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Introduction to the topic:

Capital Structure Management or Planning the Capital


Structure
Estimation of capital requirements for current and future needs is
important for a firm. Equally important is the determining of capital mix.
Equity and debt are the two principle sources of finance of a business.
But, what should be the proportion between debt and equity in the
capital structure of a firm now much financial leverage should a firm
employ? This is a very difficult question. To answer this question, the
relationship between the financial leverage and the value of the firm or
cost of capital has to be studied. Capital structure planning, which aims
at the maximisation of profits and the wealth of the shareholders,
ensures the maximum value of a firm or the minimum cost of the
shareholders. It is very important for the financial manager to determine
the proper mix of debt and equity for his firm. In principle every firm
aims at achieving the optimal capital structure but in practice it is very
difficult to design the optimal capital structure. The management of a
firm should try to reach as near as possible of the optimum point of debt
and equity mix.

Essential Features of a Sound Capital Mix


A sound or an appropriate capital structure should have the following
essential features:

i. Maximum possible use of leverage.

ii. The capital structure should be flexible.

iii. To avoid undue financial/business risk with the increase of debt.

iv. The use of debt should be within the capacity of a firm. The firm
should be in a position to meet its obligation in paying the loan and
interest charges as and when due.

v. It should involve minimum possible risk of loss of control.

vi. It must avoid undue restrictions in agreement of debt.

vii. The capital structure should be conservative. It should be


composed of high grade securities and debt capacity of the
company should never be exceeded.
viii. The capital structure should be simple in the sense that can be
easily managed and also easily understood by the investors.

ix. The debt should be used to the extent that it does not threaten the
solvency of the firm.

Capital Structure of a Company refers to the composition or make up of its


Capitalization and it includes all long term Capital resources i.e. loans,
reserves, shares and bond. It shows the mix of a company's long-term debt,
specific short-term debt, common equity and preferred equity. The capital
structure is how a firm finances its overall operations and growth by using
different sources of funds. In finance, capital structure refers to the way a
corporation finances its assets through some combination of equity, debt, or
hybrid securities. A firm's capital structure is then the composition or
'structure' of its liabilities. For example, a firm that sells $20 billion in equity
and $80 billion in debt is said to be 20% equity-financed and 80%
debtfinanced.
The firm's ratio of debt to total financing, 80% in this example is
referred to as the firm's leverage. In reality, capital structure may be highly
complex and include tens of sources. Gearing Ratio is the proportion of the
capital employed of the firm which come from outside of the business
finance, e.g. by taking a short term loan etc.Debt comes in the form of bond
issues or long-term notes payable, while equity is classified as common
stock, preferred stock or retained earnings. Short-term debt such as working
capital requirements is also considered to be part of the capital structure
structure. A company's proportion of short and long-term debt is considered
when analyzing capital Structure. When people refer to capital structure they
are most likely referring to a firm's debt-to-equity ratio, which provides
insight into how risky a company is. Usually a company more heavily financed
by debt poses greater risk, as this firm is relatively highly levered.
The long term creditors would judge the soundness of the firm on the basis
of the long term financial strength measured in terms of ability to pay the
interest regularly as well as repay the installment of the principal on due
dates or in one lump sum at the time of maturity. Accordingly, there are two
different, but mutually dependent and interrelated, types of leverage ratio
First Ratio which are based on the relationship between borrowed funds and
owner’s capital. In this Paper, researcher explain the different leverage ratio
as also how they can be used to draw inferences regarding the financial
soundness of the firm.
Profitability and Capital Structure: EBIT – EPS Analysis
The financial leverage affects the pattern of distribution of
operating profit among various types of investors and increases the
variability of the EPS of the firm. Therefore, in search for an appropriate
capitals structure for a firm, the financial manager must analysis the
effects of various alternative financial leverages on the EPS. Given a level
of EBIT, EPS will be different under different financing mix depending
upon the extent of debt financing. The effect of leverage on the EPS
emerges because of the existence of fixed financial charge i.e., interest
on debt financial fixed dividend on preference share capital. The effect
of fixed financial charge on the EPS depends upon the relationship
between the rate of return on assets and the rate of fixed charge. If the
rate of return on assets is higher than the cost of financing, then the
increasing use of fixed charge financing (i.e., debt and preference share
capital) will result in increase in the EPS. This situation is also known
favourable financial leverage or Trading on Equity. On the other
hand, if the rate of return on assets is less than the cost of financing,
then the effect may be negative and therefore, the increasing use of debt
and preference share capital may reduce the EPS of the firm.
The fixed financial charge financing may further be analyzed with
reference to the choice between the debt financing and the issue of
preference shares. Theoretically, the choice is tilted in favour of debt
financing because of two reasons: (i) the explicit cost of debt financing
i.e., the rate of interest payable on debt instruments or loans is generally
lower than the rate of fixed dividend payable on preference shares, and
(ii) interest on debt financing is tax-deductible and therefore the real
costs (after-tax) is lower than the cost of preference share capital.
Thus, the analysis of the different capital structure and the effect
of leverage on the expected EPS will provide a useful guide to select a
particular level of debt financing. The EBIT-EPS analysis is of significant
importance and if undertaken properly, can be an effective tool in the
hands of a financial manager to get an insight into the planning and
designing the capital structure of the firm.

PROFILE OF THE COMPANY AND THE


MARKET SCENARIO
COMPANY OVERVIEW
IOCL (Indian Oil Corporation) was formed in 1964 as the result of merger of
Indian Oil Company Ltd. (Estd. 1959) and Indian Refineries Ltd. (Estd. 1958).

Indian Oil Corporation Ltd. is currently India's largest company by sales with
a turnover of Rs.4,38,710 crore (USD 65.4 billion) and profit of Rs. 19,106 crore
(USD 2.8 billion) for fiscal 2016-17.
Indian Oil Corporation Ltd. is the highest ranked Indian company in the
Prestigious Fortune ‘Global 500’. It is ranked at 168th position in 2017. It is also
the 20th largest petroleum company in the world. Indian Oil and its
subsidiaries today accounts for 49% petroleum products market share in India.
Indian Oil group has sold 83.5 mn tonnes of Petroleum including 10 mn
tonnes of natural gas in the domestic market and in the yr 2016-17.

IOCL GROUP
IOCL Group consists of Indian Oil Corporation Ltd. and the following
subsidiaries:
Lanka IOC Ltd
Indian Oil (Mauritius) Ltd.
IOCL Middle East FZE
Indian Oil Technologies Ltd.
Chennai Petroleum Corporation Ltd. (CPCL)
Bongaigaon Refinery & Petrochemicals Ltd (BRPL)

IndianOil refineries achieved the highest ever crude throughput


of 65.19 million tonnes during the year 2016-17 as against a 56.69
million tonnes in 2015-16. The capacity utilisation (excluding Paradip
Refinery) was 105.1 per cent as against 103.7 during 2015-16. IndianOil is an
Indian state owned oil and gas company headquartered in New Delhi . As of 30
June, 2017, the Promoters Government of India held approx. 57.34% of the
shares in Indian Oil. Public held the rest 42.66% of the shares - this includes
Mutual Fund Companies, Foreign portfolio Investors, Financial Institutions/
Banks, Insurance Companies, Individual Shareholders and Trusts. It is one of
the Maharatna status companies of India apart from Coal India Limited, NTPC
Limited, Oil and Natural Gas Corporation, Steel Authority of Indian Limited,
Bharat Heavy Electricals Limited and Gas Authority of India Limited.

Group Companies
IndianOil is currently metamorphosing from a pure sectoral company with dominance in
downstream in India to a vertically integrated, transnational energy behemoth. The
Corporation is already on the way to becoming a major player in petrochemicals by
integrating its core refining business with petrochemical activities, besides making large
investments in E&P and import/marketing ventures for oil & gas in India and abroad.

Name Business

Indian Subsidiaries

Chennai Petroleum Corporation Limited Refining of petroleum products

Plantation of Jatropha and extraction of oil for


IndianOil - CREDA Biofuels Limited
Bio-diesels

Indian Catalyst Private Limited Manufacturing of FCC catalyst / additive

Foreign Subsidiaries

IndianOil (Mauritius) Ltd. Mauritius Terminalling, Retailing & Aviation refuelling

Lanka IOC PLC,Sri Lanka Retailing, Terminalling & Bunkering

IOC Middle East FZE, UAE Lube blending & marketing of lubricants

Investment company for E&P Project in


IOC Sweden AB, Sweden
Venezuela

IOCL (USA) Inc., USA Participation in Shale Gas Asset Project

IndOil Global B.V. Netherlands Exploration & Production

CAPITAL STRUCTURE
A mix of a company's long-term debt, specific short-term debt, common
equity and preferred equity . The capital structure is how a firm finances its
overall operations and growth by using different sources of funds.
Debt comes in the form of bond issues or long-term notes payable, while
equity is classified as common stock, preferred stock or retained earnings.
Short-term debt such as working capital requirements is also considered to
be part of the capital structure. But the IOCL does not issue the preference
shares and debenture to the public of the company
COMPONENTS OF CAPITAL STRUCTURE:

SHARE CAPITAL
CONSOLIDATED FINANCIAL STATEMENTS
For the purpose of the Company’s capital management, capital includes issued equity capital, share premium and all other
equity reserves
attributable to the equity holders of the parent. The primary objective of the Company’s capital management is to
maximise the shareholder value.
The Company manages its capital structure and makes adjustments in light of changes in economic conditions and
requirements. To maintain or
adjust the capital structure, the Company may adjust the dividend payment to shareholders, return capital to shareholders
or issue new shares.
The Company monitors capital using debt equity ratio, which is borrowings divided by Equity. The Company’s endeavour is
to keep the debt
equity ratio around 1:1.

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