PGDM Executive 2017-‘18

Corporate Finance

Estimation of Cost of Equity For EICHER

MOTORS

Submitted By: Abhinandan Jain (170301001)

Eicher Motors

Eicher Motors is the flagship company of Eicher Group which is the parent company of Royal
Enfield and is a leading player in Indian automobile industry.
The world’s oldest motorcycle brand in continuous production, Royal Enfield has made its
distinctive motorcycles since 1901. Royal Enfield operates in India, and over 40 countries
around the world. With development facilities in Leicestershire, UK and Chennai, India,
Royal Enfield makes its motorcycles in Tamil Nadu.
As per the stats the revenue of Eicher in 2016 was $1.4 Billion, operating income was $x66
Million and the net income was $52 Million.

CAPM
CAPM or Capital Asset Pricing model is a model that describes the relationship
between systematic risk and expected return for assets.
The formula for Cost of Equity is :
RiskFree Rate of Return + Beta * (Market Rate of Return – RiskFree Rate of Return).

### ####
𝒓𝒂 = 𝒓𝒇 + 𝜷(𝒓 𝒎 − 𝒓𝒇 )

Where
𝒓𝒇 = Risk free rate of return
𝜷=Beta value of stock
𝒓𝒎 =Market rate of return
Risk free return is the rate of return paid on risk free investments( like Treasuries).
The measure of risk ( Beta) is calculated as a regression on the company’s stock price.

The higher the value of beta the higher is the volatility and the relative risk as compared to
the general market

Generally , a company with a high beta has a high degree of risk, is going to pay more to
obtain equity.

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Cost of Equity of Eicher Motors.

1. To calculate to cost of equity the historical data of Eicher Motors has been taken
from Nifty 50 of the past 30 months.
2. Also the Stock market Index value has been taken from the Nifty 500 for the same
time period in order to compare with the market trend.
3. The log return of stock price and price market index has been calculated.
4. Then the regression analysis has been done to calculate the beta value. The result
obtained are as follows:

Keeping the objectives in view, the hypothesis for the regression is :

H0: There is no relationship between returns of stock and market returns.

Ha: There is a positive relationship between returns of stock and market returns

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R-squared is a statistical measure of how close the data are to the fitted regression line. For
Eicher Motors it can be seen that only 3.39 % of the stock price variation of Eicher Motors
can be explained by the NSE index movement.

Since the p value is greater than significance level(0.05) so the null hypothesis cannot be
rejected.

Risk Free Rate Calculation

Rf = YTM of 10Year Treasury bill – Liquidity premium
YTM Of 10 Year Treasury bill 7.94%
Liquidity Premium 1.20%
Rf 6.74%

Return of Market portfolio = Average monthly return from market x 12

= 0.1674 = 16.74%
Cost Of Equity = 6.74 + (16.74 – 6.74) x 0.4255
= 10.995 %

X Variable 1 Line Fit Plot

0.2

0.15

0.1

0.05

0 Y
Y

-0.08 -0.06 -0.04 -0.02 0 0.02 0.04 0.06 0.08 Predicted Y

-0.05

-0.1

-0.15

-0.2
X Variable 1

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Beta Value Analysis

Beta is the statistical measure which compares the volatility of a given stock against the
volatility of the market.

The market's beta is always 1 as it is the benchmark against which all the stocks are
compared.

When a stock has a beta greater than 1, it means the stock is expected to increase by more
than the market in up markets and decrease more than the market in down markets.

Conversely, a stock with a beta lower than 1 is expected to rise less than the market when
the market is moving up , but fall less than the market when the market is moving down.

Eicher Motors Limited shows a Beta of 0.4225.This is significantly lower than 1.

The volatility of Eicher Motors Limited according to this measure is significantly lower than
the market volatility

Conclusion

• The Beta value of Eicher Motors is less than 1 and so the stock is a conservative
stock.
• The growth of Eicher Motors is constrained due to the existing capacity .
• The industry is struggling to cope up with rising raw materials prices , however Eicher
Motor is able to maintain its margin due to improved realisation and cost
efficiencies.
• In commercial vehicle market in spite of maintaining the overall market share the
realizations have decreased due to prevailing discounts in the market.
• Eicher Motors is also a conservative stock due to increase in competition from other
vehicle manufactures.

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