presented.

Ratio analysis is an attempt to derive quantitative measure or guides concerning the financial health and profitability of business enterprises. Ratio analysis can be used both in trend and static analysis. There are several ratios at the disposal of an analyst but their group of ratio he would prefer depends on the purpose and the objective of analysis. Ratio analysis can provide valuable information about a company's financial health. A financial ratio measures a company's performance in a specific area.

ROLE OF RATIO ANALYSIS: It is true that the technique of ratio analysis is not a creative technique in the sense that it uses the same figure & information, which is already appearing in the financial statement. At the same time, it is true that what can be achieved by the technique of ratio analysis cannot be achieved by the mere preparation of financial statement. Ratio analysis helps to appraise the firm in terms of their profitability & efficiency of performance, either individually or in relation to those of other firms in the same industry. The process of this appraisal is not complete until the ratio so computed can be compared with something, as the ratio all by them do not mean anything. This comparison may be in the form of intra firm comparison, inter firm comparison or comparison with standard ratios. Thus proper comparison of ratios may reveal where a firm is placed as compared with earlier period or in comparison with the other firms in the same industry.

30

PURPOSE OF RATIO ANLYSIS:

1] To identify aspects of a businesses performance to aid decision making 2] Quantitative process may need to be supplemented by qualitative factors to get a complete picture. 3] 5 main areas: Liquidity the ability of the firm to pay its way Investment/shareholders information to enable decisions to be made on the extent of the risk and the earning potential of a business investment Gearing information on the relationship between the exposure of the business to loans as opposed to share capital Profitability how effective the firm is at generating profits given sales and or its capital assets Financial the rate at which the company sells its stock and the efficiency with which it uses its asset

31

CURRENT RATIO
Meaning: This ratio compares the current assets with the current liabilities. It is also known as working capital ratio or solvency ratio. It is expressed in the form of pure ratio. Formula: CURRENT ASSETS CURRENT LIABILITIES Current ratio measures the ability of the company to meet its current liability, i.e., current assets gets converted into cash in the operating cycle of the firm and provides the funds needed to pay for current liability. The higher the current ratio, the greater the short-term solvency. Recommended current ratio is 2: 1. Any ratio below indicates that the entity may face liquidity problem but also Ratio over 2: 1 as above indicates over trading, that is the entity is under utilizing its current assets. Note: 1. Current Assets consists of Sundry Debtors Loans and Advances Inventories 32

Cash & Bank Balances

Table 3.1[a]
Formula: CURRENT ASSETS CURRENT LIABILITIES

Year

Current Assets

Current Liabilities

Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

21399787.42 26814854.59 51816270.96 100596714.72 173250236.00

20313490.26 35374419.75 25931566.46 55746578.14 439963090.00

1.05 0.75 1.99 1.84 0.39

INTERPRETATION:
According to the rule of Thumb the standard ratio is 2:1. The ratio of the company is 1.05%, 0.75%, 1.99%, 1.84% and 0.39% respectively during the period 2004, 2005, 2006, 2007 and 2008 respectively. The ratio of the company is below than the accepted standard, so the companys current ratio was not in good position when compared to the period 2006-07. 33

Chart 3.1[a]

C UR R E NT R ATIO
2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 1.99 1.84

1.05 0.75 0.39

R AT IO

2003-04 2004-052005-06 2006-072007-08 Y E AR

34

LIQUID RATIO Meaning:

Liquid ratio is also known as acid test ratio or quick ratio. Liquid ratio compares the quick assets with the quick liabilities. It is expressed in the form of pure ratio. The term quick assets refer to current assets, which can be converted into, cash immediately or at a short notice without diminution of value.

Formula:
LIQUID ASSETS CURRENT LIABILITIES Liquid ratio indicates the extent to which a company can pay its current liabilities without relying on the sale of inventory. This is a fairly stringent measure of liquidity because it is based on those current assets, which are highly liquid. Inventories are excluded from the numerator of this ratio because they are deemed the least liquid component of current assets. Generally, a quick ratio of 1:1 is considered good. One drawback of the quick ratio is that it ignores the timing of receipts and payments. Note: 1. Liquid Assets consists of Sundry Debtors Loans and Advances Cash & Bank Balances

35

Table 3.1[b]

Formula:
LIQUID ASSETS CURRENT LIABILITIES Year Liquid Assets Current Liabilities Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

778536625.42 1784685.59 23199745.46 54215652.70 100470256.00

20313490.26 35374419.75 25931566.46 55746578.14 439963090.00

0.38 0.50 0.89 0.97 0.24

INTERPRETATION:
According to the rule of Thumb the standard ratio is 1:1. The above table indicates that quick ratio during the period 2004, 2005, 2006, 2007and 2008 is 0.38%, 0.50%, 0.89%, 0.97% and 0.24% respectively. The ratio is not equal to the rule of thumb. So the liquidity position of the company is not good.

36

Chart 3.1[b]

L IQUID R ATIO
1 0 .9 0 .8 0 .7 0 .6 0 .5 0 .4 0 .3 0 .2 0 .1 0 0.8 9 0.9 7

RATIO

0.5 0 .3 8 0.17

2 003 -0 42 00 4 -052 00 5-0 62 006-0 7 200 7-08 Y EAR

37

ABSOLUTE LIQUID RATIO

Meaning: This is also called as super quick ratio. This ratio considers only the absolute liquidity available with the firm. Formula: ABSOLUTE LIQUID ASSETS CURRENT LIABILITIES Since cash and bank balances and short term marketable securities are the most liquid assets of a firm, financial analysts look at the cash ratio. If the super liquid assets are too much in relation to the current liabilities then it may affect the profitability of the firm. Note: 1. Absolute Liquid Assets consists of Cash & Bank Balances

38

Table 3.1[c]

Formula: ABSOLUTE LIQUID ASSETS CURRENT LIABILITIES Year Absolute Liquid Assets Current Liabilities Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

62618.79 282977.34 772480.00 644671.35 2521598.00

20313490.26 35374419.75 25931566.46 55746578.14 439963090.00

3.08 7.99 0.02 0.01 0.005

INTERPRETATION:
According to the rule of Thumb the standard ratio is 1:2. The accepted standard was 0.5. During the period 2004, 2005 the ratio of the company is 3.08%, 7.99% respectively. But during the period 2006, 2007 and 2008 the ratio has decreased to 0.02%, 0.01% and 0.005% respectively. So the company does not have sufficient short term financial position.

Chart 3.1[c]
39

ABS OLUTE L IQUIDR ATIO

7.99 8 7 6 5 4 3 2 1 0
2003-04 2004-05

R ATIO

3.08

0.02
2005-06

0.01
2006-07

0.005
2007-08

Y E AR

INVENTORY TURNOVER RATIO

40

Meaning: It refers to the number of times the inventory is sold and replaced during the accounting period. It reflects the efficiency of inventory management. The higher the ratio, the more efficient is the management of inventories, and vice versa Formula: NET SALES AVERAGE INVENTORY AT COST Average Inventory at Cost = 2 However, a high inventory turnover may also result from a low level of inventory, which may lead to frequent stock outs and loss of sales and customer goodwill. For calculating ITR, the average of inventories at the beginning and the end of the year is taken. Note: Average Inventory at Cost consist of Opening Stock Closing Stock Opening Stock + Closing Stock

Table 3.1[d]

41

Formula: NET SALES AVERAGE INVENTORY AT COST

Year

Net Sales

Average Inventory At Cost

Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

44461429.00 75624679.05 178188777.00 218745260.00 221390640.00

13113736.50 11257115.50 16066044.00 34263627.50 50157818.00

3.33 6.71 11.09 6.23 4.41

INTERPRETATION:
The above table indicates that the inventory turnover ratio during the period 2004, 2005, 2006, 2007and 2008 is 3.33%, 6.71%, 11.09%, 6.23% and 4.41% respectively. The companys turnover keeps on changing. So, the inventory turnover ratio of the company was not static in nature.

Chart 3.1[d]

42

INVE NT OR Y TUR NOVERR AT IO

12 10 8 R AT IO 6 4 2 0 2003-042004-052005-062006-072007-08 Y E AR 3.33 6.71 6.23 4.41 11.09

DEBTORS TURNOVER RATIO

Meaning: It is calculated by dividing the net credit sales by average debtors outstanding during the year. It measures the liquidity of a firm's debts. Net credit sales are the gross credit sales minus 43

returns, if any, from customers. Average debtors are the average of debtors at the beginning and at the end of the year. This ratio shows how rapidly debts are collected. The higher the debtors turnover ratio the better it is for the organization.

Formula: TOTAL SALES DEBTORS

Table 3.1[e]

Formula: TOTAL SALES 44

DEBTORS

Year

Total Sales

Debtors

Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

44461429.00 75624679.05 178188777.00 218745260.00 221390640.00

4386464.03 9967519.00 9382894.93 31710364.09 32134846.00

10.13 7.58 18.99 6.74 6.66

INTERPRETATION:
The above table indicates that the debtors turnover ratio during the period 2003-04, 2004-05, and 2005-06 is 10.13%, 7.58%, and 18.99%, respectively. But during the period 200607 and 2007-08 it is decreased to 6.74% and 6.66% respectively. So, the companys debt collection period is good.

Chart 3.1[e]

45

D E B TOR STUR NOVERR ATIO

20 18 16 14 18.99

R ATIO

12 10 8 6 4 2 0

10.13 7.58 6.74 6.88

2003-04 2004-05 2005-06 2006-07 2007-08

YEAR

DEBT EQUITY RATIO

MEANING:

46

This ratio compares the long-term debts with shareholders fund. The relationship between borrowed funds & owners capital is a popular measure of the long term financial solvency of a firm. This relationship is shown by debt equity ratio. Alternatively, this ratio indicates the relative proportion of debt & equity in financing the assets of the firm. It is usually expressed as a pure ratio. Formula: OUTSIDERS FUND SHARE HOLDERS FUND Debt equity ratio is also called as leverage ratio. Leverage means the process of the increasing the equity shareholders return through the use of debt. Leverage is also known as gearing or trading on equity. Debt equity ratio shows the margin of safety for long-term creditors & the balance between debt & equity. Note: 1. Outsiders fund consist of Loan 2. Shareholders fund consist of Owners Capital Reserves and surplus

Table 3.1[f]

Formula: 47

OUTSIDERS FUND SHARE HOLDERS FUND

Year

Outsiders Fund

Share Holders Fund

Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

30785660.69 55308268.94 101288713.10 147334799.30 344477995.00

847246.94 1178332.00 57418466.57 82604574.56 351377321.00

36.33 46.93 1.76 1.78 0.98

INTERPRETATION:
As a general rule, there must be an approximate mix of outsiders and shareholder fund. The above table indicates the debt equity ratio during the period 2003-04, 2004-05, 2005-06 and 2006-07 is 36.33%, 46.93%, 1.76% and 1.78% respectively. So, here there is a high debt equity ratio. It indicates there was greater outsiders fund than owners or share holders fund. But in the period 2008 it has been reduced to 0.98%. So, the debt of the company will be reduced in the future years.

Chart 3.1[f]

48

DEBT EQUITY R ATIO

50 40 RATIO 30 20 10 0 1.76 1.78 0.98 36.33 46.93

2003-04 2004-05 2005-06 2006-07 2007-08

Y EAR

FIXED ASSETS TURNOVER RATIO

Meaning:

49

This ratio measures the efficiency with which fixed assets are employed. A high ratio indicates a high degree of efficiency in asset utilization while a low ratio reflects an inefficient use of assets. Formula: FIXED ASSETS SHARE HOLDERS FUND However, this ratio should be used with caution because when the fixed assets of a firm are old and substantially depreciated, the fixed assets turnover ratio tends to be high (because the denominator of the ratio is very low). Note: 1. Shareholders fund consist of Owners Capital Reserves and surplus

Table 3.1[g]

Formula: 50

FIXED ASSETS SHARE HOLDERS FUND Year Fixed Assets Share Holders Fund Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

8868504.11 29671746.95 106890908.68 127329885.62 260497305.00

847246.94 1178332.00 57418466.57 82604574.56 351377321.00

10.46 25.18 1.86 1.54 0.74

INTERPRETATION:
The ratio less than 100% implies that owners fund is more than fixed assets. It implies that the owners fund is not sufficient to finance fixed assets. The ratio 60-65% is satisfactory. So, here the company does not have sufficient fund to finance fixed assets.

Chart 3.1[g]

51

F IX E DAS S E TSTUR NOVERR ATIO

30 25 20 R AT IO 15 10 5 0 1.86 1.54 0.74 10.46 25.18

2003-042004-052005-062006-072007-08 Y E AR

WORKING CAPITAL TURNOVER RATIO

Meaning: The working capital turnover ratio is also referred to as net sales to working capital. It indicates a companys effectiveness in using its working capital. The working capital turnover ratio is calculated as follows: net annual sales divided by the average amount of 52

working capital during the same 12 month period. As with most financial ratios, should compare the working capital turnover ratio to other companies in the same industry and to the same companys past and planned working capital turnover ratio. Formula: COST OF SALES NET WORKING CAPITAL It indicates the composition & quality of the working capital. This ratio also helps to study the solvency of a concern. It is a qualitative test of solvency. It shows the extent of funds blocked in stock. If investment in stock is higher it means that the amount of liquid assets is lower. Note: 1. Working capital consist of Current assets Current liabilities

Table 3.1[h]

Formula: COST OF SALES NET WORKING CAPITAL

53

Year

Cost Of Sales

Net Working Capital

Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

44461429.00 75624679.05 178188777.00 218745260.00 221390640.00

1086297.16 8559565.16 25884704.50 46861910.06 124341783.00

40.92 8.83 6.88 4.56 1.78

INTERPRETATION:
The above table indicates that the working capital turnover ratio during the period 2004, 2005, 2006, 2007and 2008 is 40.92%, 8.83%, 6.88%, 4.56% and 1.78% is respectively. So, here the ratio is not too low or too high. So the company has utilized their working capital properly.

Chart 3.1[h]

54

W OR K ING C AP ITALTUR NOVE RR ATIO

45 40 35 30 25 20 15 10 5 0 8.83 6.88 4.56 40.92

R ATIO

1.78

2003-042004-05 2005-062006-072007-0 8 Y EAR

GROSS PROFIT RATIO

Meaning:

55

This ratio measures the relationship between gross profit and sales. It is defined as the excess of the net sales over cost of goods sold or excess of revenue over cost. This ratio shows the profit that remains after the manufacturing costs have been met. Formula: GROSS PROFIT NET SALES It measures the efficiency of production as well as pricing. This ratio helps to judge how efficient the concern is managing its production, purchase, selling & inventory, how good its control is over the direct cost, how productive the concern , how much amount is left to meet other expenses & earn net profit. X 100

Table 3.1[i]

56

Formula: GROSS PROFIT NET SALES X 100

Year

Gross Profit

Net Sales

Ratio

2003-04 2004-05 2005-06 2006-07 2007-08

4726664.17 4688193.46 10828369.17 248094630.50 42955066.60

44461429.00 75624679.05 178188777.00 218745260.00 221390640.00

10.63 10.54 14.31 13.40 19.40

INTERPRETATION:
The above table indicates that the gross profit ratio during the period 2004, 2005, 2006, 2007and 2008 is 10.63%, 10.54%, 14.31%, 13.4%, and 19.40% respectively. A higher gross profit ratio indicates a better result in the company. So here the gross profit ratio for the period 2008 is higher when compared to the previous year 2007. So the company is running in a good condition.

Chart 3.1[i]

57

GR OS SPR OF ITR AT IO
20 18 16 14.31 13.4 14 12 10.63 10.54 10 8 6 4 2 0 19.4

R ATIO

2003-04 200 4-05 2005-06 20 06-07 200 7-08

YEAR

NET PROFIT RATIO

Meaning:

58

Net Profit ratio indicates the relationship between the net profit & the sales it is usually expressed in the form of a percentage. This ratio shows the net earnings (to be distributed to both equity and preference shareholders) as a percentage of net sales. Formula: NET PROFIT NET SALES It measures the overall efficiency of production, administration, selling, financing, pricing and tax management. Jointly considered, the gross and net profit margin ratios provide an understanding of the cost and profit structure of a firm. X 100

Table 3.1[j]

59

Formula: NET PROFIT NET SALES Year Net Profit Net Sales Ratio X 100

2003-04 2004-05 2005-06 2006-07 2007-08

-930250.97 1228818.32 9105950.57 19007950.56 28780697.00

44461429.00 75624679.05 178188777.00 218745260.00 221390640.00

-2.09 1.62 5.11 8.68 12.99

INTERPRETATION:
The above table indicates the net profit ratio for the period 2004, 2005, 2006, 2007and 2008 is -2.09% 1.62%, 5.11%, 8.68% and 12.99% respectively. In the 2004 there is a loss. But the company has slowly increased their profit in these years.

Chart 3.1[j]

60

NET PROF IT RATIO

14 12 10 8 R ATIO 6 4 2 0 -2 -4 2003-04 2004-05 2005-06 2006-07 2007-08 Y EAR -2.09 1.62 5.11 8.68 12.99

3.4 COST OF CAPITAL

The cost of capital is a central concept in financial management. It is used for evaluating investment projects, for determining the capital structure, for assessing leasing proposal, for setting the rates. The company cost of capital is the rate of return expected by the existing capital providers. 61

In business and finance, the cost of capital is the cost of obtaining funds for, or, conversely, the required return necessary to meet its cost of financing a capital budgeting project. Said another way, it is "the minimum return that a company should make on its own investments, to earn the cash flow out of which investors can be paid their return." Cost of capital encompasses the two fundamental sources of financing: the cost of debt (including bonds and loans) and the cost of equity. Capital (money) used for funding a business should earn returns for the capital providers who risk their capital. For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital. In other words, the risk-adjusted return on capital (that is, incorporating not just the projected returns, but the probabilities of those projections) must be higher than the cost of capital. The cost of debt is relatively simple to calculate, as it is composed of the rate of interest paid. In practice, the interest-rate paid by the company will include the risk-free rate plus a risk component (risk premium), which itself incorporates a probable rate of default (and amount of recovery given default). For companies with similar risk or credit ratings, the interest rate is largely exogenous. The cost of equity is more challenging to calculate as equity does not pay a set return to its investors. Similar to the cost of debt, the cost of equity is broadly defined as the riskweighted projected return required by investors, where the return is largely unknown. The cost of equity is therefore inferred by comparing the investment.

EQUITY FINANCING
If you decide to accept investments from family and friends, you will be using a form of financing called equity financing. The cost of equity or the return required by equity shareholders is the same in both the cases. 62

Formula: Cost of equity = Earnings per Share Book value Advantages of Equity Financing:

You can use your cash and that of your investors when you start up your business for all the start-up costs, instead of making large loan payments to banks or other organizations or individuals. You can get underway without the burden of debt on your back.

If you have prepared a prospectus for your investors and explained to them that their money is at risk in your brand new start-up business, they will understand that if your business fails, they will not get their money back.

Depending on who your investors are, they may offer valuable business assistance that you may not have. This can be important, especially in the early days of a new firm.

Disadvantages of Equity Financing: Remember that your investors will actually own a piece of your business; how large that piece is depends on how much money they invest. Investors do expect a share of the profits where, if you obtain debt financing, banks or individuals only expect their loans repaid Since your investors own a piece of your business, you are expected to act in their best interests as well as your own, or you could open yourself up to a lawsuit. In some cases, if you make your firms securities available to just a few investors.

Table 3.4(a) COST OF EQUITY

63

Cost of equity =

Earnings per Share Book value

Year

Earnings Per Share

Book Value

Cost of Equity

2003-04 2004-05 2005-06 2006-07 2007-08 INTERPRETATION:

-0.18 0.24 2.57 2.79 3.09

0.16 0.16 16.20 23.30 26.60

-1.12 1.50 0.16 0.12 0.12

The above table shows that the cost of equity of -1.12 in 2003-04 had increased to 1.50 in the year 2004-05 and in the year 2007-08 it has been reduced to 0.12.

COST OF DEBT
Debt may be issued at par, at premium or discount. It may be perpetual or redeemable. "Debt" involves borrowing money to be repaid, plus interest. Formula: 64

Cost of Debt = Debt

financial charges (1- T)

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 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

65

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.

Table 3.4(b) COST OF DEBT

Cost of Debt = Debt

Financial charges

(1- T)

66

Year

Financial charges

Debt

(1- tax)

Cost of debt

2003-04 2004-05 2005-06 2006-07 2007-08

1784935.17 2679202.87 8042473.28 9964831.59 15417792.00

10472170.43 19933849.19 75357146.00 91588221.14 295569542.00

0.63 0.91 0.89 0.89

0.17 0.082 0.091 0.089 0.045

INTERPRETATION: The above table shows that the cost of debt had been increasing during the 5 years period of study. That is in the year 2003-04 the firm does not paid tax due to loss. And during the period 2005-06 the debt has been increased to 0.091 and had been decreased to 0.045 in the year 2007-08.

3.5 WEIGHTED AVERAGE COST OF CAPITAL

The Weighted Average Cost of Capital (WACC) is used in finance to measure a firm's cost of capital. The total capital for a firm is the value of its equity (for a firm without outstanding warrants and options, this is the same as the company's market capitalization) plus the cost of its debt (the cost of debt should be continually updated as the cost of debt changes as a result of interest rate changes). Notice that the "equity" in the debt to equity ratio is the market value of all equity, not the shareholders' equity on the balance sheet. To calculate the firms weighted cost of 67

capital, we must first calculate the costs of the individual financing sources: Cost of Debt Cost of Preference Capital Cost of Equity Capital Calculation of WACC is an iterative procedure which requires estimation of the fair market value of equity capital The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. WACC is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Companies raise money from a number of sources: common equity, preferred equity, straight debt, convertible debt, exchangeable debt, warrants, options, pension liabilities, executive stock options, governmental subsidies, and so on. Different securities are expected to generate different returns. WACC is calculated taking into account the relative weights of each component of the capital structure and is used to see if the investment is worthwhile to undertake.

Table 3.5(a)
Year 2003-04 Proportion Cost 0.07 -1.12 0.93 0.17 1.00 -0.95

Sources Cost of Equity Cost of Debt Total

Amount 800000.00 10472170.43 11272170.43

Weight -0.0784 0.1564 0.078

Overall cost of capital = 0.078* 100 68

= 7.8

INTERPRETATION:
The analysis shows that during 2004, the cost of capital was 7.8% among the various cost of capital, cost of debt is high.

Table 3.5(b)

Sources Cost of Equity Cost of Debt Total

Amount 800000.00 19933849.19 20733849.19

Year 2004-05 Proportion Cost 0.04 1.50 0.96 0.08 1.00 1.58

Weight 0.06 0.08 0.14

Overall cost of capital = 0.14* 100 = 14 69

INTERPRETATION:
The analysis shows that during 2004-05, the cost of capital was 14% among the various cost of capital, cost of debt is high.

Table 3.5(c)

Sources Cost of Equity Cost of Debt Total

Amount 57418466.57 75357146.00 132775612.60

Year 2005-06 Proportion Cost 0.43 0.16 0.57 0.09 1.00 0.25

Weight 0.07 0.05 0.12

Overall cost of capital = 0.12* 100 = 12

INTERPRETATION:
70

The analysis shows that during 2005-06, the cost of capital was 12% among the various cost of capital, cost of equity is high.

Table 3.5(d)

Sources Cost of Equity Cost of Debt Total

Amount 82604574.56 91588221.14 17492795.70

Year 2006-07 Proportion Cost 0.47 0.12 0.53 0.08 1.00 0.20

Weight 0.06 0.04 0.10

Overall cost of capital = 0.10* 100 = 10

INTERPRETATION:
71

The analysis shows that during 2004, the cost of capital was 10% among the various cost of capital, cost of equity is high.

Table 3.5(e)

Sources Cost of Equity Cost of Debt Total

Amount 92377321.00 295569542.00 387946863.00

Year 2007-08 Proportion Cost 0.24 0.12 0.76 0.04 1.00 0.16

Weight 0.03 0.03 0.06

Overall cost of capital = 0.06* 100 =6

INTERPRETATION:
The analysis shows that during 2007-08, the cost of capital was 6% among the various cost of capital, cost of debt and cost of equity both are equal. 72

3.6 Correlation
Several sets of (x, y) points, with the correlation coefficient of x and y for each set. Note that the correlation reflects the noisiness and direction of a linear relationship (top row), but not the slope of that relationship (middle), nor many aspects of nonlinear relationships (bottom). N.B.: the figure in the center has a slope of 0 but in that case the correlation coefficient is undefined because the variance of Y is zero. Formula: Correlation (r) = XY (X-Y) X-(X) Y-(Y) In statistics, correlation (often measured as a correlation coefficient, ) indicates the strength and direction of a linear relationship between two random variables. That is in contrast with the usage of the term in colloquial speech, which denotes any relationship, not necessarily linear. In general statistical usage, correlation refers to the departure of two random variables from independence. In this broad sense there are several coefficients, measuring the degree of correlation, adapted to the nature of the data. Techniques in Determining Correlation There are several different correlation techniques. The Survey System's optional Statistics Module includes the most common type, called the Pearson or product-moment correlation. The module also includes a variation on this type called partial correlation. The latter is useful when you want to look at the relationship between two variables while removing the effect of one or two other variables.

73

Like all statistical techniques, correlation is only appropriate for certain kinds of data. Correlation works for quantifiable data in which numbers are meaningful, usually quantities of some sort. It cannot be used for purely categorical data, such as gender, brands purchased, or favorite color.

Table 3.6(a)
The following table presents the data relating to cost of equity and earnings per share:

Correlation (r) =

Year

Cost of equity (x)

Earnings per Share (y)

XY

2003-04 2004-05 2005-06 2006-07 2007-08

-1.12 1.50 0.16 0.12 0.12 Total

-0.18 0.24 2.57 2.79 3.09

0.202 0.360 0.411 0.335 0.371 1.679

1.254 2.250 0.026 0.014 0.014 3.558 24.0271 0.0324 0.0576 6.6049 7.7841 9.5481

0.0406 0.1296 0.1717 0.1089 0.1336

0.5846

r = 1.679/ r = 2.19

INTERPRETATION:
74

The correlations mentioned between two variables are +2.19. So, there is a high positive correlation between two variables cost of equity and earnings per share.

Table 3.6(b)
The following table presents the data relating to cost of Debt and earnings per share:

Year

Cost of Debt (x)

Earnings per Share (y)

XY

0.00088 2003-04 2004-05 2005-06 2006-07 2007-08 0.17 0.082 0.091 0.089 0.082 -0.18 0.24 2.57 2.79 3.09 -0.0306 0.0196 8 0.2338 7 0.2483 1 0.2533 8 0.0289 0.00672 0.00828 0.00792 0.00672 0.0324 0.0576 6.6049 7.7841 9.5481 4 0.00013 2 0.00193 7 0.00196 7 0.00170 4 0.05855 24.0271 0.006624

Total

0.75524

r = 0.75524/ 75

r = 9.28

INTERPRETATION:
The correlations mentioned between two variables are +9.28. So, there is a high positive correlation between two variables cost of debt and earnings per share.

CHAPTER IV 4.1 FINDINGS

RATIO ANALYSIS
Current Ratio of the company was not satisfactory when compared to the previous years.

Absolute liquid Ratio of the company does not have sufficient short term financial position.

The inventory turnover ratio of the company was not static in nature. So, it may increase or decrease.

The Debtors turnover ratio had decreased in the year 2007-08. So, the company had collected their debt amount within a short period of time.

Outsiders fund had been reduced in the year 2007-08 when compared to the previous years. So the debt had been reduced slowly.

The gross profit of the company also increased when compared to previous years. 76

The net profit ratio of the company has been increasing slowly.

COST OF CAPITAL
The cost of equity had been reduced in the year 2007-08.

The cost of debt had been reduced to 0.045 in the year 2007-08.

WEIGHTED AVERAGE COST OF CAPITAL

Among the various cost of capital cost of debt is high during the period 2003-04, 2004-05 and during the period 2005-06, 2006-07 cost of Equity is high and in the period 2007-08 cost of equity and cost of debt are equal.

CORRELATION
There is a positive correlation between the two variables cost of equity and earnings per share. There is a positive correlation between the two variables cost of debt and earnings per share.

77

4.2 SUGGESTIONS
The liquidity position of the company has to be increased to meet their current obligations. Even though the company has outsiders fund to reduce their risk. The owners fund also needed to finance fixed asset. So, the owners or shareholders of the company has to concentrate in their investment and have to increase their capital. The short term financial position of the company has not been satisfied in the existing level. So, the company has to take necessary steps to improve their financial position. In the year 2007-08 the companys equity and debt both are equal. So, the company has to increase their equity capital and reduce their debt to improve the overall performance of the company.

78

4.3 CONCLUSION
The study reveals the capital structure of the company for the past 5 years starting from 2003-04 to 2007-08. The study will enable the company to plan for its future capital requirements. From the study, it is concluded that the capital structure of the company was satisfactory and debt of the company must be reduced for improving the company. The company must maintain good liquidity position to improve their profit. So, I conclude that the companys capital structure was fine even though there is an improvement in equity to achieve better position and also the share holders of the company must concentrate on their capital investment. So that the company should can concentrate in deviated areas in the future.

79

BIBILIOGRAPHY
1. SHARMA R.K., SHASHI GUPTA A.K., Management Accounting principles and practice, kalyani publisher, Seventh Revised Edition. 2. KHAN M.Y. AND JAIN P.K., Financial Management, New Delhi, Tata Mc Graw Hill Publishing Company Ltd., Second Edition. 3. PANDEY I.M., Financial Management, Vikas Publishing House Pvt. Ltd., Seventh Revised Edition. 4. www.Textile industries.com 5. www. Investopedia. Com 6. www. Wikipedia.com

80