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Transcript of Fm Project 2
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F.M. II ASSIGNMENT
Part - 2
SUBMITTED TO,
MR. SURYA NARAYAN MOHAPATRA
SUBMITTED BY,
ARADHANA SINGH
ANSHUMAN SARANGI
SAMIR RAPAUEL
SHRESTHA DAS
KARTHIK KUMAR S.A.
BATCH20112013
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Capital Structure
Capital structure is combination of sources of funds in which we can include two main sources'
proportion. One is share capital and other is Debt. All four theories are just explaining the effect
of changing the proportion of these sources on the overallcost of capital and total value of firm.
If I have to write theories of capital structure in very few lines, I will only say that it propounds
or presents the effect on overall cost of capital and market or total value of firm, if I change my
capital structure from 50: 50 to any other proportion. First 50 represent the share capital and
second 50 represent the Debt. Now, I am ready to explain these four theories of capital structure
in simple and clean words.
1st Theory of Capital Structure
Name of Theory = Net Income Theory of Capital Structure
This theory gives the idea for increasing market value of firm and decreasing overall cost of
capital. A firm can choose a degree of capital structure in which debt is more than equity
share capital. It will be helpful to increase the market value of firm and decrease the value of
overall cost of capital. Debt is cheap source of finance because its interest is deductible from
net profit before taxes. After deduction of interest company has to pay less tax and thus, it
will decrease theweighted average cost of capital.
http://www.svtuition.org/2009/06/cost-of-capital-and-methods-of.htmlhttp://www.svtuition.org/2009/06/cost-of-capital-and-methods-of.htmlhttp://www.svtuition.org/2009/06/cost-of-capital-and-methods-of.htmlhttp://www.svtuition.org/2010/04/weighted-average-cost-of-capital.htmlhttp://www.svtuition.org/2010/04/weighted-average-cost-of-capital.htmlhttp://www.svtuition.org/2010/04/weighted-average-cost-of-capital.htmlhttp://2.bp.blogspot.com/_DJEIRrK4tl4/S_EhpSPJfvI/AAAAAAAAFQM/LBLJUacedt4/s1600/theory+of+capitl+structure.PNGhttp://www.svtuition.org/2010/04/weighted-average-cost-of-capital.htmlhttp://www.svtuition.org/2009/06/cost-of-capital-and-methods-of.html -
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For example if you have equity debt mix is 50:50 but if you increase it as 20: 80, it will
increase the market value of firm and its positive effect on the value of per share.
High debt content mixture of equity debt mix ratio is also called financial leverage.
Increasing of financial leverage will be helpful to for maximize the firm's value.
2nd Theory of Capital Structure
Name of Theory = Net Operating income Theory of Capital Structure
Net operating income theory or approach does not accept the idea of increasing the financial
leverage under NI approach. It means to change the capital structure does not affect overall
cost of capital and market value of firm. At each and every level of capital structure, market
value of firm will be same.
3rd Theory of Capital Structure
Name of Theory = Traditional Theory of Capital Structure
This theory or approach of capital structure is mix of net income approach and net operating
income approach of capital structure. It has three stages which you should understand:
Ist Stage
In the first stage which is also initial stage, company should increase debt contents in its
equity debt mix for increasing the market value of firm.
2nd Stage
In second stage, after increasing debt in equity debt mix, company gets the position of
optimum capital structure, where weighted cost of capital is minimum and market value of
firm is maximum. So, no need to further increase in debt in capital structure.
3rd Stage
Company can gets loss in its market value because increasing the amount of debt in capital
structure after its optimum level will definitely increase the cost of debt and overall cost of
capital.
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4th Theory of Capital Structure
Name of theory = Modigliani and Miller
MM theory or approach is fully opposite of traditional approach. This approach says thatthere is not any relationship between capital structure and cost of capital. There will not
effect of increasing debt on cost of capital.
Value of firm and cost of capital is fully affected from investor's expectations. Investors'
expectations may be further affected by large numbers of other factors which have been
ignored by traditional theorem of capital structure.
CAPITAL STRUCTURE POLICY OF Maruti
The logic of capital structure policy of MUL is to increase its net worth by ploughing back ofprofit in this way to reduce cost of equity as a cheaper cost if its net worth is strengthen byploughing back of profits, which is not dividend bearing. Looking at figures in Table-1 clearly
indicates that, an increase amount of reserve and surplus included in net worth is seen over years
with exception of 2010-11. Keeping the equity capital constant throughout the period of study,the company increased its net-worth with the utilization of reserve & surplus by the same
amount. The company increased its capitalization from Rs. 7484.7 crore in the year 2007 to
14176.8 crore with correspondingly less use of long term debt from Rs. 900 cr. to 309.3 crore.
during the study. Both the excess capitalization and increase in the use of debt in certain yearswere commensurate by the reserve and surplus i.e., by successful ploughing back of profit
instead of making additional issue of equity shares. If the same was made by fresh issue of equity
shares the company would not be able to reward its shareholders more in terms of return. Sincereserve & surplus was not divided bearing, its utilization brought down the cost of equity and at
the same time it maintained the lower base of equity share- holders resulting higher amount of
EPS.
Year Total Capital
Long term
Employed
Equity share
Capital Reserves and surplus Net Worth
2007-08 7484.7 900.2 144.5 8270.9 8415.4
2008-09 9315.6 698.9 144.5 9200.4 9344.9
2009-10 10043.8 309.3 144.5 13723 13867.5
2010-11 12656.5 821.4 144.5 11690.6 11835.1
2011-12 14176.8 309.3 144.5 13723 13867
The above table has been prepared to reflect the relative method of finance adopted by the company. It is seen from the table that the net-worthof the company constituted equity capital and reserve & surplus
Above table has been prepared to reflect the relative method of finance adopted by the company.
It is seen from the table 3 that the net-worth of the company constituted equity capital and
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reserve & surplus and it was 4.9% of equity capital and 95.1% of reserve & surplus in the year
2001-02. In the following years the company stated increasing the proportion of reserve &surplus from 95.3% to 98.5% with decrease in the proportion of equity capital from 4.7% to
0.98% during the period from 2002-03 to 2011-12. One can observe from the table that a
percentage decrease in the equity capital led to the same percentage increase in the reserve and
surplus. For example 5% percentage decrease in equity capital led to 55 increases in the reserveand surplus in the second year of study and so on. Thus increase in the proportion of reserve and
surplus to net worth in this way might cause reduction in the cost of equity during the study
period.
CAPITAL STRUCTURE POLICY OF Mahindra and Mahindra
The logic of capital structure policy of Mahindra and Mahindra is to increase its net worth byploughing back of profit in this way to reduce cost of equity as a cheaper cost if its net worth is
strengthen by ploughing back of profits. Looking at figures in Table-1 clearly indicates that, an
increase in amount of reserve and surplus included in net worth is seen over years. The equitycapital increased in marginal proportions throughout the period of study, the company increased
its net-worth with the utilization of reserve & surplus by the same amount. The company
increased its capitalization from Rs. 5188.9 crore in the year 2007 to 12718.68 crore withcorrespondingly less use of long term debt from Rs. 1636 crore to 2405.29 crore during the
study. Both the excess capitalization and increase in the use of debt in certain years were
commensurate by the reserve and surplus i.e., by successful ploughing back of profit and also
additional issue of equity shares. Fresh issue of equity shares were made by the company andthus was not be able to reward its shareholders more in terms of return. Since reserve & surplus
was divided bearing, its utilization increased the cost of equity and at the same time it increased
the base of equity share- holders resulting lowering amount of EPS.
Year Total Capital
Long term
Employed
Equity share
Capital Reserves and surplus Net Worth
2007-08 5188.9 1636 238.03 3314.87 3552.9
2008-09 6937.13 2587.06 239.07 4111 4350.07
2009-10 9296.73 4052.76 272.62 4971.35 5243.97
2010-11 10710.38 2880.15 282.95 7539.27 7830.23
2011-12 12718.68 2405.29 293.62 9985.8 10313.39
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CAPITAL STRUCTURE POLICY OF Tata Motors
The logic of capital structure policy of Tata Motors is to increase its net worth by ploughing back
profit in this way to reduce cost of equity as a cheaper cost if its net worth is strengthen by
ploughing back of profits. Looking at figures in Table clearly indicates that, an increase in
amount of reserve and surplus included in net worth is seen over years. The equity capital
increased in marginal proportions throughout the period of study, the company increased its net-
worth with the utilization of reserve & surplus by the same amount. The company increased its
capitalization from Rs. 10878 crore in the year 2007 to 35912.05 crore with correspondingly less
use of long term debt from Rs. 4009.14 crore to 15898.75 crore during the study. Both the excess
capitalization and increase in the use of debt in certain years were commensurate by the reserve
and surplus i.e., by successful ploughing back of profit and also additional issue of equity shares.
Fresh issue of equity shares were made by the company and thus was not be able to reward its
shareholders more in terms of return. Since reserve & surplus was divided bearing, its utilization
increased the cost of equity and at the same time it increased the base of equity share- holdersresulting lowering amount of EPS.
Year Total Capital
Long term
Employed
Equity share
Capital Reserves and surplus Net Worth
2007-08 10,878.89 4,009.14 385.41 6,484.34 6,869.75
2008-09 14,120.02 6,280.52 385.54 7,453.96 7,839.50
2009-10 25,559.83 13,165.56 514.05 11,880.22 12,394.27
2010-1131,429.69 16,625.91 570.6
14,233.1814,803.78
2011-12 35,912.05 15,898.75 634.65 19,375.59 20,013.30
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Dividend policy
At the end of each year, every publicly traded company has to decide whether to return cash to
its stockholders and, if yes, how much in the form of dividends. The owner of a private company
has to make a similar decision about how much cash he plans to withdraw from the business, and
how much to reinvest. Firms in the United States generally pay dividends every quarter, whereas
firms in other countries typically pay dividends on a semi-annual or annual basis.
The Dividend Payment Time Line
Dividends in publicly traded firms are usually set by the board of directors and paid out to
stockholders a few weeks later. There are several key dates between the time the board declares
the dividend until the dividend is actually paid.
The first date of note is the dividend declaration date, the date on which the board of directors
declares the dollar dividend that will be paid for that quarter (or period).
This date is important because by announcing its intent to increase, decrease, or maintain
dividend, the firm conveys information to financial markets. Thus, if the firm changes its
dividends, this is the date on which the market reaction to the changeis most likely to occur.
The next date of note is the ex-dividend date, at which time investors have to have bought the
stock in order to receive the dividend. Since the dividend is not received by investors buying
stock after the ex-dividend date, the stock price will generally fall on that day to reflect that loss.
At the close of the business a few days after the ex-dividend date, the company closes its stock
transfer books and makes up a list of the shareholders to date on the holder of- record date.
These shareholders will receive the dividends. There should be generally be no price effect on
this date.
The final step involves mailing out the dividend checks on the dividend payment date. In
most cases, the payment date is two to three weeks after the holder-of-record
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Types of Dividends
There are several ways to classify dividends. First, dividends can be paid in cash or as additional
stock. Stock dividends increase the number of shares outstanding and generally reduce the price
per share. Second, the dividend can be a regular dividend, which is paid at regular intervals
(quarterly, semi-annually, or annually), or a specialdividend, which is paid in addition to theregular dividend. Most U.S. firms pay regular dividends every quarter; special dividends are paid
at irregular intervals. Finally, firms sometimes pay dividends that are in excess of the retained
earnings they show on their books. These are called liquidating dividends and are viewed by the
Internal Revenue Service as return on capital rather than ordinary income. Consequently,
* Some facts about dividend policy
- Dividends follow earnings
* Payment Procedures
* Why do firms pay dividends?
- Dividends don't matter: The Miller Modigliani Theorem
- Dividends are taxed heavier than capital gains : Arguments against dividend payments
* Evidence from ex-dividend day price changes
- Dividends are more certain than capital gains: The bird in the hand fallacy
- Dividends are a good use for excess cash
Measures of Dividend Policy
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* Dividend Payout : measures the percentage of earnings that the company pays in dividends= Dividends / Earnings
* Dividend Yield : measures the return that an investor can make from dividends alone =Dividends / Stock Price
Three Schools Of Thought On Dividends
1. If
(a) there are no tax disadvantages associated with dividends
(b) companies can issue stock, at no cost, to raise equity, whenever needed
Dividends do not matter, and dividend policy does not affect value.
2. If dividends have a tax disadvantage,
Dividends are bad, and increasing dividends will reduce value
2. If stockholders like dividends, or dividends operate as a signal of future prospects, Dividends are good, and increasing dividends will increase value
The balanced viewpoint
If a company has excess cash, and few good projects (NPV>0), returning money to
stockholders (dividends or stock repurchases) is GOOD. If a company does not have
excess cash, and/or has several good projects (NPV>0), returning money to
stockholders (dividends or stock repurchases) is BAD.
PAYMENT PROCEDURES
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* Significant Dates
Declaration date: The dividend is declared at a board of directors meeting. On this date
the directors issue a statement similar to the following: " On November 15, 1984, the
directors of the XYZ corporation met and declared a regular quarterly dividend of Rs. 50per share, plus an extra dividend of 25 Rs. per share, payable to the holders of record on
December 15, payment to be made on January 2, 1985."
Holder-of-record date: At the close of the business on the holder-of-record date,
December 15, the company closes its stock transfer books and makes up a list of theshareholders on that date. These shareholders will receive the dividends
Ex-dividend date: Suppose you buy 100 shares on December 13, 1984. Will the
company be notified in time? To avoid conflict, the brokerage industry has set up theconvention of declaring that the right to the dividend remains with the stock until 4 days
prior to the holder-of-record date; on the fourth day before the record date the right to thedividend no longer goes with the stock. This date is called the ex-dividend date. The ex-dividend date in this example in December 11, 1984.
Payment date: The Company mails the checks to the recorded holders on January 2,1985.
WHY DO FIRMS PAY DIVIDENDS?
The Miller-Modigliani Hypothesis: Dividends do not affect valueBasis: If a firm's investment policy (and hence cash flows) don't change, the value of the firm
cannot change with dividend policy. If we ignore personal taxes, investors have to be indifferentto receiving either dividends or capital gains.
* Underlying Assumptions:
(a) There are no tax differences between dividends and capital gains.(b)
If companies pay too much in cash, they can issue new stock, with no flotationcosts or signaling consequences, to replace this cash.
(c) If companies pay too little in dividends, they do not use the excess cash for badprojects or acquisitions.
* The Tax Response: Dividends are taxed more than capital gains
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Basis: Dividends are taxed more heavily than capital gains. A stockholder will therefore prefer to receive
capital gains over dividends.
Practical aspects of Dividend Policy
While deciding on the dividend policy, firms face two questions
1. What should be the average pay ratio?2. How stable should the dividends be over time?
Firms consider the following factors to determine the payout ratio
1. Funds requirement The dividend pay out ratio of firms depends on the firms futurerequirements for funds. Long term financial forecasting of funds can assess this
requirement. Usually firms, which have plans for substantial financial investment, need
funds to exploit the available opportunities. Thus, they keep their dividend payout ratio
low. On the other hand, firms, which have very few investment avenues have largerdividend pay out ratio.
2. Liquidity It is another factor which influences the dividend payout ratio as dividendsinvolved cash payment. Firms, which desire to pay dividends may not do so, because ofinsufficient liquidity. This usually happens in the case of profitable and expanding firms,
which have very low liquidity because of substantial investments.
3. Availability of external sources of financing Firms which have easy access to externalsources of funds enjoy a great deal of flexibility in deciding the dividend payout ratio.For such firms, dividend payout decision is somewhat independent of its investment
decision as well as its liquidity position. Such firms are usually more generous in their
dividend policies. While on the other hand, firms, which do not have easy access to
external sources of funds, have to rely on the internal sources of funds or investmentpurposes. Such firms are usually very conservative in their dividend policy decisions.
4. Shareholder preference Preferences of shareholder are onother major factor, whichinfluence dividend payout. If shareholders prefer current income to capital gains, then thefirm may follow the liberal dividend policy. While on the other hand if they prefer capital
gain to dividend income, then firms follow the conservative dividend policy.
5. Difference in the cost of external equity and retained earningsThe cost of equity in allcases except for those raised by way of rights issue is higher than the cost of retained
earnings. Depending on the extent of this difference in cost, firms decide the relative
proportion of external equity and retained earnings to be used. This affects the dividend
policy decision of the company.6. ControlRaising money from external resources may lead to dilution of control, in case
money is raised by issuing public equity. Internal financing on the other hand does not
lead to any dilution of control. Hence, if management and shareholders are averse todilution of control, then firms prefer to rely more on retained earnings. Thus, such
companies may adopt, the conservative dividend policy.
7. Taxes In India dividend income for the individuals is free, however capital gains aretaxable. Thus, in that case shareholders who are in high tax bracket may prefer dividendincome rather than capital gains. However, if tax on dividends is viewed from point of
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view of corporates, they have to pay dividend tax. Thus, this may influence the
companies dividend policy.
Dividend policy
A company's dividend policy is the company's usual practice when deciding how big a dividendpayment to make.
Dividend policy may be explicitly stated, or investors may infer it from the dividend payments acompany has made in the past. If a company states a dividend policy it usually takes the form of
a target pay-out ratio.
If a company has not stated a dividend policy then investors will infer it. Assumptions that
investors are likely to make are:
The DPS will be maintained at at least the previous year's level (excluding special dividends) -unless dividend cover is very low or the company has warned that a dividend cut is possible
If the payout ratio has been maintained at a roughly constant level in the past, the same will bedone in the future
Any other pattern of dividend growth will continue as long as the cover does not fall too low.Companies do not normally increase dividends unless they are confident that the increase is
sustainable. This means that increasing the dividend is a way in which the management of acompany can signal investors that they are confident.
DIVIDEND POLICY OF MUL
http://moneyterms.co.uk/payout_ratio/http://moneyterms.co.uk/dps/http://moneyterms.co.uk/special-dividend/http://moneyterms.co.uk/dividend_cover/http://moneyterms.co.uk/dividend_cover/http://moneyterms.co.uk/dividend_cover/http://moneyterms.co.uk/dividend_cover/http://moneyterms.co.uk/special-dividend/http://moneyterms.co.uk/dps/http://moneyterms.co.uk/payout_ratio/ -
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Table-2 shows that DPS of first two years of consideration is same and thereafter the companyhas been increasing DPS at a slow rate. The dividend payout ratio of the company is gradually
decreasing during the study period.
Year EPS DPS Dividend payout2007-08 59.91 4.5 8.342544849
2008-09 59.07 5 8.325852112
2009-10 42.18 3.5 8.297771456
2010-11 86.45 6 6.940427993
2011-12 79.21 7.5 9.468501452
Table 2
DIVIDEND POLICY OF Tata Motors
Table-2 shows that DPS of first two years of consideration has remained same and thereafter the
company has been increasing DPS at an incremental rate. The dividend payout ratio of the
company has decreased in the first 2 yrs and then the it is increasing in a steady rate during the
study period.
Year EPS DPS Dividend payout2007-08 49.65 15 35.34
2008-09 52.63 15 32.51
2009-10 19.48 6 34.52
2010-11 39.26 15 44.28
2011-12 28.55 20 80.96
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DIVIDEND POLICY OF Mahindra n Mahindra
Table-2 shows that DPS of first two years of consideration is same and thereafter the company
has been decreasing DPS at a slow rate except the final year 2011-12. The dividend payout ratioof the company is cyclical during the study period first increasing then again decreasing
alternatively.
Year EPS DPS Dividend payout
2007-08 44.88 11.50 30.39
2008-09 46.15 11.50 29.10
2009-10 30.69 10.00 37.29
2010-11 36.89 9.50 29.87
2011-12 45.33 11.50 30.15