PPT on Cost of Capital
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Transcript of PPT on Cost of Capital
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7/28/2019 PPT on Cost of Capital
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Summer Training
Presentation
On
Cost Of Capital
Of
Shree Cememt LimitedFrom:- CHETAN PRAKASH SANKHLA
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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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An Example of Cost of Capital
For example if a firm borrows Rs. 5 crore at an interest of11% 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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Assumption of Cost of Capital
While computing the cost of capital, the following assumptionsare made:
The cost can be either explicit or implicit.
The financial and business risks are not affected by investing
in new investment proposals.
The firms capital structure remains unchanged.
Cost of each source of capital is determined on an after tax
basis.
Costs of previously obtained capital are not relevant for
computing the cost of capital to be raised from specific
source.
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Computation of specific costs
A firm can raise funds from different sources such as loan,equity shares, preference shares, retained earnings etc. All
these sources are called components of capital.
Computation of specific cost of capital helps in
determining the overall cost of capital for the firm and inevaluating the decision to raise funds from a particular
source.
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COST OF DEBT CAPITAL
Cost of Debt is the effective rate that a company pays onits 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. 5lacs 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 undistributedprofits of the company.
If reduces the earning per shares of existing share holdersresulting 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 somuch 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
Earning Yeild 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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WACC OF SHREE CEMENT LIMITED (2009-2010)
Source
(1)
Amount
Rs.
(2)
Weights
(3)
After tax
Cost
(4)
Weighted
Cost
(5)= (3) * (4)
E.S. Capital 801268.41 .8322 10.56 8.79
Debentures 161570.37 .1678 05.65 0.95
Total 962838.78 1.00 9.74
Weighted Average Cost of Capital (WACC) 9.74%
WACC = (We * Ke) + (Wd * Kd)WhereWe = Weight of equity
Wd = Weight of Debt.
Ke = Cost of Equity Share capital
Kd = Cost of Debt. capital
WACC = ( 0.8322 * 10.56) +( 0.1678 *05.65 ) = 9.74%
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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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Thank You