Alembic Galss Industry

Financing Decision

A Project ReportOn

Financing Decision At

Alembic Glass Industries Ltd.

As a Partial Fulfillment Of

Master of Business Administration Programme

Prepared By

Unnati Rawal

Submitted ToN.R. Institute of Business Management

Gujarat UniversityAhmedabad

24th July 2004


Financing Decision

PREFACE

During my training at ALEMBIC GLASS INDUSTRIES LTD., (AGIL), I observed that the practical very essential to import a practical knowledge along with a theoretical knowledge provided in the four walls of the classroom. In order to make the First Year M.B.A. student with an industrial environment, university made it compulsory to visit at least one industry according training has a great importance to get familiar with industrial environment because it is to confirmed time. In objective behind the industrial training in the First Year M.B.A. is to gain in depth knowledge about the specialized functional area of management i.e. finance management.

During the training period at AGIL Vadodara, my things which one are necessary for being a student of financial management. The training explain me the meaning of financial management is true sense. It provided me a comprehensive and analytical study of industrial environment of the organization.

Really speaking, this unit visit has provided a encouraging and critical analysis of growth of our industries. In this way there was a sincere and honest attempt behind the training to give the practical knowledge of industrial structure.

My heartily wishes are always with the company for its bright future.


Financing Decision

ACKNOWLEDGEMENT

Practical training is an important part of the First Year M.B.A. Programmme. The study is expected to acquire sufficient practical knowledge about the various issues on the different management subjects taught to us during the First Year. The main object of such training is to fill the gap between theoretical framework and actual practice of management principles. As trainee in Alembic Glass Industries Ltd., (AGIL) Vadodara it was my pleasure to visit individually all the functional areas and gain in depth knowledge of financial practice of the organizations.

It was a great opportunity for me to be there in AGIL as a trainee, which would not have been possible without the co-operation of the AGIL staff. So, I would like to sincerely express my gratitude to Mr. A.M. Kamdar, General Manager, Finance and Mr. R.R. Akbari, Assistant Finance Manager for the same without the help of them this would have not been possible.

Even I would like to thank Mr. N.M. Khandelwal, Director as well as Mr. Neeraj Amarnani who had helped me a lot to make my theoretical knowledge background strong which was of due importance for undergoing this training.

Last but not the least I would even like to thank the staff of AGIL, which was also much co-operative and helped me a lot during my training.

I would like to wish AGIL best wishes for the future to come.


Financing Decision

EXECUTIVE SUMMARY

The purpose of the study was the “FINANCING DECISION” at Alembic Glass Industries Ltd., (AGIL) wherein I was suppose to deal with the subject for the capital restructuring.

The report comprises of the various financial long term as well as short-term sources of finance, which were evaluated for the restructuring for AGIL. In order to deal with the sources and to incorporate in the capital restructure the various cost for the same are also calculated. Even the weighted average cost of the capital was also incorporated so that the structure can be evaluated accordingly.

Apart from the sources of financing even the other ways of raising the funds are evaluated. The firm can also raise the funds through the Mergers, Acquisitions or even the Takeovers. Even which is the most useful way i.e. Merger to deal out for the same is evaluated for AGIL and even the advantages of the same within the firm and outside the firm is also known.

There are certain limitations even of the study, which are taken into account and are incorporated in the report.


Financing Decision

BRIEF COMPANY HISTORYAlembic Glass Industries Limited ( the Company ) was originally a division of Alembic Limited promoted by late Shri R.B. Amin. In 1944, the company matured in to separate organisation. The mission of the company was development of the glass and ceramic industry and all things and materials pertaining to glass Industry.

The company was incorporated as a Private Limited Company in the Year 1944. Soon after 7 years the decorating plant was established. In the next year, the company started production of flint and amber horosilicate vials on automatic machines. In the subsequent year of an automatic plant for production of press wares was installed. In the year 1965, the Banglore plant was established for manufacturing hollow wares. The company began the production of smoky Yera wares on MPD machines.

The company manufactures Pressed - wares such as Glasses, tumblers, bowls, cups, dishes, mugs, plates, jars, saucers, dinner sets, gift sets, etc., required by the hotel industries and household customers. And Hollow - wares such as bottles, vials, etc., required by the industrial customers such as, food processing, pharmaceuticals, distillery, soft drink manufacturers, etc. The company’s pressed wares enjoys consumable preference due to the following strategic advantage.

Strategic advantage for the company :--

The following are the main strategies for the company:

National brand:The company is producing its products under brand name of ‘YERA’ and ‘PREMA’; ‘YERA’ is very popular and national brand. The brand equity of the company is very high. Value of 'YERA' brand is estimated about Rs 75 to Rs 100 crores.

Widest distribution network:The company has widest distribution network consist of 130 distributors and about 10000 stockiest/ retain operators in all over India.

Superior quality of products:

Largest range

Largest range about 100 products of the company available, which is the highest in India. Details of range of main products are as under: --

(a) Tumbler :-In different designs, patterns and shapes, plain and decorating imorted stckers, crystal, heavy bottom, tall, arrow ,cut, fluted, etc.

(b) Bottles with caps and without caps :-Plain and decorated in different shape of round, square mouths with air tight caps and without caps.

(c) Bowls and casseroles :-Plain and decorated crystals, spiral, fancy, fluted bowls in different shape of square, round, octagonal, etc. plain and decorated casseroles in different sizes.


Financing Decision

.

(d) Juicer/ beer mugs in different pattern and design of square, crystal, L shaped, fancy, frosted, hexagonal, etc.

(e) Plain and decorated round plates

(f) Jugs (including pourers and without pourers) in plain and decorated in different shapes and designs of oval.

(g) Gift pack :-Plain and decorated lemon set, plain dinner sets, pudding sets, crystal bowls sets, gold line cups and saucers, tumbler sets, charmin/ wild strawberry, florimunda/ Indiana sets.

(h) YERA opal:-Plain decorated opal ware products in different size, design and shape viz. Full and quarter plates, cups and saucers, tea/ coffee mugs, bowls, casseroles and gift packs, pudding sets, etc.

Presently, the company has only one plant in opertion at Vadodara. The Banglore unit which manufactured hollow wares and flint glass was closed down in past due to severe power problem.

In 1987, the company has entered into an agreement with Dharak Limited, Vadodara, to transfer Vadodara unit of the company. This agreement was basically made for the labour rationalisation, whereby it was thought prudent to reduce labour cost, improve labour efficiency and to keep troublesome elements out of the company. The agreement was expired on 1st October 2003.

The Company has taken pressed ware production facilities from the closed

pressed ware glass factroy near Bharuch on lease base for a period of 3 years to

enhance the production capacity and stared the production.


Financing Decision

GLASS INDUSTRIES AND the Company Growth potential of the Glass Industry :--

The growth of Glass Industry as a whole is expected about 5% p.a. for the next three to 5 years. Market of plain and decorated pressed ware products (kitchen wares and table wares viz. Cups, saucers, mugs, plates, bowls, casseroles) is about 100 crores, where share of the Company is about 20 % in volume and 30 % in value. Market share of plain and decorated opal ware product is about 40 crores, where share of the Company , as a new entrant is about 5%, which will be planned to increase up to 10% within next 2-3 years. The market of the hollow wares product is more than 600 crores.

Competition :--

The competition in overall glass industry is very stiff and severe. Competition in case of pressed ware products is mainly from unorganized sector, located in north India particularly from Firozabad because they are selling the products at low price and without charging of duty and tax . Secondly, because of global liberalization policy of the government, the dumping of imported products, the glass wares also made available in India having attractive designs and colors. The cut throat competition is prevailing in case of hollow ware products. Main players in the race of competition in these segments are Gujarat Glass Industries (GGI), Larsen and Toubro Ltd. (L&T), Hindustan National Glass Owens Built (Thaper group), Victory Glass, Excel Glass, etc. These are also corporate merger and acquisition cases taking place for availability of locational benefits by way of saving in transportation cost, maximum utilization of specialization and expertise of particular group in specific products, thereby they are offering the product at low price.The company will be in a better position to face the challenge in pressed ware products. Because the company from the very beginning has widest distribution network spread in all over the India, national brand name ‘YERA’ reaching the consuming consumers and satisfy their dynamic requirements by making the availability of the products at all time and at all places.

Distribution network :--

The customers/ consumers of pressed ware products are speared and scattered in India. The company has established widest distribution network of 130 main distributors and about 10000 stockiest/ retail operators in all over India. Through the well-organized distribution network, the company is reaching to its final consuming customers and meeting their all-dynamic requirements by making availability of its product at all time and places. The company is selling its product to the main distributor and the are selling to stockiest/ retail operators and later are selling to the final customers. The customers of hollow ware products are mostly industrial corporate sector companies which are mainly in the area of pharmaceutical and drug, food processing, beverage, cold drinks/ soft drinks/ liquor, etc. the company was supplying hollow ware products directly to those companies as per their requirements.

Introduction of new products :--


Financing Decision

The company is continuously introducing new products in all its category of product as per taste, performance, choice and requirements of consumers and alteration in its existing products according to the need and preference of consumers.

GENERAL INFORMATION

NAME : - ALEMBIC GLASS INDUSTRIES LIMITED

REGISTERED OFFICE : - ALEMBIC ROAD, VADODARA-390003.

BOARD OF DIRECTORS : - SHRI CHIRAYU R. AMIN SMT. MALIKA C. AMIN MISS YERA R. AMIN SHRI SHAUNAK C. AMIN SHRI SURENDRA J. AMIN DR. GANNATH R. DHOLAKIA COMPANY SECRETARY : -

AUDITORS : - K.S.AIYAR & CO. (C.A) 4th floor, Janmbhoomi Bhavan, 24-26,Janmbhoomi Marg, Fort, Mumbai - 400001.

BANKERS : - Pragti Sahkari Bank Ltd. , Alembic Road, Vadodara

R & T AGENTS : - M/S.INTIME SPECTRUM REGISTRY LIMITED 201,Sidcup Tower, Near Marble Arch, Race Course, Vadodara - 390007

STOCK EXCHANGES : - THE STOCK EXCHANGE, MUMBAI VADODARA STOCK EXCHANGE LIMITED


Financing Decision

FINANCE MANAGEMENT

INTRODUCTION

Finance Management is the managerial activity, which is concerned with the planning and controlling of the firm's financial resources. The subject of financial management is of great interest to practicing managers and academicians.

We can say that it is growing and there are many new things that can be researched and developed continuously.

OBJECTIVES OF FINANCE MANAGEMENT

Value Maximization

This is the prime objective of finance management, maximizing value of the firm and centric goal of all other departments formulated around it. Here value of the firm means shareholders wealth and that reflects through market price of share. This is broad concept than other.

Profit Maximization

It is considered to be a short term objective which is to be maximized. Other Objectives

Other miscellaneous objectives advocated by different scholars of the society , however , it is not possible for any organisation to satisfy all the stake holders equally , therefore, there are possibilities to partial fulfillment of such objectives.

MAJOR DECISIONS INVOLVED IN FINANCE MANAGEMENT

Investment decision Financing decision Dividend decision Liquidity decision

These four are the major decisions involved in finance management and taking these decisions expediently is the task of finance manager. In this report I have been assigned e aspects related to cost evaluation of capital restructuring and its financial resources for the CompanyHere in my study I have to evaluate different sources of financing for the proposed investment. There are mainly two types of fund available viz. short term and long


Financing Decision

term depend upon the requirement and availability we have to select respective sources.

SOURCES OF LONG TERM FINANCE

There are following different sources available for long term finance out of which one or more can be adopted depend upon the nature of capex and business requirement for investment purpose. The following are the sources:

Equity Capital Preference Capital Debenture Long Term Loan Public Deposits

In this report I will be working on the project considering the following points for the above sources of finance and evaluate these from the Company's point of view.

Definition Criteria Constrains Procedure Advantages/Disadvantages Suitability to the company

All these points are evaluated with reference to each source of finance and after that the short-term sources are evaluated and finally we will reach to the conclusion that which source is more suitable for the company.


Financing Decision

EQUITY CAPITAL

Equity shares are the ownership security i.e. Equity shareholders are the real owners of the business. They enjoy the residual profits of the company after having paid off preference shareholders and other creditors of the company and their liability is limited to the amount of capital they contributed to the company. The prime advantage of issuing equity share by the company is that without any fixed obligation for payment of dividends, it offers permanent capital with limited liability for repayment. The funds remain with in company throughout its lifetime and are only to be repaid at the time of liquidation of the company.

PURPOSE OF EQUITY CAPITAL

The main purpose of collecting funds through equity capital is to use them for the longer period of time. Equity capital is raised normally at the time when the company is floated. The funds collected through equity capital are mainly utilized for the purpose of incurring capital expenditure. Subsequently also during its lifetime the company can issue equity shares upto the limit specified in capital clause of Memorandum & Articles for which the company is authorized for meeting various purpose viz. long-term working capital requirements, expansion, modernization etc.

PROCEDURE FOR THE ISSUE OF EQUITY SHARES

Any company issuing equity shares is required to meet and satisfy the required guidelines of related Sections, Clauses, Sub-Clauses, notifications, Circulars, press Notes / releases of Companies Act, 1956, Security & Exchange Board of India, Stock Exchange, The Registrar of Companies, Reserve Bank of India and to take approvals as may be required from the concern authorities and Government Departments.A Company can issue equity share in one of the following route:

1) Public issue

This is one of the most popular way of raising funds from public. Companies issue equity securities to public in the primary market by making an initial public offering and get them listed on the stock exchange(s). These securities are then traded in the secondary market

Steps involved in making an IPO: -1. Approval of Board2. Appointment of Other Intermediaries: -

Mangers, Co-Managers and Advisors Underwriters Bankers Brokers


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Registrars3. Filing of the Prospectus with SEBI4. Filing of the Prospectus with ROC5. Printing and dispatch of the prospectus with the issue form6. Filing of initial listing application7. Statutory Announcement8. Collection and Processing of applications9. Allotment of shares10. Listing of issue

2) Right Issue

Under Sec.81 of the Companies Act, 1956 when a company issues additional equity capital to the existing shareholders on pro-rata basis is called Right Issue. The company sends "LETTER OF OFFER" to its existing shareholdersand they can renounce their rights in favour of any other person(s) at market-determined rate/premium. The cost of floating right issue will be comparatively less than that of public offer since these shares are issued to existing shareholders, thereby eliminating the marketing and other relevant public issue expenses.

3) Private Placement

The private placement method involves direct selling of equity shares or preference shares or debentures securities to a limited number of institutional or high net worth investors. This avoids the delay involved in going public and also reduces cost related to public offer. Normally company appoints a merchant banker to network with the institutional investors and negotiate the price of issue.

4) Preferential Allotment

An issue of equity by a listed/unlisted/private limited company to selected investors is referred as preferential allotment. It is not related to public issue and it is subject to following regulations: -

The shareholders of the company must pass a necessary special resolution and the Company must obtain government special approval under section 81(1A) before company makes final allotment, if stipulated.

The price at which preferential allotment of share is made should not be lower than the higher of the average of the weekly high and low of the closing price of the share quoted on the stock exchange during the six months period before the relevant date.

Securities issued to the promoter group by this method are subject to a lock in period of three years and to other categories of investor's for a lock in period of one year.

5) Global Depository Receipts (GDR)

A GDR is a negotiable instrument, which represents publicly traded local currency equity share. GDR is only instrument in the form of a depository receipt or certificate created by the overseas Depository bank outside India and issued to non-residence investors against the issue of ordinary shares or foreign currency convertible bonds of the issuing company. GDRs are considered as a common equity of the issuing company and are entitled to dividends and voting rights since the date of its issuance.


Financing Decision

6) American Depository Receipts (ADR)

ADR is a dollar denominated negotiable certificate, it represents non -US company's publicly traded equity. It was devised to help Americans invest in overseas securities and to assist non -US companies wishing to have their stock traded in the American Markets. A Company wishes to go for ADR needs to be financially very strong.

COST OF RAISING FUNDS THROUGH EQUITY

In this section cost has been calculated as a percentage of total issued capital and this amount is to be considered as floating/floatation cost and is to be utilized in arriving at the cost of equity capital.

Initial Public Offer

Underwriting Expenses 1.00%Brokerage 1.50%Lead manager's FeesRegistrar FeesSEBI Procedural ChargesPromotion Expenses 5.50% Banking Charges ROC Expenses related to Registration and Filling Other permissions and act related Expenses Printing, Postage of Prospectus, Forms and other Materials

Total Expenditure 8.00%

Right Issue

Legal chargesApproval from Shareholders and BOD 3.00%Advertisement ExpensesPrinting and Postage Charges


Private Placement

Legal chargesBrokerage 4.00%Merchant Banker ChargesOther Miscellaneous Charges



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Preferential Allotment


GDR and ADR

Total Expenditure 10.0% to 12.0%

Recurring Expenses (Every Year in all the cases)

All the cost is to be equity capital and must be spread over a period of 10 to 15 years to decide effective cost of raising shares.

COST OF EQUITY CAPITALThere are two approaches for calculating cost of equity capital

Dividend Capitalization Model

Cost of Capital = D/ P (1-f) + g

Where: D = Dividend expected at the end of year oneP = Market price per sharef = floatation costg = Growth rate in dividend

For eg. The Company is expected to pay the dividend at 7%, the market price of the shares is Rs. 150, the floatation for the issue of the share is 2% and the growth rate of dividend is @12%.

Therefore, considering the above, the cost of equity arrived is

Capital Asset Pricing Model (CAPM)

Cost of Capital = Rf + ( Rm - Rf )

Where:Rf = Risk Free Rate of ReturnRm = Rate of Return on Market Portfolio = Beta of the Security

The example for the same i.e. CAPM method is stated in the later report on the page

LEGAL CONSIDERATION

The following are the binding constrains that suppose to be followed by companies at the time of issuing the Equity Capital


Financing Decision

The Companies Act ' 1956 SEBI Guidelines Stamp Act Stock Exchange related rules and formalities

Some additional formalities: -

1. A company cannot issue equity shares beyond its authorized capital, if it wants to do so then first it has to increase its authorized capital. For that Special Resolution is required to be passed Form No.5 is required to be filed with the ROC along with required stamp duty

and Registration fees.2. According to section 292 of the Companies Act 1956 only the Board of Directors are authorized to issue shares. As per Sec.81 of the Companies Act fresh shares should be first issued to existing shareholders unless shareholders pass special resolution to offer those shares to the outsiders.3. Within 2 months of the issue company has to issue share certificate.4. Within 30 days of allotment, intimation to ROC in Form No.2 to be given.5. In case of public issue apart from the company law, SEBI guidelines and other stock market related formalities to be followed.6. New share will be ranking pari-passu with the existing shares after allotment.

ADVANTAGES OF EQUITY CAPITAL

1. Dividend is payable out of the profit subject to recommendations of Board of Directors.

2. Dividend Declaration and rate determined by the Board of Direcotors so Shareholders have less interference.

3. Equity capital enhances creditworthiness of the company. In general other things are being same larger the equity base, greater the ability of the firm to raise debt finance.

4. Presently equity dividend is tax-exempt in hands of investors.5. Limited liability of shareholders

DISADVANTAGES OF EQUITY CAPITAL

1. Cost of equity is usually highest. The rate of return required by the equity shareholders is generally higher as compared to other debt instruments.

2. The company has to pay tax on the dividend payment that is extra burden on company.

3. The initial issue cost of Equity capital is higher than other sources4. There is dilution of control if the equity base is broader.5. Risk associated with equity shares is more than other sources so investors are

reluctant to invest in this.


Financing Decision

PREFERENCE CAPITAL

"PREFERENCE SHARE CAPITAL" means, with reference to any company limited by shares, that part of the share capital of the company, which fulfills both the following requirements, viz-

(a) With respect to dividends, it carries or will carry a preferential right/carry first charge over the equity shareholders for the dividends a fixed amount or an amount calculated at a fixed rate from the residual profit remaining with the company.

(b) With respect to capital, at the time of liquidation of the company, their dues will be settled prior to those of equity shareholders.

Basically preference share represents hybrid form of financing. They have certain features of Equity shares like: -

Preference dividend is paid out of distributable profits only. Preference dividend is not an obligatory payment. However, it is to be paid before

dividend on equity shares is paid. Preference dividend is not a tax-deductible expense.

And have certain features of debentures like:-

Fixed dividend rate. They enjoy priority over equity shareholders. Generally, Preference shareholders do not enjoy voting rights except in certain

special cases.

PURPOSE OF ISSUING PREFERENCE SHARES

The main purpose of issuing preference shares is also to acquire long-term funds. Funds collected through preference shares are normally utilized to finance long-term fund requirements and to meet various other financial obligations. Sometimes companies also issue preference shares to better their debt-equity ratio, which is one of the crucial criteria, which banks and other financial institutions consider before approving various loan requirements of the company.

TYPES OF PREFERENCE SHARES

Cumulative and Non-Cumulative Preference Shares: Cumulative preference shares are those shares in which if dividend is not paid in a particular year, it gets carried forward and becomes payable in the next year. For example. If dividend on 12% cumulative preference shares is not paid for a period of 3 years, a dividend arrears of 36% is payable. It must be noted that a company cannot declare equity dividends unless preference dividends with arrears are paid.


Financing Decision

Redeemable and Perpetual Preference Shares: Redeemable Preference shares have a maturity period, on completion of which shares have to be redeemed, while perpetual preference shares does not have and maturity period.

Convertible and Non-Convertible Preference Shares Preference Shares gets converted to equity shares after a specified period of time if they are of convertible nature, which is not the case with non-convertible preference shares.Preference can be combined like partly redeemable and convertible with different options.

COST OF PREFERENCE CAPITAL

The principal cost to the company as far as preference shares are concerned is definitely the dividend expense. The initial expenditure of preference shares is very less compared to the equity as preference shares are normally privately placed or given to selected investors only. COST OF CAPITAL n

P = D/(1+kp) t + F/(1+kp)n t=1

kp in the above equation is approximately equal to : K = D + [(F-P) / N](F+P) / 2

Where,K = CostD = Dividend RateF = Redemption PriceP = Issue PriceN = Maturity Period

The example for the same is given in the later report on the page

LEGAL CONSIDERATIONS

Following are the important points that are to be considered from legal point of view:

1 In case of redeemable preference shares, they can be redeemed subject to following conditions: Such shares shall be redeemed only out of profits of the company, which

would otherwise be available for dividend or out of proceeds of fresh issue. No such shares shall be redeemed unless they are made fully paid up. Where such shares are redeemed otherwise than out of proceeds of fresh

issue, there shall out of profits which would otherwise have been available for dividend, a sum equal to the nominal amount of the shares redeemed be transferred to a reserve fund to be called "Capital Redemption Reserve"

2 The amount in Capital Redemption Reserve can be used to issue fully paid bonus shares.

3 Maximum period of redemption for companies limited by shares is 20 years.4 Preference shareholders have a right to vote in following cases:

They have a right to vote only on resolutions that directly affect their rights attached to preference shares.


Financing Decision

They have a right to vote on any resolution if the preference dividends are in arrears for a period of two or more years.

ADVANTAGES OF PREFERENCE SHARES

1 There is no legal obligation to pay dividend. A company does not face any legal consequences if it skips preference dividend.

2 There is no dilution of control, as preference shares do not carry any voting rights.3 Preference Capital is regarded as a part of net worth. Therefore, it enhances

creditworthiness of the company.4 Preference dividends are tax exempt in the hands of investors.

DISADVANTAGES OF PREFERENCE CAPITAL

1 Compared to debt capital it is a little expensive source of financing as dividends paid is not a tax-deductible expense for the company.

2 If a company skips preference dividends for a period of 2 years, it has to grant voting rights to preference shareholders.

3 Skipping of preference dividends can be adversely affect image of the firm in the capital market.


Financing Decision

DEBENTURES

Debentures are the creditorship securities issued by the company for the purpose of collecting long-term funds in form of debt. A debenture certificate is a document through which a company acknowledges the debt that it owes to the person(s) in the certificate and which will be repayable after certain period of time. Like equity shareholders, debentureholders are not the owners of the company but are the creditors of the company. The obligation of the company towards its debentureholders is similar to that of a borrower who promises to pay interest and principal amount at specified time. Therefore, it does not matter whether company earns profit or not it has to pay interest to debentureholders.

Certain significant features and noteworthy points related to debentures:-

1 Whenever a debenture issue is made, a trustee is appointed through a trust-deed. The trustee is usually a bank, financial institution or an insurance company. The principal role of a trustee is to protect interest of debentureholders and to see that company fulfills its contractual obligation. A trustee is paid remuneration on per annum basis.

2 Interest rates may be fixed or floating and payable annually or semi-annually.3 Debentures are usually secured by a charge on immovable properties of the

company.4 If a company issues debentures with a maturity period of more than 18 months, it

has to create) Debenture Redemption Reserve (DRR) and if the company is listed one, the amount in it should be at least half of the issue amount before redemption commences.

5 Debentures may have call and put options.

PURPOSE OF ISSUING DEBENTURES

Here also the main purpose is to obtain long-term funds for the purpose of financing various long and short-term projects. This source is less costly when compared to equity and preference issues as interest paid on debentures is usually fixed and is a tax-deductible expense but the disadvantage is that a company has to regularly pay interest irrespective of profit earning.

TYPES OF DEBENTURES

Non Convertible Debentures Non-Convertible debentures are redeemed on completion of maturity period and are not converted to equity shares.

Convertible Debentures Convertible debentures on achieving maturity are converted to equity shares. Convertible debentures can be further classified into following two types: -

(a) Fully Convertible Debentures: These debentures get converted into equity shares after a specified period of time at one stroke or in installments. These debentures may or may not carry interest till the date of conversion. In case of companies with an established


Financing Decision

reputation and stable market price, FCD's are very attractive to the investors as their bonds are getting automatically converted to equity shares. Which may at the time of conversion be quoted much higher in the market compared to what the debentureholders paid at the time of FCD issue.

(b) Partly Convertible Debentures: These are debentures, a portion of which will be converted into equity share capital after a specified period, whereas the non-convertible portion of the PCD will be redeemed as per the terms of the issue after the maturity period.

COST OF ISSUING DEBENTURE

The cost of issuing the debenture which are incurred only once i.e. one time expenditure related to issue of debenture are written in the year of issue itself and are not spread over the life of debenture.

Nature of Expenditure

1 Fixed interest rate2 Stamp Duty 3 Trustee's Remuneration 4 Processing Charges (Front Fees) 5 Printing and Postage6 ROC Registration Charges 7 Mortgage Fees8 Acceptance Fees

Note: Floatation cost to be built up and to be added on fixed interest rate for arriving at the effective cost of preference capital.



1 A Board Resolution should be passed for approving the proposal to issue debentures, finalize terms and conditions of Trust Deed and for convening general meeting to secure consent of shareholders.

2 In case of private placement the company is required to hold negotiations with prospective lenders and obtain applications.

3 Within 30 days of allotment return in Form No. 2 is to be filed with ROC.4 Within 30 days of creation of charge return in Form No. 10 and Form No. 13

should be filed with ROC5 Debenture Redemption Reserve (DRR) should be created for the purpose of

redemption and company shall credit adequate amount out of its profits every year until the debenture are fully redeemed.

6 The security for debenture should be created within 6 months of the issue of debenture. In case security is not created within 12 months, a penal interest of 2% should be paid to debentureholders.

7 The issue proceeds shall be kept in an escrow account until documents for creation of security are executed.


Financing Decision

ADVANTAGES OF DEBENTURE CAPITAL

1 Interest paid to debentureholders is a tax-deductible expense, whereas equity and preference dividends are paid out of profit after tax.

2 Raising of funds through debentures does not result in dilution of control because debentureholders are not entitled to vote.

3 Issue costs of debentures are significantly lower than that of equity and preference capital.

4 Debentureholders do not have share in the value created by the company as payments are limited to interest and principal.

5 The burden of servicing debentures is generally fixed in nominal terms.

DISADVANTAGES OF DEBENTURE CAPITAL

1 Financial obligation on part of company as far as payment of interest and principal amount is concerned is fixed. Failure to meet this obligation can cause great deal of financial embarrassment and even lead to bankruptcy.

2 Company can face financial crises and its creditability can get affected if it defaults is paying interest to debentureholders.


Financing Decision

TERM LOANS

Term Loans constitute one of the major sources of debt finance for a long-term project. Historically, term loans given by banks, financial institutions viz., IDBI, ICICI etc. and state financial corporations have been the primary source of long-term debt for private firms and most public firms. Term loans represent a source of debt finance, which is generally acquired to finance acquisition of fixed assets and working capital margin. Here Term loans should not be confused with short-term bank loans, which are acquired to finance short-term working capital need and whose maturity period is normally less than a year. In this section term loans are discussed in both of its forms viz. rupee term loans and foreign currency term loans

TERM LOANS

RUPEE TERMS FOREIGN CURRENCY

F.C. Loan F.C. ECB’s Loan

Certain significant features and noteworthy points related to term loans: -

1 Term loans can be availed in both forms viz., rupee as well as foreign currency2 The interest and principal repayment on term loans are definite obligations that are

payable irrespective of the financial situation of the company.3 The interest rate on the term loan will be fixed after the financial institution

appraises the project and assesses the credit risk, which is subjected to certain floor rate that differs from industry to industry.

4 Term loans are generally secured through mortgage or by way of deposit of title deeds of immovable tangible or intangible properties or hypothecation of movable properties.

5 Financial institutions apart from the security also place certain restrictive covenants on the borrowing firm.

6 Financial Institutions also ask collateral securities to have a comfort level.

PURPOSE OF TERM LOANS

The main purpose of going for term loans is to get long-term funds for the purpose of financing various fixed assets and other sources.

Nature of Expenditure

1 Fixed Interest Rate2 Stamp Duty3 Processing Charges 4 Legal and Registration Fees


Financing Decision

5 Charge Creation/Registration6 Brokerage/Intermediary Expenses7 Certification Charges 8 Other miscellaneous Expenses

Here for per annum cost calculation expenditure other than interest will be spread over the loan period.Floatation cost to be built up and to be added as fixed interest rate for arriving at the effective cost.

TOTAL COST

Per Annum Cost = Total Cost (1-t)

TERM LOANS (FOREIGN CURRENCY)

In this source of finance the corporate obtain the term loan from the local bank but in foreign currency. In the present scenario this is one of the cheapest source of finance available to the companies provided they manage through effective hedging instrument to minimize the cost of borrowing various exchange and other risks associated with the source in an efficient manner. The funds through this source can be utilized for various expansions and other projects.

COST OF TERM LOANS (FOREIGN CURRENCY)

The main cost here is the interest cost that the company pays to the lending bank or financial institution. The interest is paid in accordance with the agreed terms, which are mutually decided by the company and the lending institution. Normally interest is paid on floating rate basis, which is LIBOR plus agreed spread. The agreed spread here rests on the risk associated with the project and creditworthiness of the company. For payment of interest the company can enter into interest rate swap or currency rate swap agreements and reduce the risk considerably.The principal difference between External Commercial Borrowings and Foreign Currency Term Loans is that in the later funds are borrowed from within the country which is not so in case of External Commercial Borrowings.To minimize the associated floating interest rate risk (LIBOR) and exchange rate (INR/US DOLLAR), the company can take suitable hedging strategies such as Cross Currency Swap (CCS) or Coupon Only Swap (COS) or Principal Only Swap(POS) with or without options. The cost of Foreign Currency borrowing including hedging cost is generally lower as compared to the term loan in INR.

RESTRICTIVE COVENANTS

In order to protect their interest, financial institutions generally impose restrictive conditions on the borrowers. While the specific set of restrictive covenants depends on the nature of the project, risk associated with it and the financial position of the borrower, loan contracts may have one or more of the following as restrictive covenants:-


Financing Decision

1 Broad base its board of directors by way of Nominee Director(s) and finalize its management set-up in consultation with and to the satisfaction of the financial institutions.

2 Restrain from undertaking any new project and / or expansion or make any investment without the prior approval of the financial institutions.

3 Refrain from additional borrowings or seek the consent of financial institutions for additional borrowings.

4 Reduce the proportion of debt in its capital structures by issuing additional equity and preference capital.

5 Limit its dividend payment to a certain rate or seek the consent of financial institutions to declare dividend at a higher rate.

6 Refrain from creating further charges on its assets.7 Provide periodic information about its operations.8 Limit the freedom of the promoters to dispose of their shareholdings.9 Effect organizational changes and appoint suitable professional staff.


Following are the points that are to be considered from the legal point of view:-

1 According to the Companies Act 1956, charge created on assets given, as a security to the loan must be registered with the Registrar of Companies. This facilitates lenders for verifying whether assets are free or secured and take decisions accordingly.

2 A board resolution should be passed for approving proposal to create/modify charge over the asset of the company.

3 Approval from members is required incase of mortgage since creation of charge amounts to disposal of immovable assets; the approval of members is required to be obtained before creation of charge for every loan.

4 An application should be made to the Reserve Bank of India for creation of charge outside India.

5 Within 30 days of creation of charge Form No. 8 and Form No. 13 should be filed with the Registrar of Companies.

6 Every company must keep at its registered office Registrar of Charges in which entry should be made regarding creation or modification of charge and it should be available to members and creditors for inspection.

ADVANTAGES OF TERM LOANS

1 Interest paid on term loans is a tax-deductible expense, whereas equity and preference dividends are paid out of profit after tax.

2 This mode of financing does not result in dilution of control, as there are no voting rights connected with this mode of financing.

3 Cost of borrowing in term loans is significantly lower.4 The burden of servicing debt is generally fixed in nominal terms. Hence debt

provides protection against high-unanticipated inflation.


Financing Decision

DISADVANTAGES OF TERM LOANS

1 This mode of financing entails fixed interest and principal repayment obligation. Failure to meet these commitments can cause great deal of financial embarrassment and even lead to bankruptcy.

2 Financial institutions impose restrictive covenants, which limits operating flexibility of the firm.

3 If the rate of inflation turns out to be unexpectedly low, the real cost of debt will be greater than expected.

An Alternative way to deal with:Other structured financing to suit the specific financing requirements of the corporate say brand financing where Bank will provide the finance against brand finance under following structure:AGI sales the National Brand to Bank with condition to resale to AGI at maturity with predetermined price or incase of consecutive default in making payment of interest or principal by AGI, the Bank will sell the Brand to Alembic Ltd., at agreed price and Alembic Ltd. will pay the outstanding balance to Bank and balance to AGI. Alembic may provide comfort level and undertaking to purchase the Brand from Bank on default by AGI.

DIAGRAM PRESENTATION:

SPECIAL PURPOSE VEHICLE (SPV) THROUGH PASSED THROUGH CERTIFICATE (PTC):

Sales Brand

AGI BANK

Sales Proceeds/Loan with Rent/Lease

Rent Payment/ Lease Payment

Resale on Maturity

ALEMBIC LTD.Resale on Default

Remaining Balance Outstanding Balance


Financing Decision

PUBLIC DEPOSIT

Deposits from the public are an important mode of finance from the corporate sector. Companies prefer to raise finance by accepting deposits rather than borrowing from banks and financial institutions, because these are in the nature of unsecured debts and not backed by any security in the form of hypothecation, mortgage lien, etc. Further deployment of funds raised through deposits is at the discretion of the company unlike loans from banks and financial institutions.

The companies (Acceptance of Deposits) Rules, 1975 defines public deposits as any deposit of money including any amount borrowed by the company but excludes:

Any amount received from or guaranteed by central or state government. Amount received from foreign government or foreign citizens. Any borrowings from banks and financial institutions. Inter corporate deposits. Security deposit received from an employee or an agent. Advance received for supply of goods or services. Amount received towards subscription to shares or debentures. Any amount received from a local authority. Any amount received from a director of the company. Bonds or debentures secured by mortgage of immovable property of the company

or with conversion option. Any unsecured loan brought in by promoters in pursuance to any stipulation by

financial institutions to that effect.

COST OF PUBLIC DEPOSITS

As far as public deposits are concerned the principal cost that the company bears as is the interest on deposits paid to the deposit holders.The total net cost to the company with regard to public deposits is after tax payment of interest.



1 The total amount of public deposits cannot exceed 25% of the aggregate of paid-up capital and free reserves.

2 Company can accept deposits from its shareholders up to a maximum limit of 10% of the aggregate of paid-up capital and free reserves.

3 The minimum tenure for which public deposits can be accepted or renewed is 12 months. It is stipulated that the maximum maturity period for the deposits cannot exceed 60 months.

4 If the company, for the purpose of meeting its short-term requirement of funds, may accept or renew deposits for less than 3 months, but such deposits should not exceed 10% of the aggregate of paid-up capital and free reserves.

5 The company shall maintain liquid assets to the extent of 15% of the deposits maturing during the financial year ending 31st March next year.


Financing Decision

ADVANTAGES OF PUBLIC DEPOSITS

1 The procedure for obtaining public deposits is fairly simple.2 No restrictive covenants are involved.3 No security is offered against public deposits. Hence, the mortgageable assets of

the firm are kept free for future fund requirements against such assets.4 The post-tax cost is fairly reasonable.

DISADVANTAGES OF PUBLIC DEPOSITS

1 The quantum of funds that can be raised by way of public deposits is limited.2 The maturity period is relatively short.3 Complex legal compliance is to be followed.


Financing Decision

WORKING CAPITAL FINANCING

The expression working capital is used to mean the gross current assets and not net current assets. The part of the business requirement are met by the current liabilities which the company or business may incur. Thus, the business may procure the stock of raw material on credit that will constitute liability at that point of time and thereby the requirement of the funds will be reduced to that extent.

BANK FINANCE AND MARGIN MONEY REQUIREMENTS:

The banks or financial institutions and the promoters can finance the working capital requirement. Mainly commercial banks finance working capital requirements of the company. As the part of the funds are made available to the business through the current liabilities, the bank will like to finance only that portion of assets which are not financed by the creditors. Thus, the net working capital is the amount, which is taken into consideration for the purpose of the sanction of various kinds of limits. The amount of portion that is financed by the bank is known as the "bank borrowings" in financial parlance. But the bank will not finance entire 100% i.e. some amount of assets is put in by the company and rest of amount must be financed by the bank. The banks may have their own norms for providing finance against the net working capital requirement is also called "margin money for working capital", which may vary from industry to industry and from bank to bank.

NET WORKING CAPITAL Promoter's contributionMargin money for WC


GROSS CURRENT

ASSETS

CURRENT LIABILITY (OTHER THAN BANK

BORROWINGS)

NET WORKING CAPITAL(REQUIREMENT

CONSIDERING FOR FINANCING BY BANK)

NET WORKING CAPITAL

ASSETS

Promoters’ contribution for margin money of W.C.

BANK FINANCE

Financing Decision

SIGNIFICANCE OF MARGIN MONEY:

The Central Bank had set up various committees for evolving suitable norms for this purpose. The Tandon committee and Chore committee are two noteworthy committees, which had made important and significant recommendations in this regard. This prime importance of the margin money for the working capital is that the amount to some extend should be brought in by the promoter. In the running Company or the on going project, the margin money will be brought in by way of internal cash accruals, bringing fresh capital, assets etc.The company has to approach any commercial bank for getting finance for the working capital requirement. The company is required to submit certain documents and financial data i.e. past current and also future projections, to the bank. Various informations's required by the bank to assess the working capital proposal is to be provided.Even profitability statement, balance sheet, fund flow statement, statement of assessment of working capital requirement, statement of ratio analysis, Schedules for repayment of loans, interest calculation, depreciation, working capital and break-up of important items of balance sheet.On the bases of above information, the bank assess the working capital requirement of the company the bank would finance the amount after keeping some percent of total Working Capital Requirement (WCR) to be poured by the Promoters.

CREDIT MONITORING ARRANGEMENTS (CMA):

It is in the form of application to be submitted by the borrowers to the bank requested for sanction/renewal/extension of banking facilities for working capital requirements.CMA normally discloses data of last two years actual and next two years estimates/projections of profitability statement, balance sheet, ratio analysis calculation of permissible bank finance, fund flow statement assumption made while preparing CMA, basis of calculation of various norms, other relevant information and details, etc.


Financing Decision

FORMS OF FINANCING WORKINGCAPITAL

Current liability management focuses on short term financing facilities for working capital requirement. Short-term financing facilities are of two types:

1. Fund based facilities2. Non-Fund based facilities

FUND BASED FACILITIES:

Credit facilities, which actually involve development of funds by the banks, are known as funds based facilities. It includes trade credit, cash credit, bank loans and commercial papers.

TRADE CREDIT:

Trade credit refers to credit that a customer gets from suppliers of goods in normal course of business. In practice the buying firms do not have to pay cash immediately for the purchase made. This deferral of payment is a short term financing called trade credit. Generally everyone wants to delay payments upto most favorable extend and want receivable as early as possible. The firm's supplier of materials and outside service extends trade credit, which appears as accounts payable on the balance sheet. Trade credit payment terms may include a discount if payment is made within a specified period, the discount is forgone and the full amount is due on specified date. Normally the total period would not be less than 6 months. But some times it can be upto 1 month also. The repayment will be in installments. According to RBI, the interest rate would be the prime leading rate (PLR). But now the banks and the borrower as per their requirements decide the interest, i.e. it may be more or even less than PLR. In most cases, the interest and installments are payable on the quarterly bases.

It may be generally divided into two parts: Bills payable/ bill discounting means domestic bills discounting and Foreign bills payable/Foreign bills discounting means export bills discounting.

BANK BORROWINGS:

Short-term borrowings are loans with maturity of one year or less. The loan may be secured or unsecured; Short-term loans are very important source of financing for a company. The cost of using public debt is considerably higher than bank debt as fixed cost associate with issuing public debt. It can be availed in the forms of overdraft, cash credit, purchase/discount of bills and loan.Signaling through bank loans:Company's supplier or customers receives signal regarding companies' financial health through its ability to raise bank loans.


Financing Decision

- Self liquidating bank loans: Borrowers use these loans to finance their operating/cash flow . The loans called self-liquidating because bankers expected the loans to be repaid from the conversion of raw materials into cash. Inventories and receivables would be liquidated at the end of the operating cycle, and cash would be used to repay the bank loan prior to the next operating cycle.

- Lines of credit: A line of credit is non-contractual agreement between the company and its bank, which permits the company to borrow upto a stated sum during the course of year. The prime future and requirement of line of credit arrangement is cleaning up. It is that must repay the line (Zero credit balance) sometimes during a year.

- Revolving credit lines: A revolving credit agreement is a legally enforceable line of credit agreement. The bank is legally committed to provide the funds to the borrower when requested.

OVER DRAFT FACILITIES:

It is over permitted by the bank in current account of the borrower upto a certain specified limit during a stipulated period. For all operational purpose, it is equivalent to cash credit facility except for the security - it may be clean i.e. without security or may be secured against tangible securities such as fixed deposit receipts against banks, national saving certificates and other such securities.

CASH CREDIT/ GETTING CREDIT IN INR OR IN FC:

A major part of working capital requirement of any company would consist of Inventory viz. raw materials, semi finished goods, finished goods, stores and spares and book debts/receivables.Finance against such current assets is generally granted by the banks in the shape of cash credit here drawings will be permitted against stocks and receivables. The borrower is allowed to withdraw funds from the bank upto the sanctioned credit limit but not at once. The interest charged on the amount actually utilizes by the borrower. The credit is the most flexible arrangement from the viewpoint of the borrower. It is the most popular method of bank finance for working capital in India.It is running account where deposits and withdrawals are permitted as frequently as required. Here the drawings are secured against the current assets and a periodical statement of the current assets is to be submitted. The credit is of two types based on the types of charged created.


Financing Decision

PACKING CREDIT RECEIVABLES:

Packing credit refers to credit that a customer gets from suppliers of goods for the packaging of materials. In Indian market receivables are linked to the prime-leading rate (PLR).The company, which also exports its good to one or more foreign countries, can also get this facility as export financing. It cannot be in the form of short-term loan.It is broadly divided into two parts: -

1. Pre-shipment advances/packing credit advances: Here, financial assistance is sanctioned to exporters to enable them to manufacture, trade and pack the goods meant for export and arrange for their eventual shipment to foreign countries. An advance to be taken by an exporter is required to be liquidated within 180 days from the date of its commencement by negotiation of export bills or receipt of export proceeds.

Types of packing credit :

(a) Clean packing credit: It is made available to an exporter only on production of the export order or a letter of credit without exercising any change or control over raw material or finished goods.

(b) Packing credit against hypothecation of goods: Export finance is available

on certain terms and conditions where the exporters has pledge interest and goods are hypothecated to the bank as security with stipulated margin.

(c) Packing credit against pledge of goods: Export finance is made available on certain terms and conditions where the exportable finished goods are pledged to the banks with approved clearing agent who will ship the same from time to time as required by the exporter. The possession of the goods so pledged lies with the bank are kept under its lock and key.

2. Post shipment advance:-

It takes following advance:

(a) Purchase/document of exports bills: After completion of shipment of goods for exports, the exporter in almost all cases is required to draw a bill on foreign buyer for submission to his banker for collection. The bill purchase/ discount facility granted is termed as “post-shipment advance”. It is backed, by the document of the title of goods, such as bill of leading, post parcel receipts or air consignment notes.

(b) Advance against export bill sent for collection: Finance is provided by banks to exporters by the way of advance against export bills forwarded through them for collection, appropriate margin is kept taking into account the creditworthiness of the party, nature of goods exported, etc.

(c) Advance against duty drawbacks, cash subsidy, etc.: To finance export losses sustained by exporters, bank advance against duty drawbacks, cash against export performance. Such advances are of clean nature.

Hypothecation of Stocks:Alembic Glass Industries Ltd.

Financing Decision

Possession of goods remains with the borrower and floating charge over the stocks is created in favor of the bank. Drawings are permitted on the bases of stock statement submitted by the borrower subject to margin stipulated for each type of stock.

Hypothecation of Book Debts:

Here, a floating charge over the receivables is created with subject to margin stipulated for each type of debt.For the purpose of delivery of the bank credit, loan credit, loan system was introduced in April 1995. This system is made available to the cases; where the maximum permissible bank finance (MPBF) exceed Rs. 10 crore.Under this system, the total amount of bank finance would be identified into two categories:

- Cash credit components- Loan components

Now a day, the loan components can be minimum as 10 to 15 days also. The borrowers are required to have a demand loan component of at least 25%. For this purpose, the MPBF has been divided into two categories:

The accounts where the MPBF is Rs. 10 crore and Rs. 20 croreThe accounts where the MPBF is Rs. 20 crore.

This facility is equivalent to overdraft facilities.

BREAK UP OF MPBF INTO LOAN AND CASH CREDITAlembic Glass Industries Ltd.

Financing Decision

However, the borrower is free to have larger share of the “loan component” in its MPBF.

Limit of MPBF Credit components Loan components

Rs.10 crore and Rs. 20 25%crore 75%

Rs.20 crore 80% 20%

FACTORING OF RECEIVABLES:


MPFB Rs.10 to Rs.20 crore

Cash credit components Rs. 4 to 8 crore (40% of MPBF)

Cash credit components (25% MPBF)

Loan components Rs.6 to 12 crore (60% of MPBF)

Loan components(Balance of MPBF)

MPFB Rs. to Rs.20 crore

Financing Decision

Factoring is a financial service, which is rendered by the specialised persons known as "factors", who deal in realizing the book debts, bills receivables, managing sundry debtors and sales registers of the commercial or trading firms. They charge commission for it. Factoring can be with or without resources; i.e.-ultimate risk may or may not be on the borrower. Thus factoring helps in realization of credit sales of trading firms. It is useful for domestic sales as well as export sales. These minimize the risk of bad debts arising on account of non- realization of credit sales. It is usually for trade credit transaction of short-term maturity not exceeding 6 months. Cost of factoring is born by seller.

Parties to factoring contract:

1. Buyer of goods who has to pay for goods brought on credit terms.2. Seller of goods who has realizes credit terms from buyer.3. Factor who act as agent in realizing credit sales from buyer and passes on the realized sum to seller after deducting his commission.

In case of default in repayment by the debtor, the receivables are reversed in company's accounts.

NON-FUND BASED FACILITIES:

Credit facilities, which do not involve actual development of funds by banks but help the borrower to obtain certain credit facilities from third parties are termed as non-fund based facilities, they include Letter of Credit (L/C) and Bank guarantee.

LETTER OF CREDIT:-

Letter of Credit (L/C) is the method of settlement of payment of domestic or international trade transaction and is widely used to finance purchase of machinery and raw materials, etc from any foreign country or domestic supplier particularly PSU’s having monopoly in their business. It contains a written undertaking given by the bank on behalf of the buyer or the seller to make payment of a stated amount on presentation of stipulated documents and fulfillment of the terms and conditions incorporated therein. Here, in most cases the buyer and seller don’t know each other and the bank functions as the intermediary for them. The bank generally asks from the borrower to give bond and stipulated margin/collateral security.

The main parties to L/C transactions:

1. SellerThe person to whom the guarantee is given to due fulfillment of the contract by principal debtor. Principal creditors are also sometimes referred to as beneficiary.

2. Issuing BankThe bank that agrees requests of the applicant and issues its L/c. As per the instruction of the applicant.


Financing Decision

3. Advising bankThe bank usually in the beneficiary’s country (issuing banks own Branch or correspondent bank) requested to advise the credit to the beneficiaries.

4. Conforming BankSometimes, the Issuing Bank requests another bank (usually the advising bank) to add conformation to the L/c. When the bank is requested to confirm the credit, agrees and adds it’s to the credit. Then such a bank is known as “Confirming Bank”.

5. Nominated BankThis is the bank (usually the advising bank) that is nominated by the Issuing Bank to pay to the seller or to accept the seller or to accept the draft from him or to negotiate with him.

BANK GUARANTEE:Here, the bank commits on behalf of the borrower, to pay the compensation to the creditor in case, the borrower makes the default in the payment at maturity. This commitment is called 'Bank Guarantee'. Bank provides guarantee facilities to its customers who may requires these facilities for various purposes. It is used when the capital equipment is to be sold or brought. The guarantee can be given to Government Department for releasing disputed claims as excise refunds, custom duty refunds, sales tax, etc. The bank asks the borrower to provide counter guarantee and stipulated margin/ collateral security.The guarantee may broadly be divided in three categories as under,

- Financial Guarantee:The bank gives these kinds of guarantees to the creditor, purely to discharge the monetary obligation of the customer in case of default.

- Performance Guarantee: The guarantees are issued for the performance of a specific contract or the obligation. In case of non-performance of the obligation, the bank compensated the losses due to the non-fulfillment of the obligations.

- Deferred Payment Guarantee:If the equipment is brought on deferred payment bases, the bank can give guarantee to the supplier that the buyer will pay all instruments when they fall due. Now, if he doesn’t pay the installment in time to the creditor, the creditor can invoke the guarantee for the defaulted installment or balance amount. This guarantee is called “Deferred Payment Guarantee”.

SECURITY REQUIRED IN BANK FINANCE :

Banks generally not provide working capital finance without adequate security the following are method of security, which the banks may require.


Financing Decision

1. Hypothecation: Under hypothecation, the borrower is required to provide security of moveable property. The borrower does not transfer the property to the bank; it remains in the possession of borrower.

2. Pledge: Under this arrangement, the borrower is required to transfer the physical possession of the property offered as a security to the bank has right to lien and goods pledge unless payment of the principal, interest and any other expense is made.

3. Mortgage: Mortgage is the transfer of a legal or equitable interest in a specific immovable property for the payment of the debt. In case of mortgage, the possession the property may remain with the borrower, with the lender getting the full legal title. The following are the various types of the mortgage:a. Simple Mortgageb. Mortgage by conditional salec. English Mortgaged. Anomalous Mortgage

4. Lien: Lien means right of the lender to retain property belonging to the borrower until he repays credit. It can be either a particular lien where the right to retain property until the claim associated with the property is fully paid/settled. Generally lien, on the other hand, is applicable till dues of the lender are paid/settled. Banks usually enjoys general lien.


Financing Decision

COMMERCIAL PAPER

Commercial Papers (CPs) are short-term unsecured promissory notes issued at a discount to face value by well-known companies that are financially strong and carry a high credit rating. They are sold directly by the issuers to investors, or else placed by the borrowers through agents like merchant banks and security houses. The flexible maturities at which they can be issued is one of the main attractions for borrowers and investors since issues cater to the needs of both. The CP market has the advantage of giving highly rated corporate borrowers cheaper funds than they could obtain from the banks while still providing institutional investors with higher interest earnings than they could obtain from the banking system. The issue of CP imparts a degree of financial stability to the system as the issuing company necessarily to remain financially strong.Commercial Paper (CP) is an important money market instrument issued by the large corporate. It is a short term secured promissory note issued at a discount to face value by the reputed companies, who carry high credit rating and have strong financial background.CPs may be called as the existing Working Capital Facility or Stand Alone Facility.

FEATURES OF COMMERCIAL PAPER

Following are the features of CP: -

They are negotiable by endorsement and delivered like pro-noted and hence are highly flexible instruments.

They are issued in multiples of Rs. 5 lakhs, but the amount should not be less than Rs. 5 lakhs by any single investor.

The maturity varies between 15 days to a year. They are purely unsecured, as any assets of the issuing company do not back

them. They normally have a buy- back facility; the issuers or dealers can buy-back the

CPs if needed. No prior approval of RBI is needed for CP issues and underwriting of the issue is

not mandatory.

REGULATIONS

Since commercial paper represents an unsecured instruments of financing. The Reserve Bank of India has stipulated certain conditions meant primarily to ensure that only financially strong companies can issue commercial paper. According to these conditions, a company can issue commercial paper provided.

It has a net worth of at least Rs.4 crore, MPBF of minimum Rs. 4 crore and are listed on stock exchange can issue CP.

The company should be sanction working capital limit by banks or All India financial institutions.

The face value of commercial paper issued by it does not exceed 75% of its working capital limit.

Rating Certificate of quantum of CP is to obtain from specialised rating agency like CARE, ICRA, and CRISIL etc. Rating must not be more than two months.


Financing Decision

It can be secured or unsecured. But it is usually unsecured and if it is unsecured the rate of interest will be slight lower.

If a company issues commercial paper, its working capital limit is lowered. On repayment of commercial paper, the bank may review the working capital limit.

For issuing CP, NOC from lead monetary bank is required. Three days in advance, the intimation is to be sent to RBI through Issuing and Paying Agent (APG).

CPs can be issued by lower rated companies followed by guarantee of rated group company say AGI can issue CPs followed by guarantee of Alembic Ltd.

COST ASPECT RELATED TO COMMERCIAL PAPERS

A Commercial paper is sold at a discount from its face value and redeemed at its face value. CPs is sold at present value of the face value. Hence, the effective cost of commercial paper can be arrived as under:-

Face Value - Net Amount Realized * 360 Net Amount Realized Maturity Period

The discount cost is the principal cost associated with this source of finance but there are certain other fees and charges that the company is required to pay which are described in the proceeding part.


Financing Decision

SHORT TERM LOANS

These are short-term loans provided by the banks for meeting working capital requirements or for other short-term needs. The repayable period of this sort of loans is generally 12 months or less than 12 months. They carry a fixed obligation on the part of the company in form of interest, which is to be paid to the bank by the company on the terms mutually agreed upon.The company in two forms can borrow these loans:

Rupees Foreign Currency

COST OF LOANS SHORT TERM ( IN RUPEES)

For the cost purpose the following are the parameters that are taken into consideration: Amount Interest Margin Security

COST OF SHORT TERM LOANS ( IN FOREIGN CURRENCY )

Here also the main cost is the interest cost which the bank and the company, may mutually agree upon, which is generally.

LIBOR + Agreed Spread

MIBOR LINKED SHORT TERM LOANS

Banks also provide short-term loans for which interest calculation is based on Mumbai Inter Bank Offering Rate (MIBOR) plus agreed spread. Such loans are meant for working capital requirement or other short term needs of the company.

Interest Cost = MIBOR + Agreed Spread

The fixation of MIBOR and spread depends on the credit worthiness of the company.AGI may avail this route of financing followed by guarantee of Alembic Ltd., if it is available.


Financing Decision

COST OF CAPITAL

FLOATATION COST CALCULATED

Preference

capital CASH FLOW

99 7 yrs 1 1.075 1.08 1.085 1.09 1.095 7.50% 8.00% 8.50% 7.50% 8.00% 8.50% 9.00% 9.50% 0 -99 -99 -99 red at par 1 7.5 8 8.5 0.93 0.93 0.92 0.92 0.91ISSUED @ 2 7.5 8 8.5 0.87 0.86 0.85 0.84 0.83PAR 3 7.5 8 8.5 0.80 0.79 0.78 0.77 0.76 4 7.5 8 8.5 0.75 0.74 0.72 0.71 0.70 5 7.5 8 8.5 0.70 0.68 0.67 0.65 0.64 6 7.5 8 8.5 0.65 0.63 0.61 0.60 0.58 7 107.5 108 108.5 0.60 0.58 0.56 0.55 0.53 8% 8% 9% 7.69% 8.20% 8.70%

Here, the option of evaluating the preference share capital cost thus it is being issued at par and redeemed at par with a floatation cost of 1%. Thus in order to arrive at the appropriate cost the various rate of interest are taken and there present value incorporated.

7.5 8 8.5 AT 7.5 AT 8 AT 8 AT 8.5 AT 8.5 AT 9 6.98 6.94 7.41 7.37 7.83 7.80 6.49 6.43 6.86 6.80 7.22 7.15 6.04 5.95 6.35 6.26 6.65 6.56 5.62 5.51 5.88 5.77 6.13 6.02 5.22 5.10 5.44 5.32 5.65 5.52 4.86 4.73 5.04 4.90 5.21 5.07 64.80 62.73 63.02 61.01 61.29 59.35TOTAL 100 97.40 100 97.44 100 97.48DIFF-A 1 1 1 DIFF-B 2.60 2.56 2.52 QUATIONT 0.19 0.20 0.20 7.5 8 8.5 COC 7.69 8.20 8.70

The cost of capital of the various rates is stated as above at the present value.

CASH FLOW 99


Financing Decision

7 yrs red at 5%pr 7.50% 8.00% 8.50%ISSUED @ 0 -99 -99 -99PAR 1 7.5 8 8.5 2 7.5 8 8.5 3 7.5 8 8.5 4 7.5 8 8.5 5 7.5 8 8.5 6 7.5 8 8.5 7 112.5 113 113.5 8% 9% 9% 8.26% 8.75% 9.25%

Here, is the different option of evaluating the source at different rates which is issued at par value as well as redeemed at the 5% premium and the redemption takes place after 7 years.

7.5 8 8.5 AT 7.5 AT 8.5 AT 8 AT 9 AT 8.5 AT 9.5 6.98 6.91 7.41 7.34 7.83 7.76 6.49 6.37 6.86 6.73 7.22 7.09 6.04 5.87 6.35 6.18 6.65 6.47 5.62 5.41 5.88 5.67 6.13 5.91 5.22 4.99 5.44 5.20 5.65 5.40 4.86 4.60 5.04 4.77 5.21 4.93 67.81 63.55 65.93 61.81 64.12 60.13TOTAL 103.01 97.71 102.92 97.70 102.82 97.70DIFF-A 4.01 3.92 3.82 DIFF-B 5.31 5.22 5.13 QUATIONT 0.76 0.75 0.75 7.5 8 8.5 COC 8.256224 8.751156 9.25

DEBENTURE

1 1.07 1.08 1.09 1.1


Financing Decision

6YEARS REDEMPTION in 3 installments2% DISC ISSUE 30% 6th year, 30% 7th year, 40% 8th yearRED. @ PAR 1 2 3 4 5 6 7 7% 8% 9% 7% 8% 9% 10%FLOATATION COST 0 -97 -97 -97 IS 1.2% 1 7.05 8.05 9.05 0.93 0.93 0.92 0.91 2 7.05 8.05 9.05 0.87 0.86 0.84 0.83 3 7.05 8.05 9.05 0.82 0.79 0.77 0.75 4 7.05 8.05 9.05 0.76 0.74 0.71 0.68 5 7.05 8.05 9.05 0.71 0.68 0.65 0.62 6 37.05 38.05 39.05 0.67 0.63 0.60 0.56

7 34.935 35.63536.33

5 0.62 0.58 0.55 0.51 8 42.82 43.22 43.62 0.58 0.54 0.50 0.47 8% 9% 10% 7.62% 8.64% 9.66%

Here the premium will be paid in the last installment to the debenture holders The remuneration will be paid at 0.05% p.a.

CASH FLOW 97 7 8 9 AT 7 AT 8 AT 8 AT 9 AT 9 AT 10 6.59 6.53 7.45 7.39 8.30 8.23 6.16 6.04 6.90 6.78 7.62 7.48 5.75 5.60 6.39 6.22 6.99 6.80 5.38 5.18 5.92 5.70 6.41 6.18 5.03 4.80 5.48 5.23 5.88 5.62 24.69 23.35 23.98 22.69 23.28 22.04 21.76 20.38 20.79 19.49 19.88 18.65 24.92 23.13 23.35 21.69 21.89 20.35 100.27 95.01 100.26 95.18 100.25 95.34DIFF-A 3.27 3.26 3.25 DIFF-B 5.26 5.08 4.91 QUATIONT 0.62 0.64 0.66 7 8 9 COC 7.622384 8.642391 9.662691


Financing Decision

7.00 8.00 9.00 AT 7 AT 8 AT 8 AT 9 AT 9 AT 10 6.59 6.53 7.45 7.39 8.30 8.23 6.16 6.04 6.90 6.78 7.62 7.48 5.75 5.60 6.39 6.22 6.99 6.80 5.38 5.18 5.92 5.70 6.41 6.18 5.03 4.80 5.48 5.23 5.88 5.62 24.69 23.35 23.98 22.69 23.28 22.04 21.76 20.38 20.79 19.49 20.04 18.80 27.83 25.84 26.05 24.20 24.40 22.68TOTAL 103.18 97.72 102.96 97.69 102.93 97.83DIFF-A 4.18 3.96 3.93 DIFF-B 5.47 5.27 5.10 QUATIONT 0.77 0.75 0.77 7.00 8.00 9.00 COC 7.77 8.75 9.77


ISSUE @ PAR RED. @ 5% PREM.

7% 8% 9%-99 -99 -99

7.05 8.05 9.057.05 8.05 9.057.05 8.05 9.057.05 8.05 9.057.05 8.05 9.05

37.05 38.05 39.0534.935 35.635 36.635

47.82 48.22 48.62

8% 9% 10%7.77% 8.75% 9.77%

Financing Decision

COST OF EQUITY:

For the calculation of the cost of equity there are various methods for the same. But from the AGIL'S point of view it is not possible to raise the funds by the way of the equity. But while evaluating the various it is necessary to even know the cost of equity though not used for the fund raising.

For the cost calculation, the dividend growth model will not be used, since AGIL has not paid the dividend to the shareholders since a long time. Thus, to determine the cost of the equity the alternative method such as capital asset pricing method is to be used, through which appropriate cost can be derived.

CAPITAL ASSET PRICING METHOD:

An alternative model for calculating AGIL'S cost of equity is the capital asset pricing model (CAPM). The use of CAPM requires the following information:

- the expected risk- free rate of return- the expected risk premium- beta of the company's return

Risk Free Rate: The risk free rate is generally approximated by the highly liquid, short-term Government Security. The yield on one year Government Bonds in India is about 605%. This rate could be used as a proxy for the risk-free rate.

Market Premium: The difference between the expected market rate of return and the risk free rate of return is the expected market premium. The average monthly sensex return during the period April '02 to March '04. This implies an annual market rate of return as 28.8%. This seems to be too sensitive and this is not reasonable for the calculation and thus we have taken 14.4%.So, if we assume that the investor expects to earn this rate of return, then the risk premium is: 0.144 - 0.065 = 0.079%

CALCULATION OF THE BETA FOR CAPM CALCULATION

BETA = N ∑ (XY) - ∑ (X) ∑ (Y) N ∑X² - (∑X)²

= 24(0.2219) - (0.5717) (0.0725)24(0.1179) - (0.5717)²

= 5.3256 - 0.99442.8296 - 0.3268

= 4.3312 / 2.5028

= 1.731


Financing Decision

COST OF EQUITY:

Ke = Rf - β (Rm - Rf)

Rf. = Government Bonds at 6.5%

Rm. = market return 0.024 p.m.0.024*12 = 0.2880.288 / 2 = 0.14414.4%

Ke = Rf - β (Rm - Rf)

= 6.5 - 1.731 (14.4 - 6.5)

= 20.174


Financing Decision

CAPITAL ASSET PRICING METHOD (CAPM)RATE OF RETURN

PRICE IN THE BEGINNING - PRICE IN THE END / PRICE IN THE BEGINNINGR = Pt – Pt-1/Pt-1

stock price

indices company return

market return

APR. '02 81 3338.16 NIL NILMAY '02

70.6 3125.73 -0.13 -0.06

JUN. '02

133.8 3244.70 0.90 0.04

JUL. '02 112.95 2987.65 -0.16 -0.08AUG. '02

97.8 3181.23 -0.13 0.06

SEP. '02 84 2991.36 -0.14 -0.06OCT. '02

93.9 2949.32 0.12 -0.01

NOV. '02

77.3 3228.82 -0.18 0.09

DEC. '02

83.95 3377.28 0.09 0.05

JAN. '03

76.2 3250.38 -0.09 -0.04

FEB. '03

96.85 3283.66 0.27 0.01

MAR. '03

90 3048.72 0.07 -0.07

APR. '03 90 2959.79 NIL -0.03MAY '03

94 3180.75 0.04 0.07

JUN. '03

109.8 3607.13 0.17 0.13

JUL. '03 127.9 3792.61 0.16 0.05AUG. '03

217.85 4244.73 0.70 0.12

SEP. '03 143 4453.24 -0.34 0.05OCT. '03

144.55 4906.87 0.01 0.10

NOV. '03

163.1 5044.82 0.13 0.03

DEC. '03

241.6 5838.96 0.48 0.16

JAN. '04

204.75 5695.67 -0.15 -0.02

FEB. '04

192 5667.51 -0.06 0.00

MAR. '04

165 5590.60 -0.14 -0.01

SUM 1.74 0.57AVERAGE

0.07 0.02


Financing Decision

CAPITAL ASSET PRICING METHOD

market return(X) company return(Y) (X*Y) (X)2 (Y)2APR. '02 NIL NILMAY '02

-0.06 -0.13 0.01 0.00 0.02

JUN. '02

0.04 0.90 0.03 0.00 0.80

JUL. '02 -0.08 -0.16 0.01 0.01 0.02AUG. '02

0.06 -0.13 -0.01 0.00 0.02

SEP. '02 -0.06 -0.14 0.01 0.00 0.02OCT. '02

-0.01 0.12 0.00 0.00 0.01

NOV. '02

0.09 -0.18 -0.02 0.01 0.03

DEC. '02

0.05 0.09 0.00 0.00 0.01

JAN. '03

-0.04 -0.09 0.00 0.00 0.01

FEB. '03

0.01 0.27 0.00 0.00 0.07

MAR. '03

-0.07 0.07 -0.01 0.01 0.00

APR. '03 -0.03 NIL NIL 0.00 NILMAY '03

0.07 0.04 0.00 0.01 0.00

JUN. '03

0.13 0.17 0.02 0.02 0.03

JUL. '03 0.05 0.16 0.01 0.00 0.03AUG. '03

0.12 0.70 0.08 0.01 0.49

SEP. '03 0.05 -0.34 -0.02 0.00 0.12OCT. '03

0.10 0.01 0.00 0.01 0.00

NOV. '03

0.03 0.13 0.00 0.00 0.02

DEC. '03

0.16 0.48 0.08 0.02 0.23

JAN. '04

-0.02 -0.15 0.00 0.00 0.02

FEB. '04

0.00 -0.06 0.00 0.00 0.00

MAR. '04

-0.01 -0.14 0.00 0.00 0.02

SUM 0.57 1.74 0.22 0.12 1.98AVERAGE

0.02 0.07


Financing Decision

WEIGHTED AVERAGE COST OF CAPITAL

Once the component costs have been calculated, they are multiplied by the weights of the various sources of capital to obtain a weighted average cost of capital (WACC). The composite, or overall sources of capital are the weighted average of the costs of various sources of funds, weights being proportion of each source of funds in the capital structure. It should be remembered that it is the weighted average concept, not the simple average, which is relevant in calculating the overall cost of capital. The simple average cost of capital is not appropriate to use because firms hardly use various sources of funds equally in the capital structure.

The following steps are involved to calculate the weighted average cost of capital:

Calculate the cost of the specific sources of funds (i.e. cost of debt, cost of equity, cost of preference capital etc.

Multiply the cost of each source by its proportion in the capital structure. Add the weighted component costs to get the firm's weighted average cost of

capital.

In financial decision-making, the cost of capital should be calculated on an after-tax basis. Therefore the component costs to be used to measure the weighted cost of capital should be the after-tax costs. If we assume that a firm has only debt and equity in its capital structure, then its weighted average cost of capital (ko) will be:

Ko = kd (1-T) wd + kewe

Where, ko is the weighted average cost of capital, kd (1-T) and ke are respectively the after-tax cost of debt and equity, D is the amount of equity.Tax rate charged for the cost calculation is at 36% as per the corporate tax rate.

The weighted average cost of capital of the amount to be raised for the Capital Restructuring:

Sources of Finance are as follows:

1. Preference shares issued at par and redeem at par at 7.5%. Preference shares worth Rs.8 crores are issued.

2. Debentures issued at par and redemption at par at 8%. Debentures amounting to Rs. 10 crores issued.

3. Term Loan at 9.5% for 6 years, one year is the monotoring period. Interest is paid semi-annually. Rs. 2 crores by term loan to be raised.

4. Cash credit to be raised at 12%. Rs. 50 lakhs to be raised by the way of cash credit.

5. Commercial Paper with face value Rs. 100 maturing after 90 days subject to roll over with discounting rate of 5%. Interest is payable quarterly. Commercial Paper amounting to Rs. 2 crores are issued.


Financing Decision

PROPORTION OF THE SOURCES IN THE CAPITAL STRUCTURE:

FORMULA: Amount to be raised by sourceTotal amount to be raised

PREFERENCE SHARES: 8,00,00,000 / 22,50,00,000 = 0.356

DEBENTURES: 10,00,00,000 / 22,50,00,000 = 0.444

TERM LOANS: 2,00,00,000 / 22,50,00,000 = 0.089

CASH CREDIT: 50,00,000 / 22,50,00,000 = 0.022

COMMERCIAL PAPER: 2,00,00,000 / 22,50,00,000 = 0.089

SOURCES AMOUNT TO BE RAISED

PROPORTION COST AFTER TAX

WEIGHTED COST

Preference shares

8,00,00,000 0.356 0.075 0.0267

Debentures 10,00,00,000 0.444 0.0587 0.0261Term Loans 2,00,00,000 0.089 0.06547 0.0058Cash Credit 50,00,000 0.022 0.0768 0.0017Commercial Paper

2,00,00,000 0.089 0.0337 0.0030

TOTAL WACOC

22,50,00,000 0.0633*100 = 6.33%

SOURCES AMOUNT TO BE RAISED

COST AFTER TAX

AMOUNT AFTER TAX

Preference shares 8,00,00,000 0.075 60,00,000Debentures 10,00,00,000 0.0587 58,70,000 Term Loans 2,00,00,000 0.06547 13,09,440Cash Credit 50,00,000 0.0768 3,84,000Commercial Paper 2,00,00,000 0.0337 6,74,000TOTAL 22,50,00,000 1.42,37,440

WEIGHTED AVERAGE COST OF CAPITAL = 1,42,37,440 = 6.33%22,50,00,000


Financing Decision

FINANCING WORKING CAPITAL GAP (WCG)

Reserve Bank of India has form time to time appointed committee to investigate into the realistic needs of various types of manufacturing industries, to eliminate the evils of the bank credit system and devise scientific methods for ascertaining their working capital needs. But post liberalization, the lending policy of commercial banks has under gone a change. The format proposed in CMA of RBI is being extensively used by the commercial bank for the purpose of the assessment of WCR of a borrowing unit. Earlier banks used to decide the amount of financing required for working capital by the companies, by the methods of Tandon Committee Approach of MPBF- Maximum Permissible Bank Finance.

TANDON COMMITTEE APPROACH:

The recommendations of the Tandon Committee are based on the operating plan, production based financing, or partial bank financing. The following are the majorRecommendations;

Inventory and Receivables Norms:

The committee has rightly pointed out that the borrower should be allowed to hold only a reasonable level of current assets, particularly inventory and receivable. The norms for reasonable level of inventory and receivable are needed to ensure rational allocation of resources and to avoid the undesirable holding and financing of current assets.The Tandon Committee suggested norms for 15 industries excluding heave engineering and highly seasonal industries, like sugar. The norms where applied to industrial borrowers, including small-scale industries, with aggregate limits from the banking system in excess of 10 lakhs.The committee admitted that the norms cannot be followed rigidly. It allowed flexibility in the application of norms when a major change in the environment justifies. The committee visualized the circumstances, such as power cuts, striks, transport delays, etc. under which the deviation from norms could be permitted.

Lending Norms:

The committee felt that the main function of the banker as a lender was to supplement the borrower's resources to carry an applicable level of current assets. This implied(a) The level of current assets must be reasonable and based on norms,(b) A part of the fund requirements for carrying current assets must be financed form ling term funds comprising owned funds and term borrowing including other non-current liabilities.

The banker was required to finance only a part of working capital gap; the other part to be finance by the borrower from the long term sources. Working capital gap is defined as current assets minus current liabilities excluding bank borrowings. Current assets will be taken at estimated value or as per the Tandon


Financing Decision

committee norms, whichever is lower. The current assets will be consisting of inventory and receivables, referred as chargeable current assets (CCA) and other current assets (OCA).

The Tandon Committee, constituted by RBI, has suggested Maximum Permissible Bank Finance (MPBF) for the fixation of credit limits. These methods are known as Method-I, Method-II, and Method-III of Tandon committee for assessment of WCR. Although as per recent announcement, the bankers are free to fix the limits, yet the practice of following the Method-II will continue for quite sometime to come.

Method-I:

Under this method, the bank will provide 75% of working capital gap i.e. (current assets-current liabilities). Also sometimes called the net working capital. Under this method the current ratio would work out to atleast 1:1 (it may be even more than this).Units engaged in the export activities, units engaged in the SSI/village and tiny sector product trading/marketing. Sick unit and the units under rehabilitation use method 1st for getting finance from the bank.

Method-II:

Under the 2nd method the borrower provides 25% of total current assets as permanent funds of the borrower and current liabilities and bank borrowings etc provide the balance. Under this method the minimum current ratio works out 1.33:1. Generally, the large corporate use 2nd method for getting finances.

Method-III:

As per this method the follower is required to finance the core assets of the company. Generally, RBI suggested the limits to the extent of 25% of the total assets. This is the level of the assets, which the borrower has to maintain essentially in the project. The funds in the core assets remain permanently blocked like the investments made in the fixed assets, such as building and plant and machinery. Here, the required current ratio is 1.5:1. This is shown as under:

25% BORROWER'S


TOTAL CURRENT ASSETS

CURRENT ASSETS

BALANCE CurrentLiabilites

Bank Borrowing

Financing Decision

The MAXIMUM PERMISSIBLE BANK FINANCE (MPBF) from the AGIL's point of view as per the Tandon Committee Recommendations from the various methods, Method-I is most appropriate for the calculation.So, the calculations of MPBF is given below:

)

As per the current years' financial results the following figures are stated:

Current Assets 2124.04Less: Current Liabilities Less Secured Loans 1348.57

(1377.94 - 29.37)

NET CURRENT ASSETS 775.47

MPBF = 0.75 (C.A. - C.L.)= 0.75 (775.47)= 581.6025 Less 29.37= 552.2325

Only Method-I is applicable from the AGI point of view, the remaining tow method is not applicable to AGI and it is not evaluated.


METHOD-I: 0.75% ( CURRENT ASSETS - CURRENT LIABILITIES)

Financing Decision

EVALUATION OF FINANCIAL SOURCESFROM AGIL POINT OF VIEW:

EQUITY SHARES:

In order to meet the contingent liability of AGIL, the Capital Restructuring is to be done in order to finance, and thus meet the requirement generated through long-term and short-term sources of financing.

Thus, to meet the requirement generated AGIL can issue either fresh equity shares to the new investors or even issue the same to the existing shareholders.

But considering the Auditor's Remarks in last year's Report and Legal Opinion taken thereon by the Company Board of Directors had made a reference BIFR under provision of Sick Industrial Companies (Special Provision) Act, 1985. There has been no further development except that the reference has only been registered.

Considering this point we can evaluate that it is not possible for AGI to issue equity shares, as the investors will be least interested in such a company that has been registered under BIFR. Even for the same reason existing shareholders will not be willing to invest further in AGI.

Even the existing shareholders are not interested for the same due to the reason that AGI has not paid the dividend since long time.

The trading volume of AGI stock is quite low as compared to the other stocks and thus even this will adversely affect the new issue of shares.

CONCLUSION:Thus, considering the above mentioned consideration it is not possible for AGIL to issue the equity shares, as it is not feasible. So, meeting the financial requirement by the way of equity is not possible as the cost incurred will also be quite high for the issue.

PREFERENCE SHARES:

Considering the AGI requirement it can raise the capital requirement from the issue of preference shares by the way of two options. As even in this source it is not possible to have more investors for the sake of convenience there will be preferential allotment of preference shares privately placed, for the reason of BIFR registration.The amount to be raised by the way of the preference shares is 10 crores for meeting the requirement. In order to raise the preference share capital the company is required to amend in the Article of Association by passing the resolution in the Extra Ordinary General Meeting with the consent of the of shareholders & BOD and even prior permission from the Company Registrar.


Financing Decision

THE TWO WAYS OF ISSUE OF PREFERENCE SHARES ARE:

1. issue of preference shares at par and redemption at par. there is a preferential placement of the preference shares. the preference shares issued are the cumulative preference shares. the issue expenditure of the preference shares is 1% the redemption of the preference shares is after 7 years at par the face value of the preference shares is Rs. 100 the cost is evaluated taking into account different dividend rates i.e. 7%,

7.5%,8%

2. issue of preference shares at par and redemption at premium. there is a preferential placement of the preference shares. the preference shares issued are the cumulative preference shares. the issue expenditure of the preference shares is 1%. the redemption of the preference shares is after 7 years at 5% premium. the face value of the preference shares is Rs. 100. the cost is evaluated taking into account different dividend rates i.e.

7%,7.5%,8%.

Thus, by issuing the preference shares whichever is having the cost effectiveness is to be incorporated in the capital structure for the payment of the liability. The structure is stated below:

Rate of dividend 7.5% 8% 8.5%Issue @ par & redeem @ par 7.69% 8.20% 8.70%

Issue @ par & redeem @ 5% premium 8.26% 8.75% 9.25%

DEBENTURES:

As we, have already seen that there are certain limitations as well as problems associated with the issue of the equity shares as well as with the preference shares. So, in order to meet the financial requirement it is possible to issue debentures by the way of private placement. Issuing the debentures by making it attractive with higher interest payment or by issuing at discount we can raise the funds.By the way of debenture to meet the requirement we may raise 10 crores. For the of debenture the land will be mortgaged. The following banks will be approached for the trusteeship: ICICI BANK, IDBI, ING VYSYA. Even for doing so we have two options.

THE TWO WAYS OF THE ISSUE OF DEBENTURES:

1. issue of debenture at 2% discount and redemption at par: the issue of the debenture is also done through the private placement only as

it is not possible to issue debenture in the open market as there will be less number of investors to invest.


Financing Decision

the debentures issued are non-convertible in nature.] the issue expenditure of debenture is 1%. as the company needs the trustee for the issue of debenture, trusteeship

expenditure to be incurred is 0.05% p.a. the redemption of debenture at par in three installments i.e. 30%, 30%, 40%

in the year 6,7,8 respectively the cost of debenture to be evaluated at the different interest rates i.e. 7.5%,

8%,8.5%.

2. issue of debenture at par and redemption at 5% premium: even these shares are to be privately placed as response in the open market is

supposed to be not effective. the debentures issued are non-convertible in nature. the issue expenditure of debenture is 1%. as the company needs the trustee for the issue of debenture, trusteeship

expenditure to be incurred is 0.05% p.a. the redemption of debenture at par in three installments i.e. 30%, 30%,40% in

the year 6,7,8 respectively and the premium is paid in the last year of redemption.

the cost of debenture to be evaluated at the different interest rates i.e. 7.5%, 8%, 8.5%

Thus, the debenture having the least cost of capital by taking into consideration is to be incorporated in the capital structure. The below stated are the various costs with the different interest rates:

Rate of Interest 7.5% 8% 8.5%Issue @ 2% discount & redeem @ par 7.62% 8.64% 9.66%issue @ par & redeem @ 5% premium 7.77% 8.75% 9.77%

TERM LOAN :

For meeting the capital requirement the company can even raise capital by the way of the Term Loan that is attainable easily as compared to the other instruments and thus term loans will become a part of the capital structure.The below stated criteria is to be taken into account for the raising of the funds:

the term loans are raised from the private banks in order to raise funds by term loans either land is used for the mortgage or

the Brand is used for the security purpose. Alembic Ltd., will stand besides as a Guarantor for the term loan from the

bank. the term loan will be repaid over a period of 7 years either by the way of

equal installments or unequal installments depending upon the cashflows generated.

in the first year only interest is payable. the principal and the interest is spread over a period of 6years. in order to raise term loan the processing charges incurred are 0.5% for the purpose of the cost evaluation different rate of interest are taken i.e.

9%, 9.5% & 10%


Financing Decision

So, in order to incorporate the term loan in the capital structure the most effective rate is to be incorporated so that the overall cost of capital is reduced. The below stated are the various rate of interest for getting the effective cost:

Rate of Interest 9% 9.5% 10%cost of raising term loan

9.05% 9.55% 10.05%

PUBLIC DEPOSITS:

The public deposits can also be raised for the financing the requirement. Even for the public deposits the below stated considerations are to be taken into account:By this source of financing the amount to be raised is also 10 crores.

in the public deposits the lenders have the option of carrying forward the public deposit even after the maturity.

the interest is compounded semi-annually. in order to arrive at the effective cost the different rates of interest is to be

considered i.e. 6.5%, 7%,7.5% p.a.

Rate of Interest 6.5% 7% 7.5%Cost of Capital 6.60% 7.12% 7.64%


Financing Decision

ALTERNATIVE METHOD BEYOND THE CAPITAL RESTRUCTURING:

When the company is not planning to have capital restructuring as part of the financing decision for the reason that the cost of the various sources of capital is quite high to be incorporated in the structure. Now when the company thinks beyond this it has the following alternatives:

- Merger or Amalgamation, Takeover, Acquisition- Hiving of Investments- Outright / Sale and Lease Back of Assets

While evaluating the various above stated alternatives from the AGIL'S point of view lets refer the first option:

MERGER OR AMALGAMATION: The merger is said to occur when two or more companies combine into one company. One or more companies may merge with an existing company or they may merge with an existing company or they may merge to form a new company laws in India use the term amalgamation for merger.Section 2(1A) of the I.T. Act, 1961, defines amalgamation as the merger of one or more companies with another company or the merger of two or more companies (called amalgamating company or companies) to form a new company (called amalgamated company) in such a way that all assets and liabilities of the amalgamating company or companies becomes assets and liabilities of the amalgamated company and shareholders holding not less than ninth-tenth in value of shares in the amalgamating company or companies become shareholders of the amalgamated company.

Merger or Amalgamation may take in two forms:

- Merger through absorption- Merger through consolidation

There would be a merger when, under sanction of court, all or a portion of assets or liabilities of a company are transferred to another company, the Transferor Company usually losing its existence in the process by automatic dissolution. The shareholders of the transferor company gets shares of the transferee against the shares held by them in the transferor company.

ACQUISITIONS: A fundamental characteristic of merger (either through absorption or consolidation) is that the acquiring company (existing or new) takes over the ownership of other companies and combines their operations with its own operations.An acquisition may be defined as an Act of acquiring effective control by one company over assets or management of another company without any


Financing Decision

combination of companies. Thus, in an acquisition two or more companies may remain independent; separate legal entity, but there may be change in control of companies.

TAKEOVER: Another may define a takeover as obtaining of control over the management of a company. An acquisition or take-over does not necessarily entail full, legal control. A Company can have effective control over another company by holding minority ownership.Under Monopolies and Restrictive Trade Practices Act, takeover means acquisition of not less than 25% of the voting power in a company. Section 372 of the Companies Act defines limit of a companies investment in the shares of another company. If a company wants to invest in more than 10 per cent of the Subscribed Capital of another company, it has to be approved in the shareholders General Meeting and also by the Central Government.The investment in shares of other companies in excess of 10 per cent of subscribed capital can result into their takeovers. While referring to the above stated options we can know that the alternative of merger or Amalgamation is far more beneficial from the context. So the below stated are the advantages of the Merger of AGIL with their owned management companies as well as with other outside companies of the same industry.

ADVANTAGES OF MERGER WITH THEIR OWNED MANAGEMENT COMPANIES:

DIVERSIFICATION OF RISK: Diversification implies growth through the combination of firms in unrelated businesses. Such mergers are called conglomerate mergers. It is difficult to justify conglomerate merger on the ground of economies, as it does not help to strengthen horizontal or vertical linkages. It is argued that it can result into reduction of total risk through substantial reduction of cyclicality of operations. Total risk will be reduced if the operations of the combining firms are negatively correlated.In practice, investors can reduce non-systematic risk (the company related risk) by diversifying their investment in shares of a large number of companies. Systematic risk (the market related risk) is not diversifiable. Therefore, the investors do not pay any premium for diversifying total risk via reduction in non-systematic risk that they can do on their own, cheaply and quickly.The reduction of the total risk, however, is advantageous from the combined company's point of view, since the combination of management and other systems strengthen the capacity of the combined firm to withstand the severity of the unforeseen economic factors, which could otherwise endanger the survival of individual companies. Conglomerate mergers can also prove to be beneficial in the case of shareholders of unquoted companies since they do not have opportunity for trading in their company's shares.

REDUCTION IN TAX LIABILITY :In a number of countries, a company is allowed to carry forward its accumulated loss to set-off against its future earnings for calculating its tax liability. A loss-making or sick company may not be in a position to earn sufficient profits in future to take advantage of the carry forward provision. If it combines with a


Financing Decision

profitable firm, the combined company can utilize the carry forward loss and save taxes. In India, a profitable company is allowed ot merge with a sick company to set-off against its profits the accumulated loss and unutilized depreciation of that company. A number of companies in India have merged to take advantage of this provision.When two companies merge through an exchange of shares are not taxable until the shares are actually not sold. When the shares are sold, they are subject to capital gains tax rate, which is much lower than the ordinary income tax rate.A strong urge to reduce tax liability, particularly when the marginal tax rate is high is a strong motivation for the combination of companies.

NO DILUTION OF CONTROL: As it is generally seen that the sick or loss making company if managed more efficiently and effectively can prove to be far more better. So generally the sick company merges with the owned management company so as that the control is retained in the hands of the same company. This helps both the transferor as well as transferee company.

DOMINANCE OF THE SHAREHOLDERS: When there is a merger, the shares of the transferor company is given to the transferee company which could either be a sick company as well as loss making company. This would lead to benefit to the shareholders of dominance on two core industries as a result of conglomerate merger.

FINANCING COST: Does the enhanced debt capacity of the merged firm reduce its cost of capital? Since the probability of insolvency is reduced due to financial stability and increased protection to lenders, the merged firm should be able to borrow at a lower rate of interest. This advantage may, however, be taken off partially or completely by increase in the shareholder' risk on account of providing better protection to lenders.Another aspect of the financing costs is issue costs. A merged firm is able to realize economies of scale in floatation and transaction costs related to an issue of capital. Issue costs are saved when the merged firm makes a larger security issue.


Financing Decision

OPERATING STATEMENT

PARTICULARS 31-3-02 31-3-03 31-3-04 31-3-05 31-3-06 31-3-07 (Actual) (Actual) (Prov.) (Est.) (Proj.) (Proj.)

1.Gross Sales 4550 5019 5645 6064 6367.15 6685.2082.Less:Excise,Salestax etc. 669 729 820 763 801.15 841.20753.Net Sales (1-2) 3881 4290 4825 5301 5566 5844Sales of stream 1083 929 815 876 941.7 1012.328Other operatonal income 105 109 120 133 139.65 146.6325

Total 5069 5328 5760 6310 6647.35 7002.964.Cost of sales:ia) Raw Materials 635 660 782 857 901.564 948ib) Packing Materials 637 752 941 990 1041.48 1095.637ii) Other Spares. 54 83 89 94 98.7 103.635iii) Power & Fuel 1660 1205 1428 1565 1643.25 1725.413iv)Direct Labour 649 744 800 840 882 926.1v) Repairs

38 76 82 86 90.3 94.815

vi) Other mfrg. Expense 223 137 246 240 252 264.6vii) Depreciation 252 233 235 240 250 260

viii) Sub Total 4148 3890 4603 4912 5159.294 5418.199ix)Op.stock of process 0 0 0 0 0 0

x) Sub-Total 4148 3890 4603 4912 5159.294 5418.199xi) Cl.stock of process 0 0 0 0 0 0

xii) Cost of Production

4148 3890 4603 4912 5159.294 5418.199

xiii) Op.stock of finished 742 664 474 510 535 562 goodsxiv) Sub-Total 4890 4554 5077 5422 5694.294 5980.199xv) Cl.stock of finished 664 474 510 535 561.75 589.8375 goodsxi) Total Cost of Sales

4226 4080 4567 4887 5132.544 5390.362

5. Gross Profit (3-4xi)

843 1248 1193 1423 1514.806 1612.598

6. Interest 107 63 54 235 195 1607. Selling & Adm. Exp. 524 477 696 640 683 642

Sub-Total 631 540 750 875 878 8028. Operating Profit[5-(6)] 212 708 443 548 636.806 810.5989. Other Income 192 46 71 103 143 152 Other Expenses 55 55 55 0 0 0

137 -9 16 103 143 15210. Profit Before Tax(8-9) 349 699 459 651 779.806 962.59811. Provision for tax 77 37 164 192 96 16212. Net Profit 272 662 295 459 683.806 800.59813.NonRecurring exp. (Cor 0 700 0 0 0 014. Retain Profit 272 -38 295 459 683.806 800.598SURPLUS CARRIED TO BALANCE SHEET


Financing Decision

Break up of expenses:31-3-02 31-3-03 31-3-04 31-3-05 31-3-06 31-3-07 (Actual) (Actual) (Prov.) (Est.) (Proj.) (Proj.)

A. Other Direct Expenses:1. Lab & Research 0 0 0 0 0 02. Insurance 15 15 15 16 16 173. Employee's Welfare 59 67 70 74 77.7 81.5854. Lease Rent/H.P. Charges 106 12 138 150 150 1505. Supervision Charges 43 43 23 0 0 0

TOTAL 223 137 246 240 243.7 248.585

B.Selling & Adm. Expenses:1. Commission 27 36 38 40 42 44.12. Publicity 47 81 90 95 99.75 104.73753. Freight & Forwarding 9 12 13 14 15 164. Sales Tax 0 0 0 0 0 05. Stationary,telephone etc. 28 26 23 24 25 266. Rent 0 0 0 0 0 07. Travelling & Conveyance 36 40 55 59 63.425 68.181888. Rates & Taxes 29 13 14 15 16 179. Miscellaneous 14 64 67 71 74.55 78.277510. Auditors' Fees etc. 1 1 1 1 2 211. Professonal Fees

12 28 130 37 38.85 40.7925

12. Others

38 0 0 0 0 0

13. Adm. Salary 115 134 207 220 232.65 246.027414. Pro.for abso. 142 0 57 66 75 0 Materials & stores 15. Loss on sales of investment 26 0 0 0 0 016. Loss on sales of assets 0 42 0 0 0 0

TOTAL 524 477 695 642 684.225 643.1168

C. Other Income:1. Dividends 26 0 0 0 0 02. Interest 1 11 32 60 96 1003. Rent 0 0 0 0 0 04. Miscellaneous 29 35 39 42 46.5024 51.487465. Profit on sale of Assets 136 0 0 0 0 06. Others

TOTAL 192 46 71 102 142.5024 151.4875

D. Other Expenses:1. Misc. expenditure w/o 55 55 55 0 0 0

TOTAL 55 55 55 0 0 0

BALANCE SHEET


Financing Decision

LIABILITIES31-3-02 31-3-03 31-3-04 31-3-05 31-3-06 31-3-07 (Actual) (Actual) (Prov.) (Est.) (Proj.) (Proj.)

SHARE CAPITAL 407 407 407 407 407 407

RESERVES & SURPLUSShare Premium 171 171 171 171 171 171Capital Reserve 0 0 0 0 0 0Investment Allowance

0 0 0 0 0 0

General Reserve 414 524 524 524 524 524Deferred Tax Account 57 59 59 59 59 59Revaluation Reserve 1984 1874 1874 1874 1874 1874Surplus 178 140 431 774 946 1236

TOTAL 2804 2768 3059 3402 3574 3864

SECURED LOANS:Prop Loan- for ONGC Liab 0 0 0 0 0 0Term Loan - IIBI 0 0 0 0 0 0Term loan - PSBI 0 0 0 0 0 0Term loan - Proposed

0 0 0 0 0 0

Cash Credit 87 35 150 150 150 150Book debt factoring 0 0 0 0 0 0Interest Liabilities

TOTAL 87 35 150 150 150 150

UNSECURED LOANS:Long Term cont.from allied 370 0 0 0 0 0Long Term liabilities (Excise) 197 197 197 197 197 197FD/Deposit from allied comp 0 0 0 0 0 0Mould Deposit 27 24 24 24 24 24Other unsecured loans 101 0 0 0 0 0

TOTAL 695 221 221 442 221 221

CURRENT LIABILITIES &PROVISIONS:Sundry creditors-Trade 232 326 350 368 386.1056 405.102

Statutory 76 111 119 125 132 138Others 263 246 264 412 638.6 989.83

Trade Advances 0 0 0 0 0 0Dividend uncashed 0 0 0 0 0 0Trustee, P.F. etc 0 0 0 0 0 0Interest Accured but not due 0 0 0 0 0 0Provisions for gratuity

200 229 260 290 320 350

Proposed dividend 0 0 0 0 0 0Provision for taxation

0 0 0 0 0 0

TOTAL 771 912 993 1195 1476.706 1882.932

4764 4343 4830 5596 5828.706 6524.932


Financing Decision

CURRENT ASSETS 1510 1473 2202 2469 3157 4096CURRENT LIABILITIES 858 947 1144 1345 1928 2339CURRENT RATIO 1.76 1.56 1.92 1.84 1.64 1.75


Financing Decision

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED ON 31ST MARCH, 2004


Financing Decision

As at As atSCHEDULE 31.03.200

431.03.2003

(Rs. in Lacs) (Rs. in Lacs)

INCOME:Sales 5,681.96 5,548.60Less: Excise Duty 317 329.92Net Sales 5,364.96 5,218.68Others L 187.63 155.02

TOTAL 5,552.59 5,373.70

EXPENDITURE:Raw Materials consumed M 864.66 660.07Stores,Spares Consumed 70.12 41.54Packing Materials Consumed 1,008.63 719.06Power & Fuel 1,432.59 1,204.74Employees ' cost N 716.45 860.65Interest and Bank charges O 15.81 62.65Reimbursement of Expenses 451.52 860.65Depreciation 222.85 233.01Others P 813.74 556.04

5,596.37 5,198.41Add/(Less):(Increase)/Decrease in Stock of finished goods M -279.84 176.05

TOTAL 5,316.53 5,374.46

PROFIT/(LOSS) BEFORE DEFERRED TAX

236.06 -0.55

Provision for Deferred tax -18.98 1.85PROFIT/(LOSS) BEFORE TAX

255.04 -2.4

Provision for Wealth tax 3.00 -Provision for Current tax 19 35.6NET PROFIT/(LOSS) AFTER TAX 233.04 -38.00(Add)/Less:Balance brought forward from last year 140.34 178.34SURPLUS CARRIED TO BALANCE SHEET

373.38 140.34

Earning per Share (Before extra ordinary item) 57.25 162.74Earning per Share (After extra ordinary item)

57.25 -9.34

LIMITATIONS OF THE STUDY


Financing Decision

Finance as the core area, which is a vast field, covers many aspects, which is not possible for us to cover. The knowledge, which we have, is quite limited and thus it makes it difficult for us to deal as the practical and the theoretical knowledge has a wide difference within.

The duration of the training was quite less to deal with the financial aspects and thus it was difficult to make out each and every aspects of the finance area.

It was very difficult to incorporate all the data in the report due to the limitation from the organization and thus certain information is not incorporated.

Even the time being departed by the executives was not much as even they has certain busy schedules to be dealt with.





LIMITATIONS OF THE STUDY


Financing Decision






Financing Decision

BIBILIOGRAPHY

FINANCIAL MANAGEMENT THEORY AND PRACTICE:Prasanna ChandraFinancial Management Theory & Practice, 5th Edition, Tata McGraw Hill Publication Company Ltd., New Delhi.

FINANCIAL MANAGEMENT THEORY AND PRACTICE:Pandey I.M.Financial Management Theory & Practice,4th Edition.

COMPANY LAW:Kapoor N.D.Company Law, 27th Edition, S. Chand Publications Ltd., New Delhi.

OTHER JOURNALS AND REPORTS:Alembic Glass Industries Ltd.

www.alembic.co.in

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