Summer Training Presentation

On

Cost Of Capital
Of Shree Cememt Limited
From:- CHETAN PRAKASH SANKHLA

Shree Cement Ltd is a Rajasthan based company of Bangur Group, located at Beawar.

It started operations in the year 1985 and has been growing ever since.
It has been participating in the infrastructure transformation of India for over two decades now. It has installed capacity of 13 mn tonnes per annum . It will invest Rs 3,500 crore to expand its cement production capacity by seven million tonnes in the next five years. It is a leading cement manufacture company in North India.
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 The turnover of the company in 2009-10 was Rs 3,632 crore and it posted a net profit of Rs 676 crore

Its manufacturing units are located at Beawar, district Ajmer, and Ras, district Pali, in Rajasthan.
It also has grinding units at Khushkhera, district Alwar in Rajasthan, near Gurgaon. The company has also established two grinding units one at Suratgarh (Rajasthan) and another at Roorke (Uttaranchal).

It has three brands under its portfolio viz. Shree Ultra Jung Rodhak Cement, Bangur Cement and Rockstrong Cement.
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Cost Of Capital
The main objective of a business firm is to maximize the wealth of its shareholders in the long-run, the Management Should only invest in those projects which give a return in excess of cost of fund invested in the project of the business. The difficulty will arise in determination of cost of funds, if is raised from different sources and different quantum.

The various sources of funds to the company are in the form of equity and debt.
The cost of capital is the rate of return the company has to pay to various suppliers of fund in the company. There are main two sources of capital for a company shareholder and lender.
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An Example of Cost of Capital

For example if a firm borrows Rs. 5 crore at an interest of 11% P.A., then the cost of capital is 11%.

Hear its the essential for the firm to invest these Rs. 5 Crore in such a way that it earn at least Rs. 55 lacks i.e. rate of return at 11%. If the return less then this, then the rate of dividend which the share holder are receiving till now will go down resulting in a decline in its market value thus the cost of capital is the reward for the use capital.

SIGNIFICANCE OF CONCEPT OF COST OF CAPITAL

1. Designing the capital structure. 2. Capital budgeting decisions. 3. Comparative study of sources of financing. 4. Evaluations of financial performance of top management.

5. Knowledge of firms expected income and inherent risks.

6. Financing and Dividend Decisions.

Assumption of Cost of Capital

While computing the cost of capital, the following assumptions are made:

The cost can be either explicit or implicit.

The financial and business risks are not affected by investing in new investment proposals.

The firms capital structure remains unchanged.

Cost of each source of capital is determined on an after tax basis.

Costs of previously obtained capital are not relevant for computing the cost of capital to be raised from specific source.
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Computation of specific costs

A firm can raise funds from different sources such as loan, equity shares, preference shares, retained earnings etc. All these sources are called components of capital. Computation of specific cost of capital helps in determining the overall cost of capital for the firm and in evaluating the decision to raise funds from a particular source.

COST OF DEBT CAPITAL

Cost of Debt is the effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. This is one part of the company's capital structure, which also includes the cost of equity.

Much theoretical work characterizes the choice between debt and equity, in a trade-off context: Firms choose their optimal debt ratio by balancing the benefits and costs.

An Example of Cost of Debt

Example-: If a company issues 12% debentures worth Rs. 5 lacs of Rs. 100 each at par, then it must be earn at least Rs.60000(12% of Rs. 5 lacs) per year on this investment to maintain the income available to the shareholders unchanged. If the company earns less than this interest rate (12%) than the income available to the shareholders will be reduced and the market value of the share will go down. Therefore, the cost of debt capital is the contractual interest rate adjusted further for the tax liability of the firm.

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Computation of Cost of Debt

The Cost of Debt (before tax) can be calculated as below: Interest Expense of the company = ---------------------------------------Total Debt X 100

To get the after-tax rate, you simply multiply the before-tax rate by one minus the marginal tax rate.
Cost of Debt = (before-tax rate x (1-marginal tax))

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COST OF PREFERENCE SHARE CAPITAL

Preference share is another source of Capital for a company. Preference Shares are the shares that have a preferential right over the dividends of the company over the common shares. A preference shareholder enjoys priority in terms of repayment vis-vis equity shares in case a company goes into liquidation. Preference shareholders, however, do not have ownership rights in the company. In the companies under observation only India Cement has preference shares issued. Cost of Preference Capital = Preference Dividend/Market Value of Preference Shree Cement has not paid any dividend to the Preference Shareholders. Thus the Cost of Preference Capital is 0 (Zero).

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COST OF EQUITY SHARE CAPITAL

The computation of cost of equity share capital is relatively difficult because nether the rate of dividend is predetermined nor the payment of dividend is legally binding. When additional equity shares are issued, the new equity share holders get propranate share in future dividend and undistributed profits of the company. If reduces the earning per shares of existing share holders resulting in a fall in marker price of shares. Therefore, at the time of issue of new equity shares, it is the duty of the management to see that the company must earn at least so much income that the market price of its existing share remains unchanged. This expected minimum rate of return is the cast of equity share capital.

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Methods to calculate Cost of Equity

(1)Dividend yield method: Ke = DPS\mP*100 (2) Earning yield method: Ke= EPS\mp*100

(3) Dividing yield plus growth in dividend method :

Ke= DPS\MP*100+G

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COST OF EQUITY SHARE CAPITAL (KE)

Particular 2009-10

Dividend Per share method

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Earning Yeild Method

8.43

Dividend yield plus growth method

10.56

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WEIGHTED AVERAGE COST OF CAPITAL

Once the specific cost of capital of the long-term sources i.e. the debt, the preference share capital, the equity share capital and the retained earnings have been ascertained, the next step is to calculate the overall cost of capital of the firm. The capital raised from various sources is invested in different projects. The profitability of these projects is evaluated by comparing the expected rate of return with overall cost of capital of the firm.

The overall cost of capital is the weighted average of the costs of the various sources of the funds, weights being the proportion of each source of funds in the total capital structure.
Thus, weighted average as the name implies, is an average of the cost of specific sources of capital employed in the business properly weighted by the proportion they held in firms capital structure.

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WACC OF SHREE CEMENT LIMITED (2009-2010)

Source Amount Rs. (1) E.S. Capital Debentures Total (2) (3) .8322 .1678 1.00 Weights After tax Cost (4) Weighted Cost (5)= (3) * (4)

801268.41 161570.37 962838.78

10.56 05.65

8.79 0.95 9.74 9.74%

Weighted Average Cost of Capital (WACC)

WACC = (We * Ke) + (Wd * Kd) WhereWe = Weight of equity Wd = Weight of Debt. Ke = Cost of Equity Share capital Kd = Cost of Debt. capital WACC = ( 0.8322 * 10.56) +( 0.1678 *05.65 ) = 9.74%
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Conclusion
Cost of Debt is decreased in 2009-10 as compared to 200809.

Cost of Equity is also decreased in 2009-10 as compared to 2008-09.

And that is why the Overall Cost of Capital or Weighted Average Cost of Capital is also decreased. Because, companys debentures is decreased and earning per share and dividend per share is increased from the previous financial year.

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Thank You

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