A Summer Training Project

ON CAPITAL STRUCTURE TELECOMMUNICATION CONSULTANT INDIA LTD. AT TCIL IT CHANDIGARH

In the Partial Fulfillment of the requirement of BACHLOR OF BUSINESS ADMINISTRATION (2012-2013)

Submitted To:
Ms.Nancy Jindal Assist professor (BIMT)

Submitted By
Neetu BBA 5th SEM

University Roll no1297006

DECLARATION
This is to certify that I, Neetu the student of Bharat group of Institute of Technology and Management studying in B.B.A 5th Semester. Roll no. 1297006 has undergone summer training in TCIL-IT in Chandigarh for six weeks and have submit a project report on the title of capital structure at TCIL as assigned by the company, for partial fulfillment of degree of Bachelor of Business Administration B.B.A. to PTU University Jalandhar. I solemnly declared that the work done by me is original and no copy of it has been submitted to any other for award of any other degree / diploma / fellowship or on similar title or topic.

NEETU

ACKNOWLEDGEMENT
A person always requires guidance & help of other to achieve success in his mission; similarly it was not possible for me to complete my project individually. I am very much thankful to all the people who have helped me to complete the project. B I am gratefully in debt to Mr. Shekhar Gharu Chief Campus Evangelist, my project guide for providing me necessary help, editing my project and required guideline for the completion of my project and for the valuable time that he gave me from his busy schedule. Last but not the least I am thankful to all my friend of inspiration and information for us. I thank to God and my parents for showing their blessings. I am thankful to our faculty guide Miss.Nancy Jindal (Department of Management Studies) of BHARAT GROUP OF INSTITUTE OF TECHNOLOGY & MANAGEMENT to help me to complete my project report.

NEETU

PREFACE

In an institute, a student learns about theoretical concepts. But in the present day scenario, environment surrounding the business is complex, dynamic and the industries are so much diversified and specialized that it requires the managers to be wholesomely nourished with knowledge and skills in the respective field of specialization. Exposure is the key in building good future managers. This research project is the result of my hard work. Research project is an integral part of bachelor of Business Administration and it aims at providing the real life experience of the industry to the students. The practical experience helps the student to view the real business world closely, which in turn widely influences their conception and perception. It provides the basic skill required to perform the survey and statistics tool needed to analysis the data. Research project is an integral part curriculum and its purpose is providing the students with the practical exposure of today changes scenario. It helps in the development of the practical skill and the analytical skill and analytical thinking process.

EXECUTIVE SUMMARY
TCIL (Telecommunication Consultants India Ltd), a prime engineering consultancy company, is a wholly owned Government of India Public Sector Enterprise under the administrative control of the Department of Telecommunications (DOT), Ministry of Communications and Information Technology, Government of India. TCIL was set up in back 1978 for providing Indian telecom expertise in all fields of telecom, Civil and IT to developing countries around the world. In Information Technology, TCIL has established its IT Training division TCIL- IT which is running various training programmes duly approved by Department of Electronics, Govt. of India for career advancement.

The project Title Financial statement analysis of TCIL IT basically deals with finding the liquidity, profitability, long term solvency position of the company. The tool which is used for this purpose is Ratio Analysis. By applying this tool we had found out that companys liquidity, profitability, solvency position is satisfactory but not good. So company should have to improve its liquidity profitability, solvency position.

CONTENTS
Sr. no.
Chapter1. Chapter2. Chapter3. Chapter4. Chapter5. Chapter6.

Title
Industry Introduction &Company profile Topic Introduction Review Literature Research Methodology Data Analysis and Result Conclusion

CHAPTER - 1 Industry Introduction

IT Industry, Information Technology Industry
Information technology, and the hardware and software associated with the IT industry, are an integral part of nearly every major global industry. The information technology (IT) industry has become of the most robust industries in the world. IT, more than any other industry or economic facet, has an increased productivity, particularly in the developed world, and therefore is a key driver of global economic growth. Economies of scale and insatiable demand from both consumers and enterprises characterize this rapidly growing sector. The Information Technology Association of America (ITAA) explains 'information technology' as encompassing all possible aspects of information systems based on computers. Both software development and the hardware involved in the IT industry include everything from computer systems, to the design, implementation, study and development of IT and management systems. Owing to its easy accessibility and the wide range of IT products available, the demand for IT services has increased substantially over the years. The IT sector has emerged as a major global source of both growth and employment

Features of the IT Industry at a Glance

Economies of scale for the information technology industry are high. The marginal cost of each unit of additional software or hardware is insignificant compared to the value addition that results from it.Unlike other common industries, the IT industry is knowledge-based. Efficient utilization of skilled labor forces in the IT sector can help an economy achieve a rapid pace of economic growth. The IT industry helps many other sectors in the growth process of the economy including the services and manufacturing sectors.

The role of the IT industry

The IT industry can serve as a medium of e-governance, as it assures easy accessibility to information. The use of information technology in the service sector improves operational efficiency and adds to transparency. It also serves as a medium of skill formation.

MAJOR STEPS TAKEN FOR PROMTION OF IT INDUSTRY

Domain of the IT Industry A wide variety of services come under the domain of the information technology industry. Some of these services are as follows: * Systems architecture * Database design and development * Networking * Application development * Testing * Documentation * Maintenance and hosting * Operational support

Most Popular in IT Industry

Information Technology Industry: Information technology, and the hardware and software. Information Economy: Information and Communication Technology has Internet Economy: The meaning of Internet Economy is developing Mobile Phones And Business Development: Its the case of Mobile Phones, where E-commerce And Economies: Most of the enterprises worldwide have conducted Broadband Spread: Use of Internet through broadband connection

Company Introduction

Telecommunications Consultants India Limited (A Government of India Enterprise)

TCIL (Telecommunication Consultants India Ltd), a prime engineering consultancy company, is a wholly owned Government of India Public Sector Enterprise under the administrative control of the Department of Telecommunications (DOT), Ministry of Communications and Information Technology, Government of India. TCIL was set up in back 1978 for providing Indian telecom expertise in all fields of telecom, Civil and IT to developing countries around the world. Company's core competence is in the fields of Switching, Transmission Systems, Cellular services, Rural Telecommunication, Optical fiber based backbone transmission systems, IT & Networking Solutions, Application Software, e-Governance, 3G Network, WIMAX Technology and also Civil construction projects. TCIL-IT has tie-up with many government agencies to impart training for career advancement.

About
In Information Technology, TCIL has established its IT Training division TCIL- IT which is running various training programmes duly approved by Department of Electronics, Govt. of India for career advancement. Keeping in view the rising need for quality IT & Telecom professionals, TCIL-IT has introduced a gamut of comprehensive training program in Software, Hardware & Networking, Telecom, Multimedia, Interior Designing and Fashion Technology through its countrywide network. Over the years TCIL-IT has built up a solid reputation for offering world class training in software, hardware, and telecom and embedded system. From Indian

Army, Banks to Multinational majors- TCIL-IT is being sought after by the biggest and the best for imparting IT Training. The curriculum development team of TCIL-IT is in regular touch with todays industry and updates the training curriculum regularly to meet its demands. As the training curriculum is designed giving importance to live project based knowledge and practical skills, the trainees will get ample time to work in Labs. To enhance the knowledge base of our aspirants there are various interactive sessions with our industry partners from time-to-time and visits of industry professionals / Engineers. ICSIL has entered in the MOU with Ministry of Small & Medium Enterprises, to conduct Computer training in their Development institute at New Delhi. Also has made MOU with NORTEL for the communication Network job for the Commonwealth Games in New Delhi. TCIL-IT has got recently the orders from Ministry of Minority affairs, Govt. of India for conducting Computer courses to 70 Minority students in New Delhi. Also got the order to conduct various training for 287 students from The Commissioner of Most Backward Classes DE notified Communities, Govt. of Tamil Nadu, and Chennai. In addition to the above, TCIL has established Training centers in 5 provinces of Afghanistan to meet the specific needs. In the process, more than 2000 Afghan official, students and teachers have been trained in last three years. TCIL has recently been empanelled by Ministry of External Affairs, Govt. of India for providing training facilities to 156 Indian Technical and Economic Cooperation (ITEC) Program partner countries under ITEC/ SCAAP (SPECIAL COMMONWEALTH AFRICAN ASSISTANCE PLAN) training program funded by Government of India. Telecommunications Consultants India Ltd (TCIL) is a leading ISO - 9001:2000 certified public sector undertaking. TCIL, a premier telecommunication consultancy and engineering company with a strong base in Telecommunication & Information Technology (IT), Today TCIL offers total telecom solutions for projects. TCIL has working/ is works in almost 45 Countries mainly in Middle East Africa, South-East Africa, South-East Asia and Europe. The Organisational Structure is formed with the objectives of providing globally world-class Technology and Indian expertise in all fields of Telecommunications and to provide total Quality management & excellence in project execution.

MISSION
"To excel and maintain leadership, in providing Communication Solutions on turnkey basis in telecommunication and information technology service sector globally.

Registered Office
Telecommunications Consultants India Limited TCIL Bhawan Greater Kailash - I New Delhi - 110 048. India. Ph : +91-11-26202020 Fax : +91-11-26242266

Head Office
TCIL-IT (ICSIL) DSIIDC Adminstrative Building Okhla Industrial Area, Phase-III New Delhi -- 110 020 Tel. No. 011-26929051 email : tcil.itc@rediffmail.com web : www.icsil.in

Chandigarh
TCIL-IT (ICS) S.C.O. 3017-18, Second Floor Sec. 22D, Chandigarh - 160 022 Phone : 0172 - 4634529 Mobile : 098767 95015 e-mail : tcil_chd@rediffmail.com

TRAINING
The business of TCIL is characterized by advanced technologies both in the field of Telecom and IT. Technology is advancing very fast and with a view to keep updated with the latest technology TCIL undertakes training activities either through its own resources or through external agencies. TCIL is having strategic tie-up to provide telecom and IT training with the following prestigious institutes of Govt. of India:

* Advanced Level Telecom Centre (ALTTC), Ghaziabad * Centre for Excellence in Telecom Technology and Management, Mumbai * Intelligent Communication Systems India Ltd.(ICSIL)

CHAPTER-2
2.1 Capital structure
The term of business relates to the state of being busy either as an individual or society as a whole, doing commercIially viable and profitable work. This term has at least three usages, depending on the scope; one is to mean a particular company or corporation, the generalized usage to refer to a particular market sector or the broadest meaning to include all activity by the community of suppliers of goods and services. Business is an economic activity as it is concerned with earning money and acquiring wealth through the production and distribution of goods and services. Businesses are predominant in capitalist economies, most being privately owned and formed to earn profit that will increase the wealth of its owners and grow the business itself. The main objective of any business owner or operator is to generate a financial return in exchange for work and acceptance of risk. There are several common forms of business ownership like sole proprietorship, partnership, corporation and cooperative. In order to generate a financial output, a financial input is most important. This financial input is termed as capital in business. In economics, capital or capital goods or real capital refers to factors of production used to create goods or services that are not themselves significantly consumed in the production process. Capital goods may be acquired with money or financial capital. In finance and accounting, capital generally refers to financial wealth especially that used to start or maintain a business. Financial capital represents obligation, and is liquidated as money for trade, and owned by legal entities. It is in the form of capital assets, traded in financial markets. Its market value is not based on the historical accumulation of money invested but on the perception by the market of its expected revenues and of the risk entailed. Financial capital can refer to money used by entrepreneurs and businesses to buy what they need to make their products or provide their services to that sector of the economy based on its operation, i.e. retail, corporate, investment banking, etc.

Financial capital refers to the funds provided by lenders (and investors) to business to purchase real capital equipment for producing goods/services. Real capital comprises physical goods that assist in the production of other goods and services. The financial capital which is required by entrepreneurs can be obtained through various sources. There are long term sources like share capital, debenture capital, venture capital, mortgage, retained profit, etc. Financial capital can also be obtained through medium term sources like term loans, leasing, etc. and through short term sources like bank overdraft, trade credit, factoring, etc. Capital contributed by the owner or entrepreneur of a business, and obtained by means of saving or inheritance, is known as own capital or equity. This capital that owners of business provide can be in the form of Preference shares/hybrid source of finance Ordinary preference shares Cumulative preference shares Participating preference shares Ordinary shares Bonus shares Founders shares

That capital which is granted by another person or institution is called borrowed capital, and this must usually be paid back with interest. This capital which the business borrows from institutions or people includes debentures: Redeemable debentures Irredeemable debentures Debentures to bearer Ordinary debentures

Thus, the sources of financing will, generically, comprise some combination of debt and equity. Financing a project through debt, results in a liability that must be serviced and hence there are cash flow implications regardless of the projects success. Equity financing is less risky in the sense of cash flow commitments, but results in a dilution of ownership and earnings.

2.2 MEANING OF CAPITAL STRUCTURE

The term Financial Management connotes that fund flows are directed according to some plan. It connotes responsibility for obtaining and effectively utilizing funds necessary for the efficient operation of an enterprise.
1

A formal definition of financial management would be the determination, acquisition, allocation and utilization of financial resources, usually with the aim of achieving some specific goals. To be more specific financial management is about analyzing financial situations, making financial decisions, setting financial objectives, formulating financial plans to attain those objectives, and providing effective systems of financial control to ensure plans progress towards the set objectives. Financial decision-making includes strategic investment decisions, such as investing in new production facilities or the acquisition of another company, and strategic financing decisions, like the decision to raise additional long-term loans. Thus, a financial manager is primarily concerned with two main types of interrelated decisions, i.e. investment decisions and financing decisions. Investment decision includes: Strategic investment decision Tactical/operational investment decisions

Similarly financing decision also includes: Strategic financing decision Tactical/operational financing decisions.

The strategic financing decision typically involves deciding the most appropriate mix of equity and long-term debt finance in the firms capital structure, also called as the capital structure decision. The tactical financing decision is related with ways to finance the firms investment in its medium and short-term assets respectively.
2

37

Capital structure refers to the combination of debt and equity capital which a firm uses to finance its long-term operations. Capital in this context refers to the permanent or long-term financing arrangements of the firm. Capital is the aggregation of the items appearing on the left hand side of the balance sheet minus current liabilities.
3

Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firms financial risks. The main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. The discipline can be divided into long-term and shortterm decisions and techniques. Capital investment decisions are long-term choices about which projects receive investments, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, the short term decisions can be grouped under the heading Working capital management. Capital investment decisions are long-term corporate finance decisions relating to fixed assets and capital structure. Decisions are based on several inter-related criteria. Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate. These projects must also be financed appropriately. If no such opportunities exist, maximizing shareholder value dictates that management returns excess cash to shareholders. Capital investment decisions thus comprise an investment decision, a financing decision, and a dividend decision. Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. The ratio between debt and equity is named leverage. It has to be optimized as high leverage can bring a higher profit but create solvency risk. As above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix can impact the valuation. Management must therefore identify the optimal mix of financing the capital structure that results in maximum value.

38

The optimum capital structure has been expressed by Ezra Solomon in the following words: Optimum leverage can be defined as that mix of debt and equity which will maximize the value of a company, i.e., the aggregate value of the claims and ownership interests represented on the credit side of the balance sheet.
4

Capital structure policy involves a choice between risk and expected return. The optimal capital structure strikes a balance between these risks and returns and thus examines the price of the stock. The pattern of capital structure of a firm has to be planned in such a way that the owners interest is maximized. There may be three fundamental patterns of capital structure in a firm: 1. Financing exclusively by equity stock. 2. Financing by equity and preferred stock. 3. Financing by equity, preferred stock and bonds.

GUIDING PRINCIPLES OF CAPITAL STRUCTURE

Which of the above patterns would be most suited to the company can be decided in the light of the fundamental principles. The guiding principles of capital structure decision are: 1. Cost principle: According to this principle ideal pattern of capital structure is one that tends to minimize cost of financing and maximize the earnings per share. Cost of capital is subject to interest rate at which payments have to be made to suppliers of funds and tax status of such payments. 2. Risk principle: This principle suggests that such a pattern should be devised so that the company does not run the risk of brining on a receivership with all its difficulties and losses. Risk principle places relatively greater reliance on common stock for financing capital requirements of the corporation and forbids as far as possible the use of fixed income bearing securities.

3.

Control principle: While deciding appropriate capital structure the financial remains undisturbed. The use of preferred stock and also bonds offers a means of raising capital without jeopardizing control.

4. Flexibility principle: According to this principle, the management should strive towards achieving such combinations of securities that the management finds it easier to maneuver sources of funds in response to major changes in needs for funds. Not only several alternatives are open for assembling required funds but also bargaining position of the corporation is strengthened while dealing with the supplier of funds. 5. Timing principle: Timing is always important in financing and more particularly in a growing concern. Maneuverability principle is sought to be adhered to in choosing the types of funds so as to enable the company to seize market opportunities and minimize cost of raising capital and obtain substantial savings. Depending on business cycles, demand of different types of securities oscillates. In times of boom when there is all-round business expansion and economic prosperity and investors have strong desire to invest, it is easier to sell equity shares. But in periods of depression bonds should be issued to attract money because investors are afraid to risk their money in stocks. moreless re

FACTORS DECISION

INFLUENCING

CAPITAL

STRUCTURE

A number of factors influence the capital structure decision of a firm. These factors can be categorized in to three categories, i.e., as per characteristics of the economy, characteristics of the industry and characteristics of the company.6 Characteristic of the Economy 1. Tempo of the business activity: If the economy is to recover from current depression and the level of business activity is expected to expand, the management should assign greater weightage to maneuverability so that the company may several alternative sources available to procure additional funds to meet its growth needs and accordingly equity stock should be given more emphasis in financing programmes and avoid issuing bonds with restrictive covenants.

2. State of capital market: Study of the trends of capital market should be undertaken in depth since cost and availability of different types of funds is essentially governed by them. If stock market is going to be plunged in bearish state and interest rates are expected to decline, the management may provide greater weightage to maneuverability factor in order to take advantage of cheaper debt later on. 3. Taxation: The existing tax provision makes debt more advantageous in relation to stock. Although it is too difficult to forecast future changes in tax rates, there is no doubt that the tax rates will not be adjusted downwards. 4. State regulation: Decision as to the make-up of capitalization is subject to state control. For e.g. Control of Capital Issues Act in India has preferred 4:1 ratio between debt and equity and 3:1 between equity and preferred stock. 5. Policy of Term-Financing Institutions: If financial institutions adopt harsh lending policy and prescribe highly restrictive terms, the management must give more significance to maneuverability principle and abstain from borrowing from those institutions so as to preserve the companys flexibility in capital funds.

Characteristics of the Industry

1. Cyclical variations: There are industries whose products are subject to wider variations in sales in response to national income, whereas some products have low income elasticity and their sales do not change in proportion in variation in national income. The management should attach more significance to flexibility and risk principle in choosing suitable sources of funds in an industry dealing in products whose sales fluctuate very markedly over a business cycle so that the company may have freedom to expand or contract the resources used in accordance with business requirements. 2. Degree of competition: Public utility concerns are generally free from intraindustry competition. In such concerns the management may wish to provide greater weightage to cost principle. But in industry which faces neck to neck competition, risk principle should be given more consideration.

3. Stage in life cycle: In infant industry risk principle should be the sub-guide line in selecting sources of funds since in such industry the rate of failure is very high. During the period of growth flexibility factor should be given special consideration so as to leave room open for easy and rapid expansion of funds used.

Characteristics of the Company

1. Size of the business: Smaller companies confront tremendous problem in assembling funds because of poor credit worthiness. In this case, special attention should be paid to flexibility principle so as to assure that as the company grows in size it is able to obtain funds when needed and under acceptable terms. This is why common stock represents major portion of the capital in smaller concerns. However, the management should also give special consideration to the factor of control. Larger concerns have to employ different types of securities to procure desired amount of funds at reasonable cost. To ensure availability of large funds for financing future expansion larger concerns may insist on flexibility principle. On the contrary, in medium sized companies who are in a position to obtain the entire capital from a single source, leverage principle should be given greater consideration so as to minimize cost of capital. 2. Form of Business Organization: Control principle should be given higher weightage in private limited companies where ownership is closely held in a few hands. In case of public limited companies maneuverability looms large because in view of its characteristics it finds easier to acquire equity as well as debt capital. In proprietorship or partnership form control is an important consideration because it is concentrated in a few hands. 3. Stability of earnings: With greater stability in sales and earnings a company can insist on leverage principle and accordingly it can undertake the fixed obligation debt with low risk. But a company with irregular earnings will not choose to burden itself with fixed charges. Such company should pay greater attention to risk principle.

4.

Age of company: Younger companies find themselves in difficult situation to raise capital in the initial years. It is therefore worthwhile to give more weightage to flexibility principle so as to have as many alternatives open as possible in future to meet the growth requirement. Established companies should insist on cost principle.

5. Asset structure of company: A company which have invested major portion of funds in long lived fixed assets and demand of whose products is assured should pay greater attention to leverage principle to take advantage of cheaper source of fund. But risk principle is more important in company whose assets are mostly receivables and inventory. 6. Credit standing: A company with high credit standing has greater ability to adjust sources of funds. In such a case, the management should pay greater attention too flexibility principle. 7. Attitude of management: Attitude of persons who are at the helm of affairs of the company should also be analyzed in depth while assigning weights to different factors affecting the pattern of capitalization. Where the management has strong desire for exclusive control, preference will have to be given to borrowing for raising capital in order to be assured of continued control. If the principal objective of the management is to stay in office, they would insist more on risk principle. But members of the Board of Directors who have been in office for pretty long time feel relatively assured and they would prefer to insist on cost principle.

CAPITAL STRUCTURE THEORIES

There are different viewpoints on the impact of the debt-equity mix on the shareholders wealth. There is a viewpoint that strongly supports the argument that the financing decision has major impact on the shareholders wealth, while according to others, the decision about the financial decision is irrelevant as regards maximization of shareholders wealth. A great deal of controversy has developed over whether the capital structure of a firm as determined by its financing decision affects its cost of capital. Traditionalists argue that the firm can lower its cost of capital and increase the market value per share by the judicious use of leverage. Modigliani & Miller, on the other hand, argue that in the absence of taxes and other market imperfections, the total value of the firm and its cost of capital are independent of capital structure. There are four major theories explaining the relationship between capital structure, cost of capital and value of the firm: 1. Net Income Approach 2. Net Operating Income Approach 3. Traditional Approach 4. Modigliani-Miller Approach There are certain underlying assumptions made in order to present the theories in a simple manner. The assumptions are as follows: 1. The firm employs only two types of capital- debt and equity. 2. There are no corporate taxes. This assumption is removed later. 3. The firm pays 100% of its earnings as dividend. 4. The firms total assets are given and they do not change, i.e. the investment decisions are assumed to be constant. 5. The firms total financing remains constant. 6. The operating earnings are not expected to grow. 7. The business risk remains constant and is independent of capital structure and financial risk. 8. All investors have the same subjective probability distribution of the future expected operating earnings for a given firm. 9. The firm has a perpetual life.

1.

Net Income Approach

The approach has been suggested by David Durand. According to this approach, the capital structure decision is relevant to the valuation of the firm, i.e., a change in the capital structure will lead to a corresponding change in the overall cost of capital as well as the total value of the firm. If the ratio of debt to equity is increased the weighted average cost of capital will decline, while the value of the firm as well as the market price of ordinary shares will increase. Conversely, a decrease in the leverage will cause an increase in cost of capital and a decline in the value of the firm as well as the market price of equity shares. The Net Income Approach is based on three assumptions: 1. There are no taxes. 2. The cost of debt is less than the equity-capitalization rate or cost of equity. 3. The use of debt does not change the risk perception of the investors. The implication of the above assumptions is that as the degree of leverage increases, the proportion of an inexpensive source of funds, i.e., debt in the capital structure increases. As a result the weighted average cost of capital tends to decline, leading to an increase in the total value of the firm. Thus, the cost of debt and cost being constant, the increased use of debt will magnify the shareholders earnings and thereby the market value of the ordinary shares. With a judicious mixture of debt and equity, a firm can evolve an optimum capital structure will be the one at which value of the firm is the highest and the overall cost of capital is the lowest. At that structure the market price per share would be maximum. If the firm uses no debt the overall cost of capital will be equal to the equity-capitalization rate. The weighted average cost of capital will decline and will approach the cost of debt as the degree of leverage reaches one.

2. Net Operating Income Approach

This approach is also suggested by David Durand. It is diametrically opposite to the Net Income Approach. The essence of this approach is that the capital structure decision of the firm is irrelevant. Any change in leverage will not lead to any change in the total value of the firm and the market price of shares, as the overall cost of capital is independent of the degree of the leverage. The Net Operating Income Approach is based on the following propositions: 1. Overall cost of capital is constant: The overall cost of capital remains constant for all degrees of leverage. The value of the firm, given the level of EBIT is determined by V = EBIT/ko. 2. Residual value of equity: The value of equity is residual which is determined by deducting the total value of debt from the total value of the firm. 3. Changes in cost of equity capital: The cost of equity increases with the degree of leverage. With the increase in the proportion of debt the financial risk of the shareholders will increase. To compensate for the increased risk, the shareholders would expect a higher rate or return. 4. Cost of debt: The cost of debt has two parts: explicit and implicit cost. The explicit cost is represented by the rate of interest. Irrespective of the degree of leverage the firm is assumed to be able to borrow at a given rate of interest. This implies that the increasing proportion of debt in the financial structure does not affect the financial risk of the lenders and they do not penalize the firm by charging higher interest. Increase in the degree of leverage causes an increase in the cost of equity. This increase in cost of equity being attributable to the increase in debt is implicit part of cost of debt. Thus the advantage associated with the use of debt supposed to be a cheaper source of funds in terms of the explicit cost is exactly neutralized by the implicit cost represented by the increase in cost of equity. As a result the real cost of debt and the real cost of equity according to Net Operating Income are the same and equal to overall cost.

3.

Traditional Approach

The Traditional Approach or the Intermediate Approach is a mid-way approach between the Net Income and Net Operating Income approach. It partly contains features of both the approaches. The traditional approach accepts that the capital structure of the firm affects the cost of capital and its valuation. However, it does not subscribe to the Net Income approach that the value of the firm will necessarily increase with all degrees of leverages. It subscribes to the Net Operating Income approach that beyond a certain degree of leverage, the overall cost of capital increases resulting in decrease in the total value of the firm. However, it differs from Net Operating Income approach in the sense that the overall cost of capital will not remain constant for all the degree of leverages. The essence of the traditional approach lies in the fact that a firm through judicious use of debt-equity mix can increase its total value and thereby reduce its overall cost of capital. According to this approach, up to a point, the content of debt in the capital structure will favorably affect the value of the firm. However, beyond that point, the use of debt will adversely affect the value of the firm. At this level of debt-equity mix the capital structure will be optimum. .If capital structure is irrelevant in a prefect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of the imperfections, by relaxing assumptions made in the M&M model. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required. Thus, the form of debt a firm chooses can act as a signal of its need for external finance. The pecking order theory is popularized by Myers(1984) when he argues that equity is a less preferred means to raise capital because when managers (who are assumed to know better about true condition of the firm than investors) issue new equity, investors believe that managers think that the firm is overvalued and managers are taking advantage of this over-valuation. As a result, investors will place a lower value to the new equity issuance.

The determination of capital structure in practice involves considerations in addition to the concerns about earning per share, value and cash flow. A firm may have enough debt servicing ability but it may not have assets to offer as collateral. Attitudes of firms with regard to financing decisions may also be quite often influenced by their desire of not losing control, maintaining operating flexibility and have convenient timing and cheaper means of raising of funds. According to Ezra Solomon and John Pringle, financial leverage affects both the magnitude and the variability of earnings per share and return on equity. For any given level of EBIT, the effect of increase in leverage is favourable if the percentage rate of operating return on assets is greater than the interest on debt and it is unfavourable if it is less. When EBIT varies over time, financial leverage magnifies the variation in earnings per share and return on equity. A great deal of controversy has developed over whether the capital of a firm as determined by its financing decision, affects its cost of capital. Traditionalists argue that the firm can lower its cost of capital and increase market value per share by the judicious use of leverage. Modigliani and Miller, on the other hand, argue that in the absence of taxes and other market imperfections, the total value of the firm and its cost of capital are independent of capital structure. This position is based on the notion that there is a conservation of investment value. No matter how you divide the pie between debt and equity claims, the total investment value of the firm stays the same. Therefore, leverage is said to be irrelevant. Hence, the proposed study makes a critical study of the capital structure of various companies over a period of a time. There are various industries like cement, pharmaceuticals, sugar, steel, petroleum, fertilizer, automobile etc. From among these, the proposed research shall study few companies in the pharmaceutical and engineering industry.

4. M-M APPROACH:
Franco Modigliani and Merton Miller (hereafter called M-M) were the first to present a formal model on valuation of capital structure. In their seminal papers (1958, 1963), they showed that under the assumptions of perfect capital markets, equivalent risk class, no taxes, 100 % dividend-payout ratio and constant cost of debt, the value of a firm is independent of its capital structure. When corporate taxes are taken into account, the value of a firm increases linearly with debt-equity ratio because of interest payments being tax exempted. M-Ms work has been at the centre stage of the financial research till date. Their models have been criticized, supported, and extended over the last 35 years. David Durand (1963) criticized the model on the ground that the assumptions used by M-M are unrealistic. Solomon (1963) argued that the cost of debt does not always remain constant. When the leverage level exceeds the accepted level, the probability of default in interest payments increases thus raising the cost of debt. This trade-off theory was challenged by Miller (1977). He argued that bankruptcy and agency costs are too small to offset the tax advantage of debt. But when personal taxes are taken into account, this advantage is completely offset by the disadvantage of personal tax. Thus, in equilibrium, the value of a firm is independent of its capital structure, even when the market is imperfect. But Millers model was rejected by De Angelo and Masulis (1980). They argued that even if bankruptcy, agency and related costs are ignored, introduction of non-tax debt shields is enough for a firm to have an optimal capital structure. And even if these costs are taken into account, an optimal capital structure exists, irrespective of availability of non-debt tax shields.The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, the value of a firm is irrelevant to how that firm is financed. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a companys value is affected by the capital structure it employs

CHAPTER-3 LITERATURE REVIEW

Brander and Lewis (1986) and Maksimovic (1988) provide the theoretical framework that links capital structure and market structure. Contrary to the profit maximisation objective postulated in industrial organisation literature, these theories, like the corporate finance theory, assume that the firms objective is to maximise the wealth of shareholders, and show that market structure affects capital structure by influencing the competitive behaviour and strategies of firms. Firms in the oligopolistic market will follow the strategy of maximising their output for improving profitability in favourable economic conditions (Brander and Lewis, 1986). In unfavourable economic conditions, they would take a cut in production and reduce their profitability. Shareholders enjoy increased wealth in good periods, but they tend to ignore decline in profitability in bad times as unfavourable consequences are passed on to lenders because of shareholders limited liability status. Thus, the oligopoly firms, in contrast to firms in the competitive markets, would employ higher levels of debt to produce more when opportunities to earn higher profits arise. The implied prediction of the output maximisation hypothesis is that capital structure and market structure have positive relationship. In corporate finance, the agency costs theory supports the use of high debt, and it is consistent with the prediction of the output maximisation hypothesis. Jensen and Meckling (1977) argue that the shareholders-lenders conflict results into risk shifting and wealth appropriation in favour of shareholders as they take on risky investment

projects (asset substitution). Hence, shareholders and managers, as their agents, are prompted to take on more borrowing to finance risky projects. Lenders would receive interest and principal if projects succeed, and shareholders would appropriate the residual income. However, lenders would lose if project fails. It is difficult and costly for debt holders to be able to assess and monitor risky projects. Even debt covenants may not be able to protect them. In terms of the product-market decisions, the implication of the agency theory is that firms would borrow more to pursue an aggressive production policy that would benefit shareholders. Yet another corporate finance theory that justifies the use of high debt is the tax-shield theory (Modigliani and Miller, 1963). Profitable firms borrow more to save taxes since interest costs are tax deductible. The output maximisation by oligopoly firms is supposed to increase their profitability. Hence, both the agency cost theory and the tax-shield theory would predict a positive relationship between capital structure and market structure. Capital structure increases the chances of financial distress and bankruptcy. Firms face costs of financial distress when they are unable to service debt. They will have high debt ratios if these costs are zero or trivial (Scott, 1976; Kim, 1978). Since costs of financial distress are non-trivial and high levered firm can actually go bankrupt, firms with high probability of bankruptcy will have low debt ratio. The chances of bankruptcy for firms with large reserve funds will be relatively less, but unlevered firms with high profitability and large reserve funds would have great competitive advantage. These firms with deep purse may not only survive but they would also gain by driving their rival firms into bankruptcy (Brander and Lewis, 1986; Bolton and Scharfstein, 1990). These firms follow a policy of aggressive production and predatory price cut to eliminate their rivals by forcing them into financial distress. Their strategy pays them off particularly when external funding is not available to firms of the target predatory price behaviour. The implication of this model is that the unlevered firm with deep purses (high profitability and reserve funds) would have incentive to increase output to drive the competitors into bankruptcy. Empirically, we can predict a negative relationship between capital structure and market structure.

Myers (1977) provides a model under which debt causes under-investment (asset substitution). Firms reject those profitable, low risk investment projects that have the possibility of passing on benefits from shareholders to lenders. Further, internal financing is cheaper than external debt or equity financing due to asymmetric information. Higher debt makes higher output costly for a levered firm. In a competitive market, unlevered or low-levered rival firms will intensify competition by increasing their output and/or lowering prices. If the levered firms continue borrowing to meet the competition, they may face financial distress and bankruptcy. Hence, the pecking order/asymmetric information theory predicts a negative relation between capital structure and market power. There are a few empirical studies that have investigated the issue of capital structure and market structure using data of the US firms. In these studies, market structure has been measured either in terms of price or quantity data or the Lerner index or the Herfindahl-Hirschman index or Tobins Q. Krishnaswamy, Mangla and Rathinasamy (1992) find a positive relation between debt and market structure, measured by the Lerner index. Chevalier (1993) provides evidence in support of a negative relation between capital structure and market structure. This result is consistent with bankruptcy costs or the asymmetric information/pecking order hypotheses. Phillips (1995), using price and quantity data for market structure, finds a positive link between capital structure and market structure, consistent with the output and limited liability effect model. In a study of international firms from forty-nine countries, Rathnasamy, Krishnaswamy and Mantripragada (2000) also report a positive relation between capital structure, measured by total debt ratio and long-term ratio and market structure measured by Tobins Q. Their finding supports the output and limited liability effect and agency theoretic risk-shifting model of capital structure and product market interaction. The results also provide support for the free cash flow model of Jensen (1986), in the form of positive relation between capital structure and profitability.

CHAPTER-4 RESEARCH METHODOLOGY

We use data of companies listed on the Kuala Lumper Stock Exchange for the period from 1993 to 2000. Our analysis covers data from 1994 to 2000 as data for year 1993 are used to calculate some variables for 1994. Companies with missing data are excluded from the study. We also exclude the financial and securities sector companies as their financial characteristics and use of leverage is substantially different from other companies. We also drop companies with zero sales and negative equity. After eliminating outliers, sample size is 208 companies for each period. We adjust data of those companies, which change their financial year. Such changes result in one year with missing data and the subsequent year data of more than 12 months. We first annualise the subsequent year data, and then substitute missing data by the mean value Our estimation model uses panel data. Panel data, unlike cross-section data, allows controlling for unobservable heterogeneity through individual (firm) effect (i). We also include dummies for time variable to measure temporal effect (t). This helps in controlling the effect of macro-economic variables on capital structure. Total debt-to-asset ratio (TD/A) at book value is our dependent variable. Independent variables include Q ratio, profitability, growth, unsystematic risk, size, ownership (number of shares) and tangibility. Q is calculated as the sum of market value of equity and book value of long-term debt and net current assets (current assets minus current liabilities). Growth (GA) is measured as one plus annual change in assets. Profitability is defined as earnings before interest and taxes divided by assets or capital (EBIT/A). Risk is defined as systematic risk, and it is measured by unlevered beta. Beta for each firm is calculated using the weekly share price data. The calculated beta for each company is unlevered for its level of leverage. Size is measured as natural log of assets. Ownership is measured by natural log of number of outstanding shares. It is assumed that larger number of shares imply diffused ownership. Tangibility is defined as fixed assets divided by assets.

CHAPTER-5 DATA ANLYSIS AND RESULTS

As per the Redundant Fixed Effect Test the probability of having identical cross sectional data is close to zero and probability of having identical time period is 0.873 (refer Table , Appendix). So we decide to go for fixed effect in cross sectional data and consider no time effect (refer Table 4, Appendix). Then we conduct Hausmans test to check an Misspecification in case of random effect. Here we get chi square value as 34.49 (refer Table Appendix) which gives a p value close to zero. So we reject the null hypothesis that there is no misspecification in case of random effect and conclude that the random effect model is inappropriate. Hence we take panel regression analysis with fixed effect on cross sectional data and no effect on time (period) variable. As we conduct the SUR (PCSE) Test (refer Table Appendix) we find the results are similar although the Intercept term and Tan appear to be statistically significant now. Other coefficients show improvement in significance, reinforcing our earlier results. The results of our empirical findings regarding effects on leverage for each of the variables are discussed as below:

PRO & PRO (-1)

Profitability of the current year (PRO) is having a negative coefficient with statistically significant t-value (-7.325). This implies that current profit plays a significant role in determining capital structure and higher is the profit lower is the leverage. This finding supports the pecking-order theory. Not only current profit, last years profit also plays a statistically significant (t-value: -2.857) role in determination of capital structure. The relation of the profitability is negative, which means more profitability leads to less leverage. Thus internal fund has remained an important source of capital financing in Indian corporate sector during the bullish phase of 200307.

SZS (-1)
Size, determined by the last years sales volume is also found to be a statistically significant (t value: 4.056) determinant of capital structure. As we get positive relation between size and leverage, we conclude that bigger firms have opted for greater debt financing of capital investments.

NDT (-1), TAX & GRO

The t-value of the coefficients of previous years NDT [NDT (-1)] is not found to be statistically significant (t value: -1.343). This shows that firms have not borrowed to save taxes. On the other hand, growth opportunity is observed to significantly (t value: -6.722) affect the capital financing behaviour. Negative coefficient of GRO suggests that during boom firms want to enjoy the benefits of growth and therefore they prefer to invest from the internal fund more, creating lower leverage. Perhaps because of this behavioural pattern, coefficient of NDT registers statistically insignificant value, implying that firms are less concerned about tax shield when the going is good. Our studies also find a statistically insignificant (t value: -0.931) role of the independent variable TAX in capital financing, most probably for the same reason. The overall behavioural pattern thus supports trade-off theory.

RESULTS
Table 1 provides means and standard deviations of the dependent and independent variables for each year from 1994 to 2000 and for the period 1994-00. The average total debt ratio (TDR) for the period of 1994-00 is 30%. However, TDR has been steadily increasing over years, ranging from 24% to 35% in 2000. Q ratio has shown fluctuations during 1994-00. It was lower in 1997 and 1998, corresponding with the financial and stock market crisis in Malaysia. Assets growth was quite high for the years from 1994 to 1996; but it showed a sharp decline in the last three years. Table 2 provides correlation matrix for the pooled sample of 1456firms/years observations . We find that size (ln A) and Q ratio have a significant positive relationship with total debt ratio while risk (unlevered beta) and profitability (EBIT/A) have a significant negative relationship. Other significant relationships exit between risk and size and size and ownership (ln NSH). The negative relationship between risk and size implies that the large firms, being more diversified have lower systematic risk. The positive relationship between size and ownership indicates that the large-sized Malaysian firms have more diffused ownership. Table 3, column two, presents results of two-way fixed firm and time effects model. Our main concern is to test the specification about the relationship between capital structure (total debt ratio) and market power (Q ratio). As predicted, we find that the coefficients of variables Q and Q are positive and the coefficient of Q is negative. All these coefficients are significant at 1% level of significance, which supports a cubic specification for the capital structure-market power relationship for Malaysian firms. We interpret this evidence as consistent with the economic theory of output maximisation and finance theories of agency costs and bankruptcy costs. For a given initial range of Q ratio, any increase in this ratio leads firms to increase output and take more risk to maximise shareholders wealth. This causes rivalry in the market and competition intensifies, particularly from unlevered firms. The fear of bankruptcy and loss of investment and profitability obliges levered firms to reduce debt. Hence, for some intermediate range of Q, the competition forces levered firms to lessen debt. Finally, for well-established, profitable firms with very high Q ratio and low
3 2 1

probability of financial distress and bankruptcy, the output maximisation seems to dominate the relation between capital structure and Q ratio.

We also find expected signs of the coefficients of profitability variables, EBIT/A, (EBIT/A) and (EBIT/A) .The coefficients of EBIT/A and (EBIT/A) are, respectively, negative and positive and statistically significant at 1% level of significance. The coefficient of (EBIT/A) is not statistically different from zero. Thus, our results confirm a saucer-shaped relationship between debt ratio and profitability. We interpret this evidence as a trade-off between the effects of asymmetric information, agency costs and tax benefits. For a given initial range of profitability, any increase in this ratio leads firms to internally finance its output growth and minimise cost of financing. It is also likely that at relatively lower levels of profitability, firms may not have much incentive to issue debt, as other non-debt tax shields may be available to them. There may also exit an intermediate range of profitability where firms do not have sufficient incentive either to increase or decrease any further. Finally, at higher levels of profitability and given their market power and intensifying competition, firms will increase borrowing to expand their output. Also, they have more profits to shield from taxes. Further, agency costs will be higher once firms reach high levels of profitability. The coefficients of other control variables are also statistically significant. Consistent with option model of Myers (1977) and the pecking order hypothesis of Myers and Majluf (1984), our results show a significant negative relation between growth and debt ratio. We also find a negative relationship between (systematic) risk and debt ratio. This finding is consistent with the trade-off theory. The positive relation between size and debt ratio is evidence in favour of the hypotheses that larger firms tend to be more diversified and less prone to bankruptcy and the transaction costs of issuing debt is smaller. The negative relation between debt ratio and the size of shareholding means that more diffused ownership results in lower leverage. The result supports the agency hypothesis. Our results indicate a significant positive relation of tangibility (FA/A ratio) with debt ratio. These results vindicate the trade-off theory that postulates a positive correlation between debt ratio and tangibility since fixed assets act as collateral in debt issues.
2 2 3 3

In Table 3 we also present the results of fixed firm effects models (without the time effect). Column three gives results of fixed effect model with standard and Whites heteroscedasticity-consistent t-values. The results of this model are similar to the twoway fixed (firm and time) model and for all variables Whites heteroscedasticity-

Table 1 Theoretical relationship with Leverage Trade-off Pecking Order Name of Variables Theory Theory Findings PRO Positive Negative Negative PRO (-1) NA* NA* Negative GRO Negative Positive Negative SZS (-1) NA* NA* Positive TAN Positive NA* Positive NDT (-1) NA* NA* No statistically significant relation TAX Positive NA* No statistically significant relation Cross-Section and Period Fixed Effects Test Equation Table 2 Dependent Variable: LV1 Method: Panel Least Squares Sample (adjusted): 2011 - 2012 Cross-sections included: 76 Total panel (balanced) observations: 304 Variable Coefficient Std. Error t-Statistic C 0.386 0.056 6.881 PRO(-1) -0.222 0.156 -1.421 PRO -0.637 0.145 -4.378 SZS(-1) -0.014 0.007 -1.937 GRO -0.023 0.007 -3.286 NDT(-1) -0.049 0.504 -0.097 TAX 0.000 0.000 -2.780 TAN 0.363 0.036 10.059 Effect Specifications R-squared 0.517 Mean dependent var Adjusted R-squared 0.506 S.D. dependent var S.E. of regression 0.156 Akaike info criterion Sum squared resid 7.194 Schwarz criterion Log likelihood 137.695 Hannan-Quinn criter. F-statistic 45.348 Durbin-Watson stat

Prob. 0.000 0.157 0.000 0.054 0.001 0.923 0.006 0.000 0.285 0.222 -0.853 -0.755 -0.814 0.432

CHAPTER-6 Conclusion
As per our empirical study we have three variables supporting pecking-order theory and two supporting trade-off theory (refer Table 1, Appendix). So we conclude that behavior of the Indian corporate sector regarding capital structure is eclectic. This is what is expected. Real life situation does not totally match with only one theory. But we get some interesting observations from our results. It is observed that firms on an average prefer to use internal funds compared to debt to fund their projects during the bullish phase. This gives a redeeming signal about the Indian corporate behavior which is found out to show more dependence on their internally generated funds than on external sources of finance. Two positive effects can come out of it. Firstly, from macroeconomic point of view this can signify more investments with the household savings getting supplemented by corporate savings. Actually, latest macroeconomic figures on corporate savings corroborate this observation. Secondly, this implies that the firms are not exposed to the vagaries of interest rates and thus volatility in interest rates and liquidity in the market may not have lethal impact on the corporate investment. This gives another clue that the bottom line of the firms may be less exposed to credit uncertainty. Low leverage can help the firms to avoid second agency conflict between shareholders and debtholders as well. But at the same time it can increase the conflict between managers and shareholders. As a concluding note, we point out some limitations of this study. Our study suffers from the limitation of a short time series. Because of that we cannot check panel unit root. Our analysis is restricted to the bull phase of the economy i.e. from 2003 to 2007 and we consider Only stock market listed companies. This gives a partial picture about overall investment behavior. However, in our opinion similar econometric study for the bearish phase during 19982003 and comparison with present results of bullish phase of 2003-07 can be very illuminating to identify whether there has been any impact of changes in conditions of stock market on the corporate behaviour and determinants of the capital structure. This should be a future research agenda.

References

Brealey, R., and Myers S. (2000) Principles of Corporate Finance, 6th ed., McGrawHill. Bradley, M., G. Jarrell, and Kim E. (1984): On the Existence of an Optimal Capital Structure: Theory and Evidence, Journal of Finance, 39, 857-878. Foam, E., and French K. (2000): Testing Tradeoff and Pecking Order Predictions about Dividends and Debt, working paper, University of Chicago and Sloan School of Management (MIT)

Galai, D., and Masulis R.(1976), The Option Pricing Model and the Risk Factor of Stock, Journal of Financial Economics, 3, 631-644. Grossman, S., and Hart O. (1982): Corporate Financial Structure and Managerial Incentives, in: McCall, J. (ed.), The Economics of Information and Uncertainty, University of Chicago Press.

Gujrati D. N. & Sangeetha (2007): Basic Econometrics: India: Tata Mc Graw-Hill. Harris, M., and Raviv A. (1991): The Theory of the Capital Structure, Journal of Finance 46, 297-355.