LEVERAGE BEHAVIOUR IN INDIA: AN EMPIRICAL...

Volume 4, Number 3, July – September’ 2015

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LEVERAGE BEHAVIOUR IN INDIA: AN EMPIRICAL STUDY

Gurnam Singh Rasoolpur

17

ABSTRACT

This empirical paper makes an attempt to study the leverage behaviour in India through a case of Modi Rubber Ltd. from the

tyres & tubes industry of the Indian corporate sector by studying its impact either favourable or unfavourable on the

profitability of the company by comparing rate of return on net assets (ROIbt2 & ROIat2) with cost of debt (Kdbt & Kdat) on

before and after tax basis during the period under study which covers a time period of ten years (effective nine years)

extending from the year 1982-83 to 1991-92 for the purpose of our study. Thus, the present empirical study is confined to

Modi Rubber Ltd. from the tyres & tubes industry of the Indian corporate sector, which is lying in the top ten companies of

tyres & tubes industry of the Indian corporate sector based on sales for the year 1991-92 for the purpose of our study. The

study reveals that debt-equity ratio2 has been varying from 67.01 percent in the 1983-85 to 50.81 percent in the year 1989-90

with declining trend during the period under study, whereas, aggregate debt-equity ratio2 of the company is worked out 58.02

percent during the period under study. It is found that cost of debt on before tax basis (Kdbt) has been varying from 17 percent

in year 1982-83 to 28 percent in the year 1989-90 with rising trend during the period under study. However, cost of debt on

after tax basis (Kdat) has been varying from 22 percent in year 1983-85 to 7 percent in the years 1985-86 and 1986-87 with

declining trend during the study period, whereas, aggregate cost of debt on before and after tax basis (Kdbt & Kdat) of the

company is worked out 21.12 percent and 11.40 percent, respectively, during the period under study. It is found that rate of

return on net assets on before tax basis (ROIbt2) has been varying from 16 percent in the year 1983-85 to 32 percent in the

year1987-88 with rising trend while the rate of return on net assets on after tax basis (ROIat2) has been varying from 19

percent in the year 1982-83 to 7 percent in the year 1985-86 with declining trend during the period under study. It is observed

that rate of return on total networth on before tax basis (RONbt) has been varying from 7 percent in the year 1983-85 to 51

percent in the year 1987-88 with rising trend with fluctuations while rate of return on total networth on after tax basis (RONat)

has been varying from 7 percent in the years 1983-85 and 1985-86 to 29 percent in the year 1987-88 with declining trend with

fluctuations during the period under study. It is also found that effective tax rate born by the company is high during the

period under study. Thus, it is concluded that the company is enjoying favourable leverage with regard to use of debt during

six out of nine years under study. Consequently, rate of return on total networth (RONbt & RONat) is higher than cost of debt

(Kdbt & Kdat) and rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis in the above said six years under

study. It means that use of debt in the capital structure of the company has positive impact on the profitability of the company

during six out of nine years under study, which consequently is contributing to the total networth of the company, which

ultimately is benefitting to the equity shareholders of the company. However, on aggregate basis, the company has also been

experiencing favourable leverage with regard to use of debt on before and after tax basis during the period under study which

further means that debt is behaving favourable during the period under study. It is also found that spread and net gain are

positive when leverage impact is positive and vice-versa during the period under study.

KEYWORDS

Return on Net Assets, Return on Total Networth, Cost of Debt etc.

INTRODUCTION

The legal framework provided by government of the concerned country governs behaviour of different source of finance. Their

costs also depend upon the legal system available to them. The use of the fixed charges funds, such as debt and preference capital

along with the owner‟s equity in the capital structure is described as financial leverage or trading on equity. It is generally

measured by the ratio called debt-equity ratio. This ratio indicates the relationship between the borrowed funds and owners‟ funds

in the capital structure of a company. Thus, debt, preference share capital and equity share capital are the major component of

capital structure and leverage. Cost of debt is lower than cost of preference share capital as well as equity share capital because the

debt holders are the first claimants on the firm‟s assets at time of its liquidation. Similarly, they are the first to be paid their

interest before any dividend is paid to preference and equity shareholders. However, preference share capital is a distinctive type

of long-term source of financing which bears some of the features of equity as well as debentures. Cost of preference share capital

is lower than the cost of equity share capital because preference shareholders are having two preferences (i.e. payment of dividend

and repayment of principal amount at the time of liquidation) over the equity shareholders. Interest paid to the debt holders is an

item chargeable to profits of a firm. However, the interest and principal repayment on debt are definite obligations that are payable

irrespective of the financial situation of a firm. Therefore, debt is riskier. It enhances the financial risk. Also, if interest and

17

Associate Professor (Commerce), P.G. Department of Commerce & Business Management, Guru Nanak College, Punjab, India,

[email protected]

mailto:[email protected]





principal payments on debt are not promptly met when due, bankruptcy, loss of control for the owners may occur. It will turn out

that use of some debt by the firm is desirable and a strong case can be made for the existence of an optimal capital structure, or

debt/equity mix. A firm should make a judicious mix of both debt and equity to achieve a capital structure, which may be the

optimal capital structure. Modigiliani and Miller (1959) gave logically consistent behavioral justification for this relationship and

denied the existence of an optimum capital structure. Barges (1963) tested the M-M hypothesis and found that the cost of capital

comes down with leverage. Singh (1998) observed that cost of capital is a significant factor in case of large-size companies, while

it is not a significant factor affecting capital structure of companies in case of medium and small-size companies. The primary aim

of corporate management is to maximize shareholders‟ value and the value of a firm in a legal and ethical manner. So, a financial

manager should consider a number of factors to set an optimal capital structure for a firm giving considerable weight to earning

rate, collateral value of assets, age, cash flow coverage ratio, cost of borrowing, size (net sales), dividend payout ratio, debt

service ratio, cost of borrowing, corporate tax rate, current ratio, growth rate, operating leverage and uniqueness (selling

cost/sales) etc. The choice between debt and equity to finance a firm‟s assets involves a trade-off between risk and return (Pandey,

Chotigeat & Ranjit, 2000). The excessive use of debt may endanger the survival of a firm, while a conservative use of debt may

deprive the firm in leveraging return to equity owners. Therefore, for taking more benefits of debt capital also by keeping away

firms from risks, a desirable debt equity combination must be used in the total capital structure. Thus, the decision regarding debt

equity mix in the capital structure of a firm is of critical one and seeks more attention.

OBJECTIVES OF STUDY

The present study has been undertaken with the following objectives:

To measure the extent of leverage ratio of Modi Rubber Ltd. from the tyres & tubes industry of the Indian corporate

sector.

To measure the extent of debt-equity ratio of Modi Rubber Ltd. from the tyres & tubes industry of the Indian corporate

sector.

To examine the impact of use and cost of debt on the profitability of Modi Rubber Ltd. of tyres & tubes industry from

the Indian corporate sector.

DATA SOURCE & SAMPLE SIZE

For studying the leverage behaviour in India in the tyres & tubes industry of the Indian corporate sector, Modi Rubber Ltd. from

this industry is selected. The study covers a time of ten years (effective nine years) extending from the year 1982-83 to 1991-92.

The company is lying in the top ten companies of tyres & tubes industry of the Indian corporate sector based on sales for the year

1991-92 for the purpose of this study. For conducting the present study, data has been compiled from the different volumes of the

Bombay Stock Exchange Official Directory.

RESEARCH METHODOLOGY

In the present study, an adequate attempt has been made to make an in-depth analysis of the leverage behaviour in India through

a case of Modi Rubber Ltd. from tyres & tubes industry of the Indian corporate sector. To analyses the results, analysis of

empirical section is organized into four parts. In the first part, analysis of debt-equity ratio and leverage ratio is done. The second

part explains the analysis of return on investment and cost of debt on before tax basis. The third part gives details of the analysis

of return on investment and cost of debt on after tax basis. In the fourth part, impact of debt on return on total networth is

presented. The company does not have preference share capital during the study period. In this study, debt-equity ratio and

leverage ratio will be same. Therefore, use of debt along with owner‟s equity will constitute leverage for our empirical work,

which further means that use of debt and leverage has same meaning over here. In this work, profitability means return on total

networth over the period under study. Return on net total assets, which is calculated and is shown in the research methodology,

is supplementary information, which further means that it is not a part for approaching and reaching to the conclusions of the

main study. To analyses the data, the following ratios along with simple statistical tools like tables, percentages, etc. have been

used for achieving the objectives of present study. Debt-Equity Ratio: It can be calculated in the following manner

Debt-Equity Raio1 =

Debt-Equity Raio2 =

Leverage Ratio: It can be calculated in the following manner:





Leverage Raio1 =

Leverage Raio2 =

Return on Total Networth: It is calculated in the following manner

Return on Total Networth on Before Tax Basis (RONbt) =

Return on Total Networth on After Tax Basis (RONat) =

Return on Net Total Assets: It is calculated in the following manner

Return on Net Total Assets on Before Tax Basis (ROIbt1) =

Return on Net Total Assets on After Tax Basis (ROIat1) = ROIbt1(1-t)

Return on Net Assets: It is calculated in the following manner

Return on Net Assets on Before Tax Basis (ROIbt2) =

Return on Net Assets on After Tax Basis (ROIat2) = ROIbt2(1-t)

Cost of Debt: The following formula is used to calculate the cost of debt

Cost Debt on Before Tax Basis (Kdbt) =

Cost of Debt on After Tax Basis (Kdat) = Kdbt(1-t)

Net Gain: The following is the formula for calculating the Net Gain

Net Gain on Before Tax Basis = Return on Total Networth (RONbt) - Return on Net Assets (ROIbt)

Net Gain on After Tax Basis = Return on Total Networth (RONat) - Return on Net Assets (ROIat)

Spread: The following is the formula for calculating the Spread

Spread on Before Tax Basis = Return on Net Assets (ROIbt) - Cost of Debt (Kdbt)

Spread on After Tax Basis = Return on Net Assets (ROIat) - Cost of Debt (Kdat)

Effective Tax Rate (t): It is calculated in the following manner:

Effective Tax Rate (t) =

Here Term Debt plus Short Term Loans & Advances comprise of debentures, long-term loans and short-term loans & advances.

Total Networth includes equity share capital, preference share capital, capital reserves including share premium and other

reserves & surplus less intangible assets. Intangible Assets include preliminary expenses, expenses on issue of shares and

debentures, goodwill, technical know-how charges, drawings & designs, patents, trademarks and copyright. While computing

total networth usually accumulated losses are deducted from the aggregate of paid up share capital plus reserves & surplus.

However, in the present study in addition to accumulated losses, goodwill, trademark, patents, & copyright have also been

deducted. It is so because separate amount of accumulated losses is not available in the Bombay Stock Exchange Official

Directory. Total networth has been also adjusted for the accounting year 1988-89 due to the change in the length of accounting

year from 1st of April to 31st of March in the next year. Depreciation, interest charges and profits and/or losses have been

changed proportionately.





EMPIRICAL RESULTS

(1) Analysis of Debt-Equity Ratio and Leverage Ratio

As revealed by table 1, debt-equity ratio2 has been varying from 67.01 percent in the 1983-85 to 50.81 percent in the year 1989-90

during the period under study. For six out of nine years under study, it has been below 60 percent. Overall, it has declining trend

over the period under study. It is highest, i.e. 67.01 percent, in the year 1983-85 due to the higher interest bearing debt raised and

lower profits earned by the company. It is lowest, i.e. 50.81 percent, in the year 1989-90 due to the repayment of principal amount

of interest bearing debt by it. On aggregate basis, the debt-equity ratio2 of the company is worked out 58.02 percent during the

period under study. Preference share capital does not exist for the company during the study period. Therefore, debt-equity ratio

and leverage ratio are same during the period under study. Thus, the company is having same debt-equity ratio and leverage ratio

experience over the study period.

Table-1: Debt-Equity Ratio of Modi Rubber Ltd.

Year Debt-Equity Ratio1 =

(In Times)

Debt-Equity Ratio2 =

(Percentage)

1982-83 1.3191 56.88

1983-85 2.0311 67.01

1985-86 1.8020 64.31

1986-87 1.6764 62.64

1987-88 1.3410 57.28

1988-89 1.1932 54.40

1989-90 1.0328 50.81

1990-91 1.0796 51.91

1991-92 1.4998 60.00

Modi Rubber

Ltd.

1.3819

Aggregate Basis

58.02

Aggregate Basis

Sources: Compiled from the Bombay Stock Exchange Official Directory, Vol. 31(iii), p. 62520.

Table-2: Leverage Ratio of Modi Rubber Ltd

Year Leverage Ratio1 =

(In Times)

Leverage Ratio2 =

(Percentage)

1982-83 1.3191 56.88

1983-85 2.0311 67.01

1985-86 1.8020 64.31

1986-87 1.6764 62.64

1987-88 1.3410 57.28

1988-89 1.1932 54.40

1989-90 1.0328 50.81

1990-91 1.0796 51.91

1991-92 1.4998 60.00

Modi Rubber

Ltd.

1.3819

Aggregate Basis

58.02

Aggregate Basis






(2) Analysis of Return on Investment and Cost of Debt on Before Tax Basis:

Return on Net Total Assets on Before Tax Basis (ROIbt1)

As revealed by table 3, rate of return on net total assets on before tax basis (ROIbt1) has been varying from 8 percent in year 1982-

83 to 19 percent in the year 1987-88 during the period under study. During eight out of nine years under study, the rate of return

on net total assets on before tax basis (ROIbt1) is below 13 percent. Overall, it has been rising over the period under study. It is

highest, i.e. 19 percent, in the year 1987-88 due to the improved production, increased turnover and exports. It is lowest, i.e. 8

percent, in the year 1982-83 due to the recession and declined profits as the company had to roll back its selling prices to 1980-81

levels. On aggregate basis, the rate of return on net total assets on before tax basis (ROIbt1) is worked out 12.08 percent during the

study period.

Return on Net Assets on Before Tax Basis (ROIbt2)

As revealed by table 3, rate of return on net assets on before tax basis (ROIbt2) has been varying from 16 percent in year 1983-85

to 32 percent in the year 1987-88 during the period under study. During six out of nine years under study, rate of return on net

assets on before tax basis (ROIbt2) is below 22 percent. Overall, it has been rising with fluctuations over the period under study

excepting for the year 1983-85 when it is 16 percent. It is highest, i.e. 32 percent, in the year 1987-88 due to the highest rate of

return on net total assets on before tax basis (ROIbt1) caused by reasons mentioned earlier such as improved production, increased

turnover and exports. It is lowest, i.e. 16 percent, in the year 1983-85 due to the lower rate of return on net total assets on before

tax basis (ROIbt1) caused by sluggish market conditions. On aggregate basis, the rate of return on net assets on before tax basis

(ROIbt2) is worked out 25.26 percent during the study period.

Cost of Debt on Before Tax Basis (Kdbt)

As revealed by table 3, cost of debt on before tax basis (Kdbt) has been varying from 17 percent in year 1982-83 to 28 percent in

the year 1989-90 during the period under study. During seven out of nine years under study, cost of debt on before tax basis (Kdbt)

is below 22 percent. Overall, it has been rising over the period under study. It is highest, i.e. 28 percent, in the year 1989-90 and

lowest, i.e. 17 percent, in the year 1982-83 during the period under study. On aggregate basis, aggregate cost of debt on before tax

basis (Kdbt) of the company is worked out 21.12 percent during the period under study.


Return on Total Networth on Before Tax Basis (RONbt)

As revealed by table 3, rate of return on total networth on before tax basis (RONbt) has been varying from 7 percent in the year

1983-85 to 51 percent in the year 1987-88 during the period under study. During five out of nine years under study, rate of return

on total networth on before tax basis (RONbt) is below 23 percent. Overall, it has been rising with fluctuations over the period

under study excepting for the years 1983-85 and 1985-86 when it is 7 percent and 21 percent respectively. It is highest, i.e. 51

percent, in the year 1987-88 due to the highest rate of return on net total assets (ROIbt1) as well as net assets (ROIbt2) on before tax

basis, lowest cost of debt (Kdbt) on before tax basis and highest excess gap of rate of return on net assets (ROIbt2) over cost of debt

(Kdbt) on before tax basis. It is lowest, i.e. 7 percent, in the year 1983-85 due to the lower rate of return on net total assets (ROIbt1)

Table-3: Impact of Debt on Return on Total Networth in Modi Rubber Ltd. (Before Tax Basis)

Year

Return on Total Assets (ROIbt1 )=

(Percentage)

Return on Net Assets (ROIbt2 )=

(Percentage)

Cost of Debt (Kdbt )=

(Percentage)

Return on Total Networth (RONbt )=

(Percentage)

1982-83 8 19 17 23

1983-85 11 16 22 7

1985-86 12.15 20.79 20.67 21

1986-87 13 22 18 28

1987-88 19 32 17 51

1988-89 12 22 18 28

1989-90 12 26 28 23

1990-91 12.30 25.89 26.13 25.63

1991-92 11 22 21 23

M R Ltd 12.08

Aggregate Basis

25.26

Aggregate Basis

21.12

Aggregate Basis

25.98

Aggregate Basis





as well as return on net assets (ROIbt2) on before tax basis. On aggregate basis, the rate of return on total networth on before tax

basis (RONbt) is worked out 25.98 percent during the study period.

(3) Analysis of Return on Investment and Cost of Debt on After Tax Basis

Return on Net Total Assets on After Tax Basis (ROIat1)

As revealed by table 4, effective tax rate has been below 66 percent during the period under study. The rate of return on net total

assets on before tax basis (ROIbt1) has been varying from 8 percent in the year 1982-83 to 19 percent in the year 1987-88 while the

rate of return on net total assets on after tax basis (ROIat1) has been varying from 11 percent in the year 1983-85 to 4 percent in the

year 1985-86 during the period under study. During six out of nine years under study, rate of return on net total assets on after tax

basis (ROIat1) has been below 8 percent. Overall, it has been declining over the period under study excepting for the years 1983-

85, 1987-88 and 1988-89 when it is 11 percent, 11 percent and 9 percent, respectively. It is highest, i.e. 11 percent, in the years

1983-84 and 1987-88 due to the non-existence of tax liability in the year 1983-85 and the highest rate of return on net total assets

on before tax basis (ROIbt1) in the year 1987-88 caused by the reasons mentioned earlier such as improved production, turnover

and exports. It is lowest, i.e. 4 percent, in the year 1985-86 caused by the very high effective tax rate, i.e. 66 percent, in this year.

On aggregate basis, the rate of return on net total assets on after tax basis (ROIat1) is worked out 6.52 percent during the study

period.

Return on Net Assets on After Tax Basis (ROIat2)

As revealed by table 4, rate of return on net assets on before tax basis (ROIbt2) has been varying from 16 percent in the year 1983-

85 to 32 percent in the year1987-88 while the rate of return on net assets on after tax basis (ROIat2) has been varying from 19

percent in the year 1982-83 to 7 percent in the year 1985-86 during the period under study. During five out of nine years under

study, rate of return on net assets on after tax basis (ROIat2) has been below 11 percent. Overall, it has been declining over the

period under study. It is highest, i.e. 19 percent, in the year 1982-83 due to the non-existence of tax liability. It is lowest, i.e. 7

percent, in the year 1985-86 due to the lowest rate of return on net total assets on after tax basis (ROIat1) caused by high effective

tax rate. On aggregate basis, the rate of return on net assets on after tax basis (ROIat2) is worked out 13.64 percent during the study

period.

Cost of Debt on After Tax Basis (Kdat)

As revealed by table 4, cost of debt on before tax basis (Kdbt) has been varying from 17 percent in year 1987-88 to 28 percent in

the year 1989-90 while cost of debt on after tax basis (Kdat) has been varying from 22 percent in year 1983-85 to 7 percent in the

years 1985-86 and 1986-87 over the period under study. During six out of nine years under study, cost of debt on after tax basis

(Kdat) has been below 11 percent. Overall, it has been declining over the period under study excepting for the year 1983-85 when

it is 22 percent. It is highest, i.e. 22 percent, in the year 1983-85 and lowest, i.e. 7 percent, in the years 1985-86 and 1986-87

during the period under study. On aggregate basis, aggregate cost of debt on after tax basis (Kdat) of the company is worked out

11.40 percent during the period under study.

Return on Total Networth on After Tax Basis (RONat)

As revealed by table 4, rate of return on total networth on before tax basis (RONbt) has been varying from 7 percent in the year

1983-85 to 51 percent in the year 1987-88 while rate of return on total networth on after tax basis (RONat) has been varying from

7 percent in the years 1983-85 and 1985-86 to 29 percent in the year 1987-88 during the period under study. During six out of

nine years under study, rate of return on total networth on after tax basis (RONat) is below 12 percent. Overall, it has been

declining with fluctuations over the period under study excepting for the year 1987-88 when it is 29 percent. It is highest, i.e. 29

percent, in the year 1987-88 due to the highest rate of return on net total assets (ROIat1) as well as net assets (ROIat2) on after tax

basis and highest excess gap of rate of return on net assets (ROIat2) over cost of debt (Kdat) on after tax basis. It is lowest, i.e. 7

percent, in the years 1983-85 and1985-86 caused by highest cost of debt (Kdbt) on before tax basis in the year 1983-85, and lowest

rate of return on net total assets (ROIat1) as well as net assets (ROIat2) on after tax basis and highest effective tax rate, i.e. 66

percent, in the year 1985-86. On aggregate basis, the rate of return on total networth on after tax basis (RONat) is worked out

14.03 percent during the study period.





Table-4: Impact of Debt on Return on Total Networth in Modi Rubber Ltd

(After Tax Basis)


Note: *No tax liability has been occurred for the years 1982-83 & 1983-85.


Supplementary Information: Figures in brackets in column 2 & 6 indicate Spread between Rate of Return on Net Total Assets

& Cost of Debt on before & after tax basis and figures in brackets in column 4 & 8 indicate Net Gain on before & after tax basis

on Net Total Assets respectively.

(4) Impact of Debt on Return on Total Networth

Tables 3, 4 and 5 show the effect of use and cost of debt (Kdbt & Kdat) on rate of return on total networth (RONbt & RONat) on

before and after tax basis for a period of nine years starting from the year 1982-83 to 1991-92. Comparison of cost of debt (Kdbt &

Kdat) with rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis shows latter is higher than former for all the

years under study excepting for the years 1983-85, 1989-90 and 1990-91. This leads to conclude that the company is enjoying

favourable leverage with regard to use of debt during six out of nine years under study. Consequently, rate of return on total

networth (RONbt & RONat) is higher than cost of debt (Kdbt & Kdat) and rate of return on net assets (ROIbt2 & ROIat2) on before

and after tax basis in the above said six years under study. It means that use of debt in the capital structure of the company has

Year Return on Total Assets ROIat1=ROIbt1(1-t)

(Percentage)

Return on Net Assets ROIat2=ROIbt2(1-t)

(Percentage)

Cost of Debt Kdat=Kdbt(1-t) (Percentage)

Return on Total Networth RONat=

(Percentage)

1982-83* 8=8 19=19 17=17 23=23

1983-85* 11=11 16=16 22=22 7=7

1985-86 12.15(1-.66)=4 20.79(1-.66)=7 20.67(1-.66)=7 7

1986-87 13(1-.61)=5 22(1-.61)=9 18(1-.61)=7 11

1987-88 19(1-.44)=11 32(1-.44)=18 17(1-.44)=10 29

1988-89 12(1-.23)=9 22(1-.23)=17 18(1-.23)=14 22

1989-90 12(1-.60)=5 26(1-.60)=10 28(1-.60)=11 9

1990-91 12.30(1-.61)=4.8 25.89(1-.61)=10.10 26.13(1-61)=10.19 10

1991-92 11(1-.50)=5.5 22(1-.50)=11 21(1-.50)=10.5 11.50

Modi

Rubber

Ltd.

6.52

Aggregate Basis

13.64

Aggregate Basis

11.40

Aggregate Basis

14.03

Aggregate Basis

Table-5: Analysis of Spread and Gain in Modi Rubber Ltd

(1)

Before Tax Basis

(2) (3) (4)

(5)

After Tax Basis

(6) (7) (8)

Year

Spread between

ROIbt2 & Kdbt (ROIbt2-Kdbt)

(%age)

Debt Impact

Net Gain (RONbt -ROIbt2 ) (%age)

Debt-Equity Ratio2 (%age)

Spread between

ROIat2 & Kdat (ROIat2-Kdat)

(%age)

Debt Impact

Net Gain (RONat-ROIat2 ) (%age)

1982-83 2(-9) Favourable 4(15) 56.88 2(-9) Favourable 4(15)

1983-85 -6(-11) Unfavourable -9(-4) 67.01 -6(-11) Unfavourable -9(-4)

1985-86 .12(-8.52) Favourable .21(8.85) 64.31 .04(-3.03) Favourable .07(3.14)


1987-88 15(2) Favourable 19(32) 57.28 8(1) Favourable 11(18)


1989-90 -2(-16) Unfavourable -3(11) 50.81 -1(-6) Unfavourable -1(4)

1990-91 -.24(-13.83) Unfavourable -.26(13.33) 51.91 -.09(-5.39) Unfavourable -.10(5.20)

1991-92 1(-10) Favourable 1(12) 60.00 .50(-5) Favourable .50(6)

Modi

Rubber

Ltd.

4.14(-9.04)

Aggregate

Basis

Favourable .72(13.90)

Aggregate

Basis

58.02

Aggregate

Basis

2.24(-4.88)

Aggregate

Basis

Favourable .39(7.51)

Aggregate

Basis





positive impact on the profitability of the company during six out of nine years under study, which consequently is contributing to

the total networth of the company, which ultimately is benefitting to the equity shareholders of the company. Leverage created

through debt by the company is not generating risk for the company in the above said six years under study because Modi Rubber

Ltd. is able to cover the cost of debt (Kdbt & Kdat) on before and after tax basis from the rate of return on net assets (ROIbt2 &

ROIat2) on before and after tax basis in the above said six years under study. However, on aggregate basis, the company has also

been experiencing favourable leverage with regard to use of debt on before and after tax basis during the period under study which

further means that debt is behaving favourably during the period under study. Further details regarding spread and net gain on

before and after basis have been in table 5. Due to favourable impact of leverage by using debt in the capital structure of the

company, spread between rate of return on net assets (ROIbt2 & ROIat2) and cost of debt (Kdbt & Kdat) on before and after tax

basis, and net gain calculated by deducting rate of return on net assets (ROIbt2 & ROIat2) from rate of return on total networth

(RONbt & RONat) on before and after basis have been positive in the above said six years under study. Spread and net gain are

negative when leverage impact is negative during the remaining three years under study.

SUMMARY AND CONCLUSIONS

In the present study, An adequate attempt has been made to make an in-depth analysis of the leverage behaviour in India through a

case of Modi Rubber Ltd. from tyres & tubes industry of the Indian corporate sector which covers a time period of ten years

(effective nine years) extending from the year 1982-83 to 1991-92 where the company is lying in the top ten companies of tyres &

tubes industry of the Indian corporate sector on the basis of sales for the year 1991-92 for the purpose of our study. The following

are the conclusions and findings of the present study.

It is observed that debt-equity ratio2 has been varying from 67.01 percent in the 1983-85 to 50.81 percent in the year

1989-90 with declining trend during the period under study, whereas, aggregate debt-equity ratio2 of the company is

worked out 58.02 percent during the period under study.

It is found that cost of debt on before tax basis (Kdbt) has been varying from 17 percent in year 1982-83 to 28 percent in

the year 1989-90 with rising trend during the period under study. However, cost of debt on after tax basis (Kdat) has

been varying from 22 percent in year 1983-85 to 7 percent in the years 1985-86 and 1986-87 with declining trend during

the study period, whereas, aggregate cost of debt on before and after tax basis (Kdbt & Kdat) of the company is worked

out 21.12 percent and 11.40 percent, respectively, during the period under study.

It is observed that the rate of return on net total assets on before tax basis (ROIbt1) has been varying from 8 percent in

the year 1982-83 to 19 percent in the year 1987-88 while the rate of return on net total assets on after tax basis (ROIat1)

has been varying from 11 percent in the year 1983-85 to 4 percent in the year 1985-86 during the period under study.

Overall, rate of return on net total assets on before tax basis (ROIbt1) is having rising trend while rate of return on net

total assets on after tax basis (ROIat1) is having declining trend over the period under study. On aggregate basis, the rate

of return on net total assets on before and after tax basis (ROIbt1 & ROIat1) is worked out 12.08 percent and 6.52 percent,

respectively, during the study period.

It is found that rate of return on net assets on before tax basis (ROIbt2) has been varying from 16 percent in the year

1983-85 to 32 percent in the year1987-88 while the rate of return on net assets on after tax basis (ROIat2) has been

varying from 19 percent in the year 1982-83 to 7 percent in the year 1985-86 during the period under study. Overall,

rate of return on net assets on before tax basis (ROIbt2) is having rising trend while rate of return on net assets on after

tax basis (ROIat2) is having declining trend over the study period. On aggregate basis, the rate of return on net assets on

before and after tax basis (ROIbt2 & ROIat2) is worked out 25.26 percent 13.64 percent, respectively, during the study

period.

It is observed that rate of return on total networth on before tax basis (RONbt) has been varying from 7 percent in the

year 1983-85 to 51 percent in the year 1987-88 while rate of return on total networth on after tax basis (RONat) has been

varying from 7 percent in the years 1983-85 and 1985-86 to 29 percent in the year 1987-88 during the period under

study. Overall, rate of return on total networth on before tax basis (RONbt) has been rising with fluctuations while rate

of return on total networth on after tax basis (RONat) has been declining with fluctuations over the period under study.

On aggregate basis, the rate of return on total networth on before and after tax basis (RONbt & RONat) is worked out

25.98 percent and 14.03 percent, respectively, during the study period.

It is observed that the company is enjoying favourable leverage with regard to use of debt during six out of nine years

under study. Consequently, rate of return on total networth (RONbt & RONat) is higher than cost of debt (Kdbt & Kdat)

and rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis in the above said six years under study.





It is also found that spread and net gain are positive when leverage impact is positive and, spread and net gain are

negative when leverage impact is negative during the period under study. On aggregate basis, spread on before and after

tax basis is worked out 4.14 percent and 2.24 percent, respectively, while net gain on before and after tax basis is

worked out 0.72 percent and 0.39 percent, respectively, during the period under study.

It is found that leverage created through debt by the company is not generating risk for the company in the above said

six years under study because Modi Rubber Ltd. is able to cover the cost of debt (Kdbt & Kdat) on before and after tax

basis from the rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis in the above said six years

under study.

It is also found that effective tax rate born by the company is high during the period under study. On aggregate basis,

effective tax rate born by the company is 46 percent during the study period.

Thus, it is concluded that the company is enjoying favourable leverage with regard to use of debt during six out of nine years

under study. Consequently, rate of return on total networth (RONbt & RONat) is higher than cost of debt (Kdbt & Kdat) and rate of

return on net assets (ROIbt2 & ROIat2) on before and after tax basis in the above said six years under study. It means that use of

debt in the capital structure of the company has positive impact on the profitability of the company during six out of nine years

under study, which consequently is contributing to the total networth of the company, which ultimately is benefitting to the equity

shareholders of the company. Leverage created through debt by the company is not generating risk for the company in the above

said six years under study because Modi Rubber Ltd. is able to cover the cost of debt (Kdbt & Kdat) on before and after tax basis

from the rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis in the above said six years under study.

However, on aggregate basis, the company has also been experiencing favourable leverage with regard to use of debt on before

and after tax basis during the period under study which further means that debt is behaving favourably during the period under

study. Due to favourable impact of leverage by using debt in the capital structure of the company, spread between rate of return on

net assets (ROIbt2 & ROIat2) and cost of debt (Kdbt & Kdat) on before and after tax basis, and net gain calculated by deducting rate

of return on net assets (ROIbt2 & ROIat2) from rate of return on total networth (RONbt & RONat) on before and after basis have

been positive in the above said six years under study. Spread and net gain are negative when leverage impact is negative during

the remaining three years under study. It is also found that effective tax rate born by the company is high during the period under

study.

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