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FORE SCHOOL OF MANAGEMENT

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We are very thankful to everyone who all supported us to complete our project effectively.

We are grateful to Prof.Himanshu Joshi for providing us proper guidelines and moral support
regarding completion of the report.

Thanking you,

Dhiren Patel (191137)

Ishan Jain (191141)

Manan Kohli (191145)

Payal Samanta (191156)

Rahul Jain (191159)

Rangoli Jain (191162)

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 /152.--0/.0/ 

S.NO. CONTENT PAGE NO.

ACKNOWLEDGEMENT 2

EXECUTIVE SUMMARY 4

ABSTRACT 5

1. INTRODUCTION 6

2. RESEARCH METHODOLOGY 8

3. HYPOTHESIS 9

4. FMCG SECTOR 10

5. IT SECTOR 11

6. TELECOM SECTOR 12

7. POWER SECTOR 13

8. TESTING & ANALYSIS OF HYPOTHESES 14

9. CONCLUSION 18

10. REFERENCES 19

11. ANNEXURES 20

 

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.6.3/&7. 31+8

The objective of the project is to understand the capital structure decisions taken in different
industries. For this, 4 industries have been taken into consideration which is as follows:

FMCG: HUL , P& G, Dabur and Nestle

IT: Infosys, HCL and Wipro

Power: Adani Power, Reliance Power and Birla Power Solutions

Telecom: Bharti Airtel, Idea Cellular and Reliance Communications

Major findings:

6 In IT and FMCG sector, investment is predominantly handled through equity

6 Capital structure in these sectors
6 Profitability of companies in each sector
6 FMCG sector have shown quite a stable profit margin over the last 4 years

Limitations: Only few companies per sector has been taken into consideration on the assumption
that some are the market leader and have been following the best possible financial practices in
the sector. Their capital structure is compared to other firms in that industry and various
hypotheses were tested.

c


15 /+1/

Corporate governance theory predicts that leverage affects agency costs and thereby influences
firm performance. We plan an approach to test this theory using profit efficiency, or how close a
firm¶s profits are to the benchmark of a best-practice firm facing the same exogenous conditions.
We also look for effect of industry structure on the capital structure. We also took into account
the relation between capital structure and ROCE. Adding to that we also found if a company in
expansion phase has high debt irrespective of the industry they are in.

The purpose of this project is to investigate empirically existence of inter-industry differences in

the capital structure of Indian firms and identify the possible sources of such variations in capital
structure. The technique used for this cross-sectional analysis is one way ANOVA analysis of
variance and co-relation between capital structure and ROCE.

Though differences is firm size contributes to the existing variation in financial leverage ratio
across industry-classes to some extent, it is the nature of the industry itself or more precisely the
differences in the fund requirement of industry groups based on the technology used, which is a
potential source of the existing variation.

KEYWORDS :

Capital Structure
Financial Leverage
ROCE
DFL

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 &0/+-Æ3/&-0

The relationship between capital structure and firm value has been the subject of considerable
debate, both theoretically and in empirical research. Throughout the literature, debate has centred
on whether there is an optimal capital structure for an individual firm or whether the proportion
of debt usage is irrelevant to the individual firm's value.

a. LITERATURE REVIEW

In their seminal article, Modigliani and Miller (1958 and 1963) demonstrate that, in a frictionless
world, financial leverage is unrelated to firm value, but in a world with tax-deductible interest
payments, firm value and capital structure are positively related. Miller (1977) added personal
taxes to the analysis and demonstrated that optimal debt usage occurs on a macro-level, but it
does not exist at the firm level. Interest deductibility at firm level is offset at the investor level.

Other researchers have added imperfections, such as bankruptcy costs (Baxter, 1967; Stiglitz,
1972), agency costs (Jensen and Meckling, 1976), and gains from leverage-induced tax shields
(DeAngelo and Masulis, 1980), to the analysis and have maintained that an optimal capital
structure may exist. Empirical work by Bradley, Jarrell and Kim (1984), Long and Malitz (1985)
and Titman and Wessells (1985) largely supports bankruptcy costs or agency costs as partial
determinants of leverage and of optimal capital structure. DeAngelo and Masulis (1980)
demonstrated that with the presence of corporate tax shield substitutes for debt (e.g. depreciation,
depletion, amortization, and investment tax credits), each firm will have "a unique interior
optimum leverage decision with or without leverage related costs".


.

 9
 
  asserts that financial markets are "informationally efficient".
That is, one cannot consistently achieve returns in excess of average on a risk-adjusted basis,
given the information publicly available at the time the investment is made.

,! : !!
 /
  The basic theorem states that, under a certain market price
process , in the absence of taxes, bankruptcy costs, and asymmetric information, and in an
efficient market, the value of a firm is unaffected by how that firm is financed



9, -
 /
  It states that companies prioritize their sources of financing (from
internal financing to equity) Hence, internal funds are used first, and when that is depleted, debt
is issued, and when it is not sensible to issue any more debt, equity is issued.
c



b. INDUSTRY REVIEW

The relationship between industry membership and capital structure has received considerable
attention. In their review of the capital structure literature, Harris and Raviv (1991) noted that it
is generally accepted that firms in a given industry will have similar leverage ratios while
leverage ratios vary across industries. Besides the corporate capital structure characteristics like
non-debt tax shields, research and development, fixed assets, individual products that are parts
that sum to a whole.

It is generally accepted that firms in a given industry have similar proportions of individual
assets and liabilities. Studies have found that specific industries have a common leverage ratio
which, over time is relatively stable. The correlation of capital structure and industry
membership also received empirical support in Schwartz and Arson (1967), Scott and Martin
(1975). Hamada (1972), using industry membership as proxy for risk class found that levered
beta values within different industries varied more than unlevered beta values.

DeAngelo and Masulis (1980) and Masulis (1983) use the documentation of this industry effect
as one argument for the presence of an industry-related optimal capital structure and imply that it
is the tax code and tax rate differences across industries that cause the intra-industry similarities
in leverage ratios.

The DeAngelo-Masulis model implies that a firm's optimal capital structure will be industry
related in part because of the evidence that tax rates vary across industry (Vanils, 1978;
Siegfried, 1984; and Rosenberg, 1969). Masulis (1983) argues further that when firms which
issue debt are moving toward the industry average from below, the market will react more
positively than when the firm is moving away from the industry average.

In this study, we test assume the following hypotheses base on the literature and industry review
and tested thereby.

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a. Research tools:
To test the sensitivity of both the industry classification and the components of the
leverage ratio, we use both Moneycontrol , Rediffmoney and Capitaline as sources of
industry averages and define the leverage ratio in terms of market value for equity and
debt.

b. Research parameters:
Capital Structure: Combination of debt and equity that a firm uses to fund its long term
financing. Debt to equity ratio= total debt/shareholder¶s equity.

Financial Leverage: It involves using fixed costs to finance the firm . The higher the
degree of financial leverage, the more volatile EPS will be, all other things remaining the
same. Degree of financial leverage can be given by :

DFL = % Change in EPS

% Change in EBIT

The financial leverage ratio is also referred to as the debt to equity ratio. This ratio
indicates the extent to which the business relies on debt financing

Profitability: a business's ability to generate earnings as compared to its expenses and

other relevant costs incurred during a specific time period. Profitability ratios: Return on
assets (ROA) & Return on investments (ROI)

c. Statistical tools used:

Anova Test
t-tests (p-value and critical value approach )

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Smaller, younger, heavily leveraged firms tend to have wider credit spreads that narrow with
maturity. Higher-rated firms²more mature, stable tend to have narrower credit spreads that
widen with maturity

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Capital structure varies across industries due in large part to industry-based differences in asset
intensity and asset value volatility. Industries with greater asset intensity and volatility indicate
greater risk and typically mandate less use of debt.

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Astute use of leverage (debt) increases the amount of financial resources available to a company
for growth and expansion. The assumption is that management can earn more on borrowed funds
than it pays in interest expense and fees on these funds

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The policy of supplementing owner's equity with borrowed money can only be supported when
the return on investment (ROI) is sufficiently large and a bigger margin of income is available
after meeting all fixed charges including cost of capital.

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Esty and Megginson (2003) suggested that more concentrated ownership and smaller syndicates
reduces agency costs through better incentives alignment and oversight of managers by owners
with a larger stake in the success of business operations .Thus, we predict that more concentrated
project ownership syndicates indicate lower project finance company risk of failure and non-
payment to creditors
6. /



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-;
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<: Indian FMCG industry at Rs 1.3 trillion in FY2010, accounts for 2.2% of GDP of
the country. With the economy showing signs of revival, the industry is expected to register a
growth rate of 15% in 2010 as compared to 12 % in 2009. The industry may witness a spate of
acquisitions & mergers. There will be a renewed focus on rural consumers too. Despite rise in
input costs, FMCG industry is likely to sustain its robust growth momentum aided by increased
rural income , taxation benefits and gradual shift from unorganised sector.

6 Growth drivers:
ô Robust GDP growth
ô Increased income
ô Increased urbanization
ô Evolving consumer lifestyle and buying behavior
ô Media proliferation
ô Tapping of rural market
6 Financial: this sector gives moderate returns , low risks
6 Challenges:
ô Prolonged food inflation : an-ongoing concern
ô Price wars due to increased competition
ô Organised retail ±threat of private labels
6 In contrast to other manufacturing sectorsFMCG is relatively less capital@intensive
6 Capital Structure:
Debt-equity ratio







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-;
;
<: The Indian Information Technology sector can be classified into the following broad
categories - IT Services, Engineering Services, ITES-BPO Services and E-Business. The
information technology sector In India is to grow by about 5.5 % this fiscal and is expected to
attain a double-digit growth by 2010-11. India's software exports, led by outsourcers like Infosys
Technologies, Tata Consultancy Services and Wipro saw a slowdown in growth to 16 percent in
2008/09 from the 20 percent expansion of previous years, as the United States -- the biggest
market -- struggled

6 Growth drivers :
ô Highly skilled human resource
ô Initiatives taken by Government (setting up Hi-Tech Parks and implementation of
e-governance projects);
ô Many global players have set-up operations in India like Microsoft, Oracle,
Adobe, etc
ô Cost competitiveness
ô öuality telecommunications infrastructure
ô Liberisation and reforms in telecom sector
6 Challenges :
ô Concentration of IT development in few cities
ô Less R & D
ô Contribution of IT sector to India¶s GDP is still rather small
6 Relatively less capital intensive industry
6 Capital structure :

D/E Ratio





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-;
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<: With a growth rate of 45 %, the Indian telecom industry is booming. On account of a
dramatic increase in the earnings from mobile and landline connections, the telecom industry in
India made revenue of US$ 8.56 billion during the quarter ending on December 31, 2009 thereby
witnessing a recovery from the economic downturn. Bharti Airtel has the credit of being the first
Indian operator to cross a subscriber base of 50 million.

6 Growth Drivers:
ô Auction of 3G spectrum
ô Tax incentives by the Govt.
ô Increasing access to internet
ô Large talent pool in R & D
ô Low labour cost
6 Challenges:
ô Decreasing ARPU (average revenue per user )
ô Slowing revenue growth and a huge pressure on profit margins
ô Rural tele-density is still less than 25%, while there is saturated urban tele-
density. But deployment in rural areas is limited due to low ARPU customers and
high cost of maintaining the network at these locations.
ô The challenge for operators is to seek new ways to deploy cost-effective network
in rural areas by selecting the appropriate technology and leverage the use of
available infrastructure to reduce costs and delays in network deployment.
6 Telecom is a very capital intensive sector
6 Capital Structure:
D/ E Ratio


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-;
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<: India has an installed power capacity of approximately 150 MW (2009 ), which is
4% of global capacity. The demand for power is growing exponentially and the scope for the
growth of this sector is immense. The overall power generation in the country has increased from
723.793 billion unit (BU) during 2008 -09 to 771.551 BU during the year 2009-10. The Indian
power sector has the fifth largest electricity generation capacity in the world and the world's third
largest transmission and distribution network

6 Growth Drivers
ô Unbundling of SEBs
ô Tax benefits
ô Accelerated Power Development and Reform Programme ( APDRP ) for
distribution, permission for trading of power , etc
ô Encouraged private investment in transmission sector through competitive
bidding (National Tariff Policy 2006 )
6 Challenges
ô Delay in technology procurements
ô Delay in environmental clearances, land acquisition and financial closures
ô Law and order problems
ô Shortage of trained manpower and equipments
ô Need of huge finance
ô Fuel unavailability
6 Capital intensive sector
6 Capital Structure:

D/E Ratio:


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Assumption: Top firms in each industry have been considered based on market capitalization

S.No.
COMPANY D/E Ratio MEAN

2006-07 2007-08 2008-09 2009-10

1 HUL 0.03 0.06 0.20 0.00 0.0725

2 BHARTI AIRTEL 0.47 0.33 0.28 0.14 0.3050

3 INFOSYS 0.01 0.00 0.00 0.00 0.0250

4
NTPC 0.52 0.5 0.59 0.59 0.5500
Table 1. D/ E Ratio of top firms in four industry

This hypothesis is tested using t-tests:

No. of samples, n = 4

Sample Mean, x = 0.238125

Sample standard deviation, s = 0.241241

NULL HYPOTHESIS: All top firms have higher D/E Ratio than 0.5; Ho : u >= 0.5
ALTERNATIVE HYPOTHESIS: Some top firms have lower D/E Ratio than 0.5; Ha : u < 0.5
t = x-u = - 2.171
s/ sqrt(n)

Using p-value approach:

p- value (at t = -2.171 and df = n-1 =3 and by interpolation) = 0.075
p- value > 0.05 , null hypothesis can¶t be rejected .
Result: Some top firms higher D/E Ratio

1!

The variation in capital structure across the top firms of different industry classes is more
prominent in the post-liberalization period .It seems that the type of industry influences the
variation in financial leverage ratio of firms across industries. This may be due to the fact that
both FMCG and IT industry are relatively less capital intensive as compared to Telecom and
Power industry, hence top firms in FMCG and IT industry have very low D/E Ratio as compared
to top firms in Power and Telecom industry. 
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NULL HYPOTHESIS: There is no significant difference between the capital structures of the
firms within the same industry
ALTERNATIVE HYPOTHESIS: There is significant difference between the capital structures
of the firms within the same industry
TESTING THIS HYPOTHESIS BY ANNOVA SINGLE FACTOR

Assumption: Level of significance = 0.05

./-+ +. 32/  10128 & 

p-value >0.05 FMCG companies have low D/E Ratio since it is

FMCG a low capital intensive sector. FMCG companies
Null hypothesis can¶t prefer taking short term funds to manage their
be rejected working capital
(Refer Table 2 & 3 in
annexure)

p-value <0.05 Though it is relatively less capital intensive,

IT however WIPRO has been taking debts in order
Null hypothesis can be to invest in assets and maybe it is going for an
rejected expansion in near future
(Refer Table 4 & 5 in
annexure)

p-value <0.05 
TELECOM
Null hypothesis can be
rejected
(Refer Table 6 & 7 in
annexure)
p-value <0.05 
POWER
Null hypothesis can be
rejected
(Refer Table 8 & 9 in
annexure)

 

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Assumption: Firms are in expansion whenever there is increase in asset by above 25 % over the
previous year

NULL HYPOTHESIS: There is no correlation between the change in fixed assets and change in
the debt equity ratio after the expansion.

ALTERNATIVE HYPOTHESIS: There is a correlation between the change in fixed assets and
change in the debt equity ratio after the expansion.

a) Test statistics: correlation

Test statistics: (0.105134)

(Refer to Table 10 & 11 )
Result : Therefore, there is no correlation between the change in fixed assets and change in the
debt equity ratio after the expansion.

b) Test statistics : t-test for paired sample with equal means

U1= mean of debt equity ratio of the firms before expansion

U2= mean of debt equity ratio of the firms after expansion.

H0: u1>=u2

Ha: u1<u2,

alpha= .05

Here p> Į (Refer Table 12)

Result : Therefore, null hypothesis cannot be rejected.

1!Firms in expansion mode may not necessarily take long-term debts. A firm may use
its equity to invest in expansion.

 

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NULL HYPOTHESIS: There is no correlation between ROI and the debt equity ratio of a firm.

ALTERNATIVE HYPOTHESIS: There is a positive correlation between ROI and the debt
equity ratio of a firm.

Test statistics= t- Test ((

(Refer Table 13 and 14)

Result :

1!

c


PROFITABILITY OF VARIOUS FIRMS (BASED ON ROA)

FIRM 2006-07 2007-08 2008-09 2009-10

HUL 24.45 6.61 9.46 11.84

NESTLE 25.39 43.40 49.09 60.29

P&G 89.70 106.79 135.56 164.70

DABUR 4.44 5.95 8.43 8.60

INFOSYS 195.41 235.84 310.9 384.69

WIPRO 63.86 79.05 85.42 120.49

TCS 82.35 111.43 136.38 76.72

RELIANCE 100.39 120.35 250.43 244.66

COMMUNICATIONS
BHARTI AIRTEL 60.17 106.34 145.01 96.24

IDEA CELLULAR 8.40 13.44 36.37 34.59

MTNL 181.07 186.7 189.88 149.97

NTPC 58.94 65.81 71.55 77.28

RELIANCE POWER 10.00 59.92 57.55 58.69

ADANI POWER 9.91 22.57 12.38 26.60

BIRLA POWER 48.02 43.61 44.54 3.85

SOLUTIONS

c


DFL OF VARIOUS FIRMS

(DFL = % CHANGE IN EPS / % CHANGE IN EBIT or Operating Profit )

FIRM 2006-07 2007-08 2008-09 2009-10

HUL

NESTLE

P&G

DABUR

INFOSYS

WIPRO

TCS

RELIANCE
COMMUNICATIONS
BHARTI AIRTEL

IDEA CELLULAR

MTNL

NTPC

RELIANCE POWER

ADANI POWER

BIRLA POWER
SOLUTIONS

c
 

 -023 &-0

REASONS FOR NOT USING LONG-TERM DEBT BY IT SECTOR

6 Don¶t require much long-term funds once they have initiated their operations
6 Business Risk is high. So to reduce their overall risk, they prefer minimizing financial
risk and distress and maintaining huge cash balances
6 Internal accruals & internal cash flows funds their operations
6 Ensure high liquidity as it enables them to make rapid shifts

 

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 100.63+. 

S.No.
STANDARD
COMPANY D/E Ratio MEAN
DEVIATION

2006-07 2007-08 2008-09 2009-10

1 HUL 0.03 0.06 0.2 0 0.0725 0.08845

2 P& G 0 0 0 0 0 0
3 NESTLE 0.04 0.01 0 0 0.0125 0.01892
4 DABUR 0.05 0.03 0.19 0.14 0.1025 0.07544
MEAN 0.03 0.025 0.0975 0.035 0.04688 0.03399
STANDARD
DEVIATION 0.0216 0.0264 0.11265 0.07 0.04875 0.04288

Table 2 : D/E Ratios of FMCG companies




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Table 3 : ANOVA Test on FMCG companies

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 S.No. COMPANY D/E MEAN STANDARD
Ratio DEVIATION

Mar '07 Mar '08 Mar '09 Mar µ10 

1 INFOSYS 0.01 0.00 0.00 0.00 0.0025 0.005

2 TCS 0.01 0.01 0.01 0.01 0.01 0.00

3 WIPRO 0.03 0.33 0.40 0.31 0.2675 0.16296

MEAN 0.01667 0.11333 0.13667 0.10667 0.09333 0.05270

STANDARD
0.01155 0.18771 0.22811 0.17616
DEVIATION

Table 4 : D/E Ratios of IT companies

Anova: Single Factor

SUMMARY
{
 
 
      
Row 1 4 0 0 0
Row 2 4 1.07 0.2675 0.026558
Row 3 4 0.04 0.01 0

ANOVA

  

 
         
Between
Groups 0.18395 2 0.091975 10.38939 0.004587 4.256495
Within Groups 0.079675 9 0.008853

Total 0.263625 11

Table 5 : ANOVA Test on IT companies

c


 S.No. STANDARD
COMPANY D/E Ratio MEAN DEVIATION

Mar '07 Mar '08 Mar '09 Mar µ10 

1 BHARTI AIRTEL 0.47 0.33 0.28 0.14 0.305 0.13626
2
RELIANCE
0.71 0.82 0.6 0.48 0.6525 0.14592
COMMUNICATIONS
3
IDEA CELLULAR 1.95 1.84 0.67 0.57 1.2575 0.73861

4 MTNL 0.00 0.00 0.00 0.00 0.00 0.00

MEAN
0.7825 0.7475 0.3875 0.2975
STANDARD
DEVIATION 0.8323 0.8025 0.3091 0.2713

Table 6 : D/ E Ratios of Telecom Companies

Anova: Single Factor

SUMMARY
{
 
 
      
Row 1 4 1.22 0.305 0.018567
Row 2 4 2.61 0.6525 0.021292
Row 3 4 5.03 1.2575 0.545558
Row 4 4 0 0 0

ANOVA

  

 
         
Between
Groups 3.494125 3 1.164708 7.958149 0.003468 3.490295
Within
Groups 1.75625 12 0.146354

Total 5.250375 15

Table 7 ANOVA Test on Telecom companies

c


 S.No. COMPANY D/E MEAN STANDARD
Ratio DEVIATION

Mar '07 Mar '08 Mar '09 Mar µ10 

1
BIRLA POWER
9
 9 9 9 0.5325 0.15903354
SOLUTIONS
2 RELIANCE
9 99 99

 9 0.0699 0.06677455
POWER
3 ADANI POWER 9
 9  
 1.3375 0.72976594
4 NTPC 9 9 9 9 0.55 0.04690416
MEAN
0.4975 0.48575 0.84165 0.665

STANDARD
0.254346 0.366323 0.917666 0.71965
DEVIATION

Table 8 : D/E Ratios of Power companies




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Table 9 : ANOVA Test on Power companies

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S.NO BEFORE AFTER % D/E RATIO D/E RATIO % D/E RATIO
CHANGE BEFORE AFTER CHANGE

1. 3771.00 4777.00 26.677 0.01 0.00 -100.000

2. 2848.50 4158.30 45.982 0.03 0.33 1000.000

3 22975.25 36119.40 57.210 0.47 0.33 -29.787

4 6109.88 10716.28 75.389 1.95 1.84 -5.641

5 4158.30 5256.30 26.405 0.33 0.40 -21.212

6 24005.19 35051.63 46.017 0.82 0.60 -26.829

7 36119.40 48092.29 33.148 0.33 0.28 -15.152

8 10716.28 16667.20 55.532 1.84 0.67 -63.587

9 7249.02 17732.94 144.625 0.00 0.00 0.000

10 604.92 2463.39 307.226 0.56 0.93 66.071

11 2463.39 6925.73 181.146 0.93 2.18 134.408

12 6925.73 15556.19 124.614 2.18 1.68 -22.936
13 675.51 862.16 27.631 0.01 0.00 -100.000

14 308.32 450.95 46.260 0.19 0.14 -26.316

15 55.53 69.54 25.229 0.48 0.50 4.167

Table 10 : D/ E Ratios of firms in expansion mode from 2006-07 to 2009-10

 

 


À*.37)
 
À*.37) 
   

Table 11: Correlation test between % change in fixed assets to % change in D/ E Ratio

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c=>?0(01*0 -.     
0À-0-/ .01*0 -. 

 

Table 12: t-Test: Paired Two Sample for Means for hypothesis 3

Firm Average ROI Average Debt-Equity Ratio

HUL 107.495 0.0725
NESTLE 148.650 0.0125
DABUR 60.795 0.1025
INFOSYS 41.880 0.0025
WIPRO 26.590 0.2675
TCS 44.630 0.0100
BHARTI AIRTEL 27.318 0.3050
RELIANCE COMMUNICATIONS 6.845 0.6525
IDEA CELLULAR 13.452 1.2575
MTNL -4.738 0.0000
BIRLA POWER SOLUTIONS 7.445 0.5325
ADANI POWER 0.378 1.3375
NTPC 13.640 0.5500

Table 13 : Average ROI and D/ E Ratio for all firms




 

 

À*.37) 
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Table 14: Correlation test for hypothesis 4

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