CHAPTER 1INTRODUCTIONThe concept of cost of capital is very
important in financial management. It is weighted average cost of
various sources of finance used by a firm may be in form of
debentures, preference share capital, retained earning and equity
share capital.A decision to invest in a particular project depend
upon the cost of capital of the firm or the cut off rate which is
minimum rate of return expected by the investors.When a firm is not
able to achieve cut off rate, the market value of share will fall.
Infact, cost of capital is minimum rate of return expected by its
investors.Every firm have different types of goals or objectives
such as profit maximization, cost minimization, wealth maximization
and maximum market share. If a firm have main objective is wealth
maximisation then that firm earn a rate of return more than its
cost of capital. The Cost of capital is the rate of return the firm
requires from investment in order to increase the value of firm in
market place.-Hampton John J.Meaning of cost of capital :-Cost of
capital is not a cost as such.It is minimum rate of return.It
included three components risk involves in every investment.(a)The
expected normal rate of return at zero risk level, example
investment in banks.(b)The premium for business risk.(c)The premium
for financial risk on account of pattern of capital
structure.significance of the cost of capitalIt is very important
concept of financial management. It play a crucial role in both
capital budgeting as well as decision relating to planning of
capital structure. It is helpful to evaluate the performance of a
firm.As a acceptance criterion in capital budgeting.As a
determinant of capital mix in capital structure.Evaluate the
performance of firm.Other decision :(a)Dividend
policy.(b)Capitalization of profit.(c)Making right issue and
working capital.(d)Leasing decision.
problem in determinating of cost of capital
Determination of cost of capital of a firm is not a easy task
because of both conceptual problem as well as uncertainties of
proposed investment and the pattern of financing.Conceptual
controversies regarding the relationship between cost of capital
and the capital structure.Histories cost and future cost.Problem in
computation of cost of capital.Problem in computation of retained
earning.Problem in assigning weights.computation of cost of
capital
Computation of overall cost of capital of a firm involves :
Computation of cost specific source of finance. Computation of
weighted average cost of capital.Computation of cost specific
source of finance :Computation of each specific source of finance
viz. debt, preference share capital, equity share capital and
retained earning.Cost of debt. capital.Cost of preference share
capital.Cost of equity share capital.Cost of retained
earning.Computation of weighted average cost of capitalWeighted
average cost of capital is average cost of various sources of
financing. Weighted average cost of capital is known as composite
cost of capital, overall cost of capital or average cost of
capital.
The project mainly deals with the Cost of Capital for Grasim
Industries Limited.Capital is basic need of business for smooth
running in market. Without capital any business never success in
market. Every firm have limited source of finance so firm takes
help of outside finance. Capital may be in the form of debentures,
equity share capital and retained earning.The project of cost of
capital has been done to know cost of various source of finance
such as cost of debentures, cost of equity, cost of retained
earning of Grasim Industries Limited
CHAPTER 2PROFILE OF GRASIM INDUSTRIES LTDGRASIM INDUSTRIES
LIMITED Incorporated on 25 August 1947 in the state of Madhya
Pradesh, Grasim Industries Limited commenced operations in 1948 in
Gwalior with a small Rayon weaving unit using imported rayon in
1954 Grasim quickly set its focus on the production of rayon i.e. a
man made cellulose fiber.The company strengthened its position. in
rayon in a cost-effective manner through horizontal and vertical
integration. Developing indigenously the expertise for producing
basic raw material-pulp, auxiliary chemicals and engineering for
plant and equipment.Alongside Grasim diversified into other core
sectors-cement and sponge iron-to emerges as one of the countries
leading industrial conglomerates, committed to keep pace with
India's much forward.To strengthen its position in cement, in
1998-99 Grasim acquired the Dharani cement additionally following
the consolidation of the Aditya Birla Groups cement, businesses,
Indian rayon's cement businesses was transferred to Grasim. With
this, Grasim's aggregate cement capacity rises to 10.83 million
tones, making it India's third largest producers.
Grasim has a leadership position in all key businesses1. Viscose
staple fiber :- India's largest producers2. Rayon Grade Wool Pulp -
Largest producer in India. 3. Caustic Soda - Largest Single
Location Membrance Cell Plant, Second Largest Producer in
India.4.Cement - Largest Producer in India.5Gas Based Sponge Iron
:- Third Largest Producer in India.With captive power facility at
all its locations, the company has ensured reliable and economic
power supply for its units. THE ADITYA VIKRAM BIRLA GROUP OF
COMPANIESGrasim Industries LimitedAlexandra Carbon Black
CompanyBihar Caustic and Chemicals LimitedBina Power Supply Company
LimitedBirla Capital International AMC LimitedBirla Communication
LimitedBirla Global Finance LimitedBirla Telecom LimitedCentury
Textile Company LimitedHindalco Industries LimitedHindustan Gas and
Industries LimitedIndian Rayon and Industries LimitedIndogulf
Fertilizers and Chemicals Corporation LimitedEssel Mining and
Industries LimitedIndo Phil Textiles Mills Inc.Indo Thai Synthetic
Co. LimitedKerala Spinners Co. LimitedPan Century Edible Oils Sdn.
Bhd.Pan Century Oil Chemicals Sdn. Bhd.P.T. Indo Bharat RayonP.T.
Indo Liberty TextilesRosa Power Supply Company LimitedTanfac
Industries LimitedThai Acrylic Fiber Company LimitedThe Carbon
Black Company LimitedThai Epoxy and Allied Products Company
LimitedThai Organnic Chemicals LimitedThai Peroxide Company
LimitedThai Polyphosphate and Chemicals Company LimitedThai Rayon
Company LimitedThai Sodium Sulphaiders and Chemicals Co.
LimitedUdyog Services LimitedGrasim Positioning :The brand has been
positioned on the fashion plank, as being young, dynamic and
perennially contemporary. The brand is focused on the customers
belonging to the age group 25-45 years.Fashion in the context
Grasim Persons is a personal statement. It is a statement that
announces the marriage of blending of both the Achievement and
Youthfulness and Refinement and Relaxation.Road Ahead :The brand
has been repositioned as a result, of which there is a gap in the
profile of the target customer and the existing customer. The
biggest challenge for the brand is to retain the existing customer
and to attract the new ones. Besides this the brand faces the
threat of spurious goods by the name Gwalior and hence needs to
concentrate on educating the customer as to what the original brand
is. This is the only way by which it can prevent the customer and
brand image loss.Graviera :Graviera is a Rs. 80 crores brand that
is into synthetic suiting in the popular segment. The brand name
was coined in the year 1976 as Graviera Grasim Gwalior.
CHAPTER 3COST OF CAPITAL OF GRASIM INDUSTRIES LTD
cost of debenture capital:Meaning of Debenture :Debt. is
includes debt. stock, loans and other securities of a company
whether constituting a change on the assets of the company or not.
Debt. is like as loan. A fix rate of interest payable on debenture
either company earn profit or not. Interest on debt. is liability
on company.Feature of Debenture :A debt. is issued under the seal
of company.It contains a contract for repayment of principal sum of
specific date.Debt. is issued in form of certificate.A debenture
holders receive interest on his debt. at fix rate as mentioned in
the certificate.cost of debt.The cost of capital is the rate of
interest payable on debt. The cost of debt. capital is measured as
the rate of discount which equates the value of post tax interest
and principal repayment with the net proceeds of debt. issue.Before
tax cost of capital.After tax cost of capital.
Before tax cost of debt. :
Kdb =
Kdb = Before tax cost of debt.
I = Interest
P= Principal.
(Note : All figures in crores)
(For the year of 2006-07, 2007-08)(Grasim Have Different types
& quantity debt.)XVii series non convertible debt.
I.Cost of debt.==14.75%XXXI Series non convertible debt.
II.Cost of debt.==8.85%XXIX Series non convertible debt.
III.Cost of debt.==9.70%XXI Series non convertible debt.
IV.Cost of debt.==13.5%XXIII Series non convertible debt.
V.Cost of debt.==12.6%XXVI Series non convertible debt.
VI.Cost of debt.==10.75%XXVIII Series non convertible debt.
VI.Cost of debt.==10.75%XXVI Series non convertible debt.
VII.Cost of debt.==10.10%XIX Series non convertible debt.
VIII.Cost of debt.==14.5%XXVII Series non convertible debt.
IX.Cost of debt.==11.25%
Conclusion : XXXI series non convertible debenture have less
cost than other series debentures.
After tax cost of debt. :Kda = Kdb (1-t) or I/NP (1-t)
Kda = After tax cost of debt.
T = Rate of Interest
(Note : Tax rate 35%)
XIII Series non convertible debt.
I. (1-35%)=9.5875 or 9.59XIXSeries non convertible debt.
II. (1-35%)=9.425 or 9.43%XXI Series non convertible debt.
III. (1-35%)=8.77%XXIII Series non convertible debt.
IV. (1-35%)=8.19%XXVI Series non convertible debt.
V. (1-35%)=6.99%XXVII Series non convertible debt.
VI. (1-35%)=7.31%XXVIII Series non convertible debt.
VII. (1-35%)=6.56%XXIX Series non convertible debt.
VIII. (1-35%)=6.30%XXXI Series non convertible debt.
IX. (1-35%)=5.75%.Conclusion : When debt. is used in form of a
source of a finance, the firm save considerable amount in repayment
of tax as interest is allowed as a deductable expenses in
computation of tax cost of debt. is reduced or after tax cost of
debt. is minimum than before tax.
cost of redeemable debt. : Some debt. is issued to be redeemed
after a certain period during the life time of a company such types
of debt. known as redeemable debt.Before tax cost of debt.After tax
cost of debt.
Before tax cost of debt.
Kdb=I=Interest
P=Proceeds at par.
Np=Net proceeds.N=Number of year in which debt. is to be
redeemed.(For the year 2006-07)XVIIISeries non convertible
debt.(redeemable at par in three annual instalments)
I.Kdb==14.75%XIXSeries non convertible debt.(redeemable at par
in three annual installments)
II.Kdb==14.5%XXVI Series non convertible debt.
III.Kdb==10.75%XXVIISeries non convertible debt.
IV.Kdb==11.25%XXVIIISeries non convertible debt.
V.Kdb==10.10%XXIXSeries non convertible debt.
VI.Kdb==9.70%
After tax cost of debt.Kda=Kdb (1-t)Kdb=Before tax cost of
debt.t=tax rate
XVIIISeries non convertible debt.Kda=14.75
(1-35%)=9.59%XIXSeries non convertible debt.14.5 (1-35%)=9.43%XXVI
Series non convertible debt.10.75 (1-35%)=6.99%XXVII Series non
convertible debt.11.25 (1-35%)=7.31%XXVIII Series non convertible
debt.10.10 (1-35%)=6.56%XXIX Series non convertible debt.9.75
(1-35%)=6.30%(For the year 2007-08)XVIII Series non convertible
debt.
VII.Kdb==14.75%
XIX Series non convertible debt.
VIII.Kdb==14.5%XXVI Series non convertible debt.
IX.Kdb==10.75%XXVIISeries non convertible debt.
X.Kdb==11.25%XXVIIISeries non convertible debt.
XI.Kdb==10.10%XXIX Series non convertible debt.
XII.Kdb==9.70%
Series short term Minor Linked Debentures :XXXI Series non
convertible debt.
XIII.Kdb==8.35%XXXIISeries non convertible debt.
XIV.Kdb==8.20%XXXIIISeries non convertible debt.
XV.Kdb==14%.XXXIV Series non convertible debt.
XVI.Kdb==7.55%XXXVSeries non convertible debt.
XVII.Kdb==6.75%XXXVISeries non convertible debt.
XVIII. Kdb ==6.08%
XXXII series non convertible debt. have less cost among all
debt. company pay interest @ 8.20% on XXXII series non convertible
debt.cost of debenture redeemable in instalments :Financial
institutions generally require principal to be amortized in
installments. A company may also issue bond or debenture to bond or
debenture to be redeemed periodically. In such a case, principal
amount is repaid each period instead of a lump sum at maturity and
hence cash flows each period include interest and principal. The
amount of interest goes on decreasing each period as it is
calculated on the outstanding amount of debt.
Formula :
Vd = Vd=Present value of bond or debenture.I1, I2 .... In=Annual
interest in period 1,2 ......, and so on.P1, P2 .... Pn= Periodic
payment of principal in period 1,2 ... and so on.N=Number of years
to maturity.Kd=Cost of debt. or required rate of return.
(For the year 2006-07, 2007-08)XIII series non convertible
debt.(redeemable at par in three equal annual installments)
I.45 = =12%.XVI series non convertible debt.(redeemable at par
in three equal annual installments)
II.50 = = 12.2%XVII series non convertible debt.(redeemable at
par in three equal annual installments)
III.85 = = 12.2%XX series non convertible debt.(redeemable at
par in three equal annual installments of 35%, 35% and 30%
respectively)
IV.530 = = 12.28%XXVI series non convertible debt.(redeemable at
par in three equal annual installments)
V.240 = = 12.73%XXIII series non convertible debt.(redeemable at
par in three equal annual installments of 33%, 33% and 34%
respectively)
VI.390 = = 12.52%XXV series non convertible debt.(redeemable at
par in three equal annual installments)
VII.120.59 = = 12.19%(Series short term miner linked debt).
VIII.30 = = 12.56%XIII series non convertible debt have less
cost than other debt. Company only pay interest @ 12% p.a.
Cost of Debt.
cost of equity share capital:
Meaning Of Equity Share CapitalEquity share are those share
which are paid dividend only when profit left after the preference
share holders. There will be no fixed rate of interest. If company
not earn sufficient profit equity share holders will received
nothing. Equity share holders have voting rights.Kinds of Share
Capital :(1)Authorized or registered share capital.(2)Issued share
capital.(3)Subscribed share capital.(4)Called up share
capital.(5)Paid up share capital.(6)Reserve share capital.Cost of
Equity Share Capital :The cost of equity share capital is a
function of the expected return by its investors. The cost of
equity capital is not the out-of-pocket cost using equity share
capital as the share holders are not paid dividend at a fixed rate
every year. Payment of dividend is not a legal binding. It may or
may not be paid. But it does not mean that equity share capital is
cost free capital. Equity share holders is the owner of the
company. Equity share is the part of capital of company.there are
four method of computation of cost of equity share capital
:1.Dividend yield method or Dividend/Price ratio method2.Dividend
yield plus growth in dividend method3.Earning yield
method4.Realised yield methodDividend yield method or
Dividend/Price ratio method :The cost of equity capital is the
discount rate that equates the present value of expected future
dividend per share with the net proceeds or current market price of
a share.Assumptions :1.Dividend rate of company unchanged.2.Risk in
the company remains unchanged.Formula :
Ke = or D= Expected dividend per share NP=Net proceeds MP=Market
price per share.(Note : All the figures in crores).(For the year
2006-07)
Earning per share =
Earning per share = = 9.01 Rs. per share.
Ke= = 1.72%(For the year 2006-07)
Earning per share = = 9.02 per share.
Ke= = 1.72%(For the year 2007-08)
Earning per share = = 11.25 Rs. per share.
Ke= = 2.14%Conclusion :Every year earning per share increase in
2006-07 EPS 9.01 Rs. and in 2007-08 EPS is 11.24 Rs. Cost of equity
share also increase.Limitations of this method :It does not
consider future earning or retained earning.It does not consider
capital gain.This method suitable only when company has stable
earning and stable dividend policy over a period of time.
Dividend yield plus growth in dividend method :This method used
when the growth rate and dividend rate constant. According this
method the cost of equity capital is based on the dividend and the
growth rate.Formula :
Ke= + GD1=Dividend.Ke=Cost of equity capital.NP=Net proceeds per
price.G=Growth rate.(Grasim have not issued share on discount,
premium)
Ke= + GKe=Cost of equity capital.MP=Market price of
shareG=Growth rate(For the year 2006-07)
Ke= + 12% = 13.72%(For the year 2007-08)
Ke= + 12% = 13.72%(For the year 2008-09)
Ke= + 12% = 14.14%Earning Yield Method :
Ke=
(For the year 2006-07)
Earning per share =
Earning per share = = Rs. 9.01 Rs. per share.
Ke= = 1.72%(For the year 2007-08)
Ke= = 1.72%(For the year 2008-09)EPS=103/9.16 = 11.25 Rs. Per
Share.
Ke= = 2.15%Use of this method :Earning per share are expected to
remain constant.Companys pay-out-ratio is 100% or when retention
ratio is zero or all available profits distribute as dividend.
realised method :All Ist three method have some drawbacks
regarding future dividend and earning. It is not possible to
estimate future dividend and earning correctly, both of these
depend upon the many uncertain factors. This method remove all
drawbacks of 1st three method. In this method calculate actual
average rate of return realised in the past, dividend received in
past along with the gain realized at the time of sale of shares
should be considered.
cost of preference capitalmeaning of preference share
capital:Preference share are those which carry the followings two
right:1)Preference share holder have a right receive dividend at
fixed rate before equity shareholder.2)When company is wound up
preference shareholders have a right to the return of capital
before that of equity share.Cost of Preference Capital :A fixed
rate of dividend is payable on preference shares. Dividend is
payable at the discretion of the Board of directors and there is no
legal binding to pay dividend, yet it does not mean that preference
capital is cost free. In case dividends are not paid to preference
shareholders, it will be affect the fund raising capacity of the
firm. Hence, dividend are usually paid regularly on preference
share except when there are no profits to pay dividends.Formula of
Calculation cost of Preference Capital :
Kp=Kp=Cost of Preference CapitalD=Annual Preference
DividendP=Preference Share Capital(Preference shares are issued at
premium or discount of floatation cost are incurred to issue
preference shares).
Kp=NP=Net Proceeds
Some times Redeemable preference share are issued which can be
redeemed or cancelled on maturity date. The cost of redeemable
preference share capital can be calculated following formula :-
Kpr=Kpr=Cost of redeemable Preference SharesD=Annual Preference
Dividend.MV=Maturity value of preference sharesNP=Net Proceeds of
Preference shares.
(There is no preference share issued by Grasim Industries
Ltd.)
cost of retained earningmeaning of retained earning:Retained
earning those earning which is not distribute among shareholders.
Company retained earning for the contingency works, other works.
Main purpose of retained earning is for smoothing running the
business in future and fulfill their needs.
Kr= + GAfter Tax
Kr= + G. (1-t) . (1-b)B=Cost of purchasing new securities or
brokeragecosts.orKr=Ke (1-t) . (1-b)(For the year 2006-07)Kr=13.72%
(1 - .35) (1-0) = 8.92%(For the year 2007-08)Kr=13.72% (1 - .35)
(1-0) = 8.92%(For the year 2008-09)Kr=14.14% (1 - .35) (1-0) =
9.19%(Grasim Industries have not issued the share on discount or
premium)
computation of weighted average capitalmeaning of weighted
average cost of capital:
It is also known as composite cost of capital. In this method
weights are provide to specific cost of capital in proportion of
various sources of funds source. The weights may be given either by
using the book value or market value of the source. If there are
differences between both then difference case weighted average cost
of capital.Limitations :It is difficult to determine the market
value because frequent fluctuations.Formula :
Kw=W=Weight, proportion of specific source of finance.X=Cost of
specific source of finance.
CHAPTER 4findings , suggestions & conclusions
Companys gross profit is good.Company must increase its exports
as it has become more effective and catchy.Company should make
their profitability investment policies which gave more
profits.Company should give prefer to low rate loans such as bank
loan. Not be issued high rate of debentures.Company should be
issued preference shares.Company should not be distributed all
amount along shareholders some part of profit made reserve or keep
for contingency.As far as cost of equity share capital is concerned
I had found its satisfactory, but company should try to keep low
rate of debentures.
conclusionsCost of capital is a long term decision. It is very
important task for any company because more capital of company
involved in long term decision. A company takes wrong decision
regarding long term decision. Company should bear more loss on that
type decision.After Cost of Capital with Grasim Industries Limited
the conclusion that the firm is going successfully running.The
earning per share of Grasim Industries Limited increase. In 2006-07
EPS was 27 Rs. and in 2008-09 EPS is 59 Rs.The cost of debentures
is less than cost of equity capital. In 2008-09 cost of different
types debt. b/w 12% to 12.73% (red. in installments) and cost of
equity capital is 14.14% in 2008-09.The dividend per share also
increasing. In 2007-08 DPS was 8 Rs. and in 2008-09 dividend per
share 10 Rs.Number of debentures also increasing. In 2007-08
debentures was 1263.53 crores Rs. now it is 1398.54 Crores Rs.Last
five years equity share capital same. No new share issued in
market.
bibliography
Books :1.Gupta Sashik. (2005) Cost of Capital, Financial
Analysis, Page No. (17.1 to 17.30)2.Chandra Prasanna (1997) : The
Cost of Capital, Financial Management, Page No. (163-189).3.Khan
M.Y. & Jain P.K. (2000) Cost of Capital, Financial Management,
Page No. (7.1 to 7.58).
Annual Report of Grasim Industries Limited(Year 2006-07)(Year
2007-08)(Year 2008-09)
Websites :www.google.com/search/cost of
capitalwww.wiki.comwww.grasim.com
