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A study on Capital Structure, EBIT-EPS analysis

In
NCL Industries Ltd. at Hyderabad

T. SUNITHA
098060143

Project submitted in partial fulfillment for the award of the


Degree of MASTER OF BUSINESS ADMINISTRATION
By
Osmania University, Hyderabad-500007

DECLARATION

I hereby declare that this project report titled CAPITAL


STRUCTURE EBIT-EPS ANALYSIS IN N.C.L INDUSTRIES
LTD. Submitted

by

me

to

the Department

of

Business

Management, O.U., Hyderabad, is a bonafide work undertaken


by me and it is not submitted to any other University or Institution
for the award of any degree/ diploma/ certificate or published any
time before.

Name and Address of the Student


of the Student
T.SUNITHA
H.NO:4-9-281,
sunitha
R.T.C. SUPERVISORS COLONY,
HAYATHNAGAR,
HYDERABAD 501505.

Signature
T.

Table of contents
CONTENT :
i.
Company Certificate
ii.
Organisation Certificate
iii.
Acknowledgement
iv.
Declaration

PAGE NUMBERS
(i)
(ii)
(iii)
(iv)

List of Tables

(i)

List of figures

(ii)

1. INTRODUCTION
2. REVIEW OF LITERATURE
3. THE COMPANY
4. COMPANY PROFILE
5. DATA ANALYSIS & PRESENTATION
Presentation and Analysis
Interpretations
6. SUMMARI & CONCLUSIONS
7. BIBLIOGRAPHY

01
2&3
06
19
04
04
47
68
73

8. APPENDICES
Appendix A Organisational structure of Bloggs Ltd
Appendix B -

ACKNOWLEDGEMENT
3

I take this opportunity to express my deep & sincere gratitude to the


management of NCL Industries Ltd. for their gesture of allowing me to
undertake this project & its various employees who lent their hand towards
the completion of this study. The cooperation I received from the wide
cross-section of employees of NCL Industries Ltd. makes it difficult to style
out individuals for acknowledgement.
However, I am particularly indebted to SATYANARAYANA &
ASSOCITATES

(CHARTERTED

ACCOUNTANTS),

UMARANI

(H.O.D), VISHWANATH, ASST. PROFESSOR, FINANCE, for allowing me


to carry out my project work in the organization and appraising by
helping me to complete this project work.

I sincerely acknowledge all the people mentioned above, without whose


cooperation, I couldn't have completed my project successfully.

NAME
T.Sunitha

INTRODUCTION:
4

CAPITAL STRUCTURE DEFINED:


The assets of a company can be financed either by increasing the
owners claim or the creditors claim. The owners claims increase when the
form raises funds by issuing ordinary shares or by retaining the earnings, the
creditors claims increase by borrowing .The various means of financing
represents the financial structure of an enterprise .The financial structure of
an enterprise is shown by the left hand side (liabilities plus equity) of the
balance sheet. Traditionally, short-term borrowings are excluded from the list
of methods of financing the firms capital expenditure, and therefore, the long
term claims are said to form the capital structure of the enterprise .The capital
structure is used to represent the proportionate relationship between debt and
equity .Equity includes paid-up share capital, share premium and reserves and
surplus.

The financing or capital structure decision is a significant managerial


decision .It influences the shareholders returns and risk consequently; the
market value of share may be affected by the capital structure decision. The
company will have to plan its capital structure initially at the time of its
promotion.

NEED AND IMPORTANCE OF CAPITAL STRUCTURE:

The value of the firm depends upon its expected earnings stream and
the rate used to discount this stream. The rate used to discount earnings stream
its the firms required rate of return or the cost of capital. Thus, the capital
structure decision can affect the value of the firm either by changing the
expected earnings of the firm, but it can affect the reside earnings of the
shareholders. The effect of leverage on the cost of capital is not very clear.
Conflicting opinions have been expressed on this issue. In fact, this issue is
one of the most continuous areas in the theory of finance, and perhaps more
theoretical and empirical work has been done on this subject than any other.
If leverage affects the cost of capital and the value of the firm, an
optimum capital structure would be obtained at that combination of debt and
equity that maximizes the total value of the firm or minimizes the weighted
average cost of capital. The question of the existence of optimum use of
leverage has been put very succinctly by Ezra Solomon in the following
words.

Given that a firm has certain structure of assets, which offers net
operating earnings of given size and quality, and given a certain structure of
rates in the capital markets, is there some specific degree of financial leverage
at which the market value of the firms securities will be higher than at other
degrees of leverage?
The existence of an optimum capital structure is not accepted by all.
These exist two extreme views and middle position. David Durand identified
the two extreme views the net income and net operating approaches.

OBJECTIVES:
The project is an attempt to seek an insight into the aspects that are
involved in the capital structuring and financial decisions of the company. This
project endeavors to achieve the following objectives.

To Study the capital structure of NCL through EBIT-EPS analysis

Study effectiveness of financing decision on EPS and EBIT of the firm.

Examining leverage analysis of NCL Ind. LTD.

Examining the financing trends in the NCL Industries LTD. for the period
of 2001-06.

Study debt/equity ratio of NCL Ind. Ltd for 2001-06.

SCOPE:
A study of the capital structure involves an examination of long term as
well as short term sources that a company taps in order to meet its
requirements of finance. The scope of the study is confined to the sources that
NCL Ind. LTD tapped over the years under study i.e. 2001-06

RESEARCH METHODOLOGY AND DATA ANALYSIS


Data relating to NCL Ind. Ltd. has been collected through
SECONDARY SOURCES:

Published annual reports of the company for the year 2001-06.


PRIMARY SOURCES:

Detailed discussions with Mr. K.R.Naidu (Vice-President).

Discussions with the Finance manager Mr. Arun Kumar, and other
members of the Finance department.
DATA ANALYSIS
The collected data has been processed using the tools of

Ratio analysis

Graphical analysis

Year-year analysis
These tools access in the interpretation and understanding of the Existing
scenario of the Capital Structure.

LIMITATION OF EPS AS A FINANCING-DECISION CRITERION


EPS is one of the mostly widely used measures of the
companys performance in practice. As a result of this, in choosing between
debt and equity in practice, sometimes too much attention is paid on EPS,
which however, has serious limitations as a financing-decision criterion.
The major short coming of the EPS as a financing-decision
criterion is that it does not consider risk; it ignores variability about the
expected value of EPS. The belief that investors would be just concerned with
the expected EPS is not well founded. Investors in valuing the shares of the
company consider both expected value and variability.

CEMENT INDUSTRY
INTRODUCTION
Cement is a key infrastructure industry. It has been decontrolled
from price and distribution n 1st March 1989 and delicensed on 25 th July
1991. However, the performance of the industry and prices of cement are
monitored regularly. The constraints faced by the industry are reviewed
in the Infrastructure coordination committee meetings held in the cabinet
secretariat under the chairmanship of secretary (coordination).

Its

performance is also reviewed by the cabinet committee n infrastructure.


CAPACITY AND PRODUCTION
India is the second largest producer of cement in the world after china.
The cement Industry comprises of 128 large cement plants with an
installed capacity of 148.28 million tones and more than 300 mini cement
plant with an estimated capacity of 11.10 million tones per annum. The
cement corporation of India, which is central public sector undertaking,
has 10 units. There are 10 large cement plants owned by various state
Governments. The total installed capacity in the country as a whole is
159.38 million tones. Actual cement production in 2002-03 was 116.35
million tones as against a production of 106.90 million tones in 2001-02,
registering a growth rate of 8.84%.
Keeping in view the trend of growth of the industry in previous
years, a production Target of 126 million tones has fixed for the year
2003-04. During the period April-June 2003, a production (provisional)
was 31.30 million tones. The industry has achieved a growth rate of 4.86
per cent during this period.

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EXPORTS
Apart from meeting the entire domestic demand, the industry is
also exporting cement and clinker. The export of cement during 2001-02
and 2003-04 was 5.14 million tones and 6.92 million tones respectively.
Export during April-May, 2003 was 1.35 million tones. Major exporters
were Gujarat Ambuja Cements Ltd. and L&T Ltd.
RECOMMENDATIONS ON CEMENT INDUSTRY
For the development of the cement industry Working Group on
cement Industry was constituted by the planning commission for the
formulation of X Five Year Plan. The working Group has projected a
growth rate of 10% for the cement industry during the plan period and has
projected creation of additional capacity of 40-62 million tones mainly
through expansion of existing plants. The working Group has identified
following thrust areas for improving demand for cement;

Further push to housing development programmes;

Promotion of concrete Highways and roads; and

Use of ready-mix concrete in large infrastructure project.


Further, in order to improve global competitiveness of the Indian Cement
Industry, the Department of Industrial policy & promotion commissioned
a study on the global competitiveness of the Indian industry through an
organization of international repute, viz. KPMG Consultancy Pvt. Ltd.
The

report

submitted

recommendations for

by

the

organization

has

made

several

making the Indian Cement Industry more

competitive in the international market. The recommendations are under


consideration.

11

TECHNOLOICAL CHANGE
Cement industry has made tremendous strides in technological up
gradation and assimilation of latest technology. At present ninety three per
cent of the total capacity in the industry is based on modern and
environment-friendly dry process technology and only seven per cent of
the capacity is based on old wet and semi-dry process technology. There
is tremendous scope for waste heat recovery in cement plants and thereby
reduction in emission level. One project for co-generation of power
utilizing waste heat in an Indian cement plant is being implemented with
Japanese assistance under Green Aid Plan. The induction of advanced
technology has helped the industry immensely to conserve energy and
fuel and to save materials substantially. Indian is also producing different
varieties of cement like Ordinary Portland Cement (OPC), Portland
Pozzolana Cement (PPC), Portland Blast Furnace Slag Cement (PBFS),
Oil Well Cement, Rapid Hardening Portland Cement, Sulphate Resisting
Portland Cement, White Cement etc. Production of these varieties of
cement conform to the BIS Specifications. It is worth mentioning that
some cement plants have set up dedicated jetties for promoting bulk
transportation and export.

12

THE CAPITAL STRUCTURE CONTROVERSY:

The value of the firm depends upon its expected earnings stream and
the rate used to discount this stream. The rate used to discount earnings stream
its the firms required rate of return or the cost of capital. Thus, the capital
structure decision can affect the value of the firm either by changing the
expected earnings of the firm, but it can affect the reside earnings of the
shareholders. The effect of leverage on the cost of capital is not very clear.
Conflicting opinions have been expressed on this issue. In fact, this issue is
one of the most continuous areas in the theory of finance, and perhaps more
theoretical and empirical work has been done on this subject than any other.
If leverage affects the cost of capital and the value of the firm, an
optimum capital structure would be obtained at that combination of debt and
equity that maximizes the total value of the firm or minimizes the weighted
average cost of capital. The question of the existence of optimum use of
leverage has been put very succinctly by Ezra Solomon in the following
words.

Given that a firm has certain structure of assets, which offers net
operating earnings of given size and quality, and given a certain structure of
rates in the capital markets, is there some specific degree of financial leverage
at which the market value of the firms securities will be higher than at other
degrees of leverage?
The existence of an optimum capital structure is not accepted by all.
These exist two extreme views and middle position. David Durand identified
the two extreme views the net income and net operating approaches.

13

1.NET INCOME APPROACH:


Under the net income approach (NI), the cost of debt and cost of equity
are assumed to be independent to the capital structure. The weighted average
cost of capital declines and the total value of the firm rise with increased use
of leverage.
2. NET OPERATING INCOME APPROACH:
Under the net operating income (NOI) approach, the cost of equity is
assumed to increase linearly with average. As a result, the weighted average
cost of capital remains constant and the total value of the firm also remains
constant as leverage is changed.
3. TRADITIONAL APPROACH:
According to this approach, the cost of capital declines and the
value of the firm increases with leverage up to a prudent debt level and after
reaching the optimum point, coverage cause the cost of capital to increase and
the value of the firm to decline.
Thus, if NI approach is valid, leverage is significant variable and
financing decisions have an important effect on the value of the firm. On the
other hand, if the NOI approach is correct then the financing decisions should
not be a great concern to the financing manager, as it does not matter in the
valuation of the firm.

Modigliani and Miller (MM) support the NOI approach by


providing logically consistent behavioral justifications in its favor. They deny
the existence of an optimum capital structure between the two extreme views;
we have the middle position or intermediate version advocated by the
traditional writers. Thus these exists an optimum capital structure at which the
cost of capital is minimum. The logic of this view is not very sound. The MM
position changes when corporate taxes are assumed. The interest tax shield

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resulting from the use of debt adds to the value of the firm. This advantage
reduces the when personal income taxes are considered.
CAPITAL STRUCTURE MATTERS: THE NET INCOME APPROACH:

The essence of the net income (NI) approach is that the firm can increase
its value or lower the overall cost of capital by increasing the proportion of
debt in the capital structure. The crucial assumptions of this approach are:
1)

The use of debt does not change the risk perception of investors; as a
result, the equity capitalization rate, kc and the debt capitalization rate, kd,
remain constant with changes in leverage.

2)

The debt capitalization rate is less than the equity capitalization rate
(i.e. kd<ke)

3)

The corporate income taxes do not exist.


The first assumption implies that, if k e and kd are constant increased use by
debt by magnifying the shareholders earnings will result in higher value of the
firm via higher value of equity consequently the overall or the weighted
average cost of capital ko, will decrease. The overall cost of capital is
measured by equation: (1)

It is obvious from equation 1 that, with constant annual net operating income
(NOI), the overall cost of capital would decrease as the value of the firm v
increases. The overall cost of capital ko can also be measured by
KO = Ke - (Ke - Kd) D/V
As per the assumptions of the NI approach Ke and Kd are
constant and Kd is less than Ke. Therefore, Ko will decrease as D/V increases.
Equation 2 also implies that the overall cost of capital K o will be equal to Ke if
the form does not employ any debt (i.e. D/V =0), and that K o will approach Kd
as D/V approaches one.

15

NET OPERATING INCOME APPROACH


According to the met operating income approach the overall capitalization rate
and the cost of debt remain constant for all degree of leverage.

rA and rD are constant for all degree of leverage. Given this, the cost of equity
can be expressed as.

The critical premise of this approach is that the market capitalizes the
firm as a whole at discount rate, which is independent of the firms debt-equity
ratio. As a consequence, the decision between debt and equity is irrelevant. An
increase in the use of debt funds which are apparently cheaper or offset by an
increase in the equity capitalization rate. This happens because equity
investors seek higher compensation as they are exposed to greater risk arising
from increase in the degree of leverages. They raise the capitalization rate rE
(lower the price earnings ratio, as the degree of leverage increases.

The net operating income position has been \advocated


eloquently by David Durand. He argued that the market value of a firm
depends on its net operating income and business risk. The change in the
financial leverage employed by a firm cannot change these underlying factors.
It merely changes the distribution of income and risk between debt and equity,
16

without affecting the total income and risk which influence the market value
(or equivalently the average cost of capital) of the firm. Arguing in a similar
vein, Modigliani and Miller, in a seminal contribution made in 1958,
forcefully advanced the proposition that the cost of capital of a firm is
independent of its capital structure.

COST OF CAPITAL AND VALUATION APPROACH

The cost of a source of finance is the minimum return expected


by its suppliers. The expected return depends on the degree of risk assumed by
investors. A high degree of risk is assumed by shareholders than debt-holders.
In the case of debt-holders, the rate of interest is fixed and the company is
legally bound to pay dividends even if the profits are made by the company.
The loan of debt-holders is returned within a prescribed period, while
shareholders will have to share the residue only when the company is wound
up. This leads one to conclude that debt is cheaper source of funds than equity.
This is generally the case even when taxes are not considered. The tax
deductibility of interest charges further reduces the cost of debt. The
preference share capital is also cheaper than equity capital, but not as cheap as
debt. Thus, using the component, or specific, cost of capital as criterion for
financing decisions and ignoring risk, a firm would always like to employ debt
since it is the cheapest source of funds.
CASH FLOW APPROACH:

One of the features of a sound capital structure is conservatism does


not mean employing no debt or small amount of debt. Conservatism is related
to the fixed charges created by the use of debt or preference capital in the
capital structure and the firms ability to generate cash to meet these fixed
charges. In practice, the question of the optimum (appropriate) debt equity
mix boils down to the firs ability to service debt without any threat of
insolvency and operating inflexibility. A firm is considered prudently financed

17

if it is able to service its fixed charges under any reasonably predictable


adverse conditions.
The fixed charges of a company include payment of interest,
preference dividend and principal, and they depend on both the amount of loan
securities and the terms of payment. The amount of fixed charges will be high
if the company employs a large amount of debt or preference capital with
short-term maturity. Whenever a company thinks of raising additional debt, it
should analyse its expected future cash flows to meet the fixed charges. It is
mandatory to pay interest and return the principal amount of debt of a
company not able to generate enough cash to meet its fixed obligation, it may
have to face financial insolvency. The companies expecting larger and stable
cash inflows in to employ fixed charge sources of finance by those companies
whose cash inflows are unstable and unpredictable. It is possible for high
growth, profitable company to suffer from cash shortage if the liquidity
(working capital) management is poor. We have examples of companies like
BHEL, NTPC, etc., whose debtors are very sticky and they continuously face
liquidity problem in spite of being profitability servicing debt is very
burdensome for them.
One important ratio which should be examined at the time of
planning the capital structure is the ration of net cash inflows to fixed changes
(debt saving ratio). It indicates the number of times the fixed financial
obligation are covered by the net cash inflows generated by the company.

18

LIMITATION OF EPS AS A FINANCING-DECISION CRITERION

EPS is one of the mostly widely used measures of the


companys performance in practice. As a result of this, in choosing between
debt and equity in practice, sometimes too much attention is paid on EPS,
which however, has serious limitations as a financing-decision criterion.
The major short coming of the EPS as a financing-decision
criterion is that it does not consider risk; it ignores variability about the
expected value of EPS. The belief that investors would be just concerned with
the expected EPS is not well founded. Investors in valuing the shares of the
company consider both expected value and variability.
EPS VARIABILITY AND FINANCIAL RISK: The EPS variability resulting form the use of leverage is called
financial risk. Financial risk is added with the use of debt because of
(a) The increased variability in the shareholders earnings and
(b) The threat of insolvency. A firm can avid financial risk altogether if
it does not employ any debt in its capital structure. But then the shareholders
will be deprived of the benefit of the financial risk perceived by the
shareholders, which does not exceed the benefit of increase EPS. As we have
seen, if a company increase its debt beyond a point the expected EPS will
continue to increase but the value of the company increases its debt beyond a
point, the expected EPS will continue to increase, but the value of the
company will fall because of the greater exposure of shareholders to financial
risk in the form of financial distress. The EPS criterion does not consider the
long-term perspectives of financing decisions. It fails to deal with the risk
return trade-off. A long term view of the effects of the financing decisions, will
lead one to a criterion of the wealth maximization rather that EPS

19

maximization. The EPS criterion is an important performance measure but not


a decision criterion.

Given limitations, should the EPS criterion be ignored in making


financing decision? Remember that it is an important index of the firms
performance and that investors rely heavily on it for their investment
decisions. Investors do not have information in the projected earnings and cash
flows and base their evaluation and historical data. In choosing between
alternative financial plans, management should start with the evaluation of the
impact of each alternative on near-term EPS. But managements ultimate
decision making should be guided by the best interests of shareholders.
Therefore, a long-term view of the effect of the alternative financial plans on
the value of the shares should be taken, o management opts for a financial plan
which will maximize value in the long run but has an adverse impact in nearterm EPS, and the reasons must be communicated to investors. A careful
communication to market will be helpful in reducing the misunderstanding
between management and Investors.

20

COMPOSITION AND OBSERVATION


The sources tapped by NCL Industries Ltd. Can be classified into:

Shareholders funds resources

Loan fund resources


SHAREHOLDER FUND RESOURCES:
Shareholders fund consists of equity capital and retained earnings.
EQUITY CAPITAL BUILD-UP

1.

From 1995, the Authorised capital is Rs.450 lacs of equity shares at


Rs.10 each. The issued equity capital is RS.1622.93 lacs at Rs.10 each for the
period 2000-2006 and subscribed and paid-up capital is Rs. 1622.93 lacs at
Rs.10 each for the period of 2001-2006.

2.

In 2001-2006 the calls in arrears added to equity is Rs.0.55 lacs and in


2000 there are no calls in arrears.

3.

There is an increase of 1.38% in the equity from 2001-2006.

21

RETAINED EARNINGS COMPOSITION


This includes

Capital Reserve

Share Premium Account

General Reserve

Contingency Reserve

Debentures Redemption Reserve

Investment Allowance Reserve

Profit & Loss Account

1.

The profit levels, company dividend policy and growth plans


determined. The amounts transferred from P&L A/c to General Reserve.
Contingency Reserve and Investment Allowance Reserve.

2.

The Investment Allowance Reserve is created for replacement of long


term leased assets and this reserve was removed from books because assets
pertaining to such reserves ceased to exist. The account was transferred to
investment allowance utilized.

22

COMPANY PROFILE
NCL Industries Ltd is a company established in 1981 and today it is marked
among the top ten Cement Production companies of India, growing at over
25% as of 2006. NCL Industries Ltd has a countrywide office, network with
fully computerized operations and a professional team & worker. The
company has an installed capacity of 297000 tones of Cement & 3000 tones of
Cement Boards. The company is expanding after Economic reforms have set
in NCL Industries has spread its wings over several high production based
mechanism as will.
The companies sister concerns include Altek Coating Products Ltd.
NCL energy ltd, NCL homes ltd, Kakatiya Chemical Ltd. the members of the
Board comprised of eminent personalities from the field of Banking, Taxation,
Corporate loss and Industry. Jaya Bharath Reddy is the Chairman and Ravi
(Managing Director) industrialist having through knowledge and experience in
cement business and allied fields, with a new appointed M.D Sri. K.Ravi. The
broad based clientele group reflects the high respect and with NCL Industries
Ltd, in production circles. The client includes repeated business houses like
NCL homes Ltd, and confident financial institutions such as OBC (Oriental
Bank of Commerce), Vijaya Bank and Canara Bank.
The Plant is located in Nalgonda District of A.P where abundant raw
materials such as Lime Stone, Fire Wood etc., are available. Apart from the
main resources River Krishna flowing adjacent to the plant.

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Theoretical Aspects
CAPITAL STRUCTURE DEFINED:

The assets of a company can be financed either by increasing the


owners claim or the creditors claim. The owners claims increase when the
form raises funds by issuing ordinary shares or by retaining the earnings, the
creditors claims increase by borrowing .The various means of financing
represents the financial structure of an enterprise .The financial structure of
an enterprise is shown by the left hand side (liabilities plus equity) of the
balance sheet. Traditionally, short-term borrowings are excluded from the list
of methods of financing the firms capital expenditure, and therefore, the long
term claims are said to form the capital structure of the enterprise .The capital
structure is used to represent the proportionate relationship between debt and
equity .Equity includes paid-up share capital, share premium and reserves and
surplus.

The financing or capital structure decision is a significant managerial


decision .It influences the shareholders returns and risk consequently; the
market value of share may be affected by the capital structure decision. The
company will have to plan its capital structure initially at the time of its
promotion.

24

FACTORS AFFECTING THE CAPITAL STRUCTURE:

LEVERAGE: The use of fixed charges of funds such as preference shares,


debentures and term-loans along with equity capital structure is described as
financial leverage or trading on. Equity. The term trading on equity is used
because for raising debt.

DEBT /EQUITY RATIO-Financial institutions while sanctioning long-term


loans insists that companies should generally have a debt equity ratio of 2:1
for medium and large scale industries and 3:1 indicates that for every unit of
equity the company has, it can raise 2 units of debt. The debt-equity ratio
indicates the relative proportions of capital contribution by creditors and
shareholders.

EBIT-EPS ANALYSIS-In our research for an appropriate capital


structure we need to understand how sensitive is EPS (earnings per share) to
change in EBIT (earnings before interest and taxes) under different financing
alternatives.
The other factors that should be considered whenever a capital
structure decision is taken are

Cost of capital

Cash flow projections of the company

Size of the company

Dilution of control

Floatation costs

25

FEATURES OF AN OPTIMAL CAPITAL STRUCTURE:

An optimal capital structure should have the following features,

PROFITABILITY: - The Company should make maximum use of


leverages at a minimum cost.

FLEXIBILITY: - The capital structure should be flexible to be able to


meet the changing conditions .The company should be able to raise funds
whenever the need arises and costly to continue with particular sources.

CONTROL: - The capital structure should involve minimum dilution of


control of the company.

SOLVENCY: - The use of excessive debt threatens the solvency of the


company. In a high interest rate environment, Indian companies are beginning
to realize the advantage of low debt.

26

CAPITAL STRUCTURE AND FIRM VALUE:


Since the objective of financial management is to maximize
shareholders wealth, the key issue is: what is the relationship between capital
structure and firm value? Alternatively, what is the relationship between
capital structure and cost of capital? Remember that valuation and cost of
capital are inversely related. Given a certain level of earnings, the value of the
firm is maximized when the cost of capital is minimized and vice versa.
There are different views on how capital structure influences value.
Some argue that there is no relationship what so ever between capital structure
and firm value; other believe that financial leverage (i.e., the use of debt
capital) has a positive effect on firm value up to a point and negative effect
thereafter; still others contend that, other things being equal, greater the
leverage, greater the value of the firm.

27

CAPITAL STRUCTURE DIAGRAM


The Capital Structure Decision Process

EMBED PBrush

28

CAPITAL STRUCTURE AND PLANNING:


Capital structure refers to the mix of long-term sources of
funds. Such as debentures, long-term debt, preference share capital including
reserves and surplus (i.e., retained earnings) The board of directors or the chief
financial officer (CEO) of a company should develop an appropriate capital
structure, which are most factors to the company. This can be done only when
all those factors which are relevant to the companys capital structure decision
are properly analysed and balanced. The capital structure should be planned
generally keeping in view the interests of the equity shareholders, being the
owners of the company and the providers of risk capital (equity) would be
concerned about the ways of financing a companys operations. However, the
interests of other groups, such as employees, customers, creditors, society and
government, should also be given reasonable consideration. When the
company lays down its objective in terms of the shareholders wealth
maximization (SWM), it is generally compatible with the interests of other
groups. Thus while developing an appropriate capital structure for its
company, the financial manager should inter alia aim at maximizing the longterm market price per share. Theoretically, there may be a precise point or
range within an industry there may be a range of an appropriate capital
structure with in which there would not be great differences in the market
value per share. One way to get an idea of this range is to observe the capital
structure patterns of companies vis--vis their market prices of shares. It may
be found empirically that there are not significant differences in the share
values within a given range. The management of a company may fix its capital
structure near the top of this range in order to make maximum use of favorable
29

leverage, subject to other requirements such as flexibility, solvency, control


and norms set by the financial institutions, the security exchange Board of
India (SEBI) and stock exchanges.

30

FEATURES OF AN APPROPRIATE CAPITAL STRUCTURE: -

The board of Director or the chief financial officer (CEO) of a company should
develop an appropriate capital structure, which is most advantageous to the company. This
can be done only when all those factors, which are relevant to the companys capital
structure decision, are properly analyzed and balanced. The capital structure should be
planned generally keeping in view the interest of the equity shareholders and financial
requirements of the company. The equity shareholders being the shareholders of the
company and the providers of the risk capital (equity) would be concerned about the ways
of financing a companys operation. However, the interests of the other groups, such as
employees, customer, creditors, and government, should also be given reasonable
consideration. When the company lay down its objectives in terms of the shareholders
wealth maximizing (SWM), it is generally compatible with the interest of the other groups.
Thus, while developing an appropriate capital structure for it company, the financial
manager should inter alia aim at maximizing the long-term market price per share.
Theoretically there may be a precise point of range with in which the market value per
share is maximum. In practice for most companies with in an industry there may be a range
of appropriate capital structure with in which there would not be great differences in the
market value per share. One way to get an idea of this range is to observe the capital
structure patterns of companies Vis-a Vis their market prices of shares. It may be found
empirically that there is no significance in the differences in the share value with in a given
range. The management of the company may fit its capital structure near the top of its range
in order to make of maximum use of favorable leverage, subject to other requirement
(SEBI) and stock exchanges.

31

A SOUND OR APPROPRIATE CAPITAL STRUCTURE SHOULD HAVE THE FOLLOWING FEATURES

1)

RETURN: the capital structure of the company should be most advantageous, subject to
the other considerations; it should generate maximum returns to the shareholders without
adding additional cost to them.

2)

RISK: the use of excessive debt threatens the solvency of the company. To the point debt
does not add significant risk it should be used other wise it uses should be avoided.

3)

FLEXIBILITY: the capital structure should be flexibility. It should be possible to the


company adopt its capital structure and cost and delay, if warranted by a changed situation.
It should also be possible for a company to provide funds whenever needed to finance its
profitable activities.

4)

CAPACITY: - The capital structure should be determined within the debt capacity of the
company and this capacity should not be exceeded. The debt capacity of the company
depends on its ability to generate future cash flows. It should have enough cash flows to
pay creditors, fixed charges and principal sum.

5)

CONTROL: The capital structure should involve minimum risk of loss of control of the
company. The owner of the closely held companys of particularly concerned about dilution
of the control.

32

APPROACHES TO ESTABLISH APPROPRIATE CAPITAL STRUCTURE:


The capital structure will be planned initially when a company is incorporated .The
initial capital structure should be designed very carefully. The management of the company
should set a target capital structure and the subsequent financing decision should be made
with the a view to achieve the target capital structure .The financial manager has also to deal
with an existing capital structure .The company needs funds to finance its activities
continuously. Every time when fund shave to be procured, the financial manager weighs the
pros and cons of various sources of finance and selects the most advantageous sources
keeping in the view the target capital structure. Thus, the capital structure decision is a
continues one and has to be taken whenever a firm needs additional Finances.
The following are the three most important approaches to decide about a firms capital
structure.

EBIT-EPS approach for analyzing the impact of debt on EPS.

Valuation approach for determining the impact of debt on the shareholders value.

Cash flow approached for analyzing the firms ability to service debt.
In addition to these approaches governing the capital structure decisions, many other factors
such as control, flexibility, or marketability are also considered in practice.
EBIT-EPS APPROACH:
We shall emphasize some of the main conclusions here .The use of fixed cost sources
of finance, such as debt and preference share capital to finance the assets of the company, is
know as financial leverage or trading on equity. If the assets financed with the use of debt
yield a return greater than the cost of debt, the earnings per share also increases without an
increase in the owners investment. The earnings per share also increase when the preference
share capital is used to acquire the assets. But the leverage impact is more pronounced in case
of debt because

33

(I)

The cost of debt is usually lower than the cost of performance share capital and

(II)

The interest paired on debt is tax deductible.

Because of its effect on the earnings per share, financial leverage is an important
consideration in planning the capital structure of a company. The companies with high level
of the earnings before interest and taxes (EBIT) can make profitable use of the high degree of
leverage to increase return on the shareholders equity. One common method of examining
the impact of leverage is to analyze the relation ship between EPS and various possible levels
of EBIT under alternative methods of financing.
The EBIT-EPS analysis is an important tool in the hands of financial manager to get an
insight into the firms capital structure management .He can considered the possible
fluctuations in EBIT and examine their impact on EPS under different financial plans of the
probability of earning a rate of return on the firms assets less than the cost of debt is
insignificant, a large amount of debt can be used by the firm to increase the earning for share.
This may have a favorable effect on the market value per share. On the other hand, if the
probability of earning a rate of return on the firms assets less than the cost of debt is very
high, the firm should refrain from employing debt capital .it may, thus, be concluded that the
greater the level of EBIT and lower the probability of down word fluctuation, the more
beneficial it is to employ debt in the capital structure However, it should be realized that the
EBIT EPS is a first step in deciding about a firms capital structure .It suffers from certain
limitations and doesnt provide unambiguous guide in determining the capital structure of a
firm in practice.

34

RATIO ANALYSIS: The primary user of financial statements are evaluating part performance and
predicting future performance and both of these are facilitated by comparison. Therefore the
focus of financial analysis is always on the crucial information contained in the financial
statements. This depends on the objectives and purpose of such analysis. The purpose of
evaluating such financial statement is different form person to person depending on its
relationship. In other words even though the business unit itself and shareholders, debenture
holders, investors etc. all under take the financial analysis differs. For example, trade
creditors may be interested primarily in the liquidity of a firm because the ability of the
business unit to play their claims is best judged by means of a through analysis of its
l9iquidity. The shareholders and the potential investors may be interested in the present and
the future earnings per share, the stability of such earnings and comparison of these
earnings with other units in thee industry. Similarly the debenture holders and financial
institutions lending long-term loans maybe concerned with the cash flow ability of the
business unit to pay back the debts in the long run. The management of business unit, it
contrast, looks to the financial statements from various angles. These statements are
required not only for the managements own evaluation and decision making but also for
internal control and overall performance of the firm. Thus the scope extent and means of
any financial analysis vary as per the specific needs of the analyst. Financial statement
analysis is a part of the larger information processing system, which forms the very basis of
any decision making process.
The financial analyst always needs certain yardsticks to evaluate the
efficiency and performance of business unit. The one of the most frequently used yardsticks
is ratio analysis. Ratio analysis involves the use of various methods for calculating and
interpreting financial ratios to assess the performance and status of the business unit. It is a
tool of financial analysis, which studies the numerical or quantitative relationship between

35

with other variable and such ratio value is compared with standard or norms in order to
highlight the deviations made from those standards/norms. In other words, ratios are
relative figures reflecting the relationship between variables and enable the analysts to draw
conclusions regarding the financial operations.
However, it must be noted that ratio analysis merely highlights the potential areas of
concern or areas needing immediate attention but it does not come out with the conclusion
as regards causes of such deviations from the norms. For instance, ABC Ltd. Introduced the
concept of ratio analysis by calculating the variety of ratios and comparing the same with
norms based on industry averages. While comparing the inventory ratio was 22.6 as
compared to industry average turnover ratio of 11.2. However on closer sell tiny due to
large variation from the norms, it was found that the business units inventory level during
the year was kept at extremely low level. This resulted in numerous production held sales
and lower profits. In other words, what was initially looking like an extremely efficient
inventory management, turned out to be a problem area with the help of ratio analysis? As a
matter of caution, it must however be added that a single ration or two cannot generally
provide that necessary details so as to analyze the overall performance of the business unit.
In order to arrive at the reasonable conclusion regarding overall performance of the
business unit, an analysis of the entire group of ratio is required. However, ration analysis
should not be considered as ultimate objective test but it may be carried further based on the
out come and revelations about the causes of variations. Some times large variations are due
to unreliability of financial data or inaccuracies contained there in therefore before taking
any decision the basis of ration analysis, their reliability must be ensured. Similarly, while
doing the inter-firm comparison, the variations may be due to different technologies or
degree of risk in those units or items to be examined are in fact the comparable only. It must
be mentioned here that if ratios are used to evaluate operating performance, these should
exclude extra ordinary items because there are regarded as non-recurring items that do not
reflect normal performance.
Ratio analysis is the systematic process of determining and interpreting the
numerical relationship various pairs of items derived form the financial statements of a

36

business. Absolute figures do not convey much tangible meaning and is not meaningful
while comparing the performance of one business with the other.
It is very important that the base (or denominator) selected for each ratio is
relevant with the numerator. The two must be such that one is closely connected and is
influenced by the other
CAPITAL STRUCTURE RATIOS

Capital structure or leverage ratios are used to analyse the long-term solvency or
stability of a particular business unit. The short-term creditors are interested in current
financial position and use liquidity ratios. The long-term creditors world judge the
soundness of a business on the basis of the long-term financial strength measured in terms
of its ability to pay the interest regularly as well as repay the installment on due dates. This
long-term solvency can be judged by using leverage or structural ratios.
There are two aspects of the long-term solvency of a firm:(i) Ability to repay the principal when due, and
(ii) Regular payment of interest, there are thus two different but mutually dependent and
interrelated types of leverage ratio such as:
(a)

Ratios based on the relationship between borrowed funds and

owners capital,

computed form balance sheet eg: debt-equity ratio, dividend coverage ratio, debt service
coverage ratio etc.,

37

a.

RETURN ON ASSETS
In this case profits are related to assets as follows
Return on assets =

Net profit after tax


Total assets

Particulars
ROA =

PAT

TOTAL
ASSETS

2001

2002

2003

2004

2005

2006

290.77

274.5

104.12

128.57

252.19

340.78

9044.4
1
3.21

8916.51
3.08

9283.8
8632.11 8985.5 6
1.21
1.43
2.72

1017.3
2
3.34

b). RETURN ON CAPITAL EMPLOYED


Here return is compared to the total capital employed. A comparison of this ratio with that
of other units in the industry will indicate how efficiently the funds of the business have
been employed. The higher the ratio the more efficient is the use of capital employed.
Return on capital employed

Net profit after taxes & Interest


Total capital employed

(Total capital employed = Fixed assets + Current assetsCurrent liabilities)


particulars
ROCE =

2001
290.77

2002
274.5

2003
104.12

7111.40

7112.91

6827.97

= 4.08

= 3.85

=1.52

2004
128.57

2005
252.19

2006
340.78

6993.93

7079.20

9994.02

=3.56

=3.40

PAT

Total Capital Emp

38

=1.83

YEAR 2000-2001
Performance of company (Amount in Rs.000s)

Gross Revenue
Profit (Loss) before tax
Earnings per share Rs.

773919
30577
1.79

Total Expenditure
Profit after tax
Dividend ratio

743342
29077
10%

YEAR 2001-2002
Performance of company (Amount in Rs.000s)
Gross Revenue
Profit (Loss) before tax
Earnings per share Rs.

742200
30279
1.69

Total Expenditure
Profit after tax
Dividend ratio

711921
27450
10%

YEAR 2002-2003
PERFORMANCE OF COMPANY (AMOUNT IN RS.000S)
Gross Revenue
Profit (Loss) before tax
Earnings per share Rs.

726774 Total Expenditure


11218
Profit after tax
0.64
Dividend ratio

715556
10412
5%

YEAR 2003-2004
PERFORMANCE
Gross Revenue
Profit (Loss) before tax
Earnings per share Rs.

OF COMPANY

(AMOUNT

IN

RS.000S)

726774 Total Expenditure


11218
Profit after tax
0.64
Dividend ratio

715556
10412
5%

YEAR 2004-2005
PERFORMANCE

OF COMPANY

39

(AMOUNT

IN

RS.000S)

Gross Revenue
Profit (Loss) before tax
Earnings per share Rs.

924313 Total Expenditure


51802
Profit after tax
1.55
Dividend ratio

872511
25219
10%

YEAR 2005-2006
PERFORMANCE

OF COMPANY

(AMOUNT

IN

RS.000S)

Gross Revenue

127524 Total Expenditure

1203680

Profit (Loss) before tax


Earnings per share Rs.

3
71313
2.10

34078
15%

Profit after tax


Dividend ratio

PERFORMANCE ANALYSIS OF 2000-2001


There has been an increase of over 25% sales, where compared to previous year there
by contributing to increase in Gross Profit which increases over 45% because of increase in
sales and decrease in cost of sales which in due to reduction in royalty for mining and other
overheads reduction. In this year the companys operating profit is around 165 lacs as
compared to a heavy loss of over 365 lacs in previous year cost reduction also contributed
to the alone. A dividend of Rs.178 lacs was declared for the year including Tax.
PERFORMANCE ANALYSIS OF 2001-2002
There has been an increase of over 20% sales when compared to cost year, which
resulted in Gross Profit of Rs.1375 lacs as against around 1300 lacs in last year. Because of
decrease in Non-Operating expenses to the time of 130 lacs the Net profit has increased. It
stood at 293 lacs in current year against 165 lacs in previous year because of redemption of
debenture and cost reduction. A dividend of Rs.162 lacs was declared during the year at
10% on equity.
PERFORMANCE ANALYSIS OF 2002-2003
1.

The production and Sales has increased by 23%

2.

Cement turn over has increased by 6% as against fall in Sales realization by 15%
last year.
40

3.

Cement Boards Division has contributed 18% more than the previous year to the
PBDIT.

4.

Perform Division realization has increased by 4% even the Turn over have came
down to 845 lacs from 1189lacs in last year.

5.

The profit After Tax has came down from 302 lacs to 112lacs in Current year
because of slope in Cement Industry.

6.

The Interest cost has come down by 24% due to reduction in Interest rates by
Commercial Banks & Public Deposits.
PERFORMANCE ANALYSIS OF 2003-2004

The Cement Industry has a successful year because of Govt. policies such as
infrastructure Development a Rural housing. There has been a small reduction in Gross
Sales and with the performance of prefab Division the Gross Profit gap has narrowed and
contributing to the EBIT. The Gross Profit has increased considerably from 1014 lacs in
Last year to 1259 lacs in Current year. The interest payment has increased by 14 lacs in the
Current year and the Profit before Tax at 331 lacs when compared to 112 lacs in Last year.
The Net profit also increased from 104 lacs in Last year to 128.57 lacs in Current year.
The Director has recommended a 7.5% Dividend and in Last year it was at 5%.

PERFORMANCE ANALYSIS OF 2004-2005


In 2004-05 the company has performed well in all decisions because of high
demand and realizations. The Gross Profit Increased considerably and the interest payments
have decreased at about 140 lacs because of loans taken from the bank at a lesser rate of

41

interest and payment of loan funds for which the company is paying higher rate of interest.
In the previous year, the cash credit granted by UCO bank to the tune of Rs.594 lacs and
losing of loan funds borrowed from Vijaya Bank and Canara Bank factors, which can
tribute to increase in the Profit before Tax to the tune of Rs.190 lacs the company declared a
dividend of 10% on its equity to its shareholders when compared to 7.5% in the previous
year. The EPS of the company also increased considerably which investors in coming
period. The company has taken up a plant expansion program during the year to increase
the production activity and to meet the increase in the demand
PERFORMANCE ANALYSIS OF 2005-2006
Company is operating in 3 segments, out of which cement contributes about 55% of
turnover while the Boards and prefab segments contribute about 45%. Huge investment in
the industrial sector over the next 3 years is expected to lead to higher cement off take on
the back of strong GDP growth across the country. It is expected that the domestic cement
consumption would grow at a CAGR of 8% for the next 5 ears. By FY 2001 the domestic
consumption is expected to grow to 199 million Tons from 136 million Tons consumption
FY2006. During the year 2005-06 your companys Gross sales increased by about 38% to
Rs.12708 Lacks from Rs.9224 Lacks in FY

2004-05. Net sales increased by about 39% to

Rs.10337 Lacks from Rs.7448 Lacks in FY 2004-05. Improved sales from all the tree
divisions particularly from prefab division contributed for increased turnover.

EBIT LEVELS
Particulars
Earnings Before
Interest & Tax

2001

2002

2003

2004

2005

2006

1096.15

969.61

618.76

803

861.16

1235.69

42

Change

126.54

477.39

294.2

234.99

374.53

% Change

11.50% 43.55% 26.83% 21.44% 30.30%

DEGREE OF FINANCIAL LEVERAGE:

The higher the quotient of DEL,


the greater the leverage. In NCL
Industries case it is increasing because of decrease in EBIT levels from 2000-2001, to 20052006.

The EBIT level is in a decreasing trend because of drastic decline in prices in Cement
Industry during above period.
In the year 2005 and 2006 the EBIT level has increased substantially because of Raise inn
Cement prices because of demand and the policies of Govt. such as rural housing and
irrigation project taken up.

43

INTERPRETATION
The EBIT level in 2001 is at 1096.15 lacs and is decreasing every year till 2003. Because of
slump in the Cement Industry less realisation. The EBIT levels in 2004 again started
growing and reached to 802.46 lacs and in 2005 were at 861.16 lakhs and in 2006 were at
861.16, because of the sale price increase per bag and increase in demand. The
infrastructure program taken up by the A.P. Govt. in the field s of rural housing irrigation
projects created demand and whole Cement Industries are making profits.

44

PERFORMANCE

EPS ANALYSIS
Particulars
Profit After Tax
Less: Preference
Dividend
Amount of Equity share
holder
No. OF equity share of
Rs.10/- each
EPS

2001
29077000

2002
2745000

2003
10412000

2004
2005
30569000 32806000
-

2006
34078000
-

29077000 27450000

10412000

12857000 25219000 34093133

16234825 16234825
1.79
1.69

16234825
0.64

16234825 16234825 16234825


0.79
1.55
2.1

45

INTERPRETATION

The PAT is in an increasing trend from 2003-2004 because of increase in sale prices and
also decreases in the cost of manufacturing. In 2005 and 2006 even the cost of
manufacturing has increased by 5% because of higher sales volume PAT has increased
considerably, which leads to higher EPS, which is at 9.36 in 2006
EBIT EPS CHART

One convenient and useful way showing the relationship between EBIT and
EPS for the alternative financial plans is to prepare the EBIT-EPS chart. The chart is easy to
prepare since for any given level of financial leverage, EPS is linearly related to EBIT. As
noted earlier, the formula for calculating EPS is
EPS = (EBIT - INT) (1 T)

(EBIT - INT) (1 T)

We assume that the level of debt, the cost of debt and the tax rate are constant. Therefore in
equation, the terms (1-T)/N and INT (=iD) are constant: EPS will increase if EBIT
increases and fall if EBIT declines. Can also be written as follows

Under the assumption made, the first part of is a constant and can be represented by an
EBIT is a random variable since it can assume a value more or less than expected. The term
(1 T)/N are also a constant and can be shown as b. Thus, the EPS, formula can be written
as:
EPS = a + bEBIT
Clearly indicates that EPS is a linear function of EBIT.

46

FINANCING DECISION

Financing strategy forms a key element for the smooth running of


any organization where flow, as a rare commodity, has to be obtained at
the optimum cost and put into the wheels of business at the right time
and if not, it would lead intensely to the shut down of the business.
Financing strategies basically consists of the following components:

Mobilization

Costing

Timing/Availability

Business interests
Therefore,

the

strategy

is

to

always

keep

sufficient

availability of finance at the optimum cost at the right time to protect


the business interest of the company.
STRATEGIES IN FINANCE MOBILIZATION
There are many options for the fund raising program of any company
and it is quite pertinent to note that these options will have to be
evaluated by the finance manager mainly in terms of:

Cost of funds

Mode of repayment

Timing and time lag involved in mobilization

Assets security

Stock options

Cournands in terms of participative management and


47

Other terms and conditions.


Strategies of finance mobilization can be through two sectors, that is,
owners resources and the debt resources. Each of the above category
can also be split into: Securitized resources; and non-securities
resources. Securitized resources are those who instrument of title can be
traded in the money market and non-securities resources and those,
which cannot be traded in the market.

48

THE FORMS OF FUNDS MOBILIZATION IS ILLUSTRATED BY A CHART:

FUNDING MIX - SOURCES

OWNERS FUND

EQUITY
CAPITAL

RETAINED
EARNINGS

BORROWED FUND

PREFERENCE
CAPITAL

CONVENTIONAL

NON- CONVENTIONAL

SOURCES

SOURCES

FINANCIAL

SUPPLIERS CREDIT

INSTITUTION

SHORT TERM

BANK

BANK BORROWINGS

CASH CREDIT

HIRE PURCHASE

DEBENTURES
FIXED DEPOSITS
ICD

49

NCL INDUSTRIES LTD. THE FUNDING MIX

Particulars

2005-06

2000-01

2001-02

2002-03

2003-04

2004-05

a) Share capital

1622.93

1622.93

1622.93

1622.93

1622.93

2179.97

b) Reserves and surplus

1502.87

796.48

890.21

881.46

948.59

937.65

c)Deferred tax
TOTAL (A)
Loan Funds

3125.8

778.62
3198.03

787.99
3301.13

2504.39

2571.52

3117.62

a) Secured Loans

1724.9

1372.53

1413.17

1167.82

1783.66

4015.28

b) Unsecured Loans

2299.16

2588.22

2161.95

2404.33

1711.95

1954.07

TOTAL (B)
TOTAL (A+B)
% of S H in total C.E
% of Loan Fund in
total C.E

4024.06
7154.86
43.72

3960.75
7158.78
44.67

3575.12
6876.24
48

3572.15
6075.92
41.22

3495.61
6067.13
42.38

5969.35
9086.97
34.3

56.28

55.33

52

58.78

57.62

65.69

Source of funds
Share holders funds

50

51

INTERPRETATION
The shareholder fund is at 3125.8 constitutes 43.72% in total C.E and loan funds constitute
56.28% in 2000-01. The Funding Mix on an average for 6 years will be 45% of
shareholders Fund and 55% of Loan Funds there by the company is trying to maintain a
good Funding Mix. The leverage or trading on equity is also good because the company
affectively utilizing the Loan Funds in the Capital Structure. So that it leads to higher profit
increase of EPS in 2003 at 0.79 to 2006 1.55

52

TERM LOANS
2000-2001
Particulars

Rs. (in Lakhs)

TERM LOANS
IDBI

0.00

IFCI

0.00
0.00

HIRE PURCHASE LOANS


TVS Lakshmi Credit Ltd

0.00

0.00

Haritha Finance Ltd

0.00

0.00

Funded interest

0.00

0.00

Non Convertible Debentures

1027.98

CASH CREDIT
Global Trust Bank

641.33

Vijaya Bank

55.59
696.92
1,724.90

UNSECURED LOANS
Deposits from public

727.76

Lease /Hire purchases

0.34

IFST Loan from Govt. of AP

0.00

Deferred sales tax loan

1.60

Deposits from stockiest & others

1,566.21

Inter corporate deposits

3.25

TOTAL

2,299.16

53

TERM LOANS
2001-2002
Particulars

Rs. (in Lakhs)

TERM LOANS
IDBI

0.00

IFCI

0.00
0.00

HIRE PURCHASE LOANS


TVS Lakshmi Credit Ltd

0.00

0.00

Haritha Finance Ltd

0.00

0.00

Funded interest

0.00

0.00

Non Convertible Debentures

677.75

CASH CREDIT
Global Trust Bank

638.21

Vijaya Bank

56.57
694.78
1,372.53

UNSECURED LOANS
Deposits from public

602.15

Lease /Hire purchases

4.64

IFST Loan from Govt. of AP

0.00

Deferred sales tax loan

0.00

Deposits from stockiest & others

1730.39

Inter corporate deposits

50.00

Others

201.04
TOTAL

2588.22

54

TERM LOANS
2002-2003
Particulars

Rs. (in Lakhs)

TERM LOANS
Indian Renewable Energy
development agency ltd.
Non convertible debentures

255.00
509.61

HIRE PURCHASE LOANS


TVS Lakshmi Credit Ltd

0.00

0.00

Haritha Finance Ltd

0.00

0.00

Funded interest

0.00

0.00

CASH CREDIT
Global Trust Bank

583.41

Vijaya Bank

65.15
648.56
1,413.17

UNSECURED LOANS
Deposits from public

600.54

Lease /Hire purchases

21.25

Canara Bank factors ltd.

100.09

Deferred sales tax loan

0.00

Deposits from stockiest & others

1,239.02

Inter corporate deposits

0.00

Others

201.04
TOTAL

2161.94

55

TERM LOANS
2003-2004
Particulars

Rs. (in Lakhs)

TERM LOANS
Indian Renewable Energy
development agency ltd.
Non convertible debentures

207.00
0.00

HIRE PURCHASE LOANS


TVS Lakshmi Credit Ltd

0.00

0.00

Haritha Finance Ltd

0.00

0.00

Funded interest

0.00

0.00

CASH CREDIT
Global Trust Bank

627.10

Vijaya Bank

174.12

Canara Bank Factors

158.98

960.20
1167.20

UNSECURED LOANS
Deposits from public

592.31

Deposits from stockiest & others

1600.68

Lease/Hire purchase

10.30

Others

201.04
TOTAL

3571.53

56

TERM LOANS
2004-2005
Particulars

Rs. (in Lakhs)

TERM LOANS
Indian Renewable Energy
development agency ltd.
Non convertible debentures

779.17
0.00

HIRE PURCHASE LOANS


TVS Lakshmi Credit Ltd

0.00

0.00

Haritha Finance Ltd

0.00

0.00

Funded interest

0.00

0.00

CASH CREDIT
Oriental Bank of Commerce

410.15

UCO Bank

594.34

Canara Bank Factors

0.00

1004.49
1167.20

UNSECURED LOANS
Deposits from public

399.69

Deposits from stockiest & others

1053.83

Lease/Hire purchase

57.39

Others

201.04

TOTAL

3495.64

57

TERM LOANS
2005-2006
Particulars

Rs. (in Lakhs)

TERM LOANS
Indian Renewable Energy
development agency ltd.
Non convertible debentures

2532.14
0.00

HIRE PURCHASE LOANS


TVS Lakshmi Credit Ltd

0.00

0.00

Haritha Finance Ltd

0.00

0.00

Funded interest

0.00

0.00

CASH CREDIT
Oriental Bank of Commerce

561.32

UCO Bank
Canara Bank Factors
UTI Bank Ltd

306.54
403.46
211.82

1483.14
4015.28

UNSECURED LOANS
Interest free from sales tax
deferment loan
Deposits from public

162.40

Deposits from stockiest & others

919.26

Lease/Hire purchase

54.25

Others

201.29

TOTAL

5969.35

616.87

58

INTERPRETATION
The Non-convertible debentures are being redeemed from 2001 and 2002 financial year
onwards and were completely repaid by 2005-2006. The cash credit assistance was
provided by Global Trust Bank and Vijaya Bank to the tune of Rs.696 lacs and Canara bank
factors to the tune Rs.158 lacs was completely repaid by taking cash credit facility from
Oriental Bank of Commerce and UCO Bank to the tune of Rs.1000 lacs. The company is
paying of deposits from public every year.
Deposits from public were stood at 727.76 lacs in 2000-2001 and in 2005-2006 it
came down to 399.69 lacs. The IRIDA has granted Rs.255 lacs term loan for installation of
energy saving equipment and the loan was again increased to 779.17 lacs in 2005-2006.

59

YEAR 2000- 2001


Position of mobilization and development of funds
(Amount in Rs.000s)
Total liabilities
Sources of funds
Paid u capital

714986

Total assets

714986

162293

150287

Secured Loans
Application of
funds
Net fixed assets
Net current assets
Accumulated losses

172496

Reserves &
surplus
Unsecured loans

522854
182008

Investments
Misc. Expenditure

6278
3846

229916

YEAR 2001 - 2002


Position of Mobilization and Development of funds
(Amount in RS. 000s)
Total liabilities
Sources of funds
Paid u capital

715878

Total assets

715878

162293

79648

Secured Loans
Application of
funds
Net fixed assets
Net current assets
Accumulated losses

137253

Reserves &
surplus
Unsecured loans

554677
150891

Investments
Misc. Expenditure

5723
4587

258822

YEAR 2002 2003


Position of Mobilization and Development of funds
(Amount in RS. 000s)
Total liabilities
Sources of funds
Paid u capital

687624

Total assets

687624

162293

Secured Loans

141317

Reserves & surplus


Deferred tax
Unsecured loans

89021
78799
216194

60

Application of funds
Net fixed assets
Net current assets
Accumulated losses

517233
160545
Nil

Investments
Misc. Expenditure

5019
4827

Financial leverage results from the presence of fixed financial charges in the
firm income stream. These fixed charges dont vary with EBIT availability post payment
balances belong to equity holders.
Financial leverage is concerned with the effect of charges in the EBIT on the
earnings available to shareholders.
YEAR 2003-2004
Position of Mobilization and Development of funds
(Amount in RS. 000s)
Total liabilities
Sources of funds
Paid u capital

703225

Total assets

703225

162293

Secured Loans
Application of funds
Net fixed assets
Net current assets
Accumulated losses

116720

Reserves & surplus


Deferred tax
Unsecured loans

88146
78799
240433

Investments
Misc. Expenditure

10000
4827

477931
211462
Nil

YEAR 2004- 2005


Position of Mobilization and Development of funds (Amount in RS. 000s)
Total liabilities
Sources of funds
Paid u capital
Secured Loans
Application of funds
Net fixed assets
Net current assets
Accumulated losses

928386 Total assets

928386

1622.93 Reserves & surplus


Deferred tax
178366 Unsecured loans

94859
1041.93
171195

481100 Investments
213820 Misc. Expenditure
Nil

61

13000
2986

YEAR 2005 2006


Position of Mobilization and Development of funds
(Amount in RS. 000s)
Total liabilities
Sources of funds
Paid u capital

1017320

Total assets

1017320

1623.48

Secured Loans
Application of funds
Net fixed assets
Net current assets
Accumulated losses

4015.28

Reserves & surplus


Deferred tax
Unsecured loans

93765
1086.23
195407

Investments
Misc. Expenditure

13000
4910

7055.88
2938.22
Nil

62

FINANCIAL LEVERAGE
INTRODUCTION:
Leverage, a very general concept, represents influence or power. In financial
analysis leverage represents the influence of a financial variable over same
other related financial variable.
Financial leverage is related to the financing activities of a firm. The sources from
which funds can be raised by a firm, from the viewpoint of the cost can be categorized into:

Those, which carry a fixed finance charge.

Those, which do not carry a fixed charge.


The sources of funds in the first category consists of various types of long
term debt including loans, bonds, debentures, preference share etc., these long-term debts
carry a fixed rate of interest which is a contractual obligation for the company except in the
case of preference shares. The equity holders are entitled to the remainder of operating
profits if any.
Financial leverage results from presence of fixed financial charges in eh firms income
stream. These fixed charges dont vary with EBIT or operating profits. They have to be paid
regardless of EBIT availability. Past payment balances belong to equity holders.
Financial leverage is concerned with the effect of changes I the EBIT on the
earnings available to shareholders.

63

DEFINITION:
Financial leverage is the ability of the firm to use fixed financial charges to
magnify the effects of changes in EBIT on EPS i.e., financial leverage involves the use of
funds obtained at fixed cost in the hope of increasing the return to shareholder.
The favorable leverage occurs when the Firm earns more on the assets
purchase with the funds than the fixed costs of their use. The adverse business conditions,
this fixed charge could be a burden and pulled down the companies wealth
MEANING OF FINANCIAL LEVERAGE:
As stated earlier a company can finance its investments by debt/equity. The
company may also use preference capital. The rate of interest on debt is fixed, irrespective
of the companys rate of return on assets. The company has a legal banding to pay interest
on debt .The rate of preference dividend is also fixed, but preference dividend are paid
when company earns profits. The ordinary shareholders are entitled to the residual income.
That is, earnings after interest and taxes belong to them. The rate of equity dividend is not
fixed and depends on the dividend policy of a company.
The use of the fixed charges, sources of funds such as debt and preference
capital along with owners equity in the capital structure, is described as financial
leverages or gearing or trading or equity. The use of a term trading on equity is
derived from the fact that it is the owners equity that is used as a basis to raise debt, that is,
the equity that is traded upon the supplier of the debt has limited participation in the
companies profit and therefore, he will insists on protection in earnings and protection in
values represented by owners equitys

64

FINANCIAL LEVERAGE AND THE SHAREHOLDERS RISK

Financial leverage magnifies the shareholders earnings we also find that the
variability of EBIT causes EPS to fluctuate within wider ranges with debt in the capital
structure that is with more debt EPS raises and falls faster than the rise and fall in EBIT.
Thus financial leverage not only magnifies EPS but also increases its variability.

The variability of EBIT and EPs distinguish between two types of riskoperating risk and financial risk. The distinction between operating and financial risk was
long ago recognized by Marshall in the following words.

OPERATING RISK: -

Operating risk can be defined as the variability of EBIT (or return on total assets).
The environment internal and external in which a firm operates determines the variability of
EBIT. So long as the environment is given to the firm, operating risk is an unavoidable risk.
A firm is better placed to face such risk if it can predict it with a fair degree of accuracy.

THE VARIABILITY OF EBIT HAS TWO COMPONENTS


1.

Variability of sales

2.

Variability of expenses

65

1. VARIABILITY OF SALES:
The variability of sales revenue is in fact a major determinant of operating
risk. Sales of a company may fluctuate because of three reasons. First the changes in
general economic conditions may affect the level of business activity. Business cycle is an
economic phenomenon, which affects sales of all companies. Second certain events affect
sales of company belongings to a particular industry for example the general economic
condition may be good but a particular industry may be hit by recession, other factors may
include the availability of raw materials, technological changes, action of competitors,
industrial relations, shifts in consumer preferences and so on. Third sales may also be
affected by the factors, which are internal to the company. The change in management the
product market decision of the company and its investment policy or strike in the company
has a great influence on the companys sales.
2. VARIABILITY OF EXPENSES: Given the variability of sales the variability of EBIT is further affected by the
composition of fixed and variable expenses. Higher the proportion of fixed expenses
relative to variable expenses, higher the degree of operating leverage. The operating
leverage affects EBIT. High operating leverage leads to faster increase in EBIT when sales
are rising. In bad times when sales are falling high operating leverage becomes a nuisance;
EBIT declines at a greater rate than fall in sales. Operating leverage causes wide
fluctuations in EBIT with varying sales. Operating expenses may also vary on account of
changes in input prices and may also contribute to the variability of EBIT.

66

FINANCIAL RISK: For a given degree of variability of EBIT the variability of EPS and ROE increases
with more financial leverage. The variability of EPS caused by the use of financial leverage
is called financial risk. Firms exposed to same degree of operating risk can differ with
respect to financial risk when they finance their assets differently. A totally equity financed
firm will have no financial risk. But when debt is used the firm adds financial risk.
Financial risk is this avoidable risk if the firm decides not to use any debt in its capital
structure.

MEASURES OF FINANCIAL LEVERAGE: -

The most commonly used measured of financial leverage are:


1)

Debt ratio: the ratio of debt to total capital, i.e.,

Where, D is value of debt, S is value of equity and V is value of total capital


D and S may be measured in terms of book value or market value. The book value of equity
is called not worth.
2)

Debt-equity ratio: The ratio of debt to equity, i.e.,

1)

Interest coverage: the ration of net operating income


charges, i.e.,

67

(or EBIT) to interest

The first two measures of financial leverage can be expressed in terms of book or
market values. The market value to financial leverage is the erotically more appropriate
because market values reflect the current altitude of investors. But, it is difficult to get
reliable information on market values in practice. The market values of securities fluctuate
quite frequently.
There is no difference between the first two measures of financial leverage in
operational terms. They are related to each other in the following manner.

These relationships indicate that both these measures of financial leverage will rank
companies in the same order. However, the first measure (i.e., D/V) is more specific as its
value ranges between zeros to one. The value of the second measure (i.e., D/S) may vary
from zero to any large number. The debt-equity ratio, as a measure of financial leverage, is
more popular in practice. There is usually an accepted industry standard to which the
companys debt-equity ratio is compared. The company will be considered risky if its debtequity ratio exceeds the industry-standard. Financial institutions and banks in India also
focus on debt-equity ratio in their lending decisions.

The first two measures of financial leverage are also measures of capital gearing.
They are static in nature as they show the borrowing position of the company at a point of
time. These measures thus fail to reflect the level of financial risk, which inherent in the
possible failure of the company to pay interest repay debt.

68

The third measure of financial leverage, commonly known as coverage ratio,


indicates the capacity of the company to meet fixed financial charges. The reciprocal of
interest coverage that is interest divided by EBIT is a measure of the firms incoming
gearing. Again by comparing the companys coverage ratio with an accepted industry
standard, the investors, can get an idea of financial risk .how ever, this measure suffers from
certain limitations. First, to determine the companys ability to meet fixed financial
obligations, it is the cash flow information, which is relevant, not the reported earnings.
During recessional economic conditions, there can be wide disparity between the earnings
and the net cash flows generated from operations. Second, this ratio, when calculated on
past earnings, does not provide any guide regarding the future risky ness of the company.
Third, it is only a measure of short-term liquidity than of leverage.

FINANCIAL LEVERAGE AND THE SHARE HOLDERS RETURN:

The primary motive of a company in using financial leverage is to magnify the


shareholders return under favorable economic conditions. The role of financial leverage in
magnifying the return of the shareholders is based under assumption that the fixed charges
funds (such as the loan from financial institutions and other sources or debentures) can be
obtained at a cost lower than the firms rate of return on net assets. Thus, when the
difference between the earnings generalized by assets financed by the fixed charges funds
and cost of these funds is distributed to the shareholders, the earnings per share (EPS) or
return on equity increase. However, EPS or ROE will fall if the company obtains the fixed
charges funds at a cost higher than the rate of return on the firms assets. It should, there
fore, be clear that EPS, ROE and ROI are the important figures for analyzing the impact of
financial leverage.

69

COMBINED EFFECT OF OPERATING AND FINANCIAL LEVERAGES


Operating and financial leverages together cause wide fluctuations in EPS
for a given change in sales. If a company employs a high level of operating and financial
leverage, even a small change in the level of sales will have dramatic effect on EPS. A
company with cyclical sales will have a fluctuating EPS; but the swings in EPS will be
more pronounced if the company also uses a high amount of operating and financial
leverage.
The degree of operating and financial leverage can be combined to see the
effect of total leverage on EPS associated with a given change in sales. The degree of
combined leverage (DCL) is given by the following equation:

Yet another way of expressing the degree of combined leverage is as


follows:

Since Q (S-V) is contribution and Q (S-V)-F-INT is the profit after interest


but before taxes, Equation 2 can also be written as follows:

70

RATIO ANALYSIS: The primary user of financial statements are evaluating part performance and
predicting future performance and both of these are facilitated by comparison. Therefore the
focus of financial analysis is always on the crucial information contained in the financial
statements. This depends on the objectives and purpose of such analysis. The purpose of
evaluating such financial statement is different form person to person depending on its
relationship. In other words even though the business unit itself and shareholders, debenture
holders, investors etc. all under take the financial analysis differs. For example, trade
creditors may be interested primarily in the liquidity of a firm because the ability of the
business unit to play their claims is best judged by means of a through analysis of its
l9iquidity. The shareholders and the potential investors may be interested in the present and
the future earnings per share, the stability of such earnings and comparison of these
earnings with other units in thee industry. Similarly the debenture holders and financial
institutions lending long-term loans maybe concerned with the cash flow ability of the
business unit to pay back the debts in the long run. The management of business unit, it
contrast, looks to the financial statements from various angles. These statements are
required not only for the managements own evaluation and decision making but also for
internal control and overall performance of the firm. Thus the scope extent and means of
any financial analysis vary as per the specific needs of the analyst. Financial statement
analysis is a part of the larger information processing system, which forms the very basis of
any decision making process.
The financial analyst always needs certain yardsticks to evaluate the
efficiency and performance of business unit. The one of the most frequently used yardsticks
is ratio analysis. Ratio analysis involves the use of various methods for calculating and
interpreting financial ratios to assess the performance and status of the business unit. It is a
tool of financial analysis, which studies the numerical or quantitative relationship between
with other variable and such ratio value is compared with standard or norms in order to
highlight the deviations made from those standards/norms. In other words, ratios are
relative figures reflecting the relationship between variables and enable the analysts to draw
conclusions regarding the financial operations.

71

However, it must be noted that ratio analysis merely highlights the potential areas of
concern or areas needing immediate attention but it does not come out with the conclusion
as regards causes of such deviations from the norms. For instance, ABC Ltd. Introduced the
concept of ratio analysis by calculating the variety of ratios and comparing the same with
norms based on industry averages. While comparing the inventory ratio was 22.6 as
compared to industry average turnover ratio of 11.2. However on closer sell tiny due to
large variation from the norms, it was found that the business units inventory level during
the year was kept at extremely low level. This resulted in numerous production held sales
and lower profits. In other words, what was initially looking like an extremely efficient
inventory management, turned out to be a problem area with the help of ratio analysis? As a
matter of caution, it must however be added that a single ration or two cannot generally
provide that necessary details so as to analyze the overall performance of the business unit.
In order to arrive at the reasonable conclusion regarding overall performance of the
business unit, an analysis of the entire group of ratio is required. However, ration analysis
should not be considered as ultimate objective test but it may be carried further based on the
out come and revelations about the causes of variations. Some times large variations are due
to unreliability of financial data or inaccuracies contained there in therefore before taking
any decision the basis of ration analysis, their reliability must be ensured. Similarly, while
doing the inter-firm comparison, the variations may be due to different technologies or
degree of risk in those units or items to be examined are in fact the comparable only. It must
be mentioned here that if ratios are used to evaluate operating performance, these should
exclude extra ordinary items because there are regarded as non-recurring items that do not
reflect normal performance.
Ratio analysis is the systematic process of determining and interpreting the
numerical relationship various pairs of items derived form the financial statements of a
business. Absolute figures do not convey much tangible meaning and is not meaningful
while comparing the performance of one business with the other.

72

It is very important that the base (or denominator) selected for each ratio is
relevant with the numerator. The two must be such that one is closely connected and is
influenced by the other.

CONCLUSIONS

1)

Sales in 2003-2004 is at 7267.74 and in 2005-2006 12752.43 lakhs those in a


decreasing trend to the extent of 20% every year. On the other hand manufacturing
expenses are at 8725.11 lakhs from 2004-2005. There has been significant increase in
cost of production during 2004-2005 because of increase in Royalty.

2)

The interest charges were 492.21 in 2004 and 357.07in 2005 and 522.56 respectively
shows that the company redeemed fixed interest bearing funds from time to time out of
profit from 2003-2004.Debantures were partly redeemed with the help of debenture
redemption reserve and other references.

3)

The PAT (Profit After Tax) in 2005-2006 is at 340.78 lakhs. The PAT has increased in
prices in whole Cement industry during the above period. The profit has increased almost
15% during the period 2003-2006.

4)

Debentures were redeemed by transfers to D.R.R. in 2004-2005.

5)

A steady transfer for dividend during 2003-2006 from P&L appropriation but in 2003
there is no adequate dividend equity Shareholders.

6)

The share capital of the company remained in charge during the three-year period
because of no public issues made by the company.

7)

The secured loans have decreased consistently from 2003-2005 and slight increase in
2006.

73

8)

The unsured loans have increased from 2003-2006. All the secured and an insecure loan
obtained by the company to optimize the leverage financially has some set books. Because
of non-payment of dividends to share holders. Because of less profit made during the
period.

9)

The reserves of the company steadily increase from 2003 to 2006. Because of less
transfer in P&L appropriation A/C and transfer to differed Tax. Thus marginalizing the
equity interest net worth of the company.

10)

The current ratio of the company in 2003-04 is at 2.08 and in 2004-05 at 1.98 and in
2005-06 at 1.95, which is as per the norms of the manufacturing Industry. The current Ratio
shows that the companys liquidity or short-term solvency is in a better position to pay off
the current liabilities as and when payable.
The quick ratio is also increased considerably during the period.

74

RECOMMENDATIONS ON CEMENT INDUSTRY


For the development of the cement industry Working Group on cement
Industry was constituted by the planning commission for the formulation of X Five
Year Plan. The working Group has projected a growth rate of 10% for the cement
industry during the plan period and has projected creation of additional capacity of 4062 million tones mainly through expansion of existing plants. The working Group has
identified following thrust areas for improving demand for cement;

Further push to housing development programmes;

Promotion of concrete Highways and roads; and

Use of ready-mix concrete in large infrastructure project.


Further, in order to improve global competitiveness of the Indian Cement Industry, the
Department of Industrial policy & promotion commissioned a study on the global
competitiveness of the Indian industry through an organization of international repute,
viz. KPMG Consultancy Pvt. Ltd. The report submitted by the organization has made
several recommendations for making the Indian Cement Industry more competitive in
the international market. The recommendations are under consideration.

75

TECHNOLOICAL CHANGE
Cement industry has made tremendous strides in technological up gradation and
assimilation of latest technology. At present ninety three per cent of the total capacity
in the industry is based on modern and environment-friendly dry process technology
and only seven per cent of the capacity is based on old wet and semi-dry process
technology. There is tremendous scope for waste heat recovery in cement plants and
thereby reduction in emission level. One project for co-generation of power utilizing
waste heat in an Indian cement plant is being implemented with Japanese assistance
under Green Aid Plan. The induction of advanced technology has helped the industry
immensely to conserve energy and fuel and to save materials substantially. Indian is
also producing different varieties of cement like Ordinary Portland Cement (OPC),
Portland Pozzolana Cement (PPC), Portland Blast Furnace Slag Cement (PBFS), Oil
Well Cement, Rapid Hardening Portland Cement, Sulphate Resisting Portland Cement,
White Cement etc. Production of these varieties of cement conform to the BIS
Specifications. It is worth mentioning that some cement plants have set up dedicated
jetties for promoting bulk transportation and export.

76

SUGGESTIONS:

1.

The company has to maintain the optimal capital structure and leverage so that in
coming years it can contribute to the wealth of the shareholders.

2.

The mining loyalty contracts should be revised so that it will decrease the direct in
the production

3.

The company has to exercise control over its out side purchases and overheads
which have effect on the profitability of the company.

4.

As the interest rates in pubic Financial institutions are in a decreasing trend after
globalization the company going on searching for loan funds at a less rate of interest as in
the case of UCO Bank.

5.

Efficiency and competency in managing the affairs of the company should be


maintained.

77

BIBLOGRAPHY
1)

Financial Management

Khan & Jain

2)

Financial Management

I.M. Pandey

3)

Financial Management

Prasanna Chandra

4)

Financial Management

R.P. Rastogi

5)

Strategic Management

John .A. Pierce

6)

World Wide Web

nclindustries.com

7)

News Papers

Financial Express
Economic Times

8)

Websites

www.nclind.com
www.google.com

78

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