Ppt on Cost of Capital Scl - Copy

8/8/2019 Ppt on Cost of Capital Scl - Copy

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Summer TrainingSummer Training

PresentationPresentationOnOn

Cost Of CapitalCost Of CapitalOfOf

Shree Cememt LimitedShree Cememt LimitedFrom:- J.ANSHUL CHAWRA


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Shree Cement Ltd is a Rajasthan based company ofBangur Group, located at Beawar.

It started operations in the year 1985 and has beengrowing ever since.

It has been participating in the infrastructuretransformation of India for over two decades now.

It has installed capacity of 13 mn tonnes per annum .

It will invest Rs 3,500 crore to expand its cementproduction capacity by seven million tonnes in the nextfive years.

It is a leading cement manufacture company in NorthIndia.


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The turnover of the company in 2009-10 was Rs3,632 crore and it posted a net profit of Rs 676 crore

Its manufacturing units are located at Beawar, districtAjmer, and Ras, district Pali, in Rajasthan.

It also has grinding units at Khushkhera, district Alwarin Rajasthan, near Gurgaon.

The company has also established two grinding unitsone at Suratgarh (Rajasthan) and another at Roorke

(Uttaranchal). It has three brands under its portfolio viz. Shree Ultra

Jung Rodhak Cement, Bangur Cement andRockstrong Cement.


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Cost Of Capital

The main objective of a business firm is to maximize the wealth

of its shareholders in the long-run, the Management Should only

invest in those projects which give a return in excess of cost of

fund invested in the project of the business.

The difficulty will arise in determination of cost of funds, if israised from different sources and different quantum.

The various sources of funds to the company are in the form of

equity and debt.

The cost of capital is the rate of return the company has to pay tovarious suppliers of fund in the company.

There are main two sources of capital for a company

shareholder and lender.


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An Example of Cost of Capital

For example if a firm borrows Rs. 5 crore at an interest of

11% P.A., then the cost of capital is 11%.

Hear its the essential for the firm to invest these Rs. 5

Crore in such a way that it earn at least Rs. 55 lacks i.e.

rate of return at 11%.

If the return less then this, then the rate of dividend which

the share holder are receiving till now will go down

resulting in a decline in its market value thus the cost of

capital is the reward for the use capital.


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SIGNIFICANCE OF CONCEPT OF COST OF CAPITAL

1. Designing the capital structure.

2. Capital budgeting decisions.

3. Comparative study of sources of financing.

4. Evaluations of financial performance of top management.

5. Knowledge of firms expected income and inherent risks.

6. Financing and Dividend Decisions.


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COST OF DEBT CAPITAL

Cost of Debt is the effective rate that a company pays on

its current debt. This can be measured in either before- or

after-tax returns; however, because interest expense is

deductible, the after-tax cost is seen most often. This is

one part of the company's capital structure, which also

includes the cost of equity.

Much theoretical work characterizes the choice between

debt and equity, in a trade-off context: Firms choose their

optimal debt ratio by balancing the benefits and costs.


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An Example of Cost of Debt

Example-: If a company issues 12% debentures worth Rs. 5

lacs of Rs. 100 each at par, then it must be earn at least

Rs.60000(12% of Rs. 5 lacs) per year on this investment to

maintain the income available to the shareholders

unchanged.

If the company earns less than this interest rate (12%) than

the income available to the shareholders will be reduced

and the market value of the share will go down.

Therefore, the cost of debt capital is the contractualinterest rate adjusted further for the tax liability of the firm.


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Computation of Cost of Debt

The Cost of Debt (before tax) can be calculated as below:

Interest Expense of the company

= ---------------------------------------- X 100

Total Debt

To get the after-tax rate, you simply multiply the before-tax

rate by one minus the marginal tax rate.

Cost of Debt = (before-tax rate x (1-marginal tax))


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COST OF PREFERENCE SHARE CAPITAL

Preference share is another source of Capital for a company.

Preference Shares are the shares that have a preferential right

over the dividends of the company over the common shares.A

preference shareholder enjoys priority in terms of repayment vis-

-vis equity shares in case a company goes into liquidation.

Preference shareholders, however, do not have ownership rightsin the company. In the companies under observation only India

Cement has preference shares issued.

Cost of Preference Capital = Preference Dividend/Market Value of

Preference

Shree Cement has not paid any dividend to the Preference

Shareholders. Thus the Cost of Preference Capital is 0 (Zero).


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COST OF EQUITY SHARE CAPITAL

The computation of cost of equity share capital is relativelydifficult because nether the rate of dividend is predetermined northe payment of dividend is legally binding.

When additional equity shares are issued, the new equity shareholders get propranate share in future dividend and undistributed

profits of the company. If reduces the earning per shares of existing share holders

resulting in a fall in marker price of shares.

Therefore, at the time of issue of new equity shares, it is the dutyof the management to see that the company must earn at least so

much income that the market price of its existing share remainsunchanged.

This expected minimum rate of return is the cast of equity sharecapital.


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Methods to calculate Cost of Equity

(1)Dividend yield method:

Ke = DPS\mP*100

(2) Earning yield method:

Ke= EPS\mp*100

(3) Dividing yield plus growth in dividend method :

Ke= DPS\MP*100+G


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COST OF EQUITY SHARE CAPITAL (KE)

Particular 2009-10

Dividend Per share method 13

EarningYeild Method 8.43

Dividend yield plus growth method 10.56


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WEIGHTED AVERAGE COST OF CAPITAL

Once the specific cost of capital of the long-term sources i.e. the debt,the preference share capital, the equity share capital and the retainedearnings have been ascertained, the next step is to calculate the overallcost of capital of the firm.

The capital raised from various sources is invested in different projects.

The profitability of these projects is evaluated by comparing theexpected rate of return with overall cost of capital of the firm.

The overall cost of capital is the weighted average of the costs of thevarious sources of the funds, weights being the proportion of eachsource of funds in the total capital structure.

Thus, weighted average as the name implies, is an average of the cost ofspecific sources of capital employed in the business properly weightedby the proportion they held in firms capital structure.


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Conclusion

Cost of Debt is decreased in 2009-10 as compared to 2008-

09.

Cost of Equity is also decreased in 2009-10 as compared to

2008-09.

And that is why the Overall Cost of Capital or Weighted

Average Cost of Capital is also decreased.

Because, companys debentures is decreased and earning

per share and dividend per share is increased from theprevious financial year.


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