Capital Structure & Financial

Leverage Analysis of Software

Industry:
Group No.
6:
Anuj Surana
Gautam Malhotra
Karan malhotra
Kush Shrimali
Nidhi Mittal
OBJECTIVES OF THE
STUDY:
• To study as to why the Capital Structure
of Software Companies is different from
other Industries.
• To study the reasons as to why software

companies are not using component of

Debt Capital to financially leverage their
Earnings.
Capital Structure:
 Capital Structure is the mixture of
sources of funds a firm uses.
Sources of Funds:
 Debt
 Preferred stock
 Common Stock
A firm with a lot of debt in its Capital
Structure is said to be highly levered.
Comparison:
Company Name Equity Retain Debt Debt-
Share ed capital Equity
Capital Earnin (S.L. + Ratio
gs U.L)
Infosys 2860 132040 0 0
Technologies Pvt.
Ltd.

Satyam Computer 1359 72217 236 0.04

Services Pvt. Ltd.

Tech Mahindra 1214 11070 950 0.08

Ltd.
WIPRO Ltd. 3503 112604 38224 0.33

HCL Technologies 1350 30800 253 0.01

Ltd.
Financial Leverage:
 Financial leverage occurs whenever a firm
finances with interest-bearing debt.

 It occurs due to the Fixed Interest Charge.

 To ascertain whether management is able to

earn more on the debt funds than the funds cost.

 If a firm does not have any interest-bearing debt

financing, then it does not have any financial risk
and cannot realize financial leverage.
Comparison:

Particula Infosys Satyam Tech WIPRO HCL

rs Mahindra
EBIT 4417 2222 7658 32596 10090

(-) INT (0) (6) (283) (1168) (249)

PBT 4417 2216 7375 31428 9841

DFL 1 1.003 1.038 1.037 1.025

Compan Quick Current Quick Quick Quick
y Assets Liabiliti Ratio Ratio Ratio
es (2007- (2006-07) (2005-
08) 06)

Infosys 1,23,26 37,310 3.30 4.5 2.96

0
Satyam 74,511 14,467 5.15 5.76 6.18

Tech 14,880 6,342 2.35 2.25 2.18

Mahindra

WIPRO 120,58 33,616 3.58 3.15 2.89

1
HCL 28,581 18,218 1.57 1.89 1.46
How Much Cash Does Your Company Need?

 HBR Article by Richard Passov.

 He proposes that Traditional Capital Structure
model should account for complications faced by
companies in Knowledge Based Industries.
 Knowledge-Intensive Companies experience
relatively high volatility of their intangible assets.
 Reasons for High Volatility:
 Assets are company specific & require
considerable investment to exploit,
 Intangible assets cannot be hedged.
How Much Cash Does Your Company Need?

 These Intangible assets cannot be easily valued

and are more vulnerable to financial distress than
firms with preponderance of tangible assets.
 To ensure against this Risk, Knowledge Intensive
Firms need to maintain large positive Cash
Balances.
 Also, only by investing in their intangible assets
can knowledge-based industries hope to preserve
the value of these assets.

In a nutshell, the business risk of these firms is

really HIGH.
 REASONS FOR NOT USING LONG-
•TERM FUNDS:
Software Firms don’t require much Long-
Term Funds once they have initiated their
operations.

•Their Business Risk is high. Thus, to reduce

their overall risk, they like to minimize their
Financial Risk.

• Internal Accruals & Internal Cash Flows

funds their Operations.

•They want to ensure High Liquidity as it

enables them to make rapid shifts.
Observations from the
Study:
 Software Firms maintain more of Cash Balances
as their require short term funds.
 These Firms are not directly impacted by changes
in Monetary Policy.
 To reduce their overall risk, they maintain huge
cash balances.
 Capital Structure depends on the Nature of
Industry.
 Service industry normally does not leverage their
earnings financially.
 It cannot be taken as a rule of thumb, as many
organizations have raised External Long-Term
Exception:
Bidding of Axon
 Two major bidders: Infosys & HCL Technologies Pvt. Ltd.
 Difference in Structure of Financing.

 Infosys:
Bid Amount: £ 407 million
To be raised through: Cash Reserves.

 HCL
Bid Amount: £ 441 million
To be raised through: £400-million loan commitment
from Standard Chartered @ 6.5%.
Hidden Benefit(HCL):
 Infosys would lose 10 % interest that it would
have earned, had the Cash been with the Bank.
 HCL would be paying 6.5 % interest to Standard
Chartered to raise the amount.
 Thus, HCL had a 3.5 % advantage over Infosys.
The term of the loan was 2.5 years. Hence, it had
a total advantage of 8.75 % over Infosys.
 This allowed HCL to raise their Bid Amount to £
441 million, 8.3 % higher than Infosys.
 HCL’s current Debt- Equity Ratio is 0.65:1