Assignment for FIN MKT_ Cost of Capital Submission

8/12/2019 Assignment for FIN MKT_ Cost of Capital Submission

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MBA (F&B) - BATCH VI

ASSIGNMENT FINANCIAL SYSTEM

Cost of Capital Calculation

SUBMITTED UNDER GUIDENCE OF

PROFF. SANKARSEN SARKAR

SUBMITTED BY

GROUP 6, SECTION 2

Team Members Enrollment Number

RAVI PRATAP SINGH TOMAR P301413CMG342

SAMEER GAIROLA P301413CMG353

SAUMYA KHARE P301413CMG358

SONAM SHARMA P301413CMG369

SONAM SHARMA P301413CMG370


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ContentsIntroduction .............................................................................................................................................. 4

Companies ................................................................................................................................................ 4

Estimation Methodology : ........................................................................................................................ 4

Cost of Debt ............................................................................................................................................. 4

Cost Of secured and unsecured Loans ...................................................................................................... 5

Cost Of Preference share .......................................................................................................................... 5

Cost of Equity ............................................................................................................................................ 6

Cost of Capital ........................................................................................................................................... 7

Cost of market returns from risk free market (Opportunity cost) .......................................................... 13

Limitations of Estimation methodologies ............................................................................................... 13

Conclusions : ........................................................................................................................................... 14


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Introduction

Objective of analysis is to estimate cost of capital for companies doing business in power /

manufacturing industry and to establish a bench mark for investing and evaluating the cost structure for

mentioned companies with respect to market (BSE / NSE).

Companies1. OM Metal Infrastructure Ltd. (Listed in NSE and BSE , Taken NSE for calculations)

2. Epic Energy Ltd. (Listed in BSE)

3. Shilchar Technologies. (Listed in BSE)

4. RTS Power Ltd. (Listed in BSE)

5.Swelwct Power. (Listed in NSE and BSE , Taken NSE for calculations)

Estimation Methodology :

Construction of cost of capital is based on weighted average cost of capital basis , where proportion of

individual cost are divided from various sources e.g Debt , Loans Preferance shares and equity shares

raised in stock exchanges in BSE and / or NSE.

WACC is a composite figure reflecting cost of each component multiplied by the weight of each

component.

WACC = we x re + wp x rp + wd x rd

we = Proportions of equity re = Cost of equity

wp = Proportion of pref capital rp = Cost of preference capital

wd = Proportion of Debt rd = Cost of debt

The analysis has been conducted based on book values / face values of capital since fund raising

through loans are not at its market value but from book value.

Cost of Debt

Cost of debt is determined by equating the cash flows of the instrument to its market price. Cost of

perpetual debt, rdis Most debts are repayable in the specified time interval.

Post tax cost of debt = rd(1-T)

oP = Present Value Market Price.

tC = Cash Flow.

o

oP

P tdd

t Crr

C or


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dr = Cost Of Debt.

T = Tax Rate.

None of the selected companies have opted for fund raising from debt market. Hence cost component

from all this parameter is zero for all companies.

Cost Of secured and unsecured Loans

Cost of secured and unsecured loans is based on the data collected from 5 year balance sheets (For

Loan amount) and profit/loss accounts (For Interest Payment) of respective companies and thus,

average cost of loans was found.

___

_

LoansofValueBook

paidInterstLR

Post tax cost of Loans = rL(1-T)

Assumptions :

1.Entire loan amount would be repaid at end of the maturity period.

2. There is no difference among various sources of loans in terms of payment terms ,rate of interests

and maturity period.

Cost Of Preference share

Cost of preference capital, rpis determined by equating its cash flows to market price. No adjustment

for tax is required.

rp is the cost of preference shares. and Dt is preference dividend.

Assumption :-

That taxes are deducted at source itself. None of selected companies have opt for fund raising through

this channel.

N

1tN

pt

p

to

)r(1

R

)r(1

DP


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Cost of Equity

Considering inconsistent dividend models and unstructured market growth offered by companies, we

have selected Capital asset pricing model for calculating cost of equity , however ,the primary

determinant of risk governs the cost of equity.

re= rf+ x (rmrf)

It relies on the market information and incorporates risk it need not know the dividend policy.

Calculations for Risk Free rate of returns : Chosen 8.8 as per 10 yr YOY basis from RBI.


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Risk premium Calculation

For calculation daily returns are calculated for period of 2008:09 to 2013:14 from respective NSE / BSE

for individual companies (for maximum available data from the date of listing)

Sensitivity (or Beta)calculation

It is important to note that for days when there was no trading for company shares data was omitted /

interloped with unitary method in order to obtain consistent regression function i.e sensitivity of data.

Assumptions

We attempted to use daily market closing price data from 2008:09 - 2013:14 for stocks listed in Bombay

Stock Exchange / National Stock Exchange and collected individual companies for the maximum tenure

with in scope of 2008:09 - 2013:14.

(1) The stocks selected should have been listed in Bombay Stock Exchange for the entire period 2008:09- 2013:14.

(2) There should be at least one trading in every month during the time period.

(3) The final 100 stocks were selected based on the number of trading days. Five value-weighted

portfolios were constructed by value ranking of the companies on the basis of market capitalization at

the end of every year and splitting these companies into value-ranked quintiles, and then forming five

portfolios based on value weights within a quintile.

Cost of Capital

Based on methodology, and data collected, cost of overall capital is framed and estimated for

companies on individual basis with respective NSE / BSE.

OM Metal Infrastructure:

Estimation of Current Cost of CapitalInputs Om Infrastructure

Equity

Number of Shares outstanding =

96,303,809.00

Face value per share =

1.00

Number of Warrants Outstanding

=

-

Current Market Price per

Warrant =

-

Current Beta =


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Epic Energy

Inputs

Equity

Number of Shares outstanding = 67,100,000

Face Value per share = 10

Number of Warrants Outstanding = 0

Current Market Price per Warrant = 0

Current Beta = 0.39

Riskfree Rate = 8.86%

Equity Risk Premium = 0.08%

Debt

Book Value of Term Loan = 12,400,000

Interest Expense on Debt = 200,000

Average Maturity = 5

Pre-tax Cost of Debt = 2%

Tax Rate = 20%

Book Value of Convertible Debt = -

Interest Expense on Convertible = -

Maturity of Convertible Bond = 0

Market Value of Convertible = 0

Debt value of operating leases = 0

Preferred Stock

Number of Preferred Shares = 0

Current Market Price per Share= 0Annual Dividend per Share = 0

Output

Estimating Market Value of Straight

Debt = 12,400,000.00

Estimated Value of Straight Debt in Convertible = -

Value of Debt in Operating leases = -


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Output

Estimating Market Value of Straight Debt =

189,400,000.00

Estimated Value of Straight Debt in Convertible =

-

Value of Debt in Operating leases

=

-

Estimated Value of Equity in Convertible =

-

Equity Debt

Preferred

Stock Capital

Market Value 101,058,400.00 189,400,000 - 290,458,400

Weight in Cost of Capital 0.15 0.27 - 0.42

Cost of Component 0.08 0.17 5.769%

RTS Power Corporation Limited :

Estimation of Current Cost of CapitalInputs

Equity

Number of Shares outstanding = 8,168,500

Face value per share = 10.00

Number of Warrants Outstanding =

Current Market Price per Warrant =

Current Beta = 0.39


Equity Risk Premium = -8.68%

Loans

Book Value of Secured/Unsecured loan = 472,000,000

Interest Expense on Secured/Unsecured

loans 94,600,000

Average Maturity =

Pre-tax Cost of Debt = 20.04%

Tax Rate = 35%

Debentures

Book Value of Convertible Debt = Interest Expense on Convertible =

Maturity of Convertible Bond =

Market Value of Convertible =

Debt value of operating leases =

Preferred Stock


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Number of Preferred Shares =

Current Market Price per Share=

Annual Dividend per Share =

Output

Estimating Market Value of Straight Debt

= 472,000,000

Estimated Value of Straight Debt in Convertible =

-

Value of Debt in Operating leases =

-

Estimated Value of Equity in Convertible

=

-

Equity Debt Preferred Stock Capital

Book Value 81,685,000.00 472,000,000.00 - 553,685,000


Cost of Component 0.06 0.13- 12%

Estimation of Current Cost of CapitalInputs Shilchar Technologies

Equity

Number of Shares outstanding =

3,813,400.00

Face value per share =

10.00

Number of Warrants

Outstanding =

-Current Market Price per

Warrant =

-

Current Beta =

0.04


Equity Risk Premium = -8.68%

Loans

Book Value of

Secured/Unsecured loan =

189,400,000.00

Interest Expense onSecured/Unsecured loans

40,200,000.0

Average Maturity =

-

Pre-tax Cost of Debt = 21.22%

Tax Rate = 35%

Debentures

Book Value of Convertible Debt


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= -

Interest Expense on Convertible

=

-

Maturity of Convertible Bond =

-

Market Value of Convertible =

-

Debt value of operating leases =

Preferred Stock

Number of Preferred Shares =

-

Current Market Price per Share=

-

Annual Dividend per Share =

-

Output

Estimating Market Value of

Straight Debt =

189,400,000

Estimated Value of Straight Debt

in Convertible =

-

Value of Debt in Operating

leases =

-

Estimated Value of Equity in

Convertible =

-

Equity Debt

Preferred

Stock Capital

Book Value 38,134,000

89,400,000 - 227,534,000


Cost of Component 0.08 0.14 - 13%

Cost of market returns from risk free market (Opportunity cost)

As mentioned Risk free rate is 8.86 for ten year , Investor may find opportunities based on Internal rate

of return or based on NPV values in order to evaluate duration and percentage of investment in

portfolio.

Limitations of Estimation methodologiesIt is assumed that there is negligible floatation cost, since it is neglected in all companies hence it has

been considered as non differentiated costs, however this is not necessary.

Cost structure of loans are considered homogeneous in all terms and conditions , which need not to be

true in all cases.


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CAPM is worked out over Book value, since calculation is based on loan funds , however in presence of

debentures etc market value is considered to be a better measure in order to estimate Cost of capital. In

present case since loans does not have market value , hence mixture of book value and market value is

avoided. One must check for implications before relying only on book value at her / his own discretion.

Conclusions :Cost of capital for companies are as follows :-

Name Of Company Cost Of capital Cost Of Debt Cost Equity

Om metals Infrastructure 21% 24 % 2%

Epic Energy 5.4% 1.29% 5.47%

Shilchar Technologies 13% 14% 8%

RTS Power 12% 13% 6%

Swelect Energy Systems 10% 11% 8%

It shows that best choice may be to invest in Epic energy , considering the compensation over opportunity

costs in this sector and understanding the requirement of portfolio diversification choices.

From the point of view of management, out of the five selected companies , four of them have a cheaper

equity as compare to debt (in form of term loans) , so it is advisable to procure funds through equity while

operating in this industry.

Reference

1. http://www.nseindia.com/

2. www.bseindia.com

3. http://www.moneycontrol.com/

4. http://in.finance.yahoo.com/q/hp?s=EPIC.BO&a=02&b=2&c=2009&d=02&e=2&f=2014&g=d5. http://www.ommetals.com/

6. http://www.epicenergy.com.

7. http://www.swelectes.com/

8. http://www.rtspower.com/

9. http://www.tradingeconomics.com/india/gdp-growth-annual

10. Book : Financial Managment by Rajiv Shrivastava and Amit Mishra . Published By TMH Publication.

11. Conditional CAPM and Cross Sectional ReturnsA study of Indian Securities Market , study

conducted by Lakshmi Narasimhan S and H.K.Pradhan.

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Assignment for FIN MKT_ Cost of Capital Submission