ON

(2008-09)

ACCURATE INSTITUTE OF MANAGEMENT AND TECHNOLOGY, GREATER NOIDA

(2008-2010)

Submitted To: R.S Tiwari

Submitted By:

HOD, MBA Deptt.

Pradeep Kumar Roll No. 0822570030

ACKNOWLEDGEMENT
In an organization, be it an industry, a school or society, no outcomes can be achieved by one man working in isolation. Its always a group working and achieving the outcome in totality. It is the outcome of all the guidance and support that I received from this organization. I would like to thank Mr. S.K. Das, G.M. (Training) for having arrangement my training in this organization. I would like to thank Mr. D.C. Kabra, Vice President (Fin. & A/Cs) for giving me a chance to work with this organization and for extending words of encouragement and wisdom. I am also thankful to Mr. Gopal Purohit, G.M. (Fin. & A/Cs), other members of the Finance & Accounts Department for making available all resources required for the completion of this project report. I would like to thank Mr. Vimal Raheja, Assist. Manager (Account &Finance). His valuable guidance and constant encouragement have helped me tremendously in the completion of this project. In the last I would like to thank Mr.S.N.Roy (Lyzing Officer, Personal) Who had helped me a lot by providing information & suggestions. Last but not the least I would like to thanks my teachers without whose feedback and encouragement, this project would not has been possible. Their help has gone a long way in successful completion of my project.

TABLE OF CONTENTS PAGES Chapter No. 1

Company Profile 4-18

Chapter No. 2
Objective of Study & R.M. 19-21

Chapter No. 3
Capital Structure Leverage Analysis EBIT-EPS Analysis Cost Of Capital Ratio Analysis 22-29 30-33 34-36 37-46 47-55

Chapter No. 4
Findings, Suggestion & Conclusion 56-59

Chapter No. 5
Annexure 60-64

Chapter No. 6
Bibliography 65-66

Chapter No. 1

COMPANY PROFILE

ADITYA BIRLA GROUP

INTRODUCTION
The Aditya Birla Group is India's first truly multinational corporation. Global in vision, rooted in values, the Group is driven by a performance ethic pegged on value creation for its multiple stakeholders. A US$ 28 billion conglomerate, with a market capitalisation of US$ 26 billion and in the League of Fortune 500, it is anchored by an extraordinary force of 100,000 employees belonging to over 25 different nationalities. Over 50 per cent of its revenues flow from its operations across the world. The Group's products and services offer distinctive customer solutions worldwide. Its 85 state-of-the-art manufacturing units and sectoral services span 20 countries India, Thailand, Laos, Indonesia, Philippines, Egypt, Canada, Australia, China, USA, UK, Germany, Hungary, Brazil, Italy, France, Luxembourg, Switzerland, Malaysia and Korea. A premium conglomerate, the Aditya Birla Group is a dominant player in all of the sectors in which it operates. Among these are viscose staple fibre, metals, cement, and viscose filament yarn, branded apparel, carbon black, chemicals, fertilisers, insulators, financial services, telecom, BPO and IT services. The Hewitt-Economic Times and Wall Street Journal Study 2007 have adjudged the Group the best employer in India and among the top 20 in Asia. Globally the group is: A metals powerhouse, among the worlds most cost-efficient aluminium and copper producers. Hindalco, from its fold, is a Fortune 500 company. It is also the largest aluminium rolling company and one of the three biggest producers of primary aluminium in Asia, with the largest single location copper smelter No.1 in viscose staple fibre

 The third largest producer of insulators The fourth largest producer of carbon black The eleventh largest cement producer and the second largest in India Among the best energy efficient fertiliser plants Among the world's top 15 and India's top three BPO companies In India, the Group holds a frontrunner position as: Indias leading copper producer A premier branded garments player The second largest player in viscose filament yarn The second largest in the chlor alkali sector Among the top five mobile telephony players A leading player in life insurance and asset management

Beyond business
A value-based, caring corporate citizen, the Aditya Birla Group inherently believes in the trusteeship concept of management. Parts of the Groups profits are ploughed back into meaningful welfare-driven initiatives that make a qualitative difference to the lives of marginalised people. These activities are carried out under the aegis of the Aditya Birla Centre for Community Initiatives and Rural Development, which are spearheaded by Mrs. Rajashree Birla.

Indian Roots
Company Grasim
::

UltraTech Cement Ltd*

Products / services Viscose staple fiber, rayon grade pulp, cement, chemicals, sponge iron, textiles Ordinary Portland cement, Portland blast furnace slag cement, Portland pozzolana cement and grey Portland cement

Shree Digvijay Cement* Hindalco :: Indian Aluminium Company Ltd* :: Bihar Caustic and Chemicals Ltd* Aditya Birla Nuvo
:: :: :: :: :: :: ::

::

Idea Cellular Ltd. Aditya Birla Insulators Limited Birla Sun Life Insurance Co.Ltd** Birla Sun Life Asset Management Company Ltd.** Birla Sun Life Distribution Company Ltd.** PSI Data Systems* TransWorks*

Cement and clinker aluminium, copper aluminium foil Caustic soda Garments, viscose filament yarn, carbon black, textiles Cellular telecommunications Insulators Insurance Mutual funds Investment planning services Application development, maintenance and enhancement solutions Customer relations management (CRM) services inbound customer service, including technical support; email / web-chat support; and outbound telemarketing. Asset-based finance, corporate finance and investment banking, capital market, treasury. Non-life insurance advisory services Garments Carbon black Multi-format stores Fluorine chemicals Iron and manganese ore mining, noble Ferro alloys, nitrogen production

:: ::

Birla Global Finance Ltd*

Birla Insurance Advisory Services Ltd :: Madura Garments :: Hi Tech Carbon Aditya Birla Retail Tanfac Industries Ltd.** Essel Mining & Industries Ltd

Joint Venture
Company Birla Sun Life Insurance Company Ltd. Tanfac Industries Ltd. Partner Sun Life (Canada) Key products / services Insurance solutions

Birla Sun Life Asset Management Company Ltd. Birla Sun Life Distribution Sun Life (Canada)

TIDCO (Tamil Nadu Industrial Fluorine chemicals Development Corporation) Sun Life (Canada) Mutual funds Investment planning services

Great Employer

Maybe you would like to take a crash course on branding, run a marathon or even go deep into the hinterland to manage a water conservation project, or probably do all of these while working quietly on a global acquisition. At the Aditya Birla Group, opportunities are only limited by your imagination. The $12 billion Indian conglomerate was ranked number one in India and among the best in Asia by Hewitt in their Best Employers Survey 2007. The India winners were chosen after a six-month long intensive research that included 230 participating companies and more than 44,000 respondent employees, representing the views of more than one million employees. The Best Employers in Asia study spanned some of the most dynamic markets in Asia attracting more than 750 employers. What is the DNA of a best employer? Contrary to the popular belief, its not a lifetime employment guarantee or remuneration but an organizations ability to provide customized solutions to an employees unique situation. Given the diverse range of organizations represented in the Best Employers in India list, to be the best, parameters like industry size, ownership and legacy didnt matter. But what did, were metrics like employee engagement and alignment, opportunities for growth and development, performance differentiation, quality of HR initiatives and employee diversity.

THE JOURNEY OF SUCCESS OF ADITYA BIRLA GROUP

The Aditya Birla Group, India's first multinational corporation, traces its origins back to the tiny village of Pilani in the Rajasthan desert, where Seth Shiv Narayan Birla started cotton trading operations in 1857. Today, the Group's footprint extends to 20 countries and its revenues are US$ 24 billion. We retrace the highlights of this remarkable journey, starting from the present: 2008 With the acquisition of novelis Hindalco has become the worlds largest rolling company. Hindalco is now a global player with a strong presence in five continents and is in the leageus of the top 7 global players. It product portfolio is a natural hedge against the volatility of the LME . 2007 :: In May 2007, Novelis became a Hindalco subsidiary with the completion of the acquisition process. The transaction makes Hindalco the world's largest aluminium rolling company and one of the biggest producers of primary aluminium in Asia, as well as being India's leading copper producer.

2006 :: Grasim Industries Limited, India; Thai Rayon Public Company Limited, Thailand and

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P.T. Indo Bharat Rayon, Indonesia form a JV with Hubei Jing Wei Chemical Fibre Company, China, for VSF. :: Hindalco awarded the Greentech Safety Silver Award for its outstanding safety performance during 2005-06. 2005 :: Indian Rayon re-christened as Aditya Birla Nuvo. :: Aditya Birla Group to set up a world-class aluminium project in Orissa. :: The Aditya Birla Group signs a framework agreement to acquire St Anne Nackawic Pulp Mill, Canada. 2004 :: Board reconstituted with Mr. Kumar Mangalam Birla taking over as Chairman. :: Completion of the implementation process to demerge the cement business of L&T and completion of open offer by Grasim, with the latter acquiring controlling stake in the newly formed company UltraTech. :: Grasim, Nagda, received the FICCI Annual Award 2003-2004 in recognition of corporate initiative in rural development. :: Bihar Caustic and Chemicals Ltd., Rehla, Jharkhand, has received the FICCI Annual Award 2003-2004 in recognition of corporate initiative in family welfare. :: Hindalco receives India CFO Award 2004 for excellence in finance in a large corporate. :: Scheme of Arrangement announced to merge Indal with Hindalco. :: Indian Rayon completes its Brownfield expansion of 40,000 TPA at Hi-Tech Carbon, Gummidipundi, taking total capacity to 1,60,000 TPA. :: Deming Award for Indo Gulf. :: Indal wins FICCI Award 2002-2003 for 'Corporate Initiative in Rural Development'. 2003 :: Mr. Kumar Mangalam Birla, Chairman of the Group, is selected as Business India's Businessman of the Year - 2003. :: Mr. Kumar Mangalam Birla is selected as The Economic Times' Business Leader of the year. :: The Group is ranked 16th in India's first ever survey of 'Great places to work in', published in Business World magazine. The Group's joint venture concern, Birla Sun Life Insurance, is ranked 9th in the same study. :: The Group is ranked 20th in a study on the 'Best Employers in India', conducted by Hewitt Associates and Business Today. :: Hindalco receives the Asian CSR Award for its "Rural Poverty Alleviation Programme". The Asian CSR Awards are Asia's premier awards programme on Corporate Social Responsibility. :: The Group acquires the Mount Gordon Copper mines in Australia, another strategic step in becoming a globally competitive copper player. :: Liaoning Birla Carbon, the Group's first carbon black company in China, is

11

incorporated. :: Indian Rayon acquires TransWorks, a leading Indian ITES / BPO company.

SECTORWISE TURNOVER OF ADITYA BIRLA GROUP

The data on this page reflects the Group's operations for FY 2007-08

ALUMINIUM
Hindalco is Asias largest primary producer of Aluminium and among the most cost-efficient producers globally. Hindalco enjoys a leadership position in primary aluminium and downstream products.

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companys integrated complex at Renukoot houses an Alumina refinery, Aluminium Smelter and facilities for production of semi fabricated products. Power is sourced from the Companys captive power Plant at Renusagar, located at distance of about 45 km from Renukoot. The Plant has a current generation capacity of 854 MW having 10 power generating units. Excellent operation standards have ensured a consistent plant load factor of over 90%. The integrated complex at Renukoot also houses two co-generation plants of 37.5 MW and 41 MW capacities respectively. Besides the integrated complex at Renukoot, Hindalcos other manufacturing facilities are located at many diverse locations in the country. Smelters are located at Hirakund, Orissa, with a captive power plant and coal mines and at Alupuram, Karla. Rolled Product facilities are located at Belur and Latoya and an Extrusions plant at Alupuram.

Production of Aluminium
Extracting Alumina from bauxite, and then smelting the alumina into aluminium, produces primary aluminum. The extraction is alumina is accomplished through a chemical process. This begins when bauxite chunks are crushed on wet ground to form slurry, which is fed into digesters, where the alumina contents of bauxite are dissolved in caustic soda and the slurry is separated into red mud and sodium alumina solution. Alumina hydrate is filtered and washed free of caustic soda and then calcined in gas suspension calcine to produce calcined alumina. In the final stage of aluminium production, calcined alumina is smelted into molten primary aluminium into rods of electrolytic cells; the alumina is dissolved in molten cryolite (Aluminium fluoride). The reaction in the cells is powered by electricity carbon anodes are used in the process. The molten aluminium is crucibles are poured modules to form ingots or billets of various sizes or transferred for further processing into semi-fabricated products. It takes the company approximately two tons of yield one ton of primary aluminium. Aluminium is the primary product of Hindalco. It has following characteristics: It is light; its density is only 1/3rd of steel. It is resistant to weather. It can be used in contact with a wide range of foodstuff.

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 It has a high reflective and finds many decorative uses. It alloys can equal or even exceed. The strength of normal construction steel. It is highly elastic. It keeps its toughness down to very low temperatures. It is easily worked and formed; it can be rolled to very thin foil. It conducts electricity and heat nearly as well as copper.

Raw Materials
Bauxite Hindalco obtained about 65% of its Bauxite requirement from its own mines and purchased around 35% of the Bauxite from the market. Caustic Soda To Cates its caustic soda need the company has set up BCCL (Bihar Caustic and Chemical Ltd.) in joint venture with the state government of Bihar. BCCL Cates around 90% of the caustic needs of Hindalco. Rest is purchased from the Kanoria Chemicals and Industries Ltd. Renukoot. CP Coke CP coke is baked with hard pitch to make carbon anodes, which are used in the process of electrolysis. Aluminium fluoride It is used in the smelting process. The company buys almost all of its aluminium fluoride from Tanfac Industries Ltd. Hard Pitch It is used along with CP Coke to make carbon anodes for the smelting processes. Power Power plays a vital role in the aluminium industry. It takes 16000 KW of power to produce one ton of aluminium. Hindalco has its own captive power plant of 900 s MW situated 35 km from its main plant at Renusagar. Hindalco also buys the deflect power from the state government of U.P.

14

Financial performance. Net sales and turnover from aluminium business in fy-08 stood at Rs71450 million as compared with Rs73444 in FY-07 A DROP OF 3%, primarily on account of a sharp decline in domestic metal realization , primarily a fall out of sharp depreciation in US $ even as LME was almost flat . in US $ terms the revenues increased by 9%. Earning before interest & taxes(EBIT) declined by 17% to Rs 24,231 million due to pressure on realization and increased costs. The cost increase was primarily on account of a sharp surge in crude prices , which resulted in high prices of its derivatives and also increased prices of alternative fuel such as coal. Aluminium producers across the globe experienced a sharp fall in EBIT.

COPPER
Copper Business
The copper business faced one of the most trying years in its entire nine years history. Despite the high prevailing copper prices and improved long term and spot Tc/Rc as compared to the previous year, business suffered on account of difficult operating conditions.

Production
The copper business suffered production disruption on account of various problems both external and internal. The heavy rainfall in the state of Gujarat during the first week of July resulted in flooding of plant as well as the neighbouring areas. Road transportation was cutoff resulting in serious dislocations in the movement of essential input and personnel not getting access to the site. The 180,000tpa Smelter 1 had been working at less than optimal levels due to longer campaign runs and underwent a 25 days over due BI-annual maintenance Shutdown in the months of November- December 2005.

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Companys new smelter was commissioned in july2005.the commissioning of new copper smelters always associated with a long-drawn ramp up process, and the experience at Dahej was no exception.

Profitability
Net Sales and Operating Revenue fdxc Net sales and operating Revenue for the year 2007-08 increased by 5% YOY on the back higher volumes increased VAP tonnage and higher mark ups for both metals. A large increased in Net Sales and Operating Revenues was though negated by a sharp decline in US doller. Net profit increased 12% to Rs.28609 Million on account of tax adjustment for earlier year. Cash profit increased from Rs.32,024 Million to Rs.34487 Million.

Production Capacity
Division
Alumina Chemicals Primary Aluminium Extrusions Rolled Products Wire Rods

Capacity
1,60,000 tpa 4,45,000 tpa 42,000 tpa 2,00,000 tpa 64,400 tpa

Location
7,00,000 tpa (Renukoot) , 1,10000 tpa (Muri) 3,50000 tpa (Belgaum) 3,45,000 tpa (Renukoot) , 1,00,000 tpa (Hirakund) 14,000 tpa (Alupuram) 30,000 tpa (Renukoot) , 12,000 tpa (Alupuram) 80,000 tpa (Renukoot) , 45,000 tpa (Begum) 45,000 tpa (Taloja) , 3,00,000tpa(mouda) 40,000 tpa (Renukoot) , 10,000 tpa (Alupuram) ,14,400 tpa(mouda)

16

Aluminium foil Aluminium Wheels Copper Cathodes Power

11,000 tpa 3,00000 tpa 5,00000 tpa 187.2mw

5,000 tpa (Silvassa) , 6,000 tpa (kalwa) Silvassa Dahej 741.7mw (Hirakud) (Renu Sagar), 78mw (Renukoot),267.5mw

BUSINESS PERFORMANCE REVIEW

As stated earlier, Company has recorded its best ever performance during fiscal 2007-08.A snapshot is provided below Aluminium Rs. Mn Share & 71,450 37.43% 24,231 82.80% 33.91% 71,414 37.19% 33.93% Copper Rs. Mn. Share 120,655 62.81% 5,034 12.20% 4.17% 1,20,596 62.81% 4.17% Unallocable Total Rs. Mn (94) 3,797 _ 85,275 192,105 29,265 38.08% 1,92,010 17.93%

Net Sales Operating Revenue EBIT EBIT Margins(%) Capital Employed ROCE(%)

Graphical Representation of EBIT

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FY08

PRIMARY ALUMINIUM PRODUCTS OF HINDALCO

Hindalco is a dominant player in primary aluminium, with over 42 per cent market share. Its product range includes

Ingots
Hindalco produces high purity ingots through the smelting process. Alloy ingots of various grades are also produced mainly used for production of castings in Auto Industry as well as electrical applications. Both these products are re-melted and further processed into a large number of products for various downstream applications. Hindalco's metal is a registered brand at London Metal Exchange (LME).

Wire rods
Hindalco manufactures wire rods, in a continuous casting and rolling process. Electrical Conductor (EC) wire rods are used for the production of cables, ACSR and AAC conductors. Alloy wire rods are used to produce AAAC conductors.

Billets
Hindalco's aluminium billets are produced by a state-of-the-art Wagstaff casting process using Airslip technology. These are top quality billets with a smooth surface finish. Billets are used mainly for producing extrusions and forgings.

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Hindalco Extrusions are manufactured from high-quality billets made out of virgin in-house metal. They have found applications in a wide spectrum of segments, such as, architectural, electrical, industrial, transport, defence and consumer durables among others. Hindalco Extrusions is a leading brand in each of these segments.

HINDALCOS ROLLED PRODUCTS

Hindalco is the world's largest aluminium rolling company with the acquisition of Novelis, the global leader in value-added high-end aluminium flat rolled products and aluminium can recycling. The combined volume of sales of flat rolled products in the world market is about 3 million tonnes and the market share is more than 20 per cent. Hindalco is the largest manufacturer of the entire range of flat rolled products in India. It enjoys nearly 60 per cent of market share and its rolled products are widely used in various segments such as packaging, transportation, building and construction, electrical, defence and general engineering applications. The company's commitment to quality and service along with its extensive infrastructure has made Hindalco a prime source for best-selling brands. Continuous improvements in manufacturing, processes, practices and systems ensure that customers' needs and expectations are fully met.

FOIL AND PACKING,

Hindalco's Foils and Packaging Division operates out of three modern, well-equipped plants located at Kalwa in Maharashtra, Silvassa in Dadra & Nagar Haveli and its subsidiary unit Indal Kollur, in Andhra Pradesh. The 'TriPlant' advantage gives the Hindalco Foil marketing team a seamless 'One Stop Shop' approach to an entire range of products. All plants employ high-end technology and professional expertise to develop visually appealing and functionally useful packaging. Delivering 'not-tried-before' solutions to customers in India and across the globe, Hindalco's Foil and Packaging Division has the distinction of being India's leading supplier of foil laminates plain, lacquered and printed. Hindalco's complete backward integration, right down to the raw material stage from bauxite ore to primary metal, guarantees full control over the quality of the final foil output.

ALLOY WHEELS

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Hindalco manufactures world-class aluminium alloy wheels at its stateof-the-art foil plant located at Silvassa, Dadra and Nagar Haveli, where alloy wheels and aluminium foil are produced. This has helped the company to optimise capacity and enhance the share of value-added semi-fabricated products. The 300,000-piece alloy wheel plant is progressively increasing production. Branded as Aura alloy wheels, these high performance wheels are available for nearly all vehicles running on the Indian roads. Maruti-Suzuki, Tata Motors, Fiat India and HMMitsubishi India have already approved them for original equipment supplies. The vendor approval process is on with a number of other automobile manufacturers.

CONCLUSION
As the conclusion the company has delivered a record performance amidst challenging business environment. The company has challenged out expansion in alumina and aggressive growth plans in aluminium. The efforts will be collected by an excellent proportionate relationship between equity and debt. Therefore the company is evident of success of these efforts in transforming the company to the league of Global Top-10 in both the metal and deliver superior value to stakeholders even in the future.

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Chapter No. 2

OBJECTIVE OF STUDY & RESEARCH METHODOLOGY

21

OBJECTIVE OF STUDY
To know about the capital structure and combination of debt and equity. The objective of study involves understanding of different aspect of capital structure. To study the different aspect related to capital structure of Hindalco Industries Limited which contributes most to make Hindalco one of the lowest cost producers in profit involving organization in the world. To have deep study about the financial leverage of the organization To study various approaches to establish target capital structure.

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RESEARCH METHODOLOGY
Research methodology used here is purely exploratory. It is used when one is seeking into the general nature of the problem, possible decisions alternatives and relevant variables that need to be considered The research methodology is highly flexible, unstructured and qualitative. Exploratory research hypothesis are either vague or ill defined, or they do not exists at all.

Sampling Plan
There has been no sampling plan as such as the study involved understanding the various process and analysing them. The study involved the detailed analysis of secondary data calculated from various sources and therefore no sample size and plan has been considered.

Data Source
Data has been collected trough literature survey and expert opinion. Literature survey includes the collection of data from various sources like study material. The part of data is collected from primary source and other from secondary source.

Primary source
Information gathered by interview and discussing with the members of department.

Secondary source
Company annual report Selected books and magazines.

Data Analysis
To analysis data I use different financial tools and techniques.

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Chapter No. 3

CAPITAL STRUCTURE
Meaning of capital structure Pattern of capital structure Optimum capital structure Sources of funds Equity verses Debentures FRICT Analysis Theories of Capital structure

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CAPITAL STRUCTURE
INTRODUCTION
For the establishment of a firm, assets are required and assets of the company can be financed either by increasing owners claim or creditors claim. The owners claim increase when firm raises fund by issuing ordinary shares or by retaining the earning; the creditors claims increases by borrowing. The various means of financing represent the financial structure of the enterprise.

MEANING
Capital structure refers to the mix of sources from where the long-term funds required in the business may be raised. Simply put, capital structure is used to represent the proportionate relationship between debt and equity. Equity includes paid up share capital, share premium and retained earnings. Capital structure decision is a significant decision. It influences shareholder return and risk. Consequently, the market value of share may be effected capital structure decision. The company have to plan its capital structure initially at the time of promotion. Consequently, whenever funds have to be raised to finance investments, a capital structure decision is involved. A demand for raising funds generates a new capital structure a decision has to be made to the quantity and forms of financing. This decision will involve an analysis of the existing capital structure and the factors, which will govern the decision at present. The companys policies to retain or distribute earnings affect the owners claim. Shareholders equity position is strengthened by retention of earning. Thus, the dividend decision has a bearing on the capital structure of the company. The new financing decision of the company may be its debt-equity mix. The debt equity mix has implications for the shareholders earnings and risk, which in turn will affect the cost of capital and the market value of the firm.

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PATTERNS OF THE CAPITAL STRUCTURE

In case of new company, the capital structure may be of any of the following patterns: Capital Structure with equity shares only Capital Structure with equity and preference shares Capital Structure with equity and debentures Capital Structure with equity, preference shares and debentures Debt is the liability on which interest has to be paid irrespective of the company profits. While equity consists of shareholder or owners funds on which payment of dividend depends upon the companys profit. A high proportion of debt content in the capital structure increases the risk and may lead to financial insolvency in adverse time. However, rasing fund through debt is cheaper as compared to financing through shares. This because figure-3 interest on debt is allowed as an expense for taxes purpose. Dividend is considered to be an appropriation of profits; hence payment on dividend does not result in any tax benefit to the company. This means if accompany, is in 50% tax bracket, pays interest at 12% on its debentures, the effective cost to it comes only 6% while if the amount is raised by 12%Preference shares, the cost of raising the amount would be 12%. Thus rasing the funds by borrowing is cheaper resulting in higher availability of profit for shareholders. This increases the earning per share of the company, which is the basic objective of the finance manager.

OPTIMUM CAPITAL STRUCTURE

A firm should try to maintain an optimum capital structure with a view of to maintain financial stability. The optimum capital structure is obtained when the market value per equity share is the maximum. It may be defined as that relationship of debt and equity securities which maximizes the value of a companys share in the stock exchange. In case a company borrows and this borrowing helps in increasing the value of companys share in the stock exchange, it can be said that the borrowing has helped the company in moving towards its optimum capital structure; In case, the borrowing results in fall in market value of the companys equity shares, it can be said that the borrowing has moved the company from its optimum capital structure.

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The objective of the firm should therefore be to select the financing or debt equity mix, which will lead to maximum value of the firm.

CONSIDERATION
The following considerations will greatly help a finance manager in achieving his goal of optimum capital structure: We should take advantage of favourable financial leverage. We should take advantage of the leverage offered by the corporate taxes. We should avoid a perceived high risk capital structure.

SOURCES OF FUNDS
Security financing- This includes financing through shares including both equity and
preference shares and debentures. Internal Financing This includes financing through depreciation funds and retained earnings. Loan Financing- This includes both short term and long-term loans.

Sources of Funds

Security Financing

Internal Financing

Loan Financing

EQUITY SHARE VERSUS DEBENTURES

A company may prefer financing through debenture as compared to equity shares on account of following reasons: Interest on debenture is allowed as an expense for tax purpose. Debenture holds have generally no say in the management of the company Underwriters may have little hesitation in accepting the companys proposal since debentures are adequately backed by the companys assets. Moreover, the company may find it beneficial to pay short-term loan by raising funds through debentures at a time when interest rates on such loans are higher as compared to the interest rate payable on the debentures. However, the company cannot go an unlimited extent of financing through debentures. It has to strike a balance between risk and saving effected by

27

raising funds through debentures. The ultimate objective is to maintain unbalanced Capital Structure.

MAJOR CONSIDERATION IN CAPITAL STRUCTURE PLANNING:

There are three major considerations, i.e. risk, cost of capital and control, which help the finance manager in determining the proportion in which he can raise funds from various sources. Although, three factors, i.e. risk, cost and control determining the capital structure of a particular business undertaking at a given point of time. The finance manager attempts to design the Capital Structure in such a manner that his risk and costs are the least and the control of the existing management is diluted to the least extent.

RISK
Risk is of two kinds, i.e., financial risk and business risk. Here we are concerned primarily with the financial risk. Financial risk also is of two types.

RISK OF CASH INSOLVENCY

As a firm raises more debt, its risk of cash insolvency increases. This is due to reasons. Firstly, higher proportion of debt in the Capital Structure increases the commitments of the company with regarded to fixed charges this means that a company stands committed to pay a higher amount of interest irrespective of the fact whether it has cash or not. Secondly, the possibility that the supplier of funds may withdraw the funds at may give point of time. Thus the long-term creditors may have to be paid back in instalments even in instalments even if sufficient cash to do so does not exist. This risk is not there in the case of equity share.

RISK OF BARIATION IN THE EXPECTED EARNING TO EQUITY SHARE- HOLDER:

In case a firm has higher debt contenting Capital Structure. The risk of variation in expected earning available to equity shareholder will be higher. This is because of trading of equity. We have already seen earlier that financial leverage works both ways, i.e. it enhances the shareholders returns by a higher or lower than the rate of interest. Thus there will be lower probability that equity shareholder will enjoy a stable dividend if the debt content is higher in the Capital Structure. In other words the relative dispersion of expected earning available to equity shareholder will be greater if the Capital Structure of a firm higher debt content.

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COST OF CAPITAL
Cost is an important consideration in capital structure decision. It is obvious that a business should be at least capable of earning enough revenue to meet its cost of capital and finance its growth. Hence, along with a risk as a factor; the finance manager has to consider the cost aspect carefully while determining the Capital Structure.

CONTROL
Along with cost and risk factor, the control aspect is also an important consideration in planning the Capital Structure. When a company issues further equity share. It automatically dilutes the controlling interest of the present owners. Similarly, preference shareholders can voting rights and thereby affect the composition of the Board of Directors in case dividend on such share is not paid for two consecutive years

TRADING ON EQUITY:
A company may raise funds either by the issue of shares or by borrowings. Borrowings carry a fixed rate of interest and this interest is payable irrespective of fact where there is profit or not. Preference shareholders are also entitled to a fixed rate of dividends but payment of dividend is, subject to the profitability of the company. In case of rate of return on the total capital employed i.e. shareholders funds plus long term borrowings, is more than the rate of interest on borrowed funds or rate of dividends on preference shares, it is said that company is trading on equity.

CURRENT YEAR (2007-2008)

32%

67%

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The graph above clearly depicts that the proportion of debt in the financing mix of Hindalco is much more as compared to share capital. The debt content is 37% whereas the proportion of share capital and reserves and surplus is 1% and 62% respectively.

s2003-04 to 2007-08
Capital Structure of Hindalco for Four Years
140000 120000 100000 80000

Proportion 40000 of Financial 20000 Mix

0

60000

FY-08 1226
171736 83285

200607 1043

200506 986

200405 928 75644 38000

200304 925 67654 25646

Share Capital Reserves Loan Fund

123137 95077 73686 49034

Share Capital Reserves Loan Fund

Years

THE FRICT ANALYSIS

A financial structure may be evaluated from various perspectives from owners point of view, return; risk and value are important consideration. From the strategic point of view, flexibility is an important concern and flexibility assumes great significance. A sound capital structure will be achieved by balancing all these consideration: FLEXIBILITY: the Capital Structure should be determined within the debt capacity of the company and this capacity should be flexible. It should be possible for a company to adapt its Capital Structure within a minimum cost and delay if warranted by a changed situation. RISK: risk depends on the variability in the firms operation. It may be caused by macro economic factor and industry and firms specific factor. The excessive use of debt magnifies the variability of shareholders earnings and threatens the solvency of the company.

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 INCOME: The Capital Structure of the company should be most advantageous to the owners of the firms. It should create value; subject to other consideration. It should generate maximum return to the shareholders with minimum additional cost. CONTROL the Capital Structure should involve the minimum risk of loss of control of the company. The owner of closely held companies is particularly concerned about dilution of control. TIMING: The Capital Structure should be feasible to implement given the current and future condition of the capital market. The sequencing of source of financing is important. The current decision influences the future option of raising capital. The FRICT analysis provides the general framework for evaluating firms Capital Structure.

THEORIES OF CAPITAL STRUCTURE

The objective of firm should be directed towards the maximisation of the value of the firm, the Capital Structure, or leverage decision should be examined from the point of view of its impact on the value of the firm. If the values of the firm can be affected by Capital Structure or financing decision, a firm would like to have a Capital Structure, which maximize the market value of the firm. There are broadly four approaches in this regard. These are: Net Income Approach Net Operating Income Approach Traditional Theory Modigliani-Miller Approach These approaches analysis relationship between the leverage, cost of capital and the values of the firm in different way. However, the following assumptions are made to understand these relationships. 1. There are only two source of funds i.e. debt and equity 2. The total assets of firm are given. The degree of leverage can be changed by selling debt to repurchase shares or selling shares to retire debt. 3. There are no retained earnings 4. The operating profit of firm is given and expected to grow. 5. The business risk is assumed to be constant and is not affected by the financing mix decision. 6. There are no corporate taxes.

31

7. The investors have the same subjective probability distribution of expected earnings.

LEAVERAGE ANALYSIS

Financial leverage

Relationship between financial leverage & rate of return.

Determination of whether Hindalco is trading on Equity.

32

LEAVERAGE ANALYSIS
Financial leverage is defined as the ability of a firm to use fixed financial charges to magnify the effect of change in E.B.I.T on the firms earning per share. The financial leverage occurs when a firms Capital Structure contain obligation of fixed financial charges. For instance, interest on debentures, dividend on preference share etc., along with owners equity to enhance earning of equity shareholders. The fixed financial charges do not vary with the operating profit. They are fixed and are to be paid irrespective of level of operating profit. The ordinary shareholders of firm are entitled to residual income i.e. earning after fixed financial charges.

Favourable and Unfavourable Financial leverage

Financial leverage may be favourable or unfavourable depending upon whether the earning made by the use of fixed interest or dividend bearing securities exceeds the explicit fixed cost, the firm has to pay for the employment of such funds or not. The leverage will be considered to be favourable so long the firm earns more on assets purchased with the funds than the fixed cost of their use. Unfavourable leverage occurs when the firm does not earn as much as the funds cost.

Significance Of Financial Leverage

Financial leverage help in deciding the appropriate Capital Structure. One of the objectives of planning an appropriate Capital Structure is to maximize the return on equity shareholders funds or maximize the earning per share. Financial leverage is double-edged sword. On one hand, it increases the earning per share and on the other hand it increases the financial risks high financial leverage means high fixed financial cost and high financial risk i.e. as the debt content in Capital Structure increases, the financial leverage increases and at the same time the financial risk is also increases i.e. risk of insolvency increases. The finance manager is required to trade-off between risk and return for determining the appropriate amount of debt.

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(Rs. in Millions)i
Particulars Net sales & operating income Total expenditure Operating profit Other income Depreciation EBIT Interest charges PBT Degree of financial leverage 2007-08 2006-07 1,92,010 183130 157999 34011 4929 5878 33062 2806 30256 1.09 2005-06 113965 2004-05 95231 (72465) 22766 2700 (4633) 20833 (1700) 19133 1.09 2003-04 62262 (47113) 15149 2093 (3174) 14068 (1612) 12456 1.13

(142980) (87914) 40150 3701 (6381) 37470 (2424) 35046 1.07 26051 2439 (5211) 23279 (2252) 21027 1.11

Relationship between financial leverage & required rate of return

Financial leverage of Hindalco

1.13 1.12 1.11 1.10 1.09 1.08 1.07 1.06 1.05 1.04 1.03 2006-07 2005-06 2004-05 2003-04

Degree of financial leverage

Degree of financial leverage

Years

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Relationship between financial leverage and firms required rate of return to equity shareholders with corporate tax is given by: Re = Ro + D/E (1-T) (Ro-Rb) Where, Re = required rate of return to equity shareholders Ro = required rate of return for an all equity firm. Rb = required rate of return to lenders
EXPLANATION: The above graph clearly depicts that with higher debt content Re i.e. required rate of return by shareholders is going up while TWACC is getting lower.

Determination of whether Hindalco is Trading on Equity

Trading on Equity
A company may raise funds either by issue of shares or by debentures. Debentures carry a fixed rate of interest and this interest has to be paid irrespective of profits. Of course, preference share are also entitled to a fixed rate of dividend depends upon the profitability of the company. In case, the rate of return on the total capital employed is more than the rate of interest on debentures or rate of dividend on preference shares, it is said that company is trading on equity.

Rate of return on equity shareholders fund =PAT/Equity shareholders fund = 28609/174359 = 16% General rate of return = (PAT + Interest) / Total capital employed = 31415/270881 = 11%
The general rate of return is only 11% while the return on equity shareholders fund is 16%. Thus, we can say that Hindalco is trading on Equity.

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EBIT-EPS ANALYSIS

36

EBIT-EPS Analysis
The design of an appropriate capital structure is one of the major decision areas in financial management. A widely used financial technique to design an appropriate capital structure is E.B.I.T-EPS analysis. As a method of capital structure planning, it essentially involves the comparison of alternative methods of financing under various assumptions of E.B.I.T. the choice of combination of source with the capital structure would be one that, for a given level of E.B.I.T. would ensure the largest EPS. Alternatively, the choice of combination should ensure the maximum market price per share. MPS = EPS * Price-Earning ratio
ii

Particulars EBIT Interest Charges PBT & Extraordinary items Extraordinary items PBT Provision for Current Tax Provision for Deferred Tax Provision for fringe benefit tax PAT No. Of Shares Outstanding EPS

2007-08 33062 2806 30256 30256 6063 875 114 28609 1167151498 24.51

2006-07 37470 (2424) 35046 35046 (9841) 551 (113) 25643 1004921647 25.52

(Rs. in million) 2005-06 23279 (2252) 21027 30 21057 (3241) (1160) (101) 16556 986116213 16.79

ii

Figures in brackets indicates negative value

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Earning Per Share of Hindalco

30

EPS

20 10 0 2006-07 2005-06

EPS

Years

INTERPREATION: In FY-2007, The EPS of Hindalco was Rs. .25.52. But In FY-2008, It decrease to Rs. 24.51 . . This change may be due to fluctuation in the sales value and operating leverage. It is obvious that net profits Hindalco greatly with small fluctuation on sales figure especially because of high fixed costs. Hence, EPS fluctuated. The Financial Leverage may heighten this effect.

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COST OF CAPITAL

39

COST OF CAPITAL
The cost of capital is a significant factor in designing the capital structure of an undertaking. The basis reason behind running a business undertaking is to earn a return at least equal to its cost of capital. Commercial undertaking has no relevance if it does not expect to earn its cost of capital. Therefore, cost of capital constitutes an important factor in various business decisions. The cost of capital estimate for a business is used for two purposes: Evaluating the performance of a business: - The operating profit generated by a business is evaluated against the minimum profit that the business is expected to generated as implied by the cost of capital for that business. The profit generated by the business over and above the minimum profit expectation is termed as the Economic Value Added (EVA) for that business.

Evaluating capital investment projects: - All projects that generate a return over and
above their respective cost of capital are EVA positive by nature and therefore value adding. The appropriate cost of capital is used therefore to evaluate such projects into those that add value and those that do not, thereby enabling financial decision-making.

MEASUREMENT OF COST OF CAPITAL

Cost of Debt
The explicit cost of debt is the interest rate as per contract adjusted for tax and the cost of raising the debt. Cost of irredeemable debentures Cost of debentures not redeemable during the lifetime of the company. Kd = I/NP * (1-T) Where, Kd = Cost of Debt after tax I = Annual Interest Rate NP= Net Proceeds of debentures T = Tax rate

Cost of redeemable debenture

If the debenture were redeemable after the expiry of a fixed period the cost of debenture would be: Kd = I (1-t) + (RV-NP) / N (RV + NP) /2

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Where, I = Annual Interest Payment NP = Net Proceeds of Debenture T = Tax Rate N = Life of Debentures

Cost of Preference Share

In the case of preference share, the dividend rate can be taken as its cost since it is this amount, which the company intends to pay against preference shares. As in the case of debt, the issue expenses or the discount / premium on issue/ redemption has also to be taken into account. Cost of irredeemable share = PD/ PO Where, PD = Annual preference dividend PO = Net proceeds in issue preference share-

Cost of redeemable preference share

If the preference share were redeemable after the expiry of a fixed period the cost of preference share would be. KP = PD + (RV-NP) / N (RV + NP) /2 Where, PD = Annual preference dividend RV = Redemption value of preference NP = Net proceeds an issue of preference share N = Life of preference share

Cost of ordinary of Equity share

Calculation of the cost of ordinary share involves a complex procedure. This is because unlike debt and preference share there is no fixed rate of interest or dividend against ordinary shares. Hence, to assign a certain cost to equity share is not a question of mere calculation. It requires an understanding of many factors basically concerning the behaviour of investor and their expectations. Since there can be different interpretations of investors behaviour, there fare many approaches regarding calculation of cost of equity share. The four main approaches are: (1) D/P (Dividend /Price) (2) E/P (Earning /Price) ratio (3) D/P + g (Dividend /Price + Growth rate of earning) and (4) Realized yield approach

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1) D /P- ratio (Dividend Price) approach

This emphasizes that dividend expected by an investor from a particular company; do so in the expectations of ascertain return. In other words, when an investor buys ordinary shares of a certain risk, he accepts a certain return. The accepted rate of return is the cost of ordinary share capital. Under this approach, therefore, the cost of ordinary share capital is calculated on the basis of the present value of the expected future stream of dividend. Ke = D / NP Where Ke = Cost of equity D = Dividend NP = Net proceeds of share

2) E /P (Earnings / Price) ratio approach

In this approach, the cost of ordinary share capital is based upon the expected rate of earnings of a company. The investor expects a certain amount of earnings whether distributed or not from the company. Ke = E / NP Where E = Earning NP = Net proceeds of shares

3) D / P + growth approach
This approach emphasis upon investor what actually expects to receive from his investments in a particular ordinary share in terms of dividend plus the rate of growth in dividend / earnings. This growth rate in dividend (g) which taken to be equal to the compound growth rate in earning per share. Ke = D / P + g Where D = Dividend per share P = Market price of the share G = Growth rate

4) Realized yield approach

This approach considers the basic factor of the D/P + g approach but, instead of using the expected values of the dividend and capital appreciation, past yields are used to denote the cost of capital. This approach is based upon the assumptions that past behaviour will be repeated in future and therefore, may be used to measure the cost of ordinary capital.

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COST OF RETAINED EARNINGS

The companies do not generally distribute the entire profits earned by them by way of dividend among their shareholders. They retain some profits for future expansion of the business. The amount retained by company, if it had been distributed among the shareholders by way of dividend, would have given them some earning. The company has deprived the shareholders of these earnings by retaining a part of profit with it. Thus, the cost of retained earnings is the earning forgone by the shareholders. Simply, stated, the opportunity cost of retained earnings may be taken as the cost of the retained earnings. It is equal to the income that shareholders could have earned by placing these funds in alternative investments.

WEIGHTED AVERAGE COST OF CAPITAL

The composite or overall cost of capital of a firm is the weighted averages of the cost of various sources of funds. Weights are taken to be the proportion of each source of funds in the capital structure. While making financing decision this overall or weighted cost is used. Each investment is financed from the pool of funds, which represents the various sources from which funds have been raised. Any decision of investment therefore has to be made with reference to the overall cost of capital and not with reference to cost of specific source of funds.

WACC = WI * KI + W2 * K2 + + Wn * Kn Calculation of the cost of capital

The elegance of a theory lies in its practical application. The theory of measuring cost of capital is not simple. Hindalco was founded in 1962. It is a large integrated aluminium, copper, chemical, foil, wheel, carbon etc. It has a total sale of Rs. 183,130 million, total gross assets of Rs. and net profit of Rs. 25,643 million in 2007. The average market price of Hindalco one share in 2007 was Rs. 177. The market value of the companys equity is obtained by multiplying the number of the outstanding shares () by the average share price. The market value of debt is assumed to be equal to the book value. On Hindalcos EPS, DPS, Payout, average share price, dividend yield, earning yield, price to book value per share and ROE for the years 1996 to 2007

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HINDALCO FINANCIAL DATA 1996-2007

Years EPS DPS B.V.of Dividend Dividend Earning ROE (Rs.) (Rs.) share payout Yield Yield (%) ratio (%) (%) (%)
1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 4.94 6.27 7.16 7.74 8.57 8.67 5.92 8.53 13.48 16.79 25.52 24.51 0.45 0.53 0.65 0.80 1.20 1.35 1.35 1.65 2.00 2.00 1.70 1.85 30.74 36.83 43.72 51.02 58.80 61.53 66.95 74.16 82.54 97.40 118.97 142.09 9.00 9.50 9.00 10.00 14.00 16.50 22.00 19.00 15.00 13.00 7.90 9.3 1.50 1.40 1.40 1.50 2.00 2.00 2.00 2.00 2.40 2.30 1.30 1.12 16.07 17.02 16.37 15.17 14.57 14.09 8.84 11.51 16.33 17.23 19.59 18.48 19.72 18.90 18.01 16.58 16.70 15.05 15.00 17.88 20.50 20.45 16.41

Estimation of Hindalcos Cost of Equity

There are two approaches for calculating the cost of equity 1. The constant dividend-growth model 2. The capital asset pricing model (CAPM)

Dividend Growth Model

The formula for calculating the cost of equity is as follows: DIV1 Ke = -------- + g P0 Where the first term DIV / P0 is the dividend yield and the second term g, is the expected (constant) growth in dividends. Hindalcos dividend yield in 2007 is . The dividend yield of the company has varied between

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Estimation of Growth Rate

In practice, four methods may be used to estimate the growth rate: 1) Internal growth:- Growth may be approximately by calculating the product of retention ratio and return on equity (ROE) g = Retention ratio * ROE This approach may be used when the firm has a stable dividend policy. Hindalcos payout ratio has fluctuated over years. However, on an average, it has distributed about 13% of its net profit and retained 87% in the past decade. In the most recent year 2006 is 2006, it retained about 85% of its profit. The companys ROE in 2006 is 20.50% and 10 years average is 17%. Assuming that the current retention ratio of 85% and ROE of 17% will continue in the future, then Hindalco is expected to grow at % year.

G = Retention ratio* ROE = 0.85*0.17 = 14%

The constant growth model has its limitation. It is not application to those companies, which have highly unstable dividend policy (or retention ratio) and fluctuating ROE. One way to overcome this limitation is to estimate Ke for a large sample of companies of equivalent risk in the same industry a use the average k, as an approximation of the cost of equity of the company under consideration. 2) Past average growth: - In practice, growth may be based on past EPS rather DPS since companies do not change their DPS frequently with changes in EPS. Thus, DPS grows at a slow rate. The average of EPS past growth rates may be used as a proxy for the future growth. There are two alternatives available for calculating the average (1) the arithmetic average and (2) the geometric average. These two methods will give different estimates of the average growth rate. The geometric average will give a compounded average and is preferable when there is much variability in EPS data. The geometric average EPS growth rate for Hindalco for the period 1996 to 2006 is as follows: EPSn EPSo (1 + g) n EPSn (1+g) n =-------EPSo

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3) Regression approach for estimating growth:- Both arithmetic average geometric methods of calculating growth have limitations. Simple average methods of calculating growth have limitations. Simple average gives the same weight to each years earning while geometric average estimates a compounded rate based on only two observations. Both techniques are quite inadequate to use when earning are widely fluctuation. The regression technique estimates growth over time (t) incorporating all observations. The linear regression model is as follows:

EPS1 = a + bt
The linear model indicates growth in terms of rupees. A better method is the log-linear regression model, which estimates growth in percentage term: In (EPS) is natural logarithm of EPS. The slope of the regression line (1+g) and it is estimates as follows: Yt In EPS In (1+g) = ---------------- Yt Where Yt is Y1-Y 9.0989 In (1+g) = ----------- = 0.1123 82.98 Taking anti-log on both sides, we get 1+g = 1.1198 g = 1.1198-1 = 0.1198 or 12% The growth rate estimated according the different methods are summarized. The growth rate estimated by log-linear model is the most appropriate since Hindalcos EPS are highly variable. Thus, for the calculation of the Hindalcos cost of equity, we shall assume that the future dividend rate will be the same as the current dividend yield (2.3%) is and that the future growth will be 12%. According to the dividend-growth model, Hindalcos cost of equity will be as follows:

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Div1 Ke = ---------------- + g P0 Ke = 2.3%+12% = 14.3%

Estimate of growth rate and cost of equity

Method Growth Rate Cost of Equity

Internal growth Arithmetic average Geometric average Long linear growth

8.8% 20.8% 12.4% 12.0%

11.1% 23.1% 14.7 % 14.3%

For different growth rate, Hindalcos cost of equity is calculated. It varies Between 11.1% to 23.1%. The geometric average and the long linear growth Methods give almost the same estimates for the growth rate and the cost of Equity, i.e. about 14-15%, for Hindalco. This seems to be a reasonable estimate Of Hindalcos cost of equity.

Capital Asset Pricing Model

An alternative model for calculating Hindalcos cost of equity is the capital asset Pricing model (CAPM). The use of CAPM requires the following information. The expected risk free rate of return The expected risk premium Beta of Hindalcos returns

Risk free rate The risk free rate is generally approximated by the highly liquid, shortTerm government security. The yield on one-year government bonds in India is about 10%. This could be used as a proxy for the risk free rate.

Market premium The difference between the expected market rate of return and the
Risk free rate of return is the expected market premium. There are no estimates of the Market premium available in India. The average monthly sensex return during the period April 2003 to 2006 has been 8%. This implies an annual market rate of return 68%

HINDALCOS COST OF DEBT

47

HINDALCO has both short term (monthly bank borrowing) and long-term debt. It also has current liabilities such as cretitors. What is the cost of current liabilities? Should it be included in the computation of weighted cost of capital? There is no unanimity on this issue. The majority view is that current liabilities do not involve any explicit cost, and therefore, should be excluded from the cost of capital calculation. An alternative view is that they involve implicit cost of current liabilities? Since they involve the same risk as bank borrowing, the before tax cost of current liabilities can be treated equal to bank borrowing. We have ignored current liabilities in the calculation of Hindalcos cost of capital. Hindalco has 85 percent short term and 15 percent long-term debt. Bank borrowing and other short term debts cost about 16 percent and long term debt about 14 percent in India. We may assume that Hindalcos will these costs in obtaining debt in future. Further, if we assume that Hindalcos short-term debt will continue to be 85 percent and long term about 14 percent in India we may assume that HINDALCO will incur these costs in obtaining debt in future. Further if we assume that Hindalcos short term debt will continue to 85 percent and long term debt and 15 percent and that corporate tax will be 35 percent, then the after tax weighted marginal cost of its debt will be:

WEIGHTED COST OF DEBT = 0.16(1-0.35)*85= 0.14(1-0.35)* 0.15 =0.0884 =0.0136=0.102 OR APPROX 10%

HINDALCOS WEIGHTED AVERAGE COST OF CAPITAL

We have estimated Hindalcos cost of equity and cost of debt. If we know the target capital structure, we can estimate Hindalcos weighted average cost of capital. Target capital structure may be expressed in the book value or market value. Let us assume that that Hindalcos will maintain its current capital structure in the future. ITS WEIGHTED AVERAGE COST OF CAPITAL will be as follows:

Sources of Capital Equity Debt

cost of capital

weight BV MV 0.72 0.28 0.84 0.16

weighted cost BV MV 0.086 0.028 0.114 0.101 0.016 0.117

0.12 0.10

Total

HINDALCOS weighted average cost of the capital is about 11 or 12 percent. Its market value weighted average cost of capital is slightly higher than book value weighted average cost of capital since the market value of equity is more than the book value .IF Hindalco is

48

considering an investment project of average risk that has the same capital structure as the Hindalco, then it can use 12 percent as discounted rate to compute projects NPV.

WACC = cost of equity*1/1+(D/E)+cost of debt * (1-T)*(D/E)/1+(D/E)

RATIO ANALYSIS

49

RATIO ANALYSIS
It is a widely used tool of financial analysis. The term ratio refers to the relationship expressed in mathematical terms between two individual figures or group of figures connected with each other in some logical manner and are selected from financial statements of the concern. A financial ratio helps to express the relationship between two accounting figures in such a way that users can draw conclusion about the performance, strengths and weaknesses of a firm. Ratio to be used for capital structure analysis: Earning per share Dividend per share P/E ratio Dividend pay-out ratio Debt-equity ratio Interest coverage ratio Return on investment

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Earning per share

EPS shows the profitability of the firm on a per share basis, it does not reflect how much is paid as dividend and how much is retained in the business.

EPS = Profit after tax/No. Of shares Significance

The EPS helps in determining the market price of the equity shares of the company. A comparison of earning per share of the company with another will also help in deciding whether the equity share capital is being effectively used or not. Helps is estimating the companys capacity to pay dividend to its equity shareholder. Particulars Earning per Share (Computed) FY-08 24.51 EPS of Hindalco FY-07 FY-06 25.52 16.79 FY-05 13.48 FY-04 8.53

EPS of Hindalco
30 25 20 15

EPS

10 5 0
FY-08 FY-07 FY-2006 FY-06 FY-2007 FY-05 FY-2004 FY-04 FY-03 FY-2005 FY-2003

EP S

Years
iii

InterpretationThe EPS of Hindalco shows an upward trend since FY-04. There is

considerable increase in EPS in FY-08. The figure is indicating that Hindalco has achieved wealth maximization objective to a great extent.
iii

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Dividend Per Share

It indicates the amount of profit distributed to shareholders per share. It is calculated as: DPS = PAT/No. Of equity shares

DPS of Hindalco
Particulars Dividend per share (Computed) FY-08 1.85 FY-07 1.70 FY-06 2.20 FY-05 2.00 FY-04 1.65

DPS of Hindalco
2.50 2.00

DPS

1.50 1.00 0.50 0.00

FY-08 FY-07 FY-06 FY-05 FY-2004 FY-04 FY-2003 FY-03 FY-2007 FY-2006 FY-2005

DPS

Years
iv

Interpretation
Over the years the DPS of Hindalco has been increasing from Rs. 1.65 per share to Rs. 1.70 per share till FY 2007. But it has increased after FY 2007 to 1.85. This Dividend payment is quite high showing that the retaining most of its earning for future investments in projects.

iv

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Price to Earning
This ratio indicates the number of times the earning per share is covered by its market price.

P/E ratio = MP per share/EPS Significance

P/E ratio helps the investor in deciding whether to buy or not to buy the share of the company at a particular market price.

Price to Earning of Hindalco

Particulars Price to Earning FY-08 6.7 FY-07 5.11 FY-06 10.9 FY-05 9.04 FY-04 13.40

Price to earning of Hindalco

14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00
FY-08 FY-07 FY-06 FY-05 FY-04

P/E

Price to earning
FYFY- FYFY- FYFY-03 2007 2006 2005 2004 2003

Years
Interpretation:
P/E ratio of Hindalco considerably increased in FY 2004, but it has decreased to great extent in FY 2008. Thus, the EPS is covered by its market price by 6.7 times.

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Dividend Payout Ratio

The ratio indicates what proportion of EPS has been used for paying dividend

Pay-out ratio = DPS/EPS

Significance
The payout ratios are indicators of the amount of earning that have been ploughed back in the business. Lower payout, the higher the amount earnings ploughed back in the business and vice-versa. Particulars DPS (Rs) EPS (Rs) Pay-out ratio FY-08 1.85 24.51 0.08 FY-07 1.70 25.52 0.07 FY-06 2.20 16.79 .13 FY-05 2 13.48 .15 FY-04 1.65 8.53 .19

Pay-out ratio of Hindalco

Payout ratio of Hindalco

0.25

Payout Ratio

0.20 0.15 0.10 0.05 0.00

Payout ratio

FY-2008FY-2007 FY-2007FY-2006 FY-2006 FY-2005 FY-2005 FY-2004 FY-2004 FY-2003 FY-2003

Years

Interpretation
The ratio has increased to a some point extent in 2008 as compared to previous Financial Years. It indicates that company is ploughing go a large amount of its earnings for future expansion of business.

54
FY-2008 FY-2007 FY-2006 FY-2005 FY-2004 FY-2003

Debt- Equity Ratio

The relationship between borrowed funds and owners capital is a popular measure of the financial solvency of a firm. That is shown by debt equity ratio. It is a ratio of the outsiders fund to the owners funds.

Debt-Equity ratio = Total Debt/ Net Worth Particulars Debt Equity ratio
FY-2008 .48 FY-2007 0.57 FY-2006 0.49 FY-2005 0.47 FY-2004 0.36 FY-2003 0.37

FY-08 FY-07

FY-06

FY-05

FY-04

FY-03

Interpretation The accepted norm for debt-equity ratio is 2:1. Thus, it is apparent that there is ample scope for the company to raise further loan capital.

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Interest-coverage ratio
The interest coverage ratio shows the number of times the interest charged is covered by funds that are ordinarily available for the payment. Since taxes are computed after interest, interest-coverage is calculated in relation to before tax earning. Depreciation is a non-cash item. Therefore, funds equals to depreciation are also available to pay interest charge. We can thus calculate interest coverage ratio as earning before depreciation, interest and taxes divide by interest.

ICR = EBIDTA / Interest

Particulars

FY-2008 FY-2007 FY-2006 FY-2005 18.09 12.65 14.98

FY-2004 9.82

FY-2003 10.72

Interest Coverage Ratio 14.21

Interest Coverage Ratio of Hindalco

20.00 18.00 16.00 14.00

Rupees

12.00 10.00 8.00 6.00 4.00 2.00 0.00 FY-08 FY-07FY-2006 FY-06 FY-05 FY-04 FY-2003 FY-03 FY-2007 FY-2005 FY-2004

Interest Coverage Ratio

Years
Interpretation
The Interest coverage ratio is considered to be ideal if it is 5 to 6 times of interest charge is covered by funds that are ordinarily available for the payment. The coverage is therefore satisfactory and the Hindalco will have sufficient cash available to pay interest.

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Return on capital employed

It is calculated by dividing EBIT by capital employed.

ROCE = EBIT / Capital employed

Particulars EBIT Capital Employed ROCE Interpretatio

FY-2008 33062 270880 0.12

FY-2007 38323.00

FY-2006 23279.00

FY-2005 20833.00

FY-2004 14068.00 104176.00 0.14

FY-2003 11992.00 94351.00 0.13

209093.00 157370.00 125869.00 0.18 0.15 0.17

ROCE of Hindalco
0.20 0.18 0.16 0.14

Percent

0.12 0.10 0.08 0.06 0.04 0.02 0.00

FY-08FY-2007 FY-07 FY-06 FY-2006 FY-05 FY-2005 FY-04 FY-2004 FY-03 FY-2003

ROCE

Years
The ROCE has decreased. It was 18% in FY-07. Now it stands at 12%.

57

Chapter No. 4

FINDINGS, SUGGESTIONS AND CONCLUSION

58

FINDINGS

The rate of return on equity shareholders funds is low than general rate of return. Hence, Hindalco is trading on equity. The debt equity ratio of 0.48 indicates that company is considering the interest of investors. The earning per share of Hindalco is showing downward trend. The proportionate increase in long-term loan fund is more than proportionate increase in share capital. The dividend pay out ratio of Hindalco is decreasing year by year. But in FY-08 It is increase so it .

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SUGGESTIONS

The debt equity ratio of Hindalco is 0.48The company has ample scope to raise further loan capital. The management should try to maintain trade-off between risk and return for determining the appropriate amount of debt in capital structure. The company should take the advantage of financial leverage very carefully as it also increases the financial risk. The management should try to substitute long term funds used to finance current assets with short term funds are generally cheaper. This will positively improve efficiency.

60

CONCLUSION
Hindalco industries ltd. has an appropriate capital structure. Hindalco is taking the full advantage of financial leverage . The endeavour of company is to maximize earning per share i.e. achieving wealth maximization objective. Hindalco is retaining lions share of earning for expansion purpose. On the whole, it can be said that Hindalco enjoys a sound financial position from the point of view of all concerned parties the corporate management, the leading institutions and the investors. The overall performance of the company is satisfactory and it will further improve when the facilities at the disposal of company are fully utilized. However, the management must remain cautious towards the financial position of the company. The management should take all possible steps in the near future to improve the financial position of the company.

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Chapter No. 5

APPENDIX

62

BALANCE SHEET
(As on 31st March 2008)

z As at 31st March, 2008 SOURCES OF FUNDS SHAREHOLDERS' FUNDS Share Capital Share capital suspense Share Warrants Reserves and Surplus LOAN FUNDS Secured Loans Unsecured Loans DEFERRED TAX LIABILITY (NET)
62054.23 21231.61 83285.84 13236.74 270880.73s 64,102.03 9,583.98 73,686.01 11,258.01 209,124.39 28,480.47 20,553.91 49,034.38 12,333.59 157,430.49 1226.48 4.06 1390.96 171736.65 1,043.25 985.66

As at 31st March, 2007

(Rs. in Million) As at 31st March, 2006

123,137.12 124,180.37

95,076.86 96,062.52

174358.15

APPLICATION OF FUNDS FIXED ASSETS Gross Block Less : Depreciation Less : Impairment Net Block Capital Work-in-Progress
126084.59 46368.07 1623.15 78093.37 11198.69 89292.06 112,526.55 40,563.25 1,896.21 70,067.09 14,764.25 84,831.34 104,182.53 35,310.72 1,043.81 67,828.00 8,329.17 76,157.17

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INVESTMENTS CURRENT ASSETS, LOANS AND ADVANCES Inventories Sundry Debtors Cash and Bank Balances Other Current Assets Loans and Advances Less : CURRENT LIABILITIES AND PROVISIONS Current Liabilities Provisions

141079.86 86,753.17 39,712.86

50979.06 15650.22 1469.77 623.04 9794.60 78516.69

43,153.14 15,045.02 6,654.96 1,188.08 11,742.20 77,783.40

40,950.88 12,484.01 9,172.85 2,447.34 7,972.66 73,027.74

28947.79 9060.09 38007.88

27,433.79 12,841.41 40,275.20 37,508.20 31.68

21,995.62 9,531.66 31,527.28 41,500.46 60.00

NET CURRENT ASSETS MISCELLANEOUS EXPENDITURE (to the extent not written off or adjusted)

40508.81 _

270880.73

209,124.39

157,430.49

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PROFIT & LOSS ACCOUNT

(For the Year ended on 31 st March 2008)

For the year Ended 31st INCOME March, 2008

(Rs. in Million) For the year ended 31st March, 2007 199,200.8 6 16,070.9 8 183,129.8 8 3,700.6 9 186,830.5 7 (4,425.1 4.76 2,43 9.11 116,40 3.87 (10,33 8.40) 3.64 10,79 8.88 113,96 ende d 31st

Gross Sales and Operating Revenues 210219.31 Less: Excise Duty 18209.04 Net Sales and Operating Revenues 192010.27 Other Income 4929.37 196939.64 EXPENDITURE (Increase)/ Decrease in Stocks (1370.26) Trade purchase 925.18 Manufacturing and other expanses 158444.27 Interest and finance charges 2806.30 depreciation 5878.09 impairment _ 166683.58 Profit before tax 30256.06

124,76

7) 230.19 147175.00 2423.88 5528.02 852.40 151784.32 35046.25

65

6063.56 Provision for tax 875.79 Provision for deferred tax Provision for fringe benefit tax 114.00 Tax adjustment for earlier years 5406.68 28609.39 Net profit Balance brought forward from previous year 1000.00 Balance brought forward from amalgamating company 15.62 Transfer from debenture redemption reserve 1721.70 Balance available for appropriations 31315.47 Appropriations DeventureRedemption Reserve 50.00 Dividend on preference shares 0.24
Dividend tax on preference shares Interim Dividend on EquityShares Tax on interim Dividend Proposed Dividend on Equity Shares Tax on proposed dividend Transfer to General Reserve Balance Carried to Balance Sheet

9841.00 551.00 113.00 _ 25643.25 550.00 _ 1450.00 27643.25

186.82 1,773.44 248.72 _ _ 24434.27 1000.00 27643.25 25.52 25.52 25.52

0.04 _ _ 2268.93 385.60 25610.66 3000.00 31315.47 24.51 24.38 19.88 19.77

Earning per Share (EPS) Basic EPS (in Rs) Diluted EPS (in Rs) Basic EPS before Tax adjustment for earlier years (in Rs)
Diluted EPS before tax adjustment for earlier year (in Rs)

25.52

66

Chapter No. 6

BIBLIOGRAPHY

67

BIBLIOGRAPHY

Pandey I.M., Financial Management Maheshwari S.N., Financial Management Chandra Prashanaa, Finance sense Annual Report Of Hindalco Industries Limited (2007 & 2008)

Magazines & Journals Light Metal Age Aluminium International Today Websites: www.aluminiumleader.com www.aditya-birla.com www.hindalco.com www.wikipedia.com

Issue February 2008 March-April, 2008

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