Leverage Analysis Project

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Chapter

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INTRODUCTION

One of the tough challenges that firms face is to determine the right amount of leverage.

Leveraging decision is important because it affects the financial performance of the firm.

The capital structure of a firm is defined as specific mix of debt and equity that a firm uses

to finance its operations. Firms can choose among many alternative capital structures. For

example, firms can issue a large amount of debt or very little debt. Firms have options of

arranging lease financing, use warrants, issue convertible bonds, sign forward contracts or

trade bond swaps. They can also issue dozens of distinct securities in countless

combinations.

When a firm considers its financing options, for example debt vs. equity, it must ensure

that the amount of leverage does not impose an excess burden on the firm. This means that

the firm should be able to meet its financial obligations during both good and bad times.

The two important points to be considered while making financing decisions are:

First, debt implies fixed financial obligations for the firm. After the firm breaks even,

meaning its earnings cover its debt obligations, any additional earnings will be distributed

among shareholders. Thus, when times are good and the firm’s earnings are high, debt

financing results in higher EPS. However, when times are bad and the firm’s earnings

barely cover its debt obligations, there is little left for shareholders and, thus, EPS is low

under debt financing. This relationship also shows that EPS exhibits a greater variation

under debt as opposed to equity financing in the two scenarios as can be seen from the

results shown in the last table.

Second, stock financing does not dilute the shares of current owners. Therefore, in the

boom scenario, existing shareholders benefit from a higher EPS, but, in the bust scenario,

they bear the whole burden of the firm’s poor performance.

To the entrepreneur and corporate Liberalization, Globalization and Privatization are the

important issues threatening the existence of a firm. In such a complex corporate

environment, it is a challenge to the Finance Manager to survive the firm in long run

perspective with the objective of maximizing the owner's wealth. With a view to achieve

this objective finance manager is required to pay his due attention on investment decision,

financing decision and dividend decision.

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Assuming that a sound investment policy and opportunity are in place, it is the intention

of this dissertation to optimize the financing decision and dividend decision in the context

of achieving the stated objective. Financing decision refers to the selection of appropriate

financing mix and so it relates to the capital structure or leverage.

Leverage is used to describe the firm's ability to use fixed cost to increase the return to its

owners. It is a tool for measuring Business Risk, Financial Risk and Overall Risk. A

company's long term debt in relation to equity is its capital structure. The larger the long

term debt, the higher the leverage. There are 3 types of leverages that are financial

leverage and combined leverage and operating leverage.

Financial Leverage* Operating Leverage= Combined Leverage.

Capital structure refers to proportion of long-term debt capital and equity capital required

to finance investment proposal. There should be an optimum capital structure, which can

be attained by the judicious exercise of financial leverage.

In order to run and manage a company, funds are needed. Right from the promotional

stage, finance plays an important role in a company’s life. If funds are inadequate and not

properly managed the entire organization suffers, it is therefore necessary that correct

estimation of the current and future need of capital be made to have an optimal capital

structure which shall help the organization to run smoothly.

The capital structure is made up of debt and equity securities and refers to permanent

financing of a firm.

On the other hand a general dictionary meaning of the term Leverage refers to an increase

of accomplishing some purpose. In Financial Management the term leverage is used to

describe the firm’s ability to use fixed cost assets or funds to increase the returns to its

owners.

This dissertation mainly concentrates on the study of effects of leverage on Manufacturing

and service sector firms.

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Chapter

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RESEARCH METHODOLOGY

The objectives for which study has been undertaken are:

1) To study the methods of raising finance and financial leverages used by the companies.

2) To examine the dividend policy of the company.

3) To assess the inter relationship between degree of financial leverage (DFL), earning per

share (EPS) and dividend per share (DPS).

4) To examine the relationship between leverage and the value of the firm

NEED FOR THE PROJECT

Leverage is an important technique which helps the management to take sound, prudent,

financial and investment decisions. It also helps to evaluate business, financial, total risk of

any organization. The task of choosing most suitable combination of different techniques in

the light of the firm’s anticipated securities for financing fund requirements earnings is

facilitated by it.  In matters relating to investment also leverage technique is immensely

helpful.  It acts as a useful guideline in setting the maximum limits by which the business of

the firm should be expanded.  For example, the management is advised to stop expanding

business the moment anticipated return on additional investment falls short of fixed charge

of debt.

Collection of data

This project is totally based on the Secondary Data, So all the data used in the project have

been collected from

1) The annual reports of the companies.

2) The Web sites of companies.

3) The study material.

The data collected from this source have been used and complied with due care as per

requirement of the study.

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Period of study

The present study covers a period of two years from 2008-2010.

Techniques of analysis

For analyzing the degree of association between DFL, EPS and DPS. The study has been

made by converting the collected data into relative measure such as ratios, percentage rather

than absolute one.

Limitation of study :

1. The study is limited to five years only. Generally twenty years data is ideal to form trend

analysis.

2. This is based on secondary data collected from the annual report of the company. It was

not possible to collect the primary data from the company's office.

Scope of the project

Capital structure employed by the companies and its effect on the EPS has been studied

previously and also the different financial constraints of both the industries have been

compared. Particularly, it is in the scope of this project to analyze the differences in the

effect of leverage on the profitability of the firms in manufacturing and service industries

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Leverage

Leverage is using given resources in such a way that the potential positive or negative

outcome is magnified in finance, this generally refers to borrowing. If the firm's Return On

Assets (ROA) is higher than the interest on the loan, then its Return On Equity (ROE) will

be higher than if it did not borrow. On the other hand, if the firm's ROA is lower than the

interest rate, then its ROE will be lower than if it did not borrow.

In other words, may be defined as, the employment of an asset or sources of fund has to pay

fixed cost or fixed return.

Types of leverage

There are three type of leverage:

1. Financial Leverage.

2. Operating Leverage.

3. Combined or composite leverage.

Financial leverage

Financial leverage is primarily concerned with the financial activities which involve raising

of funds from the sources from which a firm has to bear fixed charges. These sources

include long-term debt (e.g.: bonds, debentures, etc) & preferential shares etc. Long-term

debt carries a contractual fixed rate of interest & obligatory. As the debt providers have

Prior claim on income & assets of a firm over equity shareholders. Their rate of interest is

generally lower than the expected return of the equity shareholders. Further, interest on debt

capital is tax-deductible expenses. These two-phenomenon lead to magnification of rate of

return on equity capital & hence E.P.S goes without saying that effects of changes in EBIT

(Earnings Before Interest & taxes) on the earning per share are shown by the financial

leverage. Financial leverage can best be described as the ability of a firm to use fixed

financial charges in EBIT on the firm earning per share.

Financial leverage helps to know the responsiveness of E.P.S. to change in the EBIT. It

involves use of funds obtained at fixed cost in the capital structure in such a way that it

increases the return for common shareholders.

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It is referred to a state at which a firm has to bear fixed financing cost arising from the use

of debt capital. The firm with high financial leverage will have a relatively high fixed

financing cost compared with low financial leverage. Financial leverage occurs when a

company employ the fixed cost of funds debt or preference share capital with a view to

maximizing earning available to equity shareholder by a way of a higher income of funds.

This technique also called ‘Trade on equity’. Financial leverage influence the financial risk

as long as the company’s earning are greater than its fixed cost it will enjoy a favorable

financial leverage position and make earning available to equity shareholders.

Financial leverage can measure with the help of the following formula:-

Financial leverage =

Financial leverage will have a favorable impact on earning per share a return of equity only.

When the firm’s return on investment exceeds the interest cost of debt it is favorable. The

impact will be unfavorable if the return on investment is less than interest.

The financial leverage measures the relationship between the EBIT & E.P.S. and it reflect

the effect of change in EBIT on the level of E.P.S. The financial leverage measures the

responsiveness of the E.P.S. to charge in EBIT If defined as degree of financial leverage-

Degree of financial leverage =

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Operating leverage

Operating leverage associated with investment activities (Assets acquisition). It occurs

anytime when firm has fixed costs that must be met regardless of volume in operating

leverage, when fixed cost remains constant the percentage change in profit

accompanying a change in volume is greater than the percentage change in volume. A

firm with high operating leverage will have a relatively high fixed cost in comparison with

a firm with low operating leverage. If a company employs operating leverage then its

operating profit will increase at a faster rate for any given increase in sale. However, if

sales fall the firm with high operating leverage will suffer more loss than the firm with the

no or low operating leverage. Therefore operating leverage called “2-edged sword”. It can

be ascertained by the help of following formula

Operating leverage =

Degree of operating leverage

A high degree of operating leverage shows the greater impact on the operating

income of the company due to variability in its sales, which is also responsible for

variability in its operating profit. It is an important determinant of operation risk.It can be

measured by % change in E.B.I.T. due to percentage change in sale.

Degree of operating leverage =

Favorable leverage is said to occur when the firm earns more on the assets purchased with

the funds than their opportunity use. It is unfavorable when firm doesn’t earn equivalent to

the cost of funds

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Composite Leverage or Combined Leverage or Total Leverage

When financial leverage is combined with operating leverage the effect of change in

revenues or earning per share is magnified. Composite/combined leverage refers to extent

to which firm has fixed operating cost as well as financial cost.

The degree of operating and financial leverage can be combined to show the effect of total

leverage on E.P.S associated with given change in sales.

Operating and financial leverage together cause wide fluctuation in E.P.S. For given change

in sales if company employs high level of operating leverage and financial leverage even a

small change in level of sales will have a dramatic effects on earning per share

It can be calculated using the following formula;-

Combined leverage =

Significance

A proper combination of both financial & operating leverage is blessing for the firm’s

growth, while improper combination of both leverages may prove curse for the growth of

company. So company should try to achieve balance of both leverages.

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INTRODUCTION

Financial leverage is primarily concerned with the financial activities, which involve raising

of funds from the sources for which a firm has to bear a fixed charge. These sources include

long-term debts (e.g. bonds, debenture etc.) and preference share capital. Long-term debt

capital carries a contractual fixed rate of interest and its payment is obligatory. As the debt

providers have prior claim on income and assets of a firm over equity shareholders, their

rate of interest is generally lower than the expected return on equity shareholders.

Further interest on debt capital is a tax-deductible expense. These two phenomenon’s lead

to the magnification of rate of return on equity capital and hence EPS. It goes without

saying that the effects of changes in EBIT on the earnings per share are shown by the

financial leverage. Financial leverage can best be described as “the ability of a firm to use

fixed financial charges to magnify the effect of changes in EBIT on the firm’s earnings per

share.

Financial leverage helps to know the responsiveness of the earnings per share (EPS) to the

changes in earnings before interest and taxes (EBIT). It involves the use of funds obtained

at a fixed cost in the hope of increasing the return to common shareholders.

Financial leverage refers to the extent to which a firm has fixed financing cost arising from

the use of debt capital. The firm with financial leverage will have a relatively high fixed

financing cost compared to the firm with a low financial leverage.

Financial leverage will occur when a company employs the fixed cost of funds, debt or

preference share capital with a view to maximizing earnings available to equity

shareholders by way of a higher income than the cost of funds.

These techniques also called “trading on equity”. Financial leverage influences the financial

risk of a company. If the earnings are insufficient for covering the fixed cost burden then

the company has to face financial risk. As long as the company’s earnings are greater than

its fixed costs, It will enjoy a favorable financial leverage position and a make use of the

earnings available to equity shareholders.

Financial leverage can be measured with the help of the following formula:

Financial leverage = EBIT / PBT

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Financial leverage will have a favorable impact on earnings per share and return on equity

only when the firms return on investment exceeds the interest cost of debt. The impact will

be unfavorable if the return on investment is less than the interest cost.

The financial leverage measures the relationship between the EBIT and EPS and it reflects

the effects of change in EBIT on the level of EPS. The financial leverage measures the

responsiveness of the EPS to a change in EBIT and is defined as a % change in EPS divided

by the % change in EBIT. Symbolically,

Financial leverage = % Change in EPS / % Change in EBIT

The behaviors of DFL reveals that :-

1. Each level of EBIT has distinct DFL.

2. DFL is undefined at financial BEP.

3. DFL will be negative when the EBIT level goes below the financial BEP.

4. DFL will be positive for all values of EBIT that are above the financial Break even point.

This will however starts to decline as EBIT increases and will reach to a limit of one (1).

By assembling DFL one can understand the impact of a change in EBIT on the EPS of the

company. It helps in assessing the financial risk of the company. It also explains the impact

of market risk on financial risk.Greater the financial leverage, wider the fluctuation in

return on equity and greater is the financial risk.

IMPLICATIONS

1. High operating leverage combined with high financial leverage will consolidate risky

situation.

2. Normal situation is one should be high and another should be low. If a company has a low

operating leverage, financial leverage can be higher and vice – versa.

3. Ideal situation is when both the leverages are low.

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APPLICATION AND UTILITY OF LEVERAGE

To understand the applications and utility of leverage in financial analysis it is important to

understand the behavior of degree of operating leverage. It is to be noted that:

1. For each level of output there is a distinct DOL.

2. At BEP, DOL is undefined.

3. If quantity is less than BEP, the DOL will be negative.(but there is no such direct

relationship that less quantity leads to decrease in EBIT no such connection to be formed.)

4. If quantity is greater than BEP the DOL will be positive (but there is no such direct

relationship. DOL may start declining after ancreasing quantity beyond certain level and

will limit to one (1).

5. A large DOL indicates that small fluctuation in the level of operation will produce large

fluctuation in the level of operating income.

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PROFITABILITY

Profitability is the ability of a company to generate profit. It is an overall measure, which

depicts the efficiency and effectiveness at which the company has been operating. It

indicates the overall result of the management's decision. Further, it reflects how best the

company has put to use its scarce resources to generate a higher rate of profitability.

Profitability is also taken as a criterion to measure and assess the relative efficiency of the

management of a company to generate profit. A company, which generates a higher rate of

profitability, is considered to be more efficient than other companies. Profitability is

represented by the return on investment (ROI). It is the overall measure of a company's

performance.

According to Du-Pont control chart, variability in profitability is explained by taking into

consideration its two components viz profit margin and asset turnover. As per this part, an

overall control is exercised on the various resources of a company and necessary corrective

action for further improvement in profitability is suggested.

Profitability is ascertained from the income statement. The various components of an

income statement and their inter-relationship embrace the profitability status of the firm.

This can be shown from the following table –

INCOME STATEMENT

Total Revenue

- Variable cost

- Fixed Expenses

= EBIT

- Interest on Debt

= Profit before Tax

- Tax

= Profit after tax

- Preference Dividend

= Equity Earnings

EBIT = Total revenue – Total cost} Total cost = V+F

Now total revenue = Quantity produced * unit selling price

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Therefore EBIT = Q * S – Q * V – F = Q (S - V) – F

Where:-

Q = Quantity produced and sold.

S = Unit selling price

V = Variable cost per unit

F = Total fixed cost.

EPS = PAT / N and EPS per equity = PAT – DP / N

Now PAT = EBIT – I – Tax on (EBIT - I)

Therefore EPS for equity = [ (EBIT – I )(1 - T) – DP] / N

Thus we can see that EBIT is related S, Q.V, and F and EPS is related to EBIT. This

relationship can be used to understand movement in related items with reference movement

in certain items.

The relationship between quantity of production sold and earning capacity established

operating leverage. The operating hints that when we change the level of operation it results

in the change In earning capacity.

The relationship between organizations total earning capacity and earning by the individual

investors establish financial leverage. The financial leverage hints that when earning

capacity changes it results in the corresponding change the earning by the individual

investor.

The relationship between the two leverage brings out the total leverage. The total leverage

hints that when there is a change in level of operation it results in the corresponding change

in the earnings by the individual investor.

Thus this relationship can be shown as:

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QUANTITY EBIT EPS

Levels of operation Earning capacity Earnings per share

Op. leverage Fin. leverage

Total Leverage

Ref: “Lecture Notes on Financial Management” by JCS Ravikant S Wawge, DBAR, SSGMCE, Shegaon

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Capital Structure

One of the tough challenges that firms face is the choice of capital structure. Capital structure decision is important because it affects the financial performance of the firm. The capital structure of a firm is defined as specific mix of debt and equity that a firm uses to finance its operations. Firms can choose among many alternative capital structures. For example, firms can issue a large amount of debt or very little debt. Firms have options of arranging lease financing, use warrants, issue convertible bonds, sign forward contracts or trade bond swaps. They can also issue dozens of distinct securities in countless combinations

Capital Structure theories

Mainly there are two different views regarding capital structure of the firm. One view states

that capital structure is relevant for any given firm. It emphasizes the determination of the

optimum capital structure of a firm at which over all concept of capital for a firm is

minimum they are increasing the total value of the firm.

The second view states that there is no optimal capital structure for any firm. The market

value of the firm is same for any capital structure (any debt/equity ratio) thus capital

structure of the firm is irrelevant.

There are four theories /approaches of expanding the relationship between capital structure

and cost of capital and value of the firm. These are as follows-

1. NI approach

2. NOI approach

3. MM approach

4. Traditional approach.

Assumptions

1. The firm employs only two types of capital ie debt and equity. there are also no preference

share.

2. There is no corporate tax. This assumption has been removed later.

3. The firm pays 100 % of its earning as dividend. Thus there is no returned.

4. The firm’s total assets are given and they do not change, in other words the investment

decisions are assumed constants.

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5. The firms total financing remain constant. the firm can change its capital structure either

by redeeming the debentures by issue of share or by raising debt and reduce equity share

capital

6. The operating earning (EBIT) is not expanded to grow.

7. The business risk remain constant is independent of capital structure and financing risk.

8. All investors are assumed to have same subjectivity of distribution of future expanded

EBIT of firm.

Perpetual life of the firm.

Uses of some symbols in our analysis of capital structure theories

S = Total market value of equity debt.

B = Total market value of debt.

V = Total market value of firm.

I = Interest payment.

NI = Net income available on equity share.

Ko = Overall cost of capital.

Ke = Equity capitalization rate.

NI Approach

Durand has suggested NI Approach. According to this approach capital structure decision is

relevant to the valuation of the firm. In other words a change in the capital structure causes

a corresponding change in the overall cost of capital as well as the total value of the firm.

According to this approach, a higher debt content in the capital structure (ie high financial

leverage) will result in decline in the overall or WACC this will cause increase in the value

of equity shares of the company, and vice versa.

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This approach is based on following assumptions:

1. The cost of debt is less than cost of equity capitalization rate.

2. The debt content does not change he risk perception of the investor.

3. There is no corporate tax.

On the basis of NI Approach Total value of the firm as –

V = S + B Where S = Ni/Ke.

NOI Approach

Durand has also suggested this approach. This approach is just opposite of NI Approach.

According do this approach the market value of firm is not at all affected by capital

structure changes. The market value of the firm ascertained by capitalizing the NOI at

overall cost of capital (Ko) which is considered to be constant. The market value of equity

is ascertained by deducting the market value of debt from market value of firm.

This approach is based on following assumptions-

1. The overall cost of capital (Ko) remains constant for all degrees of debt equity of leverage.

2. The marked capitalization value of the firm as a whole and the spilt between debt and

equity is no relevant.

3. The use of debt having low cost increase in equity capitalization rate (Ke) Thus the

advantage of debt is set off exactly by increase in capitalization rate (Ke).

4. There is no corporate tax.

The following formula can ascertain according to this approach the value of the firm:-

V = EBIT/Ko

And value of equity (S) = V-B

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M-M Approach

This is Modigliani and Miller approach. According to this approach the value of the firm is

independence of its capital structure however there is basic difference between the two. The

NOI approach is purely definitional and conceptual. It does not provide operational

justification for relevance of capital structure in valuation of the firm. While MM approach

support the NOI approach providing behavioral justification for irrelevance of total

valuation and cost of capital of the firm from its capital structure, in other words MM

approach maintaining that the average cost of capital does not change with the change in the

debt weighed equity mix or capital structure of the firm.

Basic Propositions

Following are the basic propositions of the MM Approach.

The overall cost of capital (Ko) and value of firm (V) are constant for all level of debt

equity mix. The total market value of the firm is given by capitalizing expected net

operating income (NOI) by the rate appropriate for risk classes.

The cost of equity (Ke) is equal to capitalization rate of pure equity steam plus premium of

financial risk. The financial risk increases with more debt content in capital structure, as a

result cost of equity (Ke) increase in manner to off set greatly the use of less expensive

source of funds represented by debt.

The cost of rate of investment purpose is completely independent of the way in which

investment is financed.

Assumptions

1. Investors are rational. They evaluate risk and return of each investment proposal

rationally before investing. They are able to maximize their return at minimum cost.

2. Capital market is 100% competitive.

3. The firm pay no any income tax thus loses its tax advantages.

4. Expected earnings are definite and constant so future earning of firm are known and

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Traditional Approach

The traditional approach also known as intermediate approach is a compromise between

two extreme of NI & NOI approach. According to this approach the value of firm can be

increase initially or using more debt as debt is cheaper source of fund than equity. Thus

optimal capital structure can be reached by debt and equity mix. Beyond the certain level

equity increases because increase in debt (financial leverage) increases the financial risk of

equity shareholder. The advantage of cheaper debt at this point capital structure is offset by

increase cost of equity. After there comes a stage when the increase cost of equity cannot be

offset by the advantage of the low cost debt. Thus overall cost of capital (Ko) according to

this certain point remain more or less constant.

According to above discussion it can conclude that the traditional theory support that the

cost of capital and value of the firm are dependent upon capital structure of firm.

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Earning per share is the reward of an investor for making his investment and it is the best

measure of performance of a firm. "The bottom line of income statement is an indictor of

performance of "think-tank" or "top-level" of the company. Ordinary investors lacking in-

depth knowledge and inside information mainly depend on EPS to make their investment

decision. So it should be the objective of financial management to maximize the EPS from

the viewpoint of both the investor and investee.

Again the objective of financial management is maximization of value measure in terms of

market price of equity share of a corporate entity. Given the objective of the firm to

maximize the value of equity share, a firm should select a desired combination of financing

mix or capital structure to achieve the goal. Theoretically, optimum capital structure implies

that combination of debt and equity at which overall cost of capital is Minimum and value

of the firms is Maximum. The prevailing view is that the value maximization criterion as a

criterion of optimal capital structure is measured in terms of market price of equity share

i.e. the value of the firms is maximized when the market price of equity share is maximized.

So according to this view maximization of market price of equity share leading to the

maximization of value of the firm is a criterion of optimum capital structure.

In this context an example of a firm may be drawn which is running with optimum debt

equity combination. Now due to the influence of some external factors i.e. sudden political

change or something like this the market price of its equity shares started decreasing and as

a result value of the firm went on decreasing. Due to the downward movement of the value

of firm. Its capital structure will not become optimum further and will need restructuring to

become optimum again.

In practice, change in market price of equity share may occur very rapidly and hence it is

very difficult to change the composition of capital structure accordingly.

Capital structure decision is an internal decision of the firm. So increase in market price of

equity share due to the influence of external factors leading to the maximization of the

value of the firm should not be a criterion of optimum capital structure. Rather EPS may be

a better substitute, as a criterion of value maximizing EPS should be the main slogan or

mul-mantra of a firm in order to realize the objective of maintaining an appropriate capital

structure.

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Dividend policy decision

Dividend decision is the major decision area of financial management. A firm is to decide

what portion of earning would be distributed to the shareholders by way of dividend and

what portion of the same would be retained in the firm for its future growth. Both dividend

and retention are desirable but they are conflicting are desirable but they are conflicting to

each other. A finance manager should be able to formulate a suitable dividend policy,

which will satisfy the shareholder without hampering future progress of the firm. It is

common that higher the earnings, higher will be the amount of dividend and vice-versa.

The firms with a history of taking on good project and the potential for more good projects

in the future acquire much more control over their dividend policy. In particular, these firms

can pay much less in dividend than they have available as cash profits and hold on to the

surplus cash because the shareholder trusts them to reinvest these profits wisely In contrast,

shareholders of firms having history of poor projects wish to have less retention of profits

because of the fear that the profits will be invested in poor projects.

The dividend policy of a firm affects the market price of the share. In general, the stability

of dividend seems to increase the marker price of the share. However the dividend policy

may affect the market price indirectly by affecting the investor’s expectations of growth and

risk associated with the stream of dividend. The dividend policy of a firm determines the

amount of retained earnings, which can be reinvested by the firm to ultimately result in

growth of the firm and subsequent increase in dividends in later years.

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Use of fixed cost bearing capital in the capital structure is termed as financial leverage.

Such capital especially debt is cheaper than the equity as the cost of debt is generally lower

than that of equity and a tax advantage is attached with its use. In these circumstances, if

total capital employed remains constant, increase in the financial leverage or use of debt

implies that relatively cheaper source of fund replaces a source of fund having relatively

higher cost. Now if a company follows this practice its net return will be attributable to the

low base of equity shareholders (lower base being due to the increase in financial

leverage).

As a result it will lead to the magnification of return to the equity and thus EPS. But one

should keep in mind that the same holds well in favorable business environment where the

company is able to earn a rate of return on investment being higher than its cost of

financing. So long this situation continues the return on equity or EPS will increase with the

increase in financial leverage.

The excess of the rate of return on investment over the fixed rate of interest and preference

dividend will go to the equity shareholders. However during the period adversity when the

company is not in a position to earn greater (at least equal) rate of return than the cost of

debt and preference share, its return on equity and EPS, instead of increase, will actually

decrease, with the increase in the financial leverage.

As higher earnings would result in higher dividend, the above discussion follows that

increase in use of financial leverage increases the Earning per share and thus Dividend per

share. Conversely decrease in the Earning and Dividend per Share.

Keeping this theoretical background in view, the efforts are made to its applicability in it

real corporate practice.

1. FIXED ASSETS

Fixed assets are those assets owned by a company that contributes to the company's income

but are not consumed in the income generating process and are not held for cash conversion

purposes. Fixed assets are tangible items usually requiring significant cash outlay and

lasting for an extended period of time.

Buildings, real estate, equipment and furniture are good examples of fixed assets. Fixed

assets are sometimes collectively referred to as 'plant'.Generally intangible long-term assets,

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such as trademarks and patents, are not categorized as fixed assets but more specifically

referred to as 'fixed intangible assets'

2. CURRENT ASSETS

It's the current assets that provide the fuel for the engine of growth in a company. Inventory

is a good example of the importance of current assets. Inventory represents assets being

held by the company for sale, and the speed of the movement of the inventory through the

company is of significant importance to the operating success of the company.

3.DEBT/EQUITY RATIO

Indicates the proportion of equity and debt that the company is using to finance its assets.

Sometimes investors only use long term debt instead of total liabilities for a more stringent

test.A ratio greater than one means assets are mainly financed with debt, less than one

means equity provides a majority of the financing.

If the ratio is high (financed more with debt) then the company is in a risky position -

especially if interest rates are on the rise.

Debt vs. Equity -- Advantages and Disadvantages

In order to expand, it is necessary for business owners to tap financial resources. Business

owners can utilize a variety of financing resources, initially broken into two categories, debt

and equity. "Debt" involves borrowing money to be repaid, plus interest. "Equity" involves

raising money by selling interests in the company. The following table discusses the

advantages and disadvantages of debt financing as compared to equity financing.

ADVANTAGES OF DEBT COMPARED TO EQUITY

Because the lender does not have a claim to equity in the business, debt does not dilute the

owner's ownership interest in the company.

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A lender is entitled only to repayment of the agreed-upon principal of the loan plus

interest, and has no direct claim on future profits of the business. If the company is

successful, the owners reap a larger portion of the rewards than they would if they had sold

stock in the company to investors in order to finance the growth.

Except in the case of variable rate loans, principal and interest obligations are known

amounts which can be forecasted and planned for.

Interest on the debt can be deducted on the company's tax return, lowering the actual cost

of the loan to the company.

Raising debt capital is less complicated because the company is not required to comply

with state and federal securities laws and regulations.

The company is not required to send periodic mailings to large numbers of investors, hold

periodic meetings of shareholders, and seek the vote of shareholders before taking certain

actions.

DISADVANTAGES OF DEBT COMPARED TO EQUITY

Unlike equity, debt must at some point be repaid.

Interest is a fixed cost which raises the company's break-even point. High interest costs

during difficult financial periods can increase the risk of insolvency. Companies that are too

highly leveraged (that have large amounts of debt as compared to equity) often find it

difficult to grow because of the high cost of servicing the debt.

Cash flow is required for both principal and interest payments and must be budgeted for.

Most loans are not repayable in varying amounts over time based on the business cycles of

the company.

Debt instruments often contain restrictions on the company's activities, preventing

management from pursuing alternative financing options and non-core business

opportunities.

The larger a company's debt-equity ratio, the more risky the company is considered by

lenders and investors. Accordingly, a business is limited as to the amount of debt it can

carry.

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The company is usually required to pledge assets of the company to the lender as

collateral, and owners of the company are in some cases required to personally guarantee

repayment of the loan.

4.FIXED-ASSET TURNOVER RATIO

The fixed-asset turnover ratio measures a company's ability to generate net sales from

fixed-asset investments - specifically property, plant and equipment (PP&E) - net of

depreciation. A higher fixed-asset turnover ratio shows that the company has been more

effective in using the investment in fixed assets to generate revenues.

The fixed-asset turnover ratio is calculated as:

This ratio is often used as a measure in manufacturing industries, where major purchases

are made for PP&E to help increase output. When companies make these large purchases,

prudent investors watch this ratio in following years to see how effective the investment in

the fixed assets was.

5. COST OF EQUITY AND COST OF DEBT

When the company issues debt, for example in the form of bonds, it to pay bondholders the

interest. This interest is tax deductible.

On the other hand, when the company issues equity, i.e. stocks, it pays dividends. This

dividend is taxed as corporate income.

Because of the ability of debt to escape taxation vis-a-vis equity, cost of debt is lower than

cost of equity. This is called a debt tax shield.

6. DIVIDENT PAYOUT RATIO

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The dividend payout ratio is the percentage of a company's annual earnings paid out as

cash dividends. Dividend payout ratios vary by industry and are affected by market

conditions and tax law. Moreover, both a low dividend payout ratio and a high dividend

payout ratio can have good or bad implications. A low dividend payout ratio can indicate a

fast-growing company whose shareholders willingly forego cash dividends, because the

company uses the extra money to generate higher returns and, in turn, a high stock price.

But a low dividend payout ratio can also point to a company that simply can't afford to pay

dividends. Similarly, a high dividend payout ratio can indicate a blue-chip that pays high

dividends and whose stock price is temporarily depressed. But a high dividend payout ratio

can also point to a mature company with few growth opportunities.

7.RETENTION RATIO

Percentage of the earnings of a firm that are not paid out to stockholders (shareholders) as

dividends but are either reinvested in the firm or are kept as reserve for specified purposes (such

as to pay off a debt or purchase a capital asset).

Calculated as:

8.FIRM VALUE

Enterprise value, or the value of capital employed, corresponds to the market value of the

enterprise’s machines and commercial activities. Enterprise value is equal to the market

value of the shareholders’ equity (stock market capitalisation if a company is quoted) plus

the market value of the net financial debt . Also called firm value.

9.GROSS PROFIT RATIO

Gross Profit Ratio shows the relationship between Gross Profit of the concern and its Net Sales. Gross Profit Ratio can be calculated in the following manner: -

Gross Profit Ratio = Gross Profit/Net Sales x 100

Where Gross Profit = Net Sales – Cost of Goods Sold

Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses – Closing Stock

And Net Sales = Total Sales – Sales Return

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Objective and Significance: Gross Profit Ratio provides guidelines to the concern

whether it is earning sufficient profit to cover administration and marketing expenses and

is able to cover its fixed expenses. The gross profit ratio of current year is compared to

previous years’ ratios or it is compared with the ratios of the other concerns. The minor

change in the ratio from year to year may be ignored but in case there is big change, it

must be investigated. This investigation will be helpful to know about any departure from

the standard mark-up and would indicate losses on account of theft, damage, bad stock

system, bad sales policies and other such reasons.

However it is desirable that this ratio must be high and steady because any fall in it would

put the management in difficulty in the realisation of fixed expenses of the business.

10.NET PROFIT RATIO

Net Profit Ratio shows the relationship between Net Profit of the concern and Its Net

Sales. Net Profit Ratio can be calculated in the following manner: -

Net Profit Ratio = Net Profit/Net Sales x 100

Where Net Profit = Gross Profit – Selling and Distribution Expenses – Office and

Administration Expenses – Financial Expenses – Non Operating Expenses + Non

Operating Incomes.

And Net Sales = Total Sales – Sales Return

Objective and Significance: In order to work out overall efficiency of the concern Net

Profit ratio is calculated. This ratio is helpful to determine the operational ability of the

concern. While comparing the ratio to previous years’ ratios, the increment shows the

efficiency of the concern.

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PHARMA INDUSTRY

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INDIAN PHARMA INDUSTRY

The pharmaceutical industry in India is among the most highly organized sectors. This

industry plays an important role in promoting and sustaining development in the field of

global medicine. Due to the presence of low cost manufacturing facilities, educated and

skilled manpower and cheap labor force among others, the industry is set to scale new

heights in the fields of production, development, manufacturing and research. In 2008, the

domestic pharma market in India was expected to be US$ 10.76 billion and this is likely to

increase at a compound annual growth rate of 9.9 per cent until 2010 and subsequently at

9.5 per cent till the year 2015.

Industry Trends

The pharma industry generally grows at about 1.5-1.6 times the Gross Domestic

Product growth. Globally, India ranks third in terms of manufacturing pharma

products by volume

The Indian pharmaceutical industry is expected to grow at a rate of 9.9 % till 2010

and after that 9.5 % till 2015

In 2007-08, India exported drugs worth US$7.2 billion in to the US and Europe

followed by Central and Eastern Europe, Africa and Latin America

The Indian vaccine market which was worth US$665 million in 2007-08 is growing

at a rate of more than 20%

The retail pharmaceutical market in India is expected to cross US$ 12-13 billion by

2012

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The Indian drug and pharmaceuticals segment received foreign direct investment to

the tune of US$ 1.43 billion from April 2000 to December 2008

Challenges

Every industry has its own sets of advantages and disadvantages under which they have to

work; the pharmaceutical industry is no exception to this. Some of the challenges the

industry faces are:

Regulatory obstacles

Lack of proper infrastructure

Lack of qualified professionals

Expensive research equipments

Lack of academic collaboration

Underdeveloped molecular discovery program

Divide between the industry and study curriculum

Government InitiativesThe government of India has undertaken several including policy

initiatives and tax breaks for the growth of the pharmaceutical business in India. Some

of the measures adopted are:

Pharmaceutical units are eligible for weighted tax reduction at 150% for the research

and development expenditure obtained.

Two new schemes namely, New Millennium Indian Technology Leadership Initiative

and the Drugs and Pharmaceuticals Research Program have been launched by the

Government.

The Government is contemplating the creation of SRV or special purpose vehicles with

an insurance cover to be used for funding new drug research

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The Department of Pharmaceuticals is mulling the creation of drug research facilities

which can be used by private companies for research work on rent

PharmaExport

In the recent years, despite the slowdown witnessed in the global economy, exports from

the pharmaceutical industry in India have shown good buoyancy in growth. Export has

become an important driving force for growth in this industry with more than 50 % revenue

coming from the overseas markets. For the financial year 2008-09 the export of drugs is

estimated to be $8.25 billion as per the Pharmaceutical Export Council of India, which is an

organization, set up by the Government of India. A survey undertaken by FICCI, the oldest

industry chamber in India has predicted 16% growth in the export of India's pharmaceutical

growth during 2009-2010.

Key players in Indian Pharmaceutical Industry

There are several national and international pharmaceutical companies that operate in India.

Most of the country's requirements for pharmaceutical products are met by these

companies. Some of them are briefly described below:

Ranbaxy Laboratories Limited is the biggest pharmaceutical manufacturing company in

India. The company is ranked at the 8th position among the global generic pharmaceutical

companies and has presence in 48 countries including world class manufacturing facilities

in 10 countries and serves to customers from over 125 countries. Ranbaxy Laboratories

2009-2010 Q3 Net Profit Results showed a profit of Rs 116.6 crore as compared to Rs

394.5 crore deficit, recorded during the corresponding period last fiscal.

Dr. Reddy's Laboratories manufactures and markets a wide range of pharmaceuticals both

in India and abroad. The company has 60 active pharmaceutical ingredients to manufacture

drugs, critical care products, diagnostic kits and biotechnology products. The company has

6 FDA plants that produce active pharma ingredients and 7 FDA inspected and ISO 9001

and ISO 14001 certified plants. Dr. Reddy's Q1 FY10 result shows the revenues of the

company at Rs. 18,189 million which is up by 21%. During this quarter the company

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introduced 24 new generic products, applied for 22 new generic product registrations and

filed 4 DMFs.

Cipla is an Indian pharmaceutical company renowned for the manufacture of low cost anti

AIDS drugs. The company's product range comprises of anthelmintics, oncology, anti-

bacterials, cardiovascular drugs, antibiotics, nutritional supplements, anti-ulcerants, anti-

asthmatics and corticosteroids. Cipla also offers other services like quality control,

engineering, project appraisal, plant supply, consulting, commissioning and know-how

transfer, support. For the financial year 2008-09 the company registered an increase of 22%

in sales and other income over the previous year.

Nicholas Piramal is the second largest pharmaceutical healthcare company in India. The

brands manufactured by the company include Gardenal, Ismo, Stemetil, Rejoint, Supradyn,

Phensedyl and Haemaccel. Nicholas Piramal has entered into join ventures and alliances

with several international corporations like Cheissi, Italy; IVAX Corp; UK, F. Hoffmann-

La Roche Ltd., Allergan Inc., USA etc.

Glaxo Smithkline (GSK) is a United Kingdom based pharma company; it is the world's

second largest pharmaceutical company. The company's portfolio of pharma products

consist of central nervous system, respiratory, oncology, vaccines, anti-infectives and

gastro-intestinal/metabolic products among others. On November 2009, the FDA had

announced that the H1N1 vaccine manufactured by GSK would join the list of the four

vaccines approved.

Zydus Cadila also known as Cadila Healthcare is an Indian pharmaceutical company

located in Gujarat. The company's 1QFY2010 results show the net sales at Rs880.3cr which

is higher than the estimated Rs773cr. The net profit was Rs124.8cr which was increase of

39%; the increase was on account of higher sales and improvement in the OPM.

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DR.REDDYS

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DR.REDDYS

Established in 1984, Dr. Reddy’s Laboratories is an emerging global pharmaceutical

company. As a fully integrated pharmaceutical company, it provides affordable and

innovative medicines through three core businesses:

Pharmaceutical Services and Active Ingredients, comprising Active Pharmaceuticals and

Custom Pharmaceuticals businesses;

Global Generics, which includes branded and unbranded generics; and

Proprietary Products, which includes New Chemical Entities (NCEs), Differentiated

Formulations, and Generic Biopharmaceuticals.

Its products are marketed globally, with a focus on India, US, Europe and Russia. Dr.

Reddy’s conducts NCE research in the areas of metabolic disorders, cardiovascular and anti

inflamation. Its strong portfolio of businesses, geographies and products gives an edge in an

increasingly competitive global market and allows to provide affordable medication to

people across the world, regardless of geographic and socio-economic barriers.

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Dr. Reddy's offers an unparalleled portfolio to customers, who include innovators and

generic formulators worldwide. With a strong product portfolio of more than 140 products,

including niches like oncology and hormones, and our “first in, last out” approach, it is little

wonder we are today the third ranked API player globally. Our goal is always to enable our

customers to be the first to launch a generic product and to provide value added services to

help them remain competitive and profitable for the entire life cycle of the product. We

have built the capabilities to consistently deliver on this promise in scale and across the

largest product range.

A highly skilled global team focuses on timely delivery of products, product development,

technology leadership, cost competitiveness, the highest levels of customer service, and full

compliance with regulatory and quality requirements. Our expertise in organic synthesis

and process development complemented by a controlled supply chain enables us to provide

our customers with high quality Bulk Actives at competitive prices. They are aggressively

building their product portfolio to cater to generic players in the emerging markets and

generic and patent challenge formulators in regulated markets.

Its operations capabilities are among its core strengths, with six USFDA approved plants in

India, one in Mexico and our latest addition, a USFDA inspected plant in Mirfield, UK,

having a total capacity of 3300KL.

Its API business is supported by our technologically advanced Product Development

infrastructure, which identifies new products and is engaged every step of the way, from

the conceptual stage to delivery of drugs to the market place. The Product Delivery Teams,

the Centres of Excellence and IP teams help create value through Intellectual Property and

proactive patenting; early development work on certain promising molecules;

breakthrough product delivery; and by delivering cost leadership in API.

All the above advantages make Dr. Reddy's API, an ideal partner in your product

development efforts.

Dr. Reddy’s Board of Directors comprises eminent individuals from diverse fields. The

Board acts with autonomy and independence in exercising strategic supervision,discharging

its fiduciary responsibilities, and in ensuring that the management observes the highest

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standards of ethics, transparency and disclosure.

Our directors are experts in the diverse fields of medicine, chemistry and medical research

human resource development, business strategy, finance, and economics. They review all

significant business decisions, including strategic and regulatory matters. Every member of

the Board, including the non-executive directors, has full access to any information related

to our company.

Committees appointed by the Board focus on specific areas, take decisions within the

authority delegated to them and make specific recommendations to the Board on matters in

their areas or purview.

SWOT ANALYSIS

Strengths:

Wholly owned subsidiaries in US and Europe

Joint ventures in China and South Africa

Markets pharmaceutical products in 115 countries

Partnerships with global pharmaceutical companies like Novartis, NOVO Nordisk,

etc.

Strong product portfolio

Manufacture and market over 250 medicines targeting a wide range of therapies

Wide range of anti-cancer drugs developed

Over 100 APIs developed

Six New Chemical Entities(NCE

Low cost base

Contributes to company’s high profit margin of around 34% of sales

Partnerships with key players in the market keeps its cost base down

Research Driven & Global Talent

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Expertise in developing innovative product formulations

6120 employees worldwide including 951 scientists in which 323 are dedicated

towards new drug discovery research.

Weaknesses:

High amount of revenues from overseas

India - a rich source of Active Pharmaceutical Ingredients (APIs), hence major

source of revenue is exports of APIs. May loose out to western world, especially

Europe, where currency is much more stable than the Indian Rupee

Over-reliance on partnerships

In order to compete effectively in global markets, strategic partnerships required to

develop products.

Lack of resources similar to US and Europe based competitors to develop a drug to

marketing stage

Generic drugs smallest focus

Smallest portion of revenues from generics at around 20%

Lack of patent legislation in India harms sales of its products

Opportunities:

Take a drug all the way to market

Take a molecule from its pipeline all the way to the market place cost-effectively

market

Buy back of the integrated drug development company from ICICI Ventures and

Citigroup

Domestic Generic drugs market

In another 4-6 years, many product patents obtained after the 2004 legislation will

go off providing an opportunity to the company increase its domestic footprint in

Generics

Threats:.

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Needs to gain FDA approval for all sources and products. Products have to pass

strict FDA trials before going to market, which can be costly and time consuming.

This may delay the company entry to particular markets which affects revenue

Competition from US and European Companies

Based in lucrative markets e.g. Novartis, Merck & Co

Revenues running into billions which dwarfs Reddy’s annual turnover Litigation

charges

Reddy’s lost the case against Pfizer for the use of generic form of Norvasc drug.

Legal cost $10m and also loss of market opportunity.

Heightened concerns about profitability of German generics business of Betapharm

All amounts in Indian Rs.MillionYear Sales % sales Contribution EBIT % EBIT EBT EPS % EPS

2008-09 68,326 37.47 14,013 9036 41.01 8064 54.48 171.45

2007-08 49,700 -23.68 10,426 6408 -53.98 5450 20.07 -67.055

2006-07 65,125 164.68 17,716 13925 723.98 12399 60.92 535.245

2005-06 24,605 21.91 4,274 2657 577.62 2013 9.59 123.02

2004-05 19,212 -5 1,502 2,46 -90.89 1,38 4.3 -67

Interpretation from DFL

From above, DFL increased from 0.737 to 1.242 during 2004-09. In the year 2008-09 the

variability of EPS is the highest. For every 1 unit change in operating profit EPS changes 49

YEAR FL DFL OL DOL CL DTL2009 1.12 1.24 1.55 1.09 1.74 4.582008 1.17 1.24 1.63 2.28 1.9 2.832007 1.12 0.74 1.27 7.39 1.43 3.252006 1.32 0.22 1.61 26.36 2.12 5.612005 1.78 0.73 6.09 18.17 10.84 13.4

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by 1.242 units. In the above case debt increased the variability in EPS as the DFL increased

from 0.735 to 1.242. Thus the financial risk also steadily increased.

Financial Risk is the added variability in earnings per share (EPS) plus the risk of possible

insolvency that is induced by the use of financial leverage. Debt increases the probability of

cash insolvency over an all-equity-financed firm.

Interpretation from DOL

The DOL increased from the year 2004-05 to 2005-06 and then decreased towards 2008-

09.In the year 2008-09 for every 1 unit change in the sales there is 1.094 units change in the

EBIT.

The closer that a firm operates to its break-even point,the higher the absolute value of its

DOL. Thus the sales are closer to break-even in the year 2005-06.

Business Risk is the inherent uncertainty in the physical operations of the firm. Its impact

is shown in the variability of the firm’s operating income (EBIT). DOL magnifies the

variability of operating profits and, hence, business risk. In the above case business risk is

highest in the year 2005-06

Interpretation from DTL

The percentage change in a firm’s earnings per share (EPS) resulting from a 1 percent

change in output (sales) is called DTL. Highest DTL is observed in the year 2004-05. For

every 1 unit increase in sales EPS changed by 13.4.

All amounts in Indian Rs.Millio

YEAR FA CA CoD CoE Dbt/Eqty DP Ratio

2009 16,220 25392 1.9 1.8 0.9 26.19

2008 12,339 20753 2 1.8 1.12 21.94

2007 38,252 33892 3.4 13.8 0.9 15.52

2006 35,315 21,565 2.1 13.7 0.7 6.25

2005 8,414 16,703 2.3 12.3 0.41 20.71

Fixed Assets and Current assets

Dr.Reddy’s had maximum fixed assets and current assets in the year 2007.Fixed assets

drastically decreased during 2008 and slightly increased towards 2009.Current assets also

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showed a similar trend but the decrease in the current assets is slightly lower compared to

fixed assets

Cost of equity and Cost of debt

From the table, the CoE is higher during the period 2004-07 and Dr.Reddy’s could use

debt as a cheaper source of capital. During 2007-09 the CoE decreased to 1.8 which is

slightly lower than the CoD which is 1.9. Thus the company enjoyed debt as a cheaper

source of capital during 2004-07.

Debt/equity ratio

In the above case the ratio is greater than 1 in 2007-08 i.e. 1.12. thus the company financed

its assets using debt and the company is In a risky position.

From the table:

EPS is highest during 2008-09 and in the same year Dr.Reddy’s paid a large percentage of

the earnings to the shareholders.

In the year 2006 though the company had highest EPS it paid very meager percentage to

the shareholders.it retained 93% of its earnings during that year.

From the table:

51

Year DP Retention ratio GPR NPR EPS2009 26.19 71.35 19.71 54.48 18.482008 21.94 79.43 14.11 20.07 13.212007 15.52 82.97 12.58 60.92 13.572006 6.25 93.9 31.55 9.59 29.012005 20.71 78.82 10.26 4.3 10.08

YEAR Dbt/Eqt VALUE WACC

2009 0.9 56151 16.8

2008 1.12 65951 20.2

2007 0.9 65612 15.6

2006 0.7 52639 12.7

2005 0.41 22440 8.3

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The debt to equity ratio and value is the firm are highest during the year 2007-08, thus

Dr.Reddy’s could leverage and debt and increase the value of the firm. Also during the

same year the WACC is low compared to previous years.

YEAR FA/CA FA/TA FATR

Sales BEP DOL

2009 0.64 0.39 1.86 68,326 24267 1.09

2008 0.59 0.37 1.91 49,700 19153 2.28

2007 1.13 0.53 1.97 65,125 13935 7.39

2006 1.64 0.62 4.95 24,605 9308 18.17

2005 0.5 0.33 3.31 19,212 16065 26.36

From the table:

FATR decreased continuously from the year 2006-09.FATR is highest in the year 2006,

which implies Dr.Reddy’s is able to use the investment on fixed assets to generate sales .

An interestion correction berween DOL , sales and BEP can be observed from the above

table i.e. DOL is high in the year 2005 when the company’s sales are closer to BEP sales.

From the Fixed assets to total assets ratio it can be noticed that the percentage of the fixed

assets in the total assets of the company is highest in the year 2006 and same is reflected

even in the FA/CA ratio for the year 2006.

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Fixed assets Vs Current assets

From the graph, the proportion of fixed assets increased from 2005-07 and then decreased.The total assets also followed the similar trend

EPS-DFL

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From the graph, it can be noticed that as DFL increased slightly and EPS varied drastically

irrespective of the DFL variations.

RANBAXY

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Ranbaxy Laboratories Limited (Ranbaxy), India's largest pharmaceutical company, is an

integrated, research based, international pharmaceutical company, producing a wide range

of quality, affordable generic medicines, trusted by healthcare professionals and patients

across geographies. Ranbaxy today has a presence in 23 of the top 25 pharmaceutical

markets of the world. The Company has a global footprint in 46 countries, world-class

manufacturing facilities in 7 countries and serves customers in over 125 countries.

In June 2008, Ranbaxy entered into an alliance with one of the largest Japanese innovator

companies, Daiichi Sankyo Company Ltd., to create an innovator and generic

pharmaceutical powerhouse. The combined entity now ranks among the top 20

pharmaceutical companies, globally. The transformational deal will place Ranbaxy in a

higher growth trajectory and it will emerge stronger in terms of its global reach and in its

capabilities in drug development and manufacturing.

Mission&Vision

Ranbaxy's mission is ‘To become a Research-based

International Pharmaceutical Company’. The Company is

driven by its vision to ‘Achieve significant business in proprietary prescription products by

2012 with a strong presence in developed markets’.

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Financials

Ranbaxy was incorporated in 1961 and went public in 1973. For the year 2009, the

Company recorded Global Sales of US $ 1519 Mn. The Company has a balanced mix of

revenues from emerging and developed markets that contribute 54% and 39% respectively.

In 2009, North America, the Company's largest market contributed sales of US $ 397 Mn,

followed by Europe garnering US $ 269 Mn and Asia clocking sales of around US $ 441

Mn.

Strategy

Ranbaxy is focused on increasing the momentum in the generics business in its key

markets through organic and inorganic growth routes. Growth is well spread across

geographies with focus on developed and emerging markets. It is the Company’s constant

endeavour to provide a wide basket of generic and innovator products, leveraging the

unique Hybrid Business Model with Daiichi Sankyo. The Company will also increasingly

focus in high growth potential segments like Vaccines and Biogenerics. These new areas

will add significant depth to the existing product pipeline.

R&D

Ranbaxy views its R&D capabilities as a vital component of its business strategy that will

provide a sustainable, long-term competitive advantage. Ranbaxy is among the few Indian

pharmaceutical companies in India to have started its research program in the late 70's, in

support of its global ambitions. A first-of-its-kind world class R&D centre was

commissioned in 1994. Today, the Company has multi-disciplinary R&D centers at

Gurgaon, in India, with dedicated facilities for generics research and innovative research.

The R&D environment reflects its commitment to be a leader in the generics space

offering value added formulations and development of NDA/ANDAs, based on its Novel

Drug Delivery System (NDDS) research capability. Ranbaxy’s first significant

international success using the NDDS technology platform came in September 1999, when

the Company out-licensed its first once-a-day formulation to a multinational company.

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WorldwideOperations

Global Pharma Companies are experiencing an ever changing landscape ripe with

challenges and opportunities. In this challenging environment Ranbaxy is enhancing its

reach leveraging its competitive advantages to become a top global player.

Driven by innovation and speed to market we focus on delivering world-class generics at

an affordable price. Our unwavering determination to achieve excellence leads us to new

global benchmarks. Our people have consistently risen above all challenges maximized

opportunities and positioned Ranbaxy as a leader in the global generics space.

Ranbaxy’s global footprint extends to 46 countries embracing different locales and

cultures to form a family of 50 nationalities with an intellectual pool of some of the best

minds in the world

RANBAXY

Year Sales % chg Contribution EBIT % EBIT EBT EPS % EPS

2009 76117 2.24 11991 10808 183.49 10097 7.05 128.37

2008 74449 6.63 -2626 -12945 -213.58 -15000 -24.85 -219.64

2007 69822 13.87 13580 11397 21.382 9985 20.77 47.4

2006 61315 18.186 9389 7546 311.305 6510 14.09 25.17

2005 51880 -2.351 3727 2282 -76.21 1611 18.83 174

YEAR FL DFL OL DOL CL DTL

2009 1.07 0.699 1.109 61.915 1.187 57.308

2008 0.86 1.03 0.202 -52.214 0.175 -33.128

2007 1.44 2.22 1.191 1.542 1.36 3.41745

2006 1.24 0.08 1.244 17.118 1.442 1.38403

2005 1.41 2.28 1.633 32.415 2.313 -74.011

Interpretation from DFL

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From above we can notice that DFL has been continuously fluctuating. In the year 2004-05

the variability of EPS is the highest. For every 1 unit change in operating profit EPS

changes by 2.283 units.

Debt increases the probability of cash insolvency over an all-equity-financed firm. Debt

also increased the variability in EPS as the DFL decreased from 2.283 to 0.699. Thus the

financial risk also decreased.

Interpretation from DOL

The DOL has decreased from the year 2004-05 to 2007-08 and then increased towards

2008-09. In the year 2008-09 for every 1unit change in the sales there will be 61.915 units

change in the EBIT.

The closer that a firm operates to its break-even point, the higher is the absolute value of its

DOL. Thus the sales are closer to break-even in the year 2008-09.

Business Risk is the inherent uncertainty in the physical operations of the firm. Its impact

is shown in the variability of the firm’s operating income (EBIT). DOL magnifies the

variability of operating profits and, hence, business risk.in the above case business risk is

highest in the year 2008-09.

Interpretation from DTL

The percentage change in a firm’s earnings per share (EPS) resulting from a 1 percent

change in output (sales) is called DPS.For 1 unit increase in sales EPS decreased by 74.011

unit.

YEAR FA CA CoD CO.E DBT/EQTY D/P Ratio2009 51135 51020 1.8 1.9 0.68 …2008 49607 58664 0.5 6.02 0.79 …2007 42045 37333 4.9 12.5 0.89 60.062006 38953 35761 2.7 13.5 0.93 94.952005 20591 28707 2.8 8.9 0.06 170.28

Ranbaxy could find the debt capital cheaper than equity capital over the period of

6 years from 2004-09. It can be noted that the highest cost of debt is greater than

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the lowest cost of equity. Thus the company enjoyed debt as a cheaper source of

capital.

Ranbaxy had maximum fixed assets in 2009 and maximum current assets in the

year 2008. Fixed assets and current assets of the company has been continuously

increasing from 2005-2009.

Debt to equity ratio of the company is less than 1. Hence the company financed

most of its assets using equity

From the table:

Ranbaxy could not declare any dividents during 2008 and 2009 because of low profits and NPR is negative for the year 2007-08 after paying taxes which indicate loss.

From the above table:

Debt to equity ratio is highest during the year 2005-06 and highest WACC during 2006-07.

The value of the firm is high in the year 2009, when the WACC and debt to equity ratio are low.

YEAR FA/CA FA/TA FATR Sales BEP DOL2009 1.00 0.50 2 76117 75090 61.915

2008 0.85 0.46 2.14 74449 -292551 -52.214

2007 1.13 0.53 2.71 69822 11223 1.542

2006 0.11 0.52 2.73 61315 12035 17.118

2005 0.72 0.42 2.92 51880 20114 32.415

From the table:

59

Year DP ratio Retn Ratio GPR NPR EPS

2009 … 100 10.52 11.72 7.05

2008 … 2.07 -22.02 -24.85

2007 60.06 -668.18 6.55 14.33 20.77

2006 94.95 16.89 12.61 9.07 14.09

2005 170.28 -259.14 2.22 5.78 18.83

Year DBT/EQTY WACC Value of the firm

2009 0.68 14.2 74892

2008 0.79 13 74155

2007 0.89 12.8 62933

2006 0.93 12 56788

2005 0.69 10.7 35186

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FATR decreased from the year 2005-09.FATR is highest in the year 2005, which implies

Ranbaxy efficiently used the investment on fixed assets to generate sales in the year 2005.

Ranbaxy operated close to BEP IN THE YEAR 2009 and this is indicated by Highest DOL

for the same year.

FA/CA ratio and FA/TA ratio are highest for the year 2007 and hence it can be inferred

that Ranbaxy invested more in fixed assets during the corresponding year.

Fixed assets Vs Current assets

From the graph, the proportion of current assets and also the total assets increased from 2005-08 and then slightly decreased during 2008-09

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EPS -DFL

The cash inflows in the year 2007-08 are not enough to meet the fixed costs and therefore

equity share holders could not realize any earnings on the equity share.in the year 2006-07

the earnings per share are maximum i.e. in this year the firm has succesfully leveraged on

the debt to increase the EPS compared to 2005-06

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AUROBINDO

Aurobindo

Among the largest 'Vertically Integrated' pharmaceutical companies in India, Aurobindo

has robust product portfolio spread over major product areas encompassing CVS, CNS,

Anti-Retroviral, Antibiotics, Gastroenterologicals, Anti-Diabetics and Anti-Allergic with

approved manufacturing facilities by USFDA, UKMHRA, WHO, MCC-SA, ANVISA-

Brazil for both APIs & Formulations and has Global presence with own infrastructure,

strategic alliances, subsidiaries & joint ventures.

Aurobindo’s R & D strengths lie in developing intellectual property in non-infringing

processes and resolving complex chemistry challenges. In the process, Aurobindo

develops new drug delivery systems, dosage formulations and applies new technology for

better processes.

Aurobindo Pharma was born of a vision. Founded in 1986 by Mr. P.V. Ramprasad Reddy,

Mr. K. Nithyananda Reddy and a small, highly committed group of professionals, the

Company became a public venture in 1992. It commenced operations in 1988-1989 with a

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single unit manufacturing active pharmaceutical ingredients. Aurobindo Pharma went

public in 1995 by listing its shares in various stock exchanges in the country. Over the

years, Aurobindo Pharma has evolved into a knowledge driven company. It is R&D

focused, has a multiproduct portfolio with multi-country manufacturing facilities, and is

becoming a marketing conglomerate across the world. Aurobindo Pharma created a name

for itself in the manufacture of bulk actives, its area of core competence. After ensuring a

firm foundation of cost effective production capabilities and a clutch of loyal customers,

the company has entered the high value speciality generic formulations segment, with a

global marketing network.

Vision

To become Asia’s leading and one among the top 15 generic pharma companies in the

world by 2015.

Mission

To become the most valued pharma partner for the world pharma fraternity by

continuously researching, developing & manufacturing a wide range of products

complying to the highest regulatory standards

Eminent Board

Corporate governance, accountability and protecting shareholder interests have always

guided the Company. There is an eminent board with considerable knowledge and

experience in pharmaceutical and healthcare, administration, teaching, banking and

consulting to guide and supervise the Company. They are adequately supported by a large

team of professional managers

Aurobindo has a global footprint

Scope of operations is large in the U.S. and Europe with considerable presence in Latin

America and emerging markets. Developmental activity is on-going in Japan and

Australia. Domestic market remains an area of strength.

Products

The Company has one of the widest product portfolio of 300+ products

Major therapeutic segments covered:

• Cardio vascular

• Neuroscience

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• Anti-retroviral

• Gastro-intestinal

• Anti-infective

• Pain management

• Osteoporosis

Capacities

There are large capacities for manufacturing formulations. This is supported by huge

manufacturing capacity for intermediates and active ingredients. There is considerable

head room even as formulations sales have been

showing secular rise quarter-on-quarter.

Performance track record

For over two decades, Aurobindo has successfully sought and worked for leadership

position in its product category.

Product knowledge, manufacturing capabilities, sensitivity to the market and relationship

with customers are the bedrock for the healthy momentum in the business. The Company

has reported profits every year and is a consistent dividend paying company. More

important, shareholder value has been increased while meeting customer needs.

This high energy pharmaceutical company has a passion to succeed in the most

competitive markets. Aurobindo’s commitment to create good health acts as a constant

driver for improvement. The Company straddles key strategies from fermentation to

formulation and is one of the most cost effective producers in the world. Vertically

integrated manufacturing process and captive raw material source makes an impact in end

product marketing. Ability to control quality and power to price has helped Aurobindo to

offer quality pharmaceuticals at affordable prices. All projects are completed within

budgeted time without cost overruns. Value creation and cost effectiveness start early at

Aurobindo. There is an excitement across the organization driving the change to become a

global resource in the pharmaceutical industry. In this journey, as in the past, care is taken

to create value for all stakeholders, and in particular to the customers and investors.

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AUROBINDO

Year Sales % sales Contribution EBIT % EBIT EBT EPS % EPS

2008-09

28852.5 19.755 2945.1 2121.1 41.243 1570.4 23.9 -55.912

2007-08

24092.8 21.698 4356 3610 44.463 3448.4 54.21 26.128

2006-07

19797.2 34.47 3217.3 2498.9 62.752 2311.6 42.98 225.11

2005-06

14722.1 27 246.6 1535.4 85.188 929 13.22 91.316

2004-05

11591.7 -13.563 1234 829.1 -60.097 429.2 6.91 -73.963

YEAR FL DFL OL DOL CL DTL

2009 1.35 1.355 1.388 2.087 1.875 1.45

2008 1.047 0.585 1.206 2.049 1.263 0.28

2007 1.081 3.587 1.287 1.82 1.392 0.34

2006 1.653 1.072 1.333 3.155 2.203 1.97

2005 1.932 1.23 1.489 4.431 2.875 0.28

2004 1.186 1.386 1.167 0.956 1.384 0.65

Interpretation from DFL

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From above we can notice that DFL has been continuously fluctuating. In the year 2006-

07 the variability of EPS is the highest. For every 1 unit change in operating profit EPS

changes by 3.587 units.

Debt increases the probability of cash insolvency over an all-equity-financed firm. Debt

also increased the variability in EPS as the DFL increases.Thus financial risk is highest in

the year 2006-07

Interpretation from DOL

The DOL has decreased from the year 2004-05 to 2008-09 .in the year 2004-05 for every

1unit change in the sales there will be 4.434 units change in the EBIT.

The closer that a firm operates to its break-even point, the higher is the absolute value of

its DOL. Thus the sales are closer to break-even in the year 2004-05.

Business Risk is the inherent uncertainty in the physical operations of the firm. Its impact

is shown in the variability of the firm’s operating income (EBIT). DOL magnifies the

variability of operating profits and, hence, business risk.in the above case business risk is

highest in the year 2004-05

Interpretation from DTL

The percentage change in a firm’s earnings per share (EPS) resulting from a 1 percent change in

output (sales) is called DPS.For 1 unit increase in sales EPS decreased by unit.

YEAR FA CA COE CoD DP ratio debt/equity2009 11579 19455 1.40 22.02 0.85

2008 9507 17219 1.14 7.06 0.932007 13713 18630 0.83 6.81 1.452006 12334 12560 0.81 13.37 0.722005 11108 8883 0.41 6.16 0.43

Aurobindo had maximum fixed assets in 2007 and maximum current

assets in the year 2009. Fixed assets and current assets of the company

has been continuously increasing from 2005-2007 and then decreased

towards 2008.

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Debt to equity ratio of the company is greater than 1 during 2006-07. Hence the

company financed most of its assets using debt in 2007.

year DP ratio Rtn ratio GPR NPR EPS

2009 22.02 92.47 20.35 16.09 23.9

2008 7.06 91.88 15.54 4.54 54.21

2007 6.81 91.34 10.87 12.41 42.98

2006 13.37 92.37 11.02 11.74 13.22

2005 6.16 87.56 9.25 4.89 6.91

From the table:

During the year 2007-08 EPS is highest but the company paid only 7% of the earnings to

the shareholders and retained 92%

of the earnings

From the table:

The value of the firm has been continuously increasing while the debt to equity ratio

increased till 2006-07 and decreased during 2007-08.

From the table:

67

Year Debt/equity WACC Value of the firm

2009 0.85 13.85 35139

2008 0.93 16.13 30487

2007 1.45 13.6 29728

2006 0.72 12.9 21825

2005 0.43 10.3 17086

YEAR FA/CA FA/TA FATR Sales BEP DOL2009 0.60 0.74 0.63 102228.4 70022 2.087

2008 0.55 0.74 0.75 85377.6 59798 2.049

2007 0.74 0.77 0.91 88566.1 53380 1.82

2006 0.98 0.75 1.26 40097.2 12654 3.155

2005 1.25 0.6 1.31 34105.2 9487 4.431

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FATR decreased from the year 2005-09.FATR is highest in the year 2005, which implies

Aurobindo efficiently used the investment on fixed assets to generate sales in the year

2005.

From the graph, it can be noticed that as DFL decreased, EPS also decreased in the corresponding

year and increased as the DFL increased. So, it can be said that DFL and EPS are positively

correlated.

Fixed assets Vs Current assets

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From the graph, we can notice that proportion of current assets is increased from 2005-09 and the proportion of fixed assets decreased. Also the total assets of the company increased

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TELECOM INDUSTRY

The Indian Telecommunications network with 203 million connections is the third largest

in the world and the second largest among the emerging economies of Asia.Today, it is the

fastest growing market in the world. The telecommunication sector continued to register

significant success during the year and has emerged as one of the key sectors responsible

for India’s resurgent India’s economic growth.

Telecom sector accounts for 1 percent of India’s GDP. Likely to double in 2-

3 years

• Telecom services contribute 30 percent to India’s total service tax revenue

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• The Indian telecom sector gives direct employment to more than 4,00,000 people, compared to

about 6,00,000 people in China

• Not just the enabler of software, BPO and ITeS companies, it is also the lifeline of a fast

growing E-commerce space

• State-of-the-art telecom infrastructure has led to the rise of cities like Mysore, Mangalore,

Jaipur, Ahmedabad, Kochi on the software services map

• This has helped spread the benefits of a booming Indian economy to beyond metros and

large cities, and wealth creation is happening in tier-2 cities

Growth

The sector, which was growing in the range of 20 to 25 per cent up to the year 2002-03, has

moved to a higher growth path of an average rate of 40-45 per cent during the last two

years.This rapid growth has been possible due to various proactive and positive decisions of

the Government and contribution of both by the public and the private sector. The rapid

strides in the telecom sector have been facilitated by liberal policies of the Government that

provide easy market access for telecom equipment and a fair regulatory

framework for offering telecom services to the Indian consumers at affordable prices.

Major Players

There are three types of players in telecom services:

• State owned companies (BSNL and MTNL)

• Private Indian owned companies (Reliance Infocomm, Tata Teleservices,)

• Foreign invested companies (Hutchison-Essar, Bharti Tele-Ventures, Escotel, Idea

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Cellular, BPL Mobile, Spice Communications)

• Fastest Growing Sector – CAGR 22% (2002-07)• Second Largest Telecom Market

– Lowest tariff charges in the world

– Wireless Subscribers – 315.3 Mn

– Wireline Subscribers – 38.4 Mn

– Teledensity – 30.6

– 23 Circles - 4 Categories ( Metro, A, B & C)

• Bharti Airtel – Largest player with presence in 23 Circles

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Year Sales %changeIn sales

Contribution EBIT %change in EBIT

EBT EPS %change in EPS

2009 29356.1 47.86 8108.2 3787.1-8.48

2740.1 0.98180

2008 19853.1 -54.36 6735.1 4138.2-49.19

2932.1 0.35-84.02

2007 43500.1 47.47 14861.8 8143.651.67

5092.5 2.19508.33

2006 29496.1 30.08 10864.3 5369.238.69

2198.1 0.36-72.09

2005 22674.5 72.9 8293.1 3871.248.98

682.7 1.29106.76

Interpretation from DFL

From the above table, DFL has been continuously fluctuating. In the year 2006-07 the

variability of EPS is the highest. For every 1 unit change in operating profit EPS changes

by 9.84 units. In the above case as the DFL decreased and the financial risk also decreased.

YEAR FA CA CoD CoE Dbt/Eqty D/P Ratio2009 61478.3 40467 1.1 7.1 0.53 …2008 58213.4 34667 1.1 8.60 1.54 …2007 60989.4 20658 1.5 14.54 1.62 …2006 38768.9 35928 1.2 18.87 2.85 …2005 35974.9 39752 7.1 28.38 2.58 …

Fixed Assets and Current assets

IDEA Cellular had maximum fixed assets and current assets in the year 2009.

Fixed assets decreased during 2008 and in turn increased towards 2009.

Current assets decreased from 2005-07 and then increased towards the year 2009.

4

YEAR FL DFL

2009 1.38 -21.2

2008 1.41 1.71

2007 1.6 9.84

2006 2.44 -1.86

2005 0.67 2.18

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Cost of equity and Cost of debt

From the table, the CoE is higher during the period 2004-05 and the company could use

debt as a cheaper source of capital. During 2007-09 the CoE decreased to 7.1 which is

higherer than the CoD which is 1.1. Thus the company enjoyed debt as a cheaper source of

capital during 2004-09

Debt/equity ratio

In the above case the ratio is greater than 1 during the four years period ( from 2004-2008)

Thus the company financed its assets using debt and the company is In a risky position in

case the interest rate increases.

Year Rtn Ratio GPR NPR EPS

2009 100 15.84 8.71 0.98

2008 100 20.51 9.91 0.35

2007 100 25.81 15.33 2.19

2006 100 24.05 11.44 0.36

2005 100 25.29 6.24 1.29

IDEA retained 100% of its earning during all the 5 years under study and hence the company did not pay dividents to its shareholders.

Though the GPR is high in the year 2004-05, the NPR is very low.

In the year 2006-07 the NPR is high and hence the EPS is also high.

Year Dbt/Eqty WACC Value2009 0.53 14.8 2166692008 1.54 13.4 1006002007 1.62 12.8 643032006 2.85 11.2 441922005 2.58 9.9 40633

From the table, it is interesting to observe that the value of the company is the highes in the

year 2008-09 when it financed most of its assets using equity i.e. debt/ equity ratio is the

low.Also the company has comparitively low value during the year 2004-05 when it

financed most of its assets using debt.Hence IDEACellular could not use debt as a cheaper

source of finance.

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YEAR FA/CA FA/TA FATR Sales Indiff. Pnt EBIT

2009 1.52 0.6 0.62 29356.1 2333 3787.1

2008 1.68 0.63 0.74 19853.1 2560 4138.2

2007 2.95 0.75 0.61 43500.1 5240 8143.6

2006 1.08 0.52 1.24 29496.1 3384 5369.2

2005 0.9 0.48 1.01 22674.5 2593 3871.2

FATR decreased from the year 2006-09.FATR is highest in the year 2006, which

implies IDEA Cellular efficiently used the investment on fixed assets to generate

sales in the year 2005.

FA/CA ratio and FA/TA ratio are highest for the year 2007.

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From the graph, the proportion of fixed assets increased and the total assets of the

company also increased from 2005-09

EPS-DFL

From the graph it can be observed that the company leveraged properly and used debt component successfully. EPS and DFL are positively correlated in the case of IDEA CELLULAR Ltd.

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BHARTI AIRTEL 

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Airtel comes to you from Bharti Airtel Limited, one of Asia’s leading integrated telecom

services providers with operations in 19 countries across Asia and Africa. Bharti Airtel

since its inception, has been at the forefront of technology and has pioneered several

innovations in the telecom sector.

The company is structured into four strategic business units - Mobile, Telemedia,

Enterprise and Digital TV. The mobile business offers services in India, Sri Lanka and

Bangladesh. The Telemedia business provides broadband, IPTV and telephone services in

89 Indian cities. The Digital TV business provides Direct-to-Home TV services across

India. The Enterprise business provides end-to-end telecom solutions to corporate

customers and national and international long distance services to telcos.

Airtel was born free, a force unleashed into the market with a relentless and unwavering

determination to succeed. A spirit charged with energy, creativity and a team driven “to

seize the day” with an ambition to become the most globally admired telecom service.

Airtel, in just ten years of operations, rose to the pinnacle to achivement and continues to

lead.

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As India's leading telecommunications company Airtel brand has played the role as a

major catalyst in India's reforms, contributing to its economic resurgence.

Today they touch peoples lives with their Mobile services, Telemedia services, to

connecting India's leading 1000+ corporates. They also connect Indians living in USA, UK

and Canada with callhome service.

Largest Private Integrated Telecom Company in India

• 3rd Largest Wireless Operator in the World

• Largest & Fastest Growing Wireless Operator in India

• Largest Telecom Company listed on Indian Stock Exchange

VISION 2020

• To build India's finest business conglomerate by 2020

• Supporting education of underprivileged children through Bharti Foundation

Strategic Intent:

– To create a conglomerate of the future by bringing about “Big

Transformations through Brave Actions.”

MISSION

• “ We at Airtel always think in fresh and innovative ways about the needs of our

customers and how we want them to feel. We deliver what we promise and go out

of our way to delight the customer with a little bit more”

CORE VALUES

• Empowering People - to do their best

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• Being Flexible - to adapt to the changing environment and evolving customer

needs

• Making it Happen - by striving to change the status quo, innovate and energize

new ideas with a strong passion and entrepreneurial spirit

OBJECTIVES AND VALUES

• To undertake transformational projects that have a positive impact on the society

and contribute to the nation building process.

• To Diversify into new businesses in agriculture, financial services and retail

business with world-class partners

• To lay the foundation for building a “conglomerate” of future

• Openness and transparency - with an innate desire to do good

• Creating Positive Impact – with a desire to create a meaningful difference in

society.

SWOT ANALYSIS

Strengths

Bharti Airtel has more than 65 million customers (July 2008). It is the largest

cellular provider in India, and also supplies broadband and telephone services - as

well as many other telecommunications services to both domestic and corporate

customers.

Other stakeholders in Bharti Airtel include Sony-Ericsson, Nokia - and Sing Tel,

with whom they hold a strategic alliance. This means that the business has access

to knowledge and technology from other parts of the telecommunications world.

The company has covered the entire Indian nation with its network. This has

underpinned its large and rising customer base.

Weaknesses

An often cited original weakness is that when the business was started by Sunil

Bharti Mittal over 15 years ago, the business has little knowledge and experience

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of how a cellular telephone system actually worked. So the start-up business had to

outsource to industry experts in the field.

Until recently Airtel did not own its own towers, which was a particular strength of

some of its competitors such as Hutchison Essar. Towers are important if your

company wishes to provide wide coverage nationally.

The fact that the Airtel has not pulled off a deal with South Africa's MTN could

signal the lack of any real emerging market investment opportunity for the business

once the Indian market has become mature.

Opportunities

The company possesses a customized version of the Google search engine which

will enhance broadband services to customers. The tie-up with Google can only

enhance the Airtel brand, and also provides advertising opportunities in Indian for

Google.

Global telecommunications and new technology brands see Airtel as a key strategic

player in the Indian market. The new iPhone will be launched in India via an Airtel

distributorship. Another strategic partnership is held with BlackBerry Wireless

Solutions.

Despite being forced to outsource much of its technical operations in the early

days, this allowed Airtel to work from its own blank sheet of paper, and to question

industry approaches and practices - for example replacing the Revenue-Per-

Customer model with a Revenue-Per-Minute model which is better suited to India,

as the company moved into small and remote villages and towns.

The company is investing in its operation in 120,000 to 160,000 small villages

every year. It sees that less well-off consumers may only be able to afford a few

tens of Rupees per call, and also so that the business benefits are scalable - using its

'Matchbox' strategy.

Bharti Airtel is embarking on another joint venture with Vodafone Essar and Idea

Cellular to create a new independent tower company called Indus Towers. This

new business will control more than 60% of India's network towers. IPTV is

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another potential new service that could underpin the company's long-term

strategy.

Threats

Airtel and Vodafone seem to be having an on/off relationship. Vodafone which

owned a 5.6% stake in the Airtel business sold it back to Airtel, and instead

invested in its rival Hutchison Essar. Knowledge and technology previously

available to Airtel now moves into the hands of one of its competitors.

The quickly changing pace of the global telecommunications industry could tempt

Airtel to go along the acquisition trail which may make it vulnerable if the world

goes into recession. Perhaps this was an impact upon the decision not to proceed

with talks about the potential purchase of South Africa's MTN in May 2008. This

opened the door for talks between Reliance Communication's Anil Ambani and

MTN, allowing a competing Inidan industrialist to invest in the new emerging

African telecommunications market.

Bharti Airtel could also be the target for the takeover vision of other global

telecommunications players that wish to move into the Indian market.

Airtel comes to you from Bharti Airtel Limited, India's largest integrated and the first

private telecom services provider with a footprint in all the 23 telecom circles. Bharti

Airtel since its inception has been at the forefront of technology and has steered the course

of the telecom sector in the country with its world class products and services. The

businesses at Bharti Airtel have been structured into three individual strategic business

units (SBU's) - Mobile Services, Airtel Telemedia Services & Enterprise Services

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AIRTEL

Year Sales % sales

Contribution EBIT % EBIT EBT EPS % EPS

2009 372328 38.55 191128 104523 33.33 85910.1 41.4 20.92008 268728 46.45 140918 78394.1 59.1 73115.4 34.23 59.72007 183492 59.01 91359.5 49272.3 91.72 46783.8 21.43 98.82006 115393 44.1 53386.5 25698.9 40.65 23454.8 10.776 652005 80076.6 68.06 38447.4 18271.1 121.03 15831.9 6.528 136.5

Year FL DFL

2008-09 1.21 0.63

2007-08 1.07 1.01

2006-07 1.05 1.08

2005-06 1.09 1.60

2004-05 1.15 1.13

Interpretation from DFL

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From above ,we can notice that DFL has decreased from the year 2004-05 towards 2008-

09. In the year 2005-06 the variability of EPS is the highest. For every 1 unit change in

operating profit EPS changes by 1.6 units. DFL decreased from 1.6 to 0.627. Thus the

financial risk also decreased

.

Fixed Assets and Current asset

Airtel had maximum fixed assets and current assets in the year 2009.Current assets increased from the year 2005-09.

Airtel retained 100% of its earnings during 2005-07 and hence could not pay any dividends to its shareholders during that period.

Its Gross Profit Ratios and Net Profit Ratios increased gradually during the given period.

15

YEAR FA CA CoE CoD Dbt/eqty D/P Ratio2009 480922.9 59172.3 9.50 8.8 0.13 5.732008 361194.0 37579.4 3.26 10.8 0.25 …2007 216814.4 44454.7 2.82 11.2 0.3 …2006 153481.2 29542.9 2.67 23.8 0.43 …2005 107594.4 21990.7 4.39 2.8 0.61 …

YEAR DP RATIO Ret ratio GPR NPR

2009 5.73 94.78 28.15 26.36

2008 … 95.22 29.33 22.58

2007 … 100 29.08 23.99

2006 … 100 27.47 22.46

2005 … 100 23.14 17.8

Year Dbt/Eqty WACC Value

2009 0.13 15.2 375301

2008 0.25 13.4 258130

2007 0.3 12.3 157751

2006 0.43 12 115362

2005 0.61 8.3 94371

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Airtel financed most of its assets using equity and debt/ equity ratios are unusually low.

A gradual increase in the value of the company can be observed.

YEAR FA/CA FA/TAFATR Sales Indf. Pnt EBIT

2009 8.13 0.89 0.88372328 67165 104523

2008 9.61 0.91 1268728 49956 78394.1

2007 4.88 0.83 1.03183492 31298 49272.3

2006 5.20 0.84 0.75115393 15706 25698.9

2005 4.89 0.83 0.7280076.6 10594 18271.1

FATR increased from the year 2005-07 and decreased towards 2009.FATR is

highest in the year 2007, which implies Airtel efficiently used the investment on

fixed assets to generate sales in the year 2007.

FA/CA ratio and FA/TA ratio are highest for the year 2008.

From the graph, the proportion of fixed assets is very high compared to current assets and the total assets of the company increased from 2005-09

EPS-DFL

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Airtel used debt to a sufficient extent to give more returns to the shareholders. Because the EPS is continuosly increasing and DFL and EPS are positively correlated in this case.

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TATA COMMUNICATIONS\

Tata Communications is a leading global provider of a new world of communications.

With a leadership position in emerging markets, Tata Communications leverages its

advanced solutions capabilities and domain expertise across its global and pan-India

network to deliver managed solutions to multi-national enterprises, service providers and

Indian consumers.

The Tata Global Network includes one of the most advanced and largest submarine cable

networks, a Tier-1 IP network, with connectivity to more than 200 countries across 400

PoPs, and nearly 1 million square feet of data center and colocation space worldwide.

Tata Communications' depth and breadth of reach in emerging markets includes

leadership in Indian enterprise data services, leadership in global international voice, and

strategic investments in operators in South Africa (Neotel), Sri Lanka (Tata

Communications Lanka Limited), and Nepal (United Telecom Limited).

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Tata Communications Limited is listed on the Bombay Stock Exchange and the National

Stock Exchange of India and its ADRs are listed on the New York Stock Exchange.

(NYSE: TCL)

Vision

Deliver a new world of communications to advance the reach and leadership of our

customers.

Commitment

Invest in building long-lasting relationships with customers and partners and lead the

industry in responsiveness and flexibility.

Tata Group Profile

Tata is a rapidly growing business group based in India with significant international

operations. Revenues in 2007-08 are estimated at $70.8 billion USD , of which 61 per

cent is from business outside India. The Group employs around 350,000 people

worldwide. The Tata name has been respected in India for 140 years for its adherence to

strong values and business ethics.

The business operations of the Tata Group currently encompass seven business sectors:

communications and information technology, engineering, materials, services, energy,

consumer products and chemicals. The Group's 27 publicly listed enterprises have a

combined market capitalisation of some $60 billion, among the highest among Indian

business houses, and a shareholder base of 3.2 million. The major companies in the Group

include Tata Steel, Tata Motors, Tata Consultancy Services (TCS), Tata Power, Tata

Chemicals, Tata Tea, Indian Hotels and Tata Communications.

The Group's major companies are beginning to be counted globally. Tata Steel became

the sixth largest steel maker in the world after it acquired Corus. Tata Motors is among

the top five commercial vehicle manufacturers in the world and has recently acquired

Jaguar and Land Rover. TCS is a leading global software company, with delivery centres

in the US, UK, Hungary, Brazil, Uruguay and China, besides India. Tata Tea is the

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second largest branded tea company in the world, through its UK-based subsidiary Tetley.

Tata Chemicals is the world's second largest manufacturer of soda ash. Tata

Communications is one of the world's largest wholesale voice carriers.

In tandem with the increasing international footprint of its companies, the Group is also

gaining international recognition. Brand Finance, a UK-based consultancy firm, recently

valued the Tata brand at $11.4 billion and ranked it 57th amongst the Top 100 brands in

the world. Businessweek ranked the Group sixth amongst the "World's Most Innovative

Companies" and the Reputation Institute, USA, recently rated it as the "World's Sixth

Most Reputed Firm."

Founded by Jamsetji Tata in 1868, the Tata Group's early years were inspired by the spirit

of nationalism. The Group pioneered several industries of national importance in India:

steel, power, hospitality and airlines. In more recent times, the Tata Group's pioneering

spirit has been showcased by companies like Tata Consultancy Services, India's first

software company, which pioneered the international delivery model, and Tata Motors,

which made India's first indigenously developed car, the Indica, in 1998 and recently

unveiled the world's lowest-cost car, the Tata Nano, for commercial launch by end of

2008.

The Tata Group has always believed in returning wealth to the society it serves. Two-

thirds of the equity of Tata Sons, the Tata Group's promoter company, is held by

philanthropic trusts which have created national institutions in science and technology,

medical research, social studies and the performing arts. The trusts also provide aid and

assistance to NGOs in the areas of education, healthcare and livelihoods. Tata companies

also extend social welfare activities to communities around their industrial units. The

combined development-related expenditure of the Trusts and the companies amounts to

around 4 per cent of the Group's net profits.

Going forward, the Group is focusing on new technologies and innovation to drive its

business in India and internationally. The Nano car is one example, as is the Eka

supercomputer (developed by another Tata company), which in 2008 is ranked the world's

fourth fastest. The Group aims to build a series of world class, world scale businesses in

select sectors. Anchored in India and wedded to its traditional values and strong ethics,

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the Group is building a multinational business which will achieve growth through

excellence and innovation, while balancing the interests of its shareholders, its employees

and wider society.

SWOT ANALYSIS

Strengths

Scale. By combining the assets of Teleglobe and TGN, VSNLI has achieved the

traffic volumes necessary to be a credible low-cost provider in the international

wholesale market.

Geographic footprint. VSNLI’s extensive network includes undersea cable,

terrestrial fibre and satellite capacity – essential for an international wholesale

provider wishing to provide end-to-end connectivity without becoming overreliant

on partners to fill the geographic gaps.

Commanding presence in international wholesale voice market. The company

is now carrying over 16 billion international voice minutes per year, a position built

on its extensive bilateral relationships.

Tier 1 ISP. VSNLI can obtain enhanced global peering capability and redundancy

as a tier-one ISP. The company has over 345Gbit/s of peering capacity with other

carriers.

Full portfolio of services. VSNLI can offer a comprehensive suite of voice, data

and mobile services, provided through a variety of network options including

submarine cable, switching gateways, IP points of presence (PoPs) and earth

stations.

Strength in signalling conversion market. VSNLI is an international provider of

mobile signalling conversion services, based on Teleglobe’s strong position in this

market.

Access to intellectual property and proprietary (VoIP) technology. Based on

Teleglobe/ITXC’s capability, VoIP enables better control of least-cost routing,

supplementing the traditional voice product portfolio with the VoIP network and

services, and innovative value-added services. This will allow more flexible

services for existing customers and the targeting of new customer segments.

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Home base in Indian market. VSNLI has direct connections to the fast growing

Indian market via VSNL, which was the first ISP in India and now offers hosting

and co-location services out of its data centres in Mumbai, Delhi, Chennai and

Bangalore. VSNL also provides IP VPN services in over 115 locations in India and

has started offering national long-distance services in some Indian towns. The

operator has rolled out its metro Ethernet services in six major cities in India and

another 18 cities globally.

Reputation. Based on Teleglobe’s long history in international wholesale, and its

existing bilateral relationships, VSNLI can claim established status in the sector.

Customer base. VSNLI has acquired a strong presence in the wholesale market,

with a multitude of blue-chip fixed and mobile customers for its voice and data

services.

Backing of the Tata Group. The Tata Group, which held 45.15% of VSNL as of

31 March 2006, has activities in business sectors from information systems and

communications to engineering, materials, services, energy, consumer products and

chemicals. It is one of India's largest business conglomerates, with revenues of

$21.9 billion in 2005/2006.

Weaknesses

Wholesale/retail conflict. As with any erstwhile wholesale provider attempting to

serve the enterprise market, VSNLI will need to reassure its wholesale customers

that its retail activities are not in direct competition with theirs.

Image. VSNLI is still not incredibly well known as a provider of corporate

communications solutions to global enterprises. The company is increasing its

profile in the marketplace, but there is some way to go before it becomes as well

known as some of its competitors.

Lack of access networks. Access is key to serving the enterprise market, and

while VSNLI now has an impressive roster of long-distance assets, it is still under-

represented as an access provider. Last mile will prove to be a challenge in

delivering services to its targeted corporate customer base.

Opportunities

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Leverage Tata Group. With Tata Group now being VSNL’s major shareholder,

VSNLI can leverage the group’s strengths in IT and network solutions to drive its

presence in the corporate marketplace.

Build applications into the network. One way in which VSNLI wants to move up

the value chain is by building applications into the network. Tata Group ownership

will help to achieve this by providing the necessary skills and resources needed to

become a credible network-based IT services provider.

Growth in mobile services. Teleglobe was one of the leading providers of

signalling services to the mobile sector, and VSNLI is doing its best to capitalise on

this. The central role this plays in mobile operators’ businesses gives VSNLI the

scope to sell other types of mobile-oriented service, and to take advantage of

expected growth in end-user mobile voice and data traffic.

Leapfrog to VoIP. With the ITXC expertise on board, VSNLI gains a boost in

moving from TDM to VoIP technology, a process that was already moving apace

and is becoming increasingly important in the international wholesale voice

market.

Reaching new voice market segments. The acquisition of ITXC meant that

Teleglobe, and now VSNLI, can expand its service portfolio to target a wider

market for voice services. VSNLI states that it is the world’s leading wholesale

VoIP carrier, and has the world’s largest VoIP network.

Threats

Competition for mobile business. With a large number of wholesale operators

focused on winning business and launching new products specifically for mobile

operators, VSNLI should not be complacent about its current standing in the sector.

Wholesale voice commoditisation. Voice prices are continuing to fall,

undermining margins and revenues in the sector.

Slump in bandwidth sales. If data growth in India runs out of steam, this will

undermine VSNLI’s core international bandwidth business, producing problems for

the company in supporting the opex costs of its significant bandwidth assets.

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TATA communication

Year Sales %change Contribution EBIT %change EBT EPS %change

2009 102228.4 19.7 16092.4 5069.7 51.09 4227.6 3.21 417.7

2008 85377.6 -37.2 11199.4 3355.3 -34.9 1489.2 0.62 -78.5

2007 88566.1 120.8 12991.1 5161.1 -31.7 3725.3 2.89 -84.3

2006 40097.2 17.56 11048.2 7561.5 19.5 6867.17 18.4 28.31

2005 34105.2   8764.8 6326.7   10539.8 14.34  

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YEAR FL DFL

2009 1.19 8.17

2008 2.25 2.24

2007 1.38 2.65

2006 1.10 1.45

2005 0.60 1.42 

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Interpretation from DFL

From above we can notice that DFL increased from the year 2005-09. In the year 2008-09 the variability of EPS is the highest. For every 1 unit change in operating profit EPS changes by 8.17 units. DFL increased from 1.42 to 8.17. Thus the financial risk also increased

From the table:

TATA invested more in fixed assets and the company fixed assets increased from 2005-09

TATA invested most of its assets using equity

TATA paid more dividends compared to IDEA and Airtel telecom

Year DP ratio Retention Ratio GPR NPR EPS

2009 29.08 75.02 11.36 13.25 3.21

2008 49.28 74.56 10.14 8.87 0.62

2007 32.02 81.37 13.71 11.25 2.89

2006 30.49 82.77 14.02 12.1 18.4

2005 28.23 100 5.46 14.47 14.34

From the table:

DP Ratio increased from 2005-08 and decreased to almost half during 2008-09

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YEAR FA CA CoE CoD Dbt/eqty DP ratio

2009 116058.7 41484.1 6.2 11.

2 0.36 29.08

2008 82963.3 29893.7 5.8 10.3 0.34 49.28

2007 68401.4 20617.6 4.2 10.1 0.11 32.02

2006 63454.7 21161 3.4 9.2 0.03 30.49

2005 30973 20236.7 3.3 6 0.01  

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TATA retained nearly 80% of its earnings for further investments

GPR and NPR decreased from 2005-08

Year Dbt/eqty VALUE WACC2009 0.36 119763.3 14.62008 0.34 86438.9 13.32007 0.11 79015.9 122006 0.03 75182.2 11.72005 0.01 55911.1 8.7

Debt/ Equity increased suddenly from 2007-08 i.e. TATA increased the proportion of debt during this period

Value of the company gradually increased from 2005-09

Year FA/CA FA/TA FATR Sales Indff. Pnt EBIT

2009 2.80 0.74 0.63 102228.4 70022 5069.7

2008 2.78 0.74 0.75 85377.6 59798 3355.3

2007 3.32 0.77 0.91 88566.1 53380 5161.1

2006 3 0.75 1.26 40097.2 12654 7561.5

2005 1.53 0.6 1.31 34105.2 9487 6326.7

FATR decreased from the year 2005-09.FATR is highest in the year 2005, which TATA Telecommunications used the investment on fixed assets to generate sales in the year 2005.

FA/CA ratio and FA/TA ratio are highest for the year 2007

FA Vs CA

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From the graph, the proportion is fixed assets is very high and also amount of total assets increased fro 2005-09.

DFL Vs EPS

From the graph. DFL and EPS moved together and seems to be correlated because as DFL decreased during 2007-08 EPS also decreased and during 2008-09 as DFL increased EPS also increased.

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SUMMARY, FINDINGS AND CONCLUSION

Chapter

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PHARMA INDUSTRY

DR.REDDYS

Dr.Reddys used both financial leverage and operating leverage to increase its

profitability and hence both financial risk and operating risk is high. Companies with

high operating leverage are vulnerable to sharp economic and business cycle swings.

Hence, Dr.Reddys reduced its business risk gradually from 2005-2009.

WACC is high and debt to equity ratio is also high and hence the financial risk is high

Sales exceeded the BEP sales in 2005. It retained on 80% of its earnings on an average

and paid dividends to its shareholders during all the five years under study.

It maintained more of current assets and is able to generate sales from the investments

on fixed assets.

RANBAXY

High DOL and comparatively low DFL and hence high business risk is higher than

financial risk.

WACC is lower compared to Dr.Reddys but Ranbaxy financed most of its assets using

equity.

Ranbaxy’s sales are close to its BEP sales in the year 2009. The firm did not pay

dividends for the past 2 years and retained all its earnings for further investments.

Ranbaxy’s investment in fixed assets increased during the given period and its FATR

decreased.

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AUROBINDO

Aurobindo used both financial and operating leverage. But the DOL is higher than DFL

. Hence business risk is higher than financial risk.

WACC is comparable to that of Ranbaxy’s.The firm used both debt and equity to an

equal extent to finance its assets

Its sales were higher than BEP sales during the five year period under study. It retained

nearly 90% of its earnings and paid dividends with the remaining earnings.

It maintained more of fixed assets and its FATR is also high.

SERVICE INDUSTRY

IDEA CELLULAR

DFL is negative during 2008-09 .It implies that EBIT during this year is less than the

BEP.

IDEA financed most of it assets using debt and hence high financial risk exists.

Low earnings per share and IDEA did not pay any dividends during the period under

study. The firm retained all its earnings for further investment.

IDEA invested more on fixed assets than on current assets.

AIRTEL

EPS is high compared to other 2 firms and Airtel retained 100% of its earnings during

2005-07 and hence could not pay any dividends to its shareholders during that period.

Airtel financed most of its assets using equity

Value of the company is high

TATA

EPS is low until 2006-07 and increased suddenly almost 9 times for the year 2007-08.

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Low debt/ equity ratios compared to others two companies under study. Hence we can

say that TATA financed most of its assets using equity.

Value of the company doubled in the past five years.

SUMMARY AND FINDINGS:

An empirical study is conducted to analyze the differences in leveraging practices within

and between Pharmaceutical industry (manufacturing) and Telecommunications industry

(service).

Key players in both the industries are chosen for study. Dr.Reddys, Aurobindo and

Ranbaxy are chosen from pharmaceutical industry and Idea Cellular, Airtel, TATA

Telecommunications from Telecommunications industry.

The degree of financial, operating leverage and combined leverage are calculated using

the information published in the annual reports of the companies.

Service and manufacturing firms differ fundamentally in overall structure and growth

dynamics. In service firms relative to manufacturing firms entry costs and capital

requirements lower because investment in machinery and equipment is almost non-

existent. If service firms lease their facilities (buildings), then their total capital invested is

mainly working capital. They rely less on physical infrastructure and machines but more on

human capital. Hence they cannot leverage on fixed costs.

Financial leverage has a positive effect on the firm's profitability but the use of excessive

debt creates agency problems among shareholders and creditors, which in turn, lead to

negative relationship between leverage and profitability.

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The existence of agency costs of debt may cause firms to take riskier investment after the

issuance of debt to expropriate wealth from the firm’s bondholders because the firm equity

is effectively a stock option.

The degree of financial, operating leverage and combined leverage are calculated using the

information published in the annual reports of the companies.

DFL, DOL,DCL,EBIT and EPS are calculated for the companies chosen and the trend is

observed for a period of 5 years. Effect of degree of leverage on the EPS and EBIT is

analyzed.An important observation is that DOL will be maximum when the firm operates

close to the break even. This is proved by calculating BEP sales and comparing with the

actual sales.

Since service firms cannot use operating leverage to increase the profitabililty as most of

the capital is predominantly working capital. So, only DFL leverage is calculated and its

effect on EPS during the given time period is analysed.So, companies in service industry

are expected to use high degree of financial leverage to increase the profitability.

But from the empirical study it is found that Debt to Equity ratio is comparatively lower for

companies in service industry. Two out of three firms (TATA and AIRTEL) chosen for

study financed most of their assets using equity and hence did not use financial leverage to

increase the profitability. On the other hand IDEA used financial leverage and pooled high

financial risk. During 2008-09 when the world suffered from recession IDEA ended up

with negative DFL i.e. EBIT is lower than BEP.

An interesting phenomenon is observed in case of firms in manufacturing industry,

operating leverage decreases as a company’s sales increases and shifts away from the

break-even point of sales.( Dr.Reddys, Ranbaxy). Also, shareholders of the firms that

financed most of their assets using equity could benefit from high EPS.

There are many factors that affect the enterprise value or the firm value. One of the

important factor which not only effects the value of the firm but also acts an indicator of

nature of financing is debt to equity ratio. So, debt to equity ratio and value of the

companies are calculated and analyzed.

Ranbaxy with comparatively low debt to equity ratio has high value of the firm. Value of

the firm can be calculated by subtracting Interest cost from Earnings before interest and

tax. It implies that the enterprise value is inversely proportional to interest cost which is in

turn directly proportional to debt to equity ratio and thus Ranbaxy which financed most of

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its assets using equity has more Firm value. In simple words degree of financial leverage

affects the firm value.

Firm’s asset structure affects its leverage in both positive and negative ways. Ability of

Assets to Support Debt also effects the leveraging decisions. Lower risk assets with more

stable market values provide better collateral for debt. With better collateral, the firm’s

ability to borrow increases.

Firms with high level of assets that can be used as collateral tend to use more debt rather

than issue new equity because costs associated with issuing equity rise due to the

asymmetry of information possessed by insiders and outsider suggests a positive

relationship between debt ratios and the firm capacity of collateralized assets.

Since service firms do not have high level of assets like manufacturing firms. Therefore,

the costs associated with this agency problem would be higher for the service firms because

of the lower level of collateralized assets.

This is clearly evident from the companies chosen for study. While Dr.Reddys, Ranbaxy

and Aurobindo has debt to equity ratios comparatively more than that of Airtel and Tata.

Theoretical research predicts positive relationship between collateralized asset and

leverage. Prior empirical studies use fixed assets as its proxy and the findings are consistent

with theoretical predictions. The findings of this paper show opposite result: leverage

decreases as the proportion of fixed asset in the total assets of the firm increases. The

service industry is usually characterized by a relatively low level of fixed assets. Current

assets can more easily be converted to cash and thus have more liquid capacity than fixed

asset. Lending institutions generally attribute more significance to the capacity to convert

borrowers’ assets into cash and we conjecture that in the service industry the importance of

current rather than fixed assets plays an important role in their decision to offer loans to

firms with high ratio of current to total assets, or a low ratio of fixed to total assets. This

supply-side argument might explain why firms who own relatively low ratios of fixed to

total assets may have higher leverage (IDEA Cellular).

Idea Cellular maintained low fixed to total assets ratio and thus could use more debt by

using current assets as collateral. Airtel and TATA maintained more of fixed assets and so

could not use them as collateral. This is proved by very low debt to equity ratios.

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Fixed asset turnover ratio of the companies is also studied. Manufacturing and other

industries requiring major-investments will often spend heavily on properties,

manufacturing plants, and equipment to push themselves ahead of the competition. A large

capital investment purchases may not immediately yield higher sales. It may take a year or

more for the company to fully utilize those investments.  If a company invested in major

improvements heavily one year, it would be wise to watch the Fixed Asset Turnover

closely over the next year to see if those investments actually helped the company.

The higher the Fixed Asset Turnover ratio, the more effective the company's investments in

Net Property Plant and Equipment have become. 

It is desirable that Gross Profit ratio must be high and steady because any fall in it would

put the management in difficulty in the realization of fixed expenses of the business. Net

Profit ratio is helpful to determine the operational ability of the concern.

NPR and GPR are stable in case of Airtel and halved during Idea Cellular.NPR is

abnormally low in case of Dr.Reddys during 2005 and abnormally high during 2007.

Abnormal decrease may be attributed to low sales.

Income tax, nondebt tax shield, firm size, and growth opportunities are the other factors

that determine capital structure choices of the firm which are not studied in this project.

The relationship between leverage and growth opportunities can be positive or negative,

depending on the nature of the growth opportunity.

Leverage has a significant negative effect on investment because of an agency problem

between shareholders and bondholders. If managers work in the interest of shareholders,

they may give up some positive net present value projects due to debt overhang. The other

argument is based on agency conflicts between managers and shareholders. They argue that

firms with free cash flow but low (or no) growth opportunities may nevertheless invest

(overinvest) in that the manager may take on projects with negative net present value.

However, such a strategy is costly to the manager, if the capital market takes into account

such potential opportunism, or there is a takeover of the firm by another company;

managers have an incentive, therefore, to recommit and increase leverage and pay out cash

as interest and principal. These theories suggest a negative relationship between leverage

and investment but only for firms with no or little growth opportunities.

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Corporate income tax has important impact on debt-equity choices. Modigliani-Miller

proposition – the corporate tax case - suggests that firms that face higher marginal tax rates

should use more debt to take advantage of tax shield.

In conclusion, financing choice is not a simple one-period decision but a dynamic

occurrence. Firms issue equity when their market valuations are high. Service firms and

manufacturing firms follow different leverage practices. One major difference observed is

that service firms use more of equity than manufacturing firms. This may be partly

attributed to differences in the asset structure of the firms.

SUGGESTIONS :-

1. High interest costs during difficult financial periods can increase the risk of

insolvency. So, the companies must not use large amount of debt.

2. Airtel and TATA should invest more on current assets so that they can obtain

debt and thus can use financial leverage.

3. Debt instruments often contain restrictions on the company's activities,

preventing management from pursuing alternative financing options and non-

core business opportunities.

4. The larger a company's debt-equity ratio, the more risky the company is

considered by lenders and investors. Accordingly, a business is limited as to the

amount of debt it can carry.

5. The company is usually required to pledge assets of the company to the lender

as collateral, and owners of the company are in some cases required to

personally guarantee repayment of the loan.

6. Growth opportunities in the economy and of the industry have to be studied

before making financing decisions.

7. Acquisition of new assets of heavy costs should be done with proper capital

budgeting supported by payback period.

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8. The process of asset securitization is a new and innovative financing method

used for funding and risk management purposes.

9. the increased use of debt causes both the costs of debt and equity to increase.

10. Signaling theory suggests firms should use less debt than MM suggest.This

unused debt capacity helps avoid stock sales, which depress stock price because

of signaling effects.

11. Managers have better information about a firm’s long-run value than outside

investors.Managers act in the best interests of current stockholders. Issue stock

if they think stock is overvalued.Issue debt if they think stock is undervalued.

As a result, investors view a common stock offering as a negative signal--

managers think stock is overvalued.

BIBLIOGRAPHY:

Maheswari S.N.: Financial Management 5th Edition

Annual reports of companies

Notes on leverage by Alex Tajirian

Paper on Financial Statement Analysis of Leverage and How It Informs

About Profitability and Price-to-Book Ratios

Paper on the effect of leverage increases on real earnings management by Irina Zagers-

Mamedova

A journal on The Determinants of Capital Structure in the Service Industry: Evidence

from United States by Amarjit Gill, Nahum Biger, Chenping Pai and Smita Bhutani

A report on telecom industry by Corporate Catalyst India

A reading on Financial Ratio Analysis prepared by Pamela Peterson Drake

Is There Room For Growth? Debt, Growth Opportunities and The Deregulation of U.S. Electric Utilities by Laarni from IBS.

Asset Securitization and Optimal Asset Structure of the Firm by Jure Skarabot.

WEBLIOGRAPHY

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www.wikiwealth.com

www.wikianswers.com

www.investopedia.com

http://www.pdf-searcher.com/pdf/leverage-analysis.html

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