Corporate Capital Structure

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CORPORATE CAPITAL STRUCTURE

EXECUTIVE SUMMERY

INTRODUCTIONThis thesis deals with questions concerning corporate capital structure. It examines show

Della tecnica company will decide his capital structure in a real life context. It also examinesif there is room for improvement when the company decide upon their capital structure.Finally, it presents our conclusion based on the case studies Modern corporate finance theorywas born with the publication of Modigliani and Miller (M&M) theoretical model aboutcapital structure in 1958. They showed that, in a capital market free of taxes, transactionscosts, and other frictions, the choice of a firm capital structure could not affect its marketvaluation The failure of management to insist on clear-cut objectives.Modern corporate finance theory was born with the publication of Modigliani and Miller(M&M) theoretical model about corporate capital structure in 1958. They showed that, in acapital market free of taxes, transactions costs, and other frictions, the choice of a firmcapital structure could not affect its market valuation. Much of the capital structure theoryduring the past forty years has involved examining how robust the model is to more realisticassumptions regarding market frictions and the information sets available to managers andshareholders. The development of agency theory in the 1980s, coupled with detailedresearch into the extent and effects of bankruptcy costs during the 1980s, leads to a yetmore detailed view of the utility of the basic M&M capital structure theory. Finally, cross-cultural examination of observed capital structure patterns in non-U.S. industrializedcountries has lead to our current mainstream view that corporations act as if there is a unique,optimal capital structure for individual firms. This results from a trade-off between the tax

benefits of increasing leverage and increasing agency and bankruptcy costs that higher debtentails. The fact that there seems to be an optimal capital structure for each individual firm is

very interesting, due to the fact that a companys result to a large extent depends on whatstructure it has. This creates incentives for companies to revise their current capital structure.Optimal Capital Structure Introduction

COMPANY INTRODUTIONAt Della Tecnica, they posses a vibrant vision, a zest for innovation and a commitment tosustainability. Started In 1996 Della Tecnica has been operating at an award winning level forover a decade now. Today with over 1600 professionals networked across five offices inIndia, they serve there clients as trusted advisors, combining localized expertise with global

perspective. At Della Tecnica there people are there key point of difference, and they havealways sought to attract the highest caliber of industry professionals. they boast a pool of

talented and experienced professionals offering an unparalleled breadth of services inArchitecture, Master Planning, Design and Build, Interiors, Development, Construction andMEP Engineering Services with a combined portfolio of over a few million sq.ft. of award-winning projects across industries throughout the country. there designers are known for theirinnovation, leadership and exceptional client service.A lot of repeat business reflects the trust and value our clients place in there experiencedArchitects. Offering most of the essential services in-house also contributes to betterexecution of projects by streamlining the team's communication and helps in delivering the

projects in the given time frame and manage the costs effectively. Our ability to integrate allthese services as individual profit centers, yet posing as a unified creative force, is in synchwith what today's world needs
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Design & BuildRecognized as the market leader's providing comprehensive turnkey solutions andconsultancy in the field of Architecture, Design and Build. The organization has extended

both vertically and horizontally into a group of six companies - related yet independentVerticals.

WHAT WILL DO COMPANYIn India's booming 'Design & Build' industry, Della Tecnica has been operating at an award-winning level for over a decade now. This amounts to a significant experience in workingcollaboratively to deliver superior Architecture and Design solutions for high profile &diverse clientele such as the UB Group, Kingfisher Airlines, Bajaj Auto, Omega, Amsons,Sahara Group, Crisil, Star TV, 9X, NDTV Imagine & Emerson Consultancy.At Della Tecnica our people are our key point of difference, and Jimmy has always sought toattract the highest caliber of industry professionals.Today, we boast a pool of talented & experienced professionals offering an unparalleled

breadth of services in Architecture, Master Planning, Design & Build, Interiors,

Development, Construction & MEP Services with a combined portfolio of over a few millionsq.ft. of award-winning projects & many more on the boards. Our designers are known fortheir innovation, leadership & exceptional client service.A lot of repeat business reflects the trust & value our clients place in our experiencedArchitects. Offering most of the essential services inhouse also contributes to better projects

by streamlining the team's communication and quality control. Our ability to integrate allthese services as individual profit centers, yet posing as a unified creative force, is in synchwith what today's world needs from design.At Della Tecnica, we posses a vibrant vision, a zest for innovation and a commitment tosustainability. Approaching challenges from different perspectives enhances our ability toinnovate. Recognized as market leaders in the field of Architecture, Design & Build, and as acomprehensive Turnkey Solution Company, the organization has extended, both verticallyand horizontally into a group of six companies -related yet independent verticals.Della Tecnica Group was started in 1996. Today with over 1500 professionals networkedacross seven offices, we serve our clients as trusted advisors, combining localized expertisewith global perspective wherever new opportunities arise. Our infrastructure allows us tosimultaneously handle more than 50 projects across the country.

RESEARCH METHODOLOGYThe company that has been selected for this study is Della tecnica, One of the leading interiordesinging company company. The accounting year of Della tecnica is calendar year i.e. from

1st Jan to 31st Dec. The relevant data for the period of 2006, 2007, 2008, 2009 have beencollected from secondary source i.e. publish Annual accounts of the company for therespective year. Data so collected have been classified, analyzed and interpretedappropriately as per the help of different statistical tool and techniques.

MEANING OF RESEARCH:Research can be understood as a combination of two words, re and search means searchagain. The origin of research is the curiosity to know the truth of nature or knowledge. It is anorganized inquiry or a purposive investigation. This search may be made through in arbitrarymethod or by a scientific method. Research can be defined as applying the methods ofscience to the art of management.

DEFINATION OF RESEARCH:


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According to WEBSTER DICTIONARY To research is to research or investigateexhaustively. It is careful or diligent search inquiry or examination especially investigation orexperimentation. It is aimed at the discovery and interpretation of facts, revision of acceptedtheories or laws in the light of net facts or practical application of such new or revisedtheories or laws; it can also be the collection of information about a particular subject.

In the words of J. Francis Rummel Research is a careful inquiry or examination to discovernew information or relationships and to expand to verify existing knowledge.

FORMULATING RESEARCH PROBLEM:The problem to be investigated must be defined unambiguously that will help indiscriminating the relevant data with irrelevant data. Once the problem is formulated a briefsummary may be written down which is called as research plan. Research plan helps theresearch to organize his ideas in a form to look.Here research problem is related to the intangible accounting practices of Della TecnicaPvt.Ltd Mumbai.

EVALUATE RESEARCH PROBLEM:

Research Problem is evaluated with the help of following ratios- EVA (Economic ValueAdded), MVA (Market Value Added), BV (Brand Value) and whether company is followingthe prescribed accounting standard related to intangible accounting practices is assessed withthe help of annual report of the company.Della Tecnicas client

SCIENTIFIC APPROACHThis thesis is a mixture of a theoretical and empirical study. A study can either be deductiveor inductive, but it can also be abductive when the researchers use a combination of the twoapproaches. The definition of the problem issue often indicates whether it is an inductive ordeductive approach. The deductive approach is preferred when the problem issue can bederived from theory and the theory forms the basis for the empirical study. On the other hand,the inductive way is preferred when the problemissue has no connection to any kind of theory and where the facts speak for themselves andseek regularity in events (Halvorsen, 1992).

Choice of scientific approachWe intend to utilize an abductive approach in our thesis since our first research question is ofan inductive nature. This is because it does not rely on theory. However, our second researchquestion is of a deductive nature since this question could be derived from theory and this

theoretical framework will form the basis of our empirical case studies.STRATEGIC APPROACHAccording to Patel and Davidson (1994), every study has a research design. The strategy oneuses when conducting a study depends on how much knowledge the researcher has about the

problem area and how well the problem is structured and formulated. There are threestrategic approaches. Optimal Capital Structure Methodology 6 The explorative approach isused when there only exists little or no knowledge of the problem area. Here the researcheroften uses several techniques for gathering information and thereby explains the problemfrom many different angles. It often concerns the initial stage of the research process. It isused to identify a problem, to specify and structure a problem, to generate ideas, and to

formulate hypotheses. This research design is characterized by flexibility in order to copewith the unexpected, and to discover ideas that are not recognized at the beginning. The


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descriptive approach is used when there already exists knowledge of the problem area and theformulation of the problem is fairly well structured. The study gets a descriptive nature whilesimultaneously investigating the issue in depth. The explanatory approach to a study assumesthat the researcher has a wide knowledge of the problem area and that there exist theories inthe area. An explanatory approach has the purpose to study a cause-and-effect connection.

Choice of strategic approachWe will use the explanatory approach since we have gained a wide knowledge within the

problem area and since there exist many theories that we intend to rely on. We further aim tostudy how different variables affect the capital structure; hence this approach would besuitable.

Research objectivesTo study the optimal capital structure of the Della tecnica and if there is room forimprovement.1. To study the theoretical aspect of the optimal capital structure.

2. To know the importance of the optimal capital structure on profitability of company.3. To study the preferences of the client due to the optimal capital structure.4. To a certain the relationship between EBIT and EPS .

Scope of the studyThe capital structure decision can influence the value of the firm through the cost of capitaland trading on equity or leverage. The optimal capital structure may be defined as that capitalstructure or combination of debt and equity thats lead to the maximum value of the firmoptimal capital structure maximize the value of the company and hence the wealth of itsowners and minimize the companys cost of capital (solomon Ezra, the theory offinancial management ). Thus, every firm should aim at achieving the optimal capitalstructure and then maintain it.The following consideration should be kept in mind while maximizing the value of the firmin achieving the optimal capital structure1) If the return on investment is higher than the fixed cost of funds, the company should

prefer to raised funds having a fixed cost, such as debenture, loans and preference sharecapital. It will increase earning per share and market value of the firm. Thus, a companyshould, make maximum possible use of leverage.2) When debt is use of source of finance, the firm saves aconsidarable amount in payment oftax as intarest is allowed as a deductable expencse in computaion of tax. Hence, the effectivecost of debt is redce, tax is leverage a company should therefore, take advantage of tax

leverage.3) The firm should avoid undue financial risk attched with the useof intrested debt financing,if the shre holders perceive high risk in using further debt-capital, it will reduce the market

price of shares.4) The capital structure should be flexible.

PROBLEM DISCUSSIONSubstantial parts of the literature concerning capital structure have dealt with issues regardingthe leverage ratios. These leverage ratios have been analyzed in many different ways. Ourresearch problem will also deal with these ratios but in an entirely new way. We have not

been able to find any material concerning how companies should decide these leverage ratios

in practice, except for some theoretical models. These models are unfortunately notapplicable in practice because of their inability to deal with important factors such as the


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firms asset structure. It would therefore be interesting to investigate how companiesdetermine their capital structure since the lack of literature within the area is as great as it is.Could it be the case that companies have developed their own models? Is the difference in thedecision process big between companies within the same industry? Does the highest leveredcompany have a totally

different procedure from the lowest levered company? It could be suspected that there existpossibilities for companies to improve their capital structures because of the lack oftheoretical guidelines. To be able to examine this kind of questions we believe that we needto investigate companies that are as comparable as possible within the sameindustry. We will therefore investigate a refined industry, since this approach enables a faircomparison. We have examined all industries in India and come to the conclusion that theBuilding Construction industry suits our purpose best. This is because all companies withinthe Building construction industry experience very similar businesses, i.e. buying, selling,managing and acquiring Building Construction properties.

PROBLEM AND PURPOSE

Our purpose is to solve the research questions stated below, which are formulated on thebasis of the problem discussion. It concerns the practical Optimal Capital StructureIntroduction matter of deciding the appropriate capital structure and the possibility ofimprovements.I. How do the Della Tecnica Pvt. Ltd. decide their capital structure?II. Are their current capital structures optimal or is there room for improvements?

CONTRIBUTIONMy thesis will shed new light on a specific area of capital structure, namely how companiesdecide their capital structures. Much work has been done in the statistical field, i.e.comparing leverage ratios through cross sectional analysis or other comparisons. Except forthe inapplicable theoretical models we have not been able to find any material concerninghow companies should act when determining their capital structure,. Our study willcomplement existing studies since we are investigating important factors that affect theoptimal capital structure for real estate companies. A further contribution is the investigationregarding how the companies could improve their current capital structures by combining theexisting theory, models and empirical findings.

LIMITATION OF STUDYDue to non availability of annual reports related to the financial year 2008-09.This project report is restricted for the four year viz 2006, 2007, 2008, and 2009.

Forms / patterns of capital structreThe capital structure of new company may consist of any of the following forms:A) Equity shares onlyB) Equity and prefeerence sharesC) Equit and debenturesD) Equity shares, Preference shares and debentures.

IMPORTANCE OF CAPITAL STRUCTURE

The term capital refers to the relationship between the various long term form s of

financing such as debenture, preference shares capital and equity share capital. Financing thefirms assets is a very crucial problem in every business and as a general rule there should


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be a proper mix of debt and equity capital in financing in the firms assets . The use of longterm fixed interest bearing debt and preference share capital along with equity shares is calledFinancing leaverage or trading on equity . the long term fixed interest bearing debt isemployed by a firm to earn more from the use of these source than their cost so as to incresethe return on owners equity. It is true that capital struture can not affect the total earning of

the firm but it can affect of share of eaning available for equity share shareholders. Say forexampale, A company has an equity capital of 1,000 shares of Rs. 100 each fully paid andearns an average profits of Rs. 30,000. Now the company want to make an expansion andneeds another Rs. 10000 the option with the copmany are eithers to isseu new shares or raiseloans [at] 10% p.a. Assuming that the company would earn the same rate of profit. It isadvisable to raise loan as by doing so earning per share magnifying. The company shall payonly Rs. 10,000 as interest and profit expected shall be Rs. 60,000 (before payment ofinterest) After the payment of interest the profit left for equity shareholders shall be Rs.50,000 (ignoring tax) it is 50% return on equity capital against 30%return otherwise however,leaverege can operate adversaly also if the rate the interest on long-terms loans is more thanthe expected rate of earning of the firm.

ESSENTIAL FEATURES OF SOUND/OPTIMAL CAPITAL MIXA sound or an appropriate capital structure should have the following essential features :I. Maximum possible use of leverage.II. The capital structure should be fllexible so that it can be easily altered.III. To avoid undue Financial business risk will increase of debt.IV. The use of debt should be within the capacity of a firm. The firm should be in position tomeet its obligationsin paying the loan and interest charges as and when due.V. It should involve minimum possible risk or loss of cantrol.VI. It must avoid undue restrictions in arregement of debd.VII. It should be easy to understand and simple to operate to the extent possible.VIII. It should minimise the cost of financing and maximise earnings per shares.

FACTORS DETERMINING THE CAPITSL STRUCTURE

I. Financial leverage or trading on equity.II. Growth and stability of sales.III. Cost of capitalIV. RiskV. Cash flow Ability to service debt.VI. Nature and size ofa firm.

VII. Cantrol.VIII. Flexibility.IX. Requirement of Investors.X. Capital market conditionXI. Asset structureXII. Purpose of financingXIII. Period of financeXIV. Cost of flotationXV. Personal considerationXVI. Corporate tax rateXVII. Legal requirements

SIGNIFICANCE OF CAPITAL GEARING


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The problem of capital gearing is very important in acompany. It has a direct bearing on thedivisable on the divisible profits of a company and hence a proper capital gearing is a veryimporatant for the smooth running of an enterpriese, In in case of a low geared company, thefixed capital by way of fixed divident on preference share and interest and interest ondebentures is low and the equity shareholders may get ahigher leaving lesser divisible profits

for the equity shareholders.The capital gearing in the financial structure of a business has been rightly completed withgears of an automobiles. The gears used to maintain the desired speed and cantrol. Initially,an automobile starts with a low gears, but as soon as it gets momentum, the low gwars ischanged to high gear to get better speed.similarly, a company may be started with high equitystarted with high eqity state. That is low gear but after momentum, it may be changed to highgearby mixing more of fixed interest bearing securities such as preference shares anddebentures. It may also be noted that capital gearing affects not only the shareholders but thedebentureholders, creditors, financial institutions, the financial maneger and others alsoconcerned with the capital gearing.

CAPITAL GEARING AND TRADE CYCLESThe tecniques of capital gearing can be sucsessfuly employed by a company during various

phases of trade cycle, ie. During the conditions of inflation and deflation, to increase the rateof return to its owners ( Equity shareholders ) and thereby increasing the value of thairinvestments. The effect of capital gearing during various phases of trade cycle is discussed

below :1) During inflation or boom period :- A company should follow the policy of high gearduring inflation or boom period as the profit of the company are higher and it can easily payfixed costs of debentures and preference shares. Furthers during boom period,the rate ofearing of the company is usualy higher than the fixed rate of interested/dividend prevailing ondebentures and preference shares. By adopting the policy of high gear, a company canincreases its earning per share and thereby a higher rate of dividend.2) During deflation or Depression period :- During depression the rate of earinigs of thecompany is lower than the rate of interest/dividend on fixed interest bearing securities andhence it can not meet the fixed costs without lowring the divisible profits and rate ofdividents, it is therefore, better for a company to remain in low gear and not to fixed interest

bearing securities as source of finance during such period.Theories of capital structureDifferent kinds of theories have been propounded by different authers to explain therelationship between capital structure, cost of capital and value of the firm. The maincontributors to the theories are Dorand, Ezra, Solomon, Modiglini and Milleer.

The important theories are discussed below :1) Net Income Approch.2) Net Operating Income Approch.3) The Tradational Approch.4) Modigliani and Miller Approch1) Net Income Approch : Accoding to this approch, a firm can minimise the waightedaverage cost of capital and increase the value of the firm as well as market price of equityshares by using debt financing to the maximum possible extent. The theories propound that acopany can increase its value and decrease the overall cost of capital by increasing the

proportion of debt in its capital structure. This approch is based upon The followingassumption :

I. The cost of debtis less than the cost of equity.II. There are no taxes.


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Where, S = V-DS = market valueof equity sharesV= totle market value of a firmD = market value of debtThe cost of equity or equity capitalisation rate can be calculated as below

Cost of equityor equity capitalisation rate (Ke) =Earning after interest and before tax= ---------------------------------------------------V-D

3) THE TRADITIONAL APPROACH.The tradational approch are also known as intermediate approch is a comprise between twothe two extremes of net income approch and net operating income approch according to thistheory, the value of the firm can be increased intionaly or the cost of capital can be decreased

by using more debt as the debt is a cheaper source of the funds than equity. Thus optimumcapital structure can be reached by a proper debt equity mix. Beyond a particullar point, the

cost of capital increased because increased debt increase the financial risk of the equityshareholders the advantage of the cheaper debt at this point of the capital can not be afset bythe advantage of low cost debt thus overall cost of capital, according to this theory decreaseupto certain point, remains more or less unchanged for modarate increased in debt thereafter ;and increase or raised beyond a certain point. Even the cost of debt may increased in thisstage due to increased financial risk. Theory has been explained

4) MODIGLIANI AND MILLER APPROACH .M & M Hypothesis is identical with the net operating income approch if taxes is ignored.However, when corporate taxesare assumed to exist, their hypothesis is similar to the netincome approch.a) In the absence of taxes. (Theory of Irrelevance) : the theory proves that the cost of capitalis not affected by changes in the capital structure or say that the debt-equity mix is irrelevantin the determination of the totle value of the firm. The reason argued is that through debt ischeaper to equity, with increased use of debt as a source of finance the cost of equity increse.This increses in cost of equity offsets that advantage of the low cost of debt. thus, althoughthe financial leverageaffects the cost of equity,the overall cost of capital remain constant.Theory emphasis the fact that a firms operating income is a determinant of its total value.The theory further propounds that beyond acertain limit of debt, the cost of debt increases dueto increases financial risk but the cost of equity falls thereby again balancing the to cost ofdebt increase ( due to increases financial risk ) but the cost of equity falls thereby again

balancing the to cost. In the opinion of Modiglini & Miller, to identical firms firms in allrespects except their capital structure can not have different market values or cost of capitalbecause of arbitrage process . In case to identical firms except for thair capital structure havedifferunt market values or cost of capital, arbitrage will take place and the investor s willengage in in parcenal leverage as against the corporate leverage ; and this willagain render the two firms to havrthe same total value.The M&M approch is based upon the following assumption :I. There are no corporate taxes.II. There is a perfect market.III. Investor act rationally.IV. The expected earnings of all the firms have identical risk characteristics.

V. The cut-of point of investment in a firm is capitalisaton rate.VI. Risk to investor depends upon the random fluctuations of expected earnings and the


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possiblity that the actual value of the variable may turn out to be different from their bestestimets .VII. All earings are distributed amongs the shareholders.

b) When corporate taxxes are assumed to exist. Theory of Relevance) Modiglini and Miller,in their article of 1963 have recognised that the value of the firm will increased or the best of

capital will decreased with structure can be achived by maximising the debt mix in the equityof a firm.

RISK RETURN TRADE OFFThus a firm has a reach a balance (trade-of) between the financial riskof non employement ofdebt to capital increase its market value.

Capital structure decisionsDebt- equity mix

Financial riskNon employement of debt capital risk ( NEDC)

Risk- return trade offMarket- value of the firm(Risk return trde off )

Financial distressDebt provides tax benefits to the firm, but it also puts pressure on the firm, since interest and

principal payments are obligations, according to the trade-off model. The closer the firm is tobankruptcy, the larger is the cost of financial distress. The ultimate financial distress isbankruptcy, where ownership of the firms assets is legally transferred from thestockholders to the bondholders (Haugen & Senbet, 1978). Bankruptcy costs are made up oftwo parts, direct and indirect costs. Direct costs can be seen as out-of-pocket cash expenses,which are directly related to the filing of bankruptcy and the action of bankruptcy. Examplesof direct costs are fees for lawyers, investment bankers, administrative fees and value ofmanagerial time spent in administering the bankruptcy(Haugen & Senbet, 1978). In 1990, Weiss estimated the direct cost of bankruptcy for 37 NewYork and American Stock Exchange firms to be 3.1% of the firm value. Warner (1977) foundthat direct costs of bankruptcy decrease when the size of the firm increases which implies thatfor large companies bankruptcy costs are less important when determiningcapital structure

than it is for smaller firms. Indirect bankruptcy costs are expenses or economic losses thatresult from bankruptcy but are not cash expenses on the process itself. Examples of suchcosts caused by bankruptcy are sales that are lost during and after bankruptcy, diversion ofmanagement time while bankruptcy is underway, and loss of key employees after the firm

becomes bankrupt. Sales can frequently be lost because of fear of impaired service and lossof trust (Titman, 1984).Altman provided a study in 1984 with a sample of 19 firms, 12 retailers, and 7 industrials thatall went bankrupt between 1970 and 1978. By Optimal Capital Structure TheoreticalFramework 24 comparing expected profits with actual profits, he found the arithmeticindirect bankruptcy costs to be 10.5% of firm value. Altman (1984) also estimated that bothindirect and direct costs together are frequently greater than 20% of firm value. These

findings give us reason to believe that bankruptcy costs are sufficiently large to support atheory of optimal capital structure that is based on the trade-off between gains from the tax


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shield and losses that come with costs of bankruptcy.

Agency costsAnother factor that can be added to the trade-off model is the agency cost, which arises due toconflicts of interests. There are two types of agency costs: agency costs of equity and agency

costs of debt. Agency cost of equity has its roots in the simple argument that you will workharder if you are the owner of the company than if you were an employee. Also, if you own alarger percentage of the company, you will work harder than if you owned a smaller

percentage of the company (Copeland & Weston, 1992). A more detailed discussion of theagency cost of equity can be found in Appendix III. Agency costs of debt occur because thereis a conflict of interest between stockholders and bondholders. As a firm increases theamount of debt in the capital structure, bondholders begin taking on an increasing fraction ofthe firms business and operating risk, but shareholders and managers still control thefirms investment and operating decisions. This gives managers a variety of different waysfor selfish strategies, which will increase their own wealth, on behalf of the cost of the

bondholders. A more detailed

explanation can be found in Appendix I

ECONOMIC VALUE ADDED:Stern and Stewart, a consultancy firm introduced a performance Measure called EconomicValue Added (EVA) to indicate the minimum return required by the shareholders to invest inthe companys shares. Economic Value Added (EVA) is the excess of actual return earned

by a firm over such minimum return required by the shareholders or investors. Here, actualreturn implies the Net Operating Profit After Tax (NOPAT) and minimum return denotes costof capital employed (WACC * CE) to earn that profit. To put it in an equation form.EV = NOPAT - (WACC x CE)Where,

NOPAT = Net Operating Profit After TaxWACC = Weighted Average Cost of CapitalCE = Capital Employed

NOPAT is calculated from net profit tax as appeared in the Profit and Loss Account byadding back interest payments and subtracting and adding non-operating income and non-operating expenses respectively. But in actual practice some other adjustments are made withthe net profit to calculate NOPAT to convert accounting profit to economic profit. Stern-Stewart have mentioned 164 types of such adjustment that are kept out of purview of thisarticle for time and constraints.WACC is the weighted average of the cost of all types of own capital and borrowed capital

such as equity share capital preference share capital, debentures, secured and unsecured loansetc. with weights equivalent to the proportion of each element in the total capital of thecompany. Capital employed denotes all finds belonging to the equity shareholders and allinterest bearing loan capital.

MARKET VALUE ADDED:

Market Value Added is used as a supplementary to Economic Value Added to evaluate theperformance of a company in the stakeholders value creation. It measures the marketvalue of the company over the value of the investors capital. In case of EVA economic

profit is taken into consideration, which is the value added by the company over given period,

the MVA is a measure of the investors perception of value added. It may be considered ascumulative measure of corporate performance.


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MVA = Current market value of debt and equity - Economic book value, where Economicbook value = Share capital + Reserve + debt.

TOTAL SHAREHOLDERS RETURN:

Total Shareholders Return (TSR) is a composite indicator which takes into account totalshareholders fund and the dividend declared / proposed by the company. It represents thechange in the capital value of a company over a period of one year, plus dividends, expressedas a percentage of gain or loss on the beginning capital value. Capital value implies capitalemployed excluding debt capital. The exclusive, of debt capital provides more accuracy inmeasuring the Total Shareholders Return (TSR).TSR = (Closing capital value Beginning capital value + Dividend) / (Beginning CapitalValue x 100).

Weighted Average Cost Of Capital - WACC

What Does Weighted Average Cost Of Capital - WACC Mean?A calculation of a firm's cost of capital in which each category of capital is proportionatelyweighted. All capital sources - common stock, preferred stock, bonds and any other long-termdebt - are included in a WACC calculation. All else help equal, the WACC of a firmincreases as the beta and rate of return on equity increases, as an increase in WACC notes adecrease in valuation and a higher risk.The WACC equation is the cost of each capital component multiplied by its proportionalweight and then summing:

Where:

Re = cost of equityRd = cost of debtE = market value of the firm's equityD = market value of the firm's debtV = E + DE/V = percentage of financing that is equityD/V = percentage of financing that is debtTc = corporate tax rateBusinesses often discount cash flows at WACC to determine the Net Present Value (NPV) ofa project, using the formula:

NPV = Present Value (PV) of the Cash Flows discounted at WACC.

APPLICATION OF ACCOUNTING

PRACTICES TECHINIQUES:

Table 8.1

ECONOMIC VALUE OF DELLA TECNICA (EVA)

(Rs. In Caror)YEAR 2006 2007 2008-09Cost of Capital Employed1.Average Debt 163 382 3422.Average Equity 2515 2402 19283.Average Capital Employed : (1+2) 2678 2784 2270

4.Cost of Debt, post-tax % 5.90 6.24 3.915.Cost of Equity % 16.38 17.59 14.47


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Corporate Capital Structure