Final Thesis Tata Motor Capital Structure 03 Feb 2012 Correction Final

7/30/2019 Final Thesis Tata Motor Capital Structure 03 Feb 2012 Correction Final

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THE INDIAN INSTITUTE OF PLANNING & MANAGEMENT

NEW DELHI

THESIS

Determinants of Capital Structure in AutomobileSector of India - Case of Tata Motors

Submitted by:

Shweta Kacker

FW/-9-11

FF3

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ABSTRACT

The term capital structure refers to the percentage of capital (money) at work in a

business by type. Broadly speaking, there are two forms of capital: equity capital and

debt capital. Each has its own benefits and drawbacks and a substantial part of wise

corporate stewardship and management is attempting to find the perfect capital structure

in terms of risk / reward payoff for shareholders. Automobile industry is a symbol of

technical marvel by human kind. Being one of the fastest growing sectors in the world its

dynamic growth phases are explained by nature of competition, product life cycle and

consumer demand. Today, the global automobile industry is concerned with consumer

demands for styling, safety, and comfort; and with labor relations and manufacturing

efficiency. The industry is at the crossroads with global mergers and relocation of

production centers to emerging developing economies. Due to its deep forward and

backward linkages with several key segments of the economy, the automobile industry is

having a strong multiplier effect on the growth of a country and hence is capable of being

the driver of economic growth. It plays a major catalytic role in developing transport

sector in one hand and help industrial sector on the other to grow faster and therebygenerate a significant employment opportunities. Also as many countries are opening the

land border for trade and developing international road links, the contribution of

automobile sector in increasing exports and imports will be significantly high. As

automobile industry is becoming more and more standardized, the level of competition is

increasing and production base of most of auto-giant companies are being shifted from

the developed countries to developing countries to take the advantage of low cost of

production.

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1. INTRODUCTION

Indian Automotive Sector:

The automobile sector is a key player in the global and Indian economy. The global

motor vehicle industry (four-wheelers) contributes 5 per cent directly to the total

manufacturing employment, 12.9 per cent to the total manufacturing production value

and 8.3 per cent to the total industrial investment. It also contributes US$560 billion to

the public revenue of different countries, in terms of taxes on fuel, circulation, sales and

registration. The annual turnover of the global auto industry is around US$5.09 trillion,

which is equivalent to the sixth largest economy in the world. In addition, the auto

industry is linked with several other sectors in the economy and hence its indirect

contribution is much higher than this. All over the world it has been treated as a leading

economic sector because of its extensive economic linkages. Indias manufacture of 7.9

million vehicles, including 1.3 million passenger cars, amounted to 2.4 per cent and 7 per

cent, respectively, of global production in number. The auto-components manufacturing

sector is another key player in the Indian automotive industry. Exports from India in this

sector rose from US$1.0 billion in 2009-10 to US$1.8 billion in 2010-11, contributing 1

per cent to the world trade in auto components in current USD. In India, the automobileindustry provides direct employment to about 5 lakh persons. It contributes 4.7 per cent

to Indias GDP and 19 per cent to Indias indirect tax revenue. Till early 1980s, there

were very few players in the Indian auto sector, which was suffering from low volumes

of production, obsolete and substandard technologies. With de-licensing in the 1980s and

opening up of this sector to FDI in 1993, the sector has grown rapidly due to the entry of

global players. A rapidly growing middle class, rising per capita incomes and relatively

easier availability of finance have been driving the vehicle demand in India, which in

turn, has prompted the government to invest at unprecedented levels in roads

infrastructure, including projects such as Golden Quadrilateral and North-East-South-

West Corridor with feeder roads. The Reserve Bank of Indias (RBI) Annual Policy

Statement documents an annual growth of 37.9 per cent in credit flow to vehicles

industry in 2009. Given that passenger car penetration rate is just about 8.5 vehicles per

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thousand, which is among the lowest in the world, there is a huge potential demand for

automobiles in the country.

Policy Environment and Evolution of Indian Auto Industry:

The policy framework of Indias automobile industry and its impact on its growth While

the ties between bureaucrats and the managers of state-owned enterprises played a

positive role especially since the late 1980s, ties between politicians and industrialists and

between politicians and labour leaders have impeded the growth. The first phase of 1940s

and 1950s was characterized by socialist ideology and vested interests, resulting in

protection to the domestic auto industry and entry barriers for foreign firms. There was a

good relationship between politicians and industrialists in this phase, but bureaucrats

played little role. Development of ancillaries segment as recommended by the L.K. Jha

Committee report in 1960 was a major event that took place towards the end of this

phase. During the second phase of rules, regulations and politics, many political

developments and economic problems affected the auto industry, especially passenger

cars segment, in the 1960s and 1970s. The third phase starting in the early 1980s was

characterized by delicensing, liberalization and opening up of FDI in the auto sector.

These policies resulted in the establishment of new LCV manufacturers (for example,

Swaraj Mazda, DCM Toyota) and passenger car manufacturers.7 All these developments

led to structural changes in the Indian auto industry. Pingle argues that state intervention

and ownership need not imply poor results and performance, as demonstrated by Maruti

Udyog Limited (MUL). Further, the non contractual relations between bureaucrats and

MUL dictated most of the policies in the 1980s, which were biased towards passenger

cars and MUL in particular. However, DCosta (2002) argues that MULs success is not

particularly attributable to the support from bureaucrats. Rather, any firm that is as good

as MUL in terms of scale economies, first-comer advantage, affordability, product

novelty, consumer choice, financing schemes and extensive servicing networks would

have performed as well, even in the absence of bureaucratic support. DCosta has other

criticisms about Pingle (2000). The major shortcoming of Pingles study is that it ignores

the issues related to sector specific technologies and regional differences across the

country.

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Productivity:

The performance of the Indian auto industry with respect to the productivity growth

Partial and total factor productivity of the Indian automobile industry have been

calculated for the period from 1990-91 to 2010-11, using the Divisia-Tornquist index forthe estimation of the total factor productivity growth. The author finds that the domestic

auto industry has registered a negative and insignificant productivity growth during the

last one and a half decade. Among the partial factor productivity indices only labour

productivity has seen a significant improvement, while the productivity of other three

inputs (capital, energy and materials) havent shown any significant improvement.

Labour productivity has increased mainly due to the increase in the capital intensity,

which has grown at a rate of 0.14 per cent per annum from 1990-91 to 2010-11.

Organized Auto Sector in India:

While the Original Equipment Manufacturers (OEMs) are at the top of the auto supply

chain, it should be noted that there are a few OEMs in India which supply some

components to other OEMs in India or abroad. Most of the Indian OEMs are members of

the Society of Indian Automobile Manufacturers (SIAM), while most of the Tier-1 auto

component manufacturers are members of the Automobile Component Manufacturers

Association (ACMA). All of them are in the organized sector and supply directly to the

OEMs in India and abroad or to Tier-1 players abroad. Tier-2 and Tier-3 auto-component

manufacturers are relatively smaller players. Though some of the Tier-2 players are in the

organized sector, most of them are in the unorganized sector. Tier-3 manufacturers

include all auto-component suppliers in the unorganized sector, including some Own

Account Manufacturing Enterprises (OAMEs) that operate with one working owner and

his family members, wherein manufacturing involves use of a single machine such as the

lathe. Auto-component manufacturers cater not only to the OEMs, but also to the after-

sales market. In the recent years, there has been a rapid transformation in the character of

the automotive aftermarket, as a fast maturing organized, skill-intensive and knowledge

driven activity. Hence, the auto industry in India possesses a very diverse and complex

structure, in terms of scale, nature of operation, market structure, etc.

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Unorganized Auto Sector in India:

The unorganized sector consists of enterprises that are not registered under certain

sections of the Factories Act.20 In this section, data on the unorganized manufacturing

sector from the National Sample Survey Organization (NSSO) is used. The unorganizedauto sector in India has grown in terms of number of enterprises, employment, output,

capital, capital intensity and labour productivity. However, capital productivity has fallen

considerably. Very similar trends are observed in OAME, NDME and DME21 in rural

and urban areas. However, it is evident that the growth of this sector has been quite low

in the rural areas than in the urban areas.

Automobiles - Domestic Performance:

The production and domestic sales of the automobiles in India have been growing

strongly. While production increased from 4.8 million units in 2003-08 to 8.5 million

units in 2010-11 (a CAGR of over 15 per cent), domestic sales during the same period

have gone up from 4.6 million to 7.9 million units (CAGR 14.2 per cent).

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A positive trend in the domestic market is that the growth has not been driven by one or

two segments, but is consistent across all key segments. Two wheelers, which constitute

the majority of the industry volume, have been growing at a rate of 14.3 per cent, three

wheelers at a rate of 14 per cent and passenger vehicles at a rate of 11.3 per cent.

Commercial vehicles have been growing at a higher rate of nearly 23.5 per cent, although

from a lower base. Since nearly all macro-economic indicators GDP, infrastructure,

population demographics, interest rates, etc. are showing a favorable trend, the

domestic market for automobiles in India is expected to continue on its growth trajectory.

Commercial Vehicles:

The commercial vehicle production in India increased from 156,706 in 2008 to 350,033

in 2011.

This segment can be divided into three categories heavy commercial vehicles (HCVs),

medium commercial vehicles (MDVs or MCVs) and light commercial vehicles (LCVs).

Medium and heavy commercial vehicles formed about 62 per cent of the total domestic

sales of CVs in 2004. These segments have also been driving growth, having grown at a

CAGR of nearly 24.7 per cent over the past five years. The key trends facilitating growth

in this sector are the development of ports and highways, increase in construction

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activities and agricultural output. With better roads and highway corridors linking major

cities, the demand for larger, multi-axle trucks is increasing in India.

Passenger Vehicles:

Passenger vehicles consist of passenger cars and utility vehicles. This segment has been

growing at a CAGR of 11.3 per cent for the past four years. A key trend in this segment

is that with rising income levels and availability of better financing options, customers

are increasingly aspiring for higher-end models. There has been a gradual shift from

entry-level models to higher-end models in each segment. For example, in passenger

cars, till recently, the Maruti 800 used to define the entry level car, and had a

predominant market share. Over the last 3-4 years, higher-end models such as Hyundai

Santro, Maruti Wagon R, Alto and Tata Indica have overtaken the Maruti 800. Another

development has been the blurring of the dividing line between utility vehicles and

passenger cars, with models like Mahindra & Mahindras Scorpio attracting customers

from both segments. Upper end sports utility vehicles (SUVs) attract potential luxury car

buyers by offering the same level of comfort in the interiors, coupled with on-road

performance capability.

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Exports of automobiles from India are booming:

While the domestic sales of automobiles have been increasing at a significant rate,

exports have taken a quantum leap in recent years. The exports of automobiles from India

have been growing at a CAGR of 39 per cent for the past four years.

Exports growth has been spearheaded by the passenger vehicle segment, which has

grown at a rate of 57.4 per cent. As a result, the share of passenger vehicles in overallvehicle exports has increased firm 18 per cent in 2001-02 to 26 per cent in 2010-11.

Europe is the biggest importer of cars from the country while predominantly African

nations import buses and trucks. The Association of South East Asian Nations (ASEAN)

region is the prime destination for Indian two wheelers.

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Competitive Advantages:

India has several competitive advantages in the automobile sector, which have been

analyzed using the following framework. Availability of skilled manpower withengineering and design capabilities India has a growing workforce that is English-

speaking, highly skilled and trained in designing and machining skills required by the

automotive and engineering industries. In a combined assessment of manpower

availability and capabilities, India ranks much ahead of other competing economies.

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Many Indian and global players are leveraging this advantage by increasingly

outsourcing activities like design and R&D to their Indian arms. The Society of Indian

Automobile manufacturers (SIAM) estimates that automotive vehicle manufacturers are

expected to invest US$ 5.7 billion in the Indian market from 2005 to 2010. Of this, about

US$ 2.3 billion will be on research and development and the rest probably on capex.

Some examples of investment in areas leveraging the engineering and design capabilities

of India include:

MICO, the Indian operation of Bosch and a key player in fuel injection

equipment, ignition systems and electricals, has invested in the MICO Application

Centre (MAC) for R&D. It has emerged as a key global R&D competency centre

catering to the entire Bosch Group. It is the first of its kind in India and the Bosch

Groups first outside Europe.

GM set up a technical centre at Bangalore that became fully operational in

September 2003. The centre focuses on both R&D and engineering, and takes up

high-value work to complement current research programs, as well as new

exploratory research projects.

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Competitive industry, with global players:

The Indian automobile industry is highly competitive with a large number of players in

each industry segment. Most of the global majors are present in the passenger vehicle and

two wheeler segments. In the components industry too, global players such as Visteon,

Delphi and Bosch are well established, competing with domestic players. The presence of

global competition has led to an overall increase in capabilities of the Indian auto sector.

Increase in competition has led to a pressure on margins, and players have become

increasingly cost efficient. Quality levels have gone up, and there is an increasing focus

on compliance to TPM, TQM and Six Sigma processes. This has led to an increased

confidence among domestic players, who are now focusing on opportunities abroad. Key

players in the components sector like Bharat Forge and Sundaram Fasteners have become

key global suppliers in their categories.

Large market with significant potential for growth in demand:

India offers a huge growth opportunity for the automobile sector the domestic market is

large and has the potential to grow further in the future due to positive demographic

trends and the current low penetration levels.

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Government Regulations and Support:

The Government of India (GoI) has identified the automotive sector as a key focus area

for improving Indias global competitiveness and achieving high economic growth. The

Government formulated the Auto Policy for India with a vision to establish a globallycompetitive industry in India and to double its contribution to the economy by 2010. It

intends to promote Research & Development in automotive industry by strengthening the

efforts of industry in this direction by providing suitable fiscal and financial incentives.

Some of the policy initiatives include:

Automatic approval for foreign equity investment upto 100 per cent of

manufacture of automobiles and component is permitted.

The customs duty on inputs and raw materials has been reduced from 20 per cent

to 15 per cent. The peak rate of customs duty on parts and components of battery-

operated vehicles have been reduced from 20 per cent to 10 per cent. These new

regulations would strengthen Indias commitment to globalization. Apart from

this, custom duty has been reduced from 105 per cent to 100 per cent on second

hand cars and motorcycles.

National Automotive Fuel Policy has been announced, which envisages a phased

program for introducing Euro emission and fuel regulations by 2010.

Tractors of engine capacity more than 1800 cc for semi-trailers will now attract

excise duty at the rate of 16 per cent.

Excise duty is being reduced on tyres, tubes and flaps from 24 per cent to 16 per

cent. Customs duty on lead is 5 per cent.

A package of fiscal incentives including benefits of double taxation treaty is now

available.

These government policies reflect the priority government accords to the automobile

sector. A liberalized overall policy regime, with specific incentives, provides a very

conducive environment for investments and exports in the sector.

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The outlook for Indias automotive sector appears bright:

The outlook for Indias automotive sector is highly promising. In view of current growth

trends and prospect of continuous economic growth of over 5 per cent, all segments of

the auto industry are likely to see continued growth. Large infrastructure development

projects underway in India combined with favorable government policies will also drive

automotive growth in the next few years. Easy availability of finance and moderate cost

of financing facilitated by double income families will drive sales in the next few years.

India is also emerging as an outsourcing hub for global majors. Companies like GM,

Ford, Toyota and Hyundai are implementing their expansion plans in the current year.

While Ford and Toyota continue to leverage India as a source of components, Hyundai

and Suzuki have identified India as a global source for specific small car models. At the

same time, Indian players are likely to increasingly venture overseas, both for organic

growth as well as acquisitions. The automotive sector in India is poised to become

significant, both in the domestic market as well as globally.

Determinants of market share of automobile industry:

Costs: sales ratio has a significant positive impact on market share. This could be

attributable to the fact that firms that manufacture high-value items are likely tohave a higher market share, since their sales, in value terms, could be higher than

others.

Emolument share has a negative effect on market share, showing that labour cost

constraints can distort a firms competitiveness.

Export: sales ratio has a significant positive effect on market share, implying that

export-oriented firms are more competitive, perhaps because of their versatility

and other merits that are required for catering to international markets.

Power/fuel cost share has a significant negative effect on market share, implying

that efficient technologies may go a long way in improving the firms

competitiveness.

Imported material expenses share in total material expenses has a negative

significant impact on market share, indicating that import of auto-components

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from abroad does not guarantee competitiveness of the firms, unless it is an item

that is unavailable in Indian industry

Borrowings share in total investments and interests share in total costs have

negative significant effect on market-share, which means that too much

dependence on credit may adversely affect a firms competitiveness. This also

calls for improvements in credit system and its cost in India.

Inventory cost share significantly distorts competitiveness, and hence, firms

following lean manufacturing are more likely to be competitive than others.

Share of imported know-how expenses in overall is competitiveness-enhancing,

and hence, firms could aggressively go for importing know-how that is required

for various aspects of production, so as to be more competitive.

Advertising costs as a share of total costs, has a significant negative effect on

market share, implying that unless the structural factors such as price and quality

are good, mere propaganda by advertising may in fact turn harmful for market

share.

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2. COMPANY PROFILE

Tata Motors Limited:

Tata Motors Ltd is a multinational corporation headquartered in Mumbai, India. Part of

the Tata Group, it was formerly known as

TELCO (TATA Engineering and

Locomotive Company). Tata Motors has

consolidated revenue of USD 16 billion

after the acquisition of British automotive

brands Jaguar and Land Rover in 2008.

It is India's largest company in the

automobile and commercial vehicle sector with upwards of 70% cumulative Market share

in the Domestic Commercial vehicle segment, and had a 0.81% share of the world market

in 2007 according to OICA data. The OICA ranked it as the 19th largest automaker,

based on figures for 2007. and the second largest manufacturer of commercial vehicles in

the world. The company is the worlds fourth largest truck manufacturer, and the worlds

second largest bus manufacturer. In India Tata ranks as the leader in every commercialvehicle segment, and is in the top 3 makers of passenger cars. Tata Motors is also the

designer and manufacturer of the iconic Tata Nano, which at INR 100,000 or

approximately USD 2300, is the cheapest production car in the world.

Established in 1945, when the company began manufacturing locomotives, the company

manufactured its first commercial vehicle in 1954 in collaboration with Daimler-Benz

AG, which ended in 1969. Tata Motors is a dual-listed company traded on both the

Bombay Stock Exchange, as well as on the New York Stock Exchange. Tata Motors in

2005, was ranked among the top 10 corporations in India with an annual revenue

exceeding INR 320 billion.

In 2004 Tata Motors bought Daewoo's truck manufacturing unit, now known as Tata

Daewoo Commercial Vehicle, in South Korea. It also acquired Hispano Carrocera SA,

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now a fully-owned subsidiary. In March 2008, it acquired the Jaguar Land Rover (JLR)

business from the Ford Motor Company, which also includes the Daimler and Lanchester

brands. and the purchase was completed on 2 June 2008.

Tata Motors has auto manufacturing and assembly plants in Jamshedpur, Pantnagar,

Lucknow, Ahmedabad and Pune in India, as well as in Argentina, South Africa and

Thailand.

History:

Tata Motors is a part of the Tata Group manages its share-holding through Tata Sons.

The company was established in 1935 as a locomotive manufacturing unit and later

expanded its operations to commercial vehicle sector in 1954 after forming a joint

venture with Daimler-Benz AG of Germany. Despite the success of its commercial

vehicles, Tata realized his company had to diversify and he began to look at other

products. Based on consumer demand, he decided that building a small car would be the

most practical new venture. So in 1998 it launched Tata Indica, India's first fully

indigenous passenger car. Designed to be inexpensive and simple to build and maintain,

the Indica became a hit in the Indian market. It was also exported to Europe, especially

the UK and Italy. In 2004 it acquired Tata Daewoo Commercial Vehicle, and in late 2005

it acquired 21% of Aragonese Hispano Carrocera giving it controlling rights of the

company. It has formed a joint venture with Marcopolo of Brazil, and introduced low-

floor buses in the Indian Market. Recently, it has acquired British Jaguar Land Rover

(JLR), which includes the Daimler and Lanchester brand names.

Expansion:

The SECOND generation Tata Indica's excellent fuel economy, powerful engine and

aggressive marketing strategy made it one of the best selling cars in the history of the

Indian automobile industry.

After years of dominating the commercial vehicle market in India, Tata Motors entered

the passenger vehicle market in 1991 by launching the Tata Sierra, a multi utility vehicle.

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After the launch of three more vehicles, Tata Estate (1992, a stationwagon design based

on the earlier 'TataMobile' (1989), a light commercial vehicle), Tata Sumo (LCV, 1994)

and Tata Safari (1998, India's first sports utility vehicle). Tata launched the Indica in

1998, the first fully indigenous passenger car of India. Though the car was initially

panned by auto-analysts, the car's excellent fuel economy, powerful engine and

aggressive marketing strategy made it one of the best selling cars in the history of the

Indian automobile industry. A newer version of the car, named Indica V2, was a major

improvement over the previous version and quickly became a mass-favourite. Tata

Motors also successfully exported large quantities of the car to South Africa.The success

of Indica in many ways marked the rise of Tata Motors.

Vehicle:

Tata Daewoo Comercial Vehicle:

With the success of Tata Indica, Tata Motors aimed to increase its presence worldwide.

In 2004, it acquired the Daewoo Commercial Vehicle Company of South Korea. The

reasons behind the acquisition were:

Company's global plans to reduce domestic exposure. The domestic commercial

vehicle market is highly cyclical in nature and prone to fluctuations in the

domestic economy. Tata Motors has a high domestic exposure of ~94% in the

MHCV segment and ~84% in the light commercial vehicle (LCV) segment. Since

the domestic commercial vehicle sales of the company are at the mercy of the

structural economic factors, it is increasingly looking at the international markets.

The company plans to diversify into various markets across the world in both

MHCV as well as LCV segments.

To expand the product portfolio Tata Motors recently introduced the 25MT GVW

Tata Novus from Daewoos (South Korea) (TDCV) platform. Tata plans to

leverage on the strong presence of TDCV in the heavy-tonnage range and

introduce products in India at an appropriate time. This was mainly to cater to the

international market and also to cater to the domestic market where a major

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improvement in the Road infrastructure was done through the National Highway

Development Project.

Hispano Carrocera:

In 2005, sensing an opportunity in the fully-built bus segment, Tata Motors acquired a

21% controlling stake in Hispano Carrocera SA, the leading European bus and coach

cabin maker. In 2009, the company picked up the remaining 79% stake in Hispano

Carrocera SA for an undisclosed sum, making it a fully-owned subsidiary.

Jaguar Cars and Land Rover:

After the acquisition of the British Jaguar Land Rover (JLR) business, which also

includes the Daimler, Lanchester and Rover brands, Tata Motors became a major player

in the international automobile market. On 27 March 2008, Tata Motors reached an

agreement with Ford to purchase their Jaguar Land Rover operations for US$2 billion.

The sale was completed on 2 June 2008. In addition to the brands, Tata Motors has also

gained access to two design centres and two plants in UK. The key acquisition would be

of the intellectual property rights related to the technologies.

Joint ventures:

Tata Motors has formed a 51:49 joint venture in bus

body building with Marco polo of Brazil. This joint

venture is to manufacture and assemble fully-built

buses and coaches targeted at developing mass rapid

transportation systems. The joint venture will absorb

technology and expertise in chassis and aggregates

from Tata Motors, and Marcopolo will provide

know-how in processes and systems for bodybuilding and bus body design. Tata and

Marcopolo have launched a low-floor city bus which is widely used by Delhi,

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Mumbai,Lucknow and Banglore transport corporations. Tata Motors also formed a joint

venture with Fiat and gained access to Fiats diesel engine technology. Tata Motors sells

Fiat cars in India and is looking to extend its relationship with Fiat and Iveco to other

segments. Tata has also formed several JV's with many small companies in various

countries around the world.

Important developments:

Tata Nano:

In January 2008, Tata Motors launched Tata Nano,

the least expensive production car in the world atabout Rs. 1,00,000 (US $2,500). The city car was

unveiled during the Auto Expo 2008 exhibition in

Pragati Maidan, New Delhi.

Tata has faced controversy over developing the Nano

as some environmentalists are concerned that the

launch of such a low-priced car could lead to mass motorization in India with adverse

effects on pollution and global warming. Tata has set up a factory in Sanand, Gujarat and

the first Nanos are to roll out summer 2009.

Tata Nano Europa has been developed for sale in developed economies and is to hit

markets in 2010 while the normal Nano should hit markets in South Africa, Kenya and

countries in Asia and Africa by late 2009. A battery version is also planned.

Tata has also been approached by a province in France named Moselle to setup Tata

Nano manufacturing plant.

Now, TATA Motors have launched in auto expo the latest TATA NANO VERSION2012.

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Tata Ace:

Tata Ace, India's first indigenously developed

sub-one ton mini truck was launched in May

2005. The mini-truck was a huge success in India

with auto-analysts claiming that Ace had changed

the dynamics of the light commercial vehicle

(LCV) market in the country by creating a new

market segment termed the small commercial vehicle (SCV) segment. Ace rapidly

emerged as the first choice for transporters and single truck owners for city and rural

transport. By October 2005, LCV sales of Tata Motors had grown by 36.6 percent to28,537 units due to the rising demand for Ace. The Ace was built with a load body

produced by Autoline Industries. By 20011, Autoline was producing 600 load bodies per

day for Tata Motors. Ace is still one of the number maker for TML, TML sold the

2,000,000th Ace in August 2008, within 4 years since its introduction.

Tata Ace has also been exported to several European, South American and African

countries. Electric-versions of Tata Ace are sold through Chrysler's Global Electric

Motorcars division.

Compressed air car:

Motor Development International of France has

developed the world's first prototype of a

compressed air car, named OneCAT. In 2007, MDI

owner Guy Negre was reported to have "the

backing of Tata".

It has airtanks that can be filled in 4 hours by

plugging the car into a standard electrical plug. In 2008 MDI planned to also design a gas

station compressor, which would fill the tanks in 3 minutes. There are no gasoline costs

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and no fossil fuel emissions from the vehicle when run in town, but "the compressed air

driving the pistons can be boosted by a fuel burner".

OneCAT is a five seat vehicle with a 200-litre (7.1 cu ft) trunk. With full tanks it is said

to run at 100 km/h (62 mph) for 90 kilometres (56 mi) range in urban cycle. There are

severe physical arguments pleading against those figures. In December 2009 Tata's vice

president of engineering systems confirmed that the limited range and low engine

temperatures were causing difficulties.

Electric vehicles:

Tata Motors unveiled the electric versions of passenger car Tata Indica and commercial

vehicle Tata Ace. Both run on lithium batteries. The company has indicated that theelectric Indica would be launched locally in India in about 2010, without disclosing the

price. The vehicle would be launched in Norway in 2009.

Tata Motors' UK subsidiary, Tata Motors European Technical Centre, has bought a

50.3% holding in electric vehicle technology firm Miljbil Grenland / Innovasjon of

Norway for US$1.93 M, which specializes in the development of innovative solutions for

electric vehicles, and plans to launch the electric Indica hatchback in Europe next year.

Operations:

Tata in India:

Tata Motors Limited is Indias largest automobile

company, with revenues of Rs 35,651.48 crore

(US$ 7.59 billion) in 2007-08. It is the leader in

commercial vehicles in each segment, and among

the top three in passenger vehicles with winning

products in the compact, midsize car and utility

vehicle segments. Tata Motors presence indeed cuts across the length and breadth of

India. Over 4 million Tata vehicles ply on Indian roads, since the first rolled out in 1954.

The companys manufacturing base in India is spread across Jamshedpur (Jharkhand),

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Pune (Maharashtra), Lucknow (Uttar Pradesh), Pantnagar (Uttarakhand) and Dharwad

(Karnataka). Following a strategic alliance with Fiat in 2005, it has set up an industrial

joint venture with Fiat Group Automobiles at Ranjangaon (Maharashtra) to produce both

Fiat and Tata cars and Fiat powertrains. The company is establishing a new plant at

Sanand (Gujarat). The companys dealership, sales, services and spare parts network

comprises over 3500 touch points; Tata Motors also distributes and markets Fiat branded

cars in India.

Tatas Global Operations:

Tata Motors has been aggressively acquiring

foreign brands to increase its global presence. Tata

Motors has operations in the UK, South Korea,

Thailand and Spain. Among them is Jaguar Land

Rover, a business comprising the two iconic British

brands that was acquired in 2008. Tata Motors has

also acquired from Ford the rights of Rover. In 2004, it acquired the Daewoo Commercial

Vehicles Company, South Koreas second largest truck maker. The rechristened Tata

Daewoo Commercial Vehicles Company has launched several new products in the

Korean market, while also exporting these products to several international markets.

Today two-thirds of heavy commercial vehicle exports out of South Korea are from Tata

Daewoo. In 2005, Tata Motors acquired a 21% stake in Hispano Carrocera, a reputed

Spanish bus and coach manufacturer, giving it controlling rights of the company.

Hispanos presence is being expanded in other markets. On Tata's journey to make an

international foot print, it continued its expansion through the introduction of new

products into the market range of buses (Starbus & Globus) as well as trucks (Novus).

These models were jointly developed with its subsidiaries Tata Daewoo and Hispano

Carrocera. In May, 2009 Tata unveiled the Tata World Truck range jointly developed

with Tata Daewoo They will debut in South Korea, South Africa, the SAARC countries

and the Middle-East by the end of 2009 In 2006, it formed a joint venture with the Brazil-

based Marcopolo, a global leader in bodybuilding for buses and coaches to manufacture

fully-built buses and coaches for India and select international markets. Tata Motors has

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expanded its production and assembly operations to several other countries including

South Korea, Thailand, South Africa and Argentina and is planning to set up plants in

Turkey, Indonesia and Eastern Europe. Tata also franchisee/joint venture assembly

operations in Kenya, Bangladesh, Ukraine, Russia and Senegal. Tata has dealerships in

26 countries across 4 continents. Though Tata is present in many counties it has only

managed to create a large consumer base in the Indian Subcontinent namely India,

Bangladesh, Bhutan, Sri Lanka and Nepal and has a growing consumer base in Italy,

Spain and South Africa

Key Ratios about Tata Motors:

Key data:

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Shareholding Pattern:

Investment Highlights:

Results Updates (Q3 FY11): The bottom-line of the company for the quarter

stood at Rs.4001.40mn from Rs. (2632.60)mn of same period of last year. Total

revenue for the third quarter stood at Rs.89799.00 mn from Rs.47586.20 which is

88.7% increased than that of a year ago period. EPS for the quarter stood at

Rs.7.36 per equity share of Rs.10.00 each. Face value has been changed for this

quarter. Expenditure of the company increased 60% YoY to Rs.78748.20mn from

Rs.49072.10mn of same period of last year. Interest expenses for the quarter stood

at Rs.2861.40mn. OPM & NPM for the quarter stood at 12% and 4% respectively.

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Quarterly Results-Standalone(Rs in mn)

As at Dec(2010) Dec(2009)%Change

NetSales 89799 47586.2 88.7Net Profit 4001.4 -2632.6

BasicEPS 7.36 -5.12

Equity Capital 5439.6 5140.5

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Introduction of new products and strong continued growth in the existing portfolio, along

with government stimulus, a benign liquidity environment and overall economic

recovery, has driven domestic demand revival during the current year. The sales volume

for the quarter (including exports) stood at 165,413 vehicles. This is a growth of 67.5%over sales of 98,760 vehicles in Q3 2009-10, which witnessed steep decline in volumes

impacted by the financial crisis. In the domestic market, Commercial Vehicles sales

increased by 88.8% to 93,520 units leading to a market share of 64.3%. With a growth of

121.6% in Q3 2010-11 over sales in Q3 2009-10, the Medium and Heavy Commercial

Vehicle segment witnessed a year on- year growth for the second quarter in a row in the

current fiscal year. Light Commercial Vehicles, led by the continued strong performance

of the Ace and its variants and on the low base of previous year, witnessed significant

growth of 70.5% over Q3 2009-10. While investment in infrastructure projects,

continuing stimulus support and smooth implementation of the change in emission norms

would influence the magnitude of growth in the coming quarters, the company has

planned several new product launches to defend and improve its market position.

Passenger Vehicles, including Fiat and Jaguar and Land Rover vehicles distributed in

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India, grew by 46% in the domestic market to 61,593 units. The market share for Tata

passenger vehicles for the period stood at 11.8%. The company launched the new Indigo

Manza during the quarter which saw the Indigo range sales grow by 63.5% over Q3

2009-10, substantially higher than the 35% growth of the Entry Mid-size Sedan market.

The company has also ramped up the production rate of the Nano at the plant in

Uttarakhand, and has till December 31, 2010 delivered 17,537 units of Nano. Along with

Fiat, the company has a joint market share of 13.1% in the industry.

Tata Motors January sales at 65,478 nos.: Tata Motors total sales (including

exports) of Tata commercial and passenger vehicles in January 2011 were 65,478

vehicles, a growth of 77% over 36,931 vehicles sold in January 2010. The

companys domestic sales of Tata commercial and passenger vehicles for January2011 were 62,202 nos., a 74 % growth over 35,704 nos. sold in January last year.

Cumulative sales (including exports) for the company for the fiscal at 498,108

nos., recorded a growth of 24 % over 400,284 nos. sold last year.

o Commercial Vehicles: The Companys sales of commercial vehicles in

January 2011 in the domestic market were 35,957 nos., the second highest

ever and a 107% growth compared to 17,373 vehicles sold in January last

year. LCV sales were 20,255 nos., the highest ever and a growth of 75%

over January last year. M&HCV sales stood at 15,702 nos., a growth of

170% over January last year. Cumulative sales of commercial vehicles in

the domestic market for the fiscal are 291,125 nos., a growth of 37% over

last year. Cumulative LCV sales are 174,276 nos., a growth of 45% over

last year, while M&HCV sales stood at 116,849 nos., a growth of 26%

over last year.

o Passenger Vehicles: The passenger vehicles business reported a total sale

and distribution off take of 28,547 nos. (26,245 Tata + 2,302 Fiat) in the

domestic market in January 2010, the highest ever and a 43% increase

compared to 19,911 nos. (18,331 Tata + 1,580 Fiat) in January last year.

Sales of Tata cars, at 22,707 nos. are the highest ever and a growth of 47%

over January 2009. Sales of the Tata Nano were 4,001 nos. The Indica

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range sales were 11,448 nos., the highest this fiscal though flat over

January last year. The Indigo range recorded sales of 7,258 nos., the

highest ever since the Indigos launch in 2002 and a growth of 83% over

January last year. The Sumo/Safari range accounted for sales of 3,538

nos., the highest this fiscal and a growth of 21% over January last year.

Jaguar Land Rover sales continued their upward trend since launch in June

with their highest sales in January. Cumulative sales and distribution off

take of passenger vehicles in the domestic market for the fiscal are

200,573 nos. (180,184 Tata + 20,389 Fiat), against 162,425 nos. (157,439

Tata + 4,986 Fiat) last year, a growth of 23%. Cumulative sales of the

Nano are 21,535 nos. Cumulative sales of the Indica range at 91,295 nos.,

reported a growth of 6%. Cumulative sales of the Indigo family are 41,724

nos., higher by 3%, coming into the positive territory for the first time this

fiscal based on the growing acceptance of the newly launched Indigo

Manza. Cumulative sales of the Sumo/Safari range are 25,630 nos., lower

by 17%.

Tata Nano wins the Indian Car of the Year (ICOTY) Award: The Tata Nano

has won the prestigious Indian Car of the Year (ICOTY) award. In its fifth year

running and modeled along the lines of the American, European and Japanese Car

of the Year, the ICOTY award and Indian Motorcycle of the Year (IMOTY)

award have been instituted by leading automotive magazines in India, in

association with JK Tyre, to bring the auto industry in India at par internationally

in recognizing their efforts.

Tata Motors launches the Sumo Grande MK II:

Tata Motors announced the launch of Grande MK II, an upgraded version of its

premium Sumo offering in the domestic market. The Grande MK II seeks to

deliver added value to customers through substantial changes in the exteriors and

interiors combined with improvements in drivability, ride and handling and

comfort. The exteriors have been accentuated by a new chrome lined grill, side

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rub rails with chrome inserts and indicators on ORVMs. The interiors have been

refreshed to give the vehicle a completely new, contemporary look with a two

tone theme complemented by a new faux wood centre console and new fabric

upholstery.

Future Product launches showcased at Auto-Expo:

PRIMA 1125

PRIMA 3128

PRIMA 3138

PRIMA 4038

PRIMA 4938

PRIMA 7548

MAGIC IRIS

LPT 1613 CNG

STARBUS HYBRID

XENON CNG

TATA ARIA

INDICA VISTA EV

TATA VENTURE

INDICA SPORTS (concept)

TATA PR1MA (concept)

SUMO GRANDE MK-II

TATA SAFARI(2012)

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Peer Group Comparison:

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Structure Target shareholders capital

Cash Cash in exchange for their shares

Share exchange A specified number of the bidders shares for each

target share.

Cash underwritten shareoffer (vendor placing).

Bidders shares, then self them to a merchant bankfor cash

Loan stock A loan stock debenture in exchange for their shares.

Convertible loan or

preferred shares

Loan stock or preferred shares convertible into

ordinary shares at a predetermined conversion rate

over a specified period.

Deferred payment Part of consideration after a specified period,

subject to performance criteria.

A companys financial strategy has many strands. Maintaining, reasonable gearing ratio

is one of them. Ensuring adequacy of lines of credit from banks is another. Taking

advantage of any tax provisions to reduce the cost of capital is also relevant. Finally,

timing of security issues to exploit favorable market conditions is an important

consideration.

The exchange ratio, ER determines how the overall added value at any PER will be

shared between B and T shareholders. When the bidder expects no synergy, it cannot

afford a higher ER than a simple ratio of the targets to the bidders share price, in order to

prevent loss of value from the acquisition. This means that no bid premium is paid to the

target. The bidder can justify a bid premium only if the acquisition produces some

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synergy, and if this synergy is credibly translated into a higher PER than the average of

the pre bid PERs.

Financing a cash offer

Internal operating cash flow

A pre-bid rights issue

A cash underwritten offer, e.g. vendor placing or vendor rights

A pre-bid loan stock issue.

Bank credit.

Use of a pre-bid loan stock issue or bank credit gives rise to a leveraged bid or leverage

buyout (LBO). The bidders internal operating cash flow is perhaps the cheapest and

easiest source, since it avoids both the transaction cost of raising finance and the delay in

doing so. However, except for relatively small acquisition targets, a bidder is unlikely to

have enough internal cash flow.

A conventional rights issue is often made by firms with a well defined acquisition

program. The cash underwritten offer is somewhat similar to a rights issue , but it may be

more flexible in that the underwriting fails, the bidder is not left with a surplus of cash.

Leveraged cash financing

One of the most important considerations in this form of financing is the ability of the

bidder to service the debt obligations. That is, periodic interest payments and capital

repayment. The bidder may relay on two alternative source of cash flows for this purpose.

Operating cash flows.

Cash proceeds from sales of the targets assets.

A careful forecast of the future operating cash flows from the target under the bidders

management must be made to assess the debt -servicing capacity.

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The high gearing that results from this method of financing may be of concern to the

bidder. There have been numerous cases of highly leveraged acquisitions causing the

decline and downfall of acquirers. One attraction of leverage is that the related interest

payment is tax deductible, thus enhancing future EPS. This compares well with a share

offer or a cash offer financed by a rights issue.

Financing with loan stock

This differs from the leveraged cash offer in that the loan stock is the consideration for

the bid and is offered to the target shareholders. They swap their shares in the target for

the loan stocks of the bidder. as noted earlier, such a loan stock may be construed as a

qualifying corporate bond, with a certain tax disadvantage compared to a share offer.

To the target shareholders, a loan stock minimizes the problem of information

asymmetry, since as in a cash offer, they are assured of a definitive sum on redemption of

the stock. for some target shareholders, accepting loan stock may mean an unwanted shift

of their portfolio weighting against equity. Further, acceptance of loan stock means loss

of control over their company.

Financing with Convertibles

Use of convertibles in acquisition financing is less common than that of straight loan

stock. Convertibles may be preferred stock (CPS) or loan stock (CLS). They represent a

bundle of two underlying security the straight preferred or loan stock, and an option on

the shares f the company. Target shareholders can, therefore, roll over their capital gains

and avoid immediate CGT.

Deferred consideration financing

Both bidders and target shareholders face valuation risk in negotiating a price and the

payment currency in a takeover. One way of mitigating this risk is to make the

consideration payable to the vendors contingent upon the future performance of the target

under their own management. In such companies, In an earn out, consideration to the

vendor is made up of the following:

An immediate payment in cash or shares of the acquirer

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A deferred payment contingent upon the target turned subsidiary achieving certain

predetermined performance levels .

Earn-outs are not free of problems. The culture shock of transformation from owning and

managing an independent company to running a subsidiary under the control of a largerfirm may be quite traumatic. For the buyer, an earn out is a way of retaining the vendors

talents. However, the vendor may lack motivation or tray to maximize short term profits

to the detriment of the long-term interests of the buyer.

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3. RESEARCH METHODOLOGY

I will use quantitative research approach in this study as it requires more of the

quantitative discussions.

Data Collection:-I will use both primary as well as secondary sources to collect the data

as follows,

Primary Research:-Direct contact to officials employed in Tata Motors and

other companies in Automobile and conducts the interviews through primary

research tool (Questionnaire).

Secondary Research: - Journals of finance, literature, news articles, books etc.

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4. LITERATURE REVIEW

Evaluating a Company's Capital Structure:

For stock investors that favor companies with good fundamentals, a "strong" balance

sheet is an important consideration for investing in a company's stock. The strength of a

company' balance sheet can be evaluated by three broad categories of investment-quality

measurements: working capital adequacy, asset performance and capital structure. In this

article, we'll look at evaluating balance sheet strength based on the composition of a

company's capital structure. A company's capitalization (not to be confused with market

capitalization) describes the composition of a company's permanent or long-term capital,

which consists of a combination of debt and equity. A healthy proportion of equity

capital, as opposed to debt capital, in a company's capital structure is an indication of

financial fitness.

Clarifying Capital Structure Related Terminology:

The equity part of the debt-equity relationship is the easiest to define. In a company's

capital structure, equity consists of a company's common and preferred stock plus

retained earnings, which are summed up in the shareholders' equity account on a balance

sheet. This invested capital and debt, generally of the long-term variety, comprises a

company's capitalization, i.e. a permanent type of funding to support a company's growth

and related assets. A discussion of debt is less straightforward. Investment literature often

equates a company's debt with its liabilities. Investors should understand that there is a

difference between operational and debt liabilities - it is the latter that forms the debtcomponent of a company's capitalization - but that's not the end of the debt story. Among

financial analysts and investment research services, there is no universal agreement as to

what constitutes a debt liability. For many analysts, the debt component in a company's

capitalization is simply a balance sheet's long-term debt. This definition is too

simplistic. Investors should stick to a stricter interpretation of debt where the debt

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component of a company's capitalization should consist of the following: short-term

borrowings (notes payable), the current portion of long-term debt, long-term debt, two-

thirds (rule of thumb) of the principal amount of operating leases and redeemable

preferred stock. Using a comprehensive total debt figure is a prudent analytical tool for

stock investors.

Is there an optimal debt-equity relationship?

In financial terms, debt is a good example of the proverbial two-edged sword. Astute use

of leverage (debt) increases the amount of financial resources available to a company for

growth and expansion. The assumption is that management can earn more on borrowed

funds than it pays in interest expense and fees on these funds. However, as successful as

this formula may seem, it does require that a company maintain a solid record of

complying with its various borrowing commitments. A company considered too highly

leveraged (too much debt versus equity) may find its freedom of action restricted by its

creditors and/or may have its profitability hurt as a result of paying high interest costs. Of

course, the worst-case scenario would be having trouble meeting operating and debt

liabilities during periods of adverse economic conditions. Lastly, a company in a highly

competitive business, if hobbled by high debt, may find its competitors taking advantage

of its problems to grab more market share. Unfortunately, there is no magic proportion of

debt that a company can take on. The debt-equity relationship varies according to

industries involved, a company's line of business and its stage of development.

However, because investors are better off putting their money into companies with strong

balance sheets, common sense tells us that these companies should have, generally

speaking, lower debt and higher equity levels.

Capital Ratios and Indicators:

In general, analysts use three different ratios to assess the financial strength of a

company's capitalization structure. The first two, the so-called debt and debt/equity

ratios, are popular measurements; however, it's the capitalization ratio that delivers the

key insights to evaluating a company's capital position. The debt ratio compares total

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liabilities to total assets. Obviously, more of the former means less equity and, therefore,

indicates a more leveraged position. The problem with this measurement is that it is too

broad in scope, which, as a consequence, gives equal weight to operational and debt

liabilities. The same criticism can be applied to the debt/equity ratio, which compares

total liabilities to total shareholders' equity. Current and non-current operational

liabilities, particularly the latter, represent obligations that will be with the company

forever. Also, unlike debt, there are no fixed payments of principal or interest attached to

operational liabilities. The capitalization ratio (total debt/total capitalization) compares

the debt component of a company's capital structure (the sum of obligations categorized

as debt + total shareholders' equity) to the equity component. Expressed as a percentage,

a low number is indicative of a healthy equity cushion, which is always more desirable

than a high percentage of debt.

Additional Evaluative Debt-Equity Considerations:

Companies in an aggressive acquisition mode can rack up a large amount of purchased

goodwill in their balance sheets. Investors need to be alert to the impact of intangibles on

the equity component of a company's capitalization. A material amount of intangible

assets need to be considered carefully for its potential negative effect as a deduction (or

impairment) of equity, which, as a consequence, will adversely affect the capitalization

ratio.

Funded debt is the technical term applied to the portion of a company's long-term

debt that is made up of bonds and other similar long-term, fixed-maturity types of

borrowings. No matter how problematic a company's financial condition may be, the

holders of these obligations cannot demand payment as long the company pays the

interest on its funded debt. In contrast, bank debt is usually subject to acceleration clauses

and/or covenants that allow the lender to call its loan. From the investor's perspective, the

greater the percentage of funded debt to total debt disclosed in the debt note in the notes

to financial statements, the better. Funded debt gives a company more wiggle room.

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Lastly, credit ratings are formal risk evaluations by credit-rating agencies - Moody's,

Standard & Poor's, Duff & Phelps and Fitch of a company's ability to repay principal

and interest on debt obligations, principally bonds and commercial paper. Here again, this

information should appear in the footnotes. Obviously, investors should be glad to see

high-quality rankings on the debt of companies they are considering as investment

opportunities and be wary of the reverse.

Seeking the Optimal Capital Structure:

Many middle class individuals believe that the goal in life is to be debt-free. When you

reach the upper echelons of finance, however, that idea is almost anathema. Many of the

most successful companies in the world base their capital structure on one simple

consideration: the cost of capital. If you can borrow money at 7% for 30 years in a world

of 3% inflation and reinvest it in core operations at 15%, you would be wise to consider

at least 40% to 50% in debt capital in your overall capital structure. Of course, how much

debt you take on comes down to how secure the revenues your business generates are - if

you sell an indispensable product that people simply must have, the debt will be much

lower risk than if you operate a theme park in a tourist town at the height of a boom

market. Again, this is where managerial talent, experience, and wisdom come into play.

The great managers have a knack for consistently lowering their weighted average cost ofcapital by increasing productivity, seeking out higher return products, and more. To truly

understand the idea of capital structure, you need to take a few moments to read Return

on Equity: The DuPont Model to understand how the capital structure represents one of

the three components in determining the rate of return a company will earn on the money

its owners have invested in it. Whether you own a doughnut shop or are considering

investing in publicly traded stocks, it's knowledge you simply must have.

Examining the results above we can see that there seems to have been a change in the

debt pattern amongst the auto companies. Just as Lev and many others presented in the

there is a change taking place in the way that we see and evaluate the corporate world and

its value drivers. Maybe the search for security has made the banks and the market

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extending the wrong companies credit; if there is a correlation between the value of the

underlying assets and the loan capacity of a corporation then companies who cannot

securitize their assets will be worse off in a recession. The auto company has up until

now been assessed as once whole entity which gives it a lower leverage compared to the

traditional company; but this would also make it better positioned and less volatile in

recession. Unfortunately the lack of further data to conclude the regression analysis and

finalize this study the data just shows us that we can identify but not explain a change.

This article did not have the aim to further increase or change the amount of information

provided to the creditors; what we can see is that suddenly corporations without any real

assets have a proportionally large amount of debt in their capital structure. The reason for

this is almost without a doubt that their market value on equity has deteriorated; but what

is interesting is that the trend related to the traditional companies has changed. This can

indicate that the loans given to the conceptual companies prior to the deterioration of the

market value of equity were proportionally larger than in the past. Further tells us that the

there has been a market driven change in how we assess corporate without any substantial

securities; if this change was driven by increased liquidity or a fundamental assessment

change in the market is for future research to tell. To conclude; there been a change in

capital structure where the proportion of debt and in long term debt over the last ten years

has increased amongst conceptual companies; it is though far away from being in the

same proportions as for the auto companies.

Growth opportunities:

For companies with growth opportunities, the use of debt is limited as in the case of

bankruptcy, the value of growth opportunities will be close to zero. This show that firms

should use equity to finance their growth because such financing reduces agency costs

between shareholders and managers, whereas firms with less growth prospects should use

debt because it has a disciplinary role. This shows that firms with growth opportunities

may invest sub-optimally, and therefore creditors will be more reluctant to lend for long

horizons. This problem can be solved by short-term financing or by convertible bonds.

From a pecking order theory perspective, growth firms with strong financing needs will

issue securities less subject to informational asymmetries, i.e. short-term debt. If these

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firms have very close relationships with banks, there will be less informational

asymmetry problems, and they will be able to have access to long term debt financing as

well. A common proxy for growth opportunities is the market value to book value of total

assets. IT companies with growth opportunities should exhibit a greater market-to-book

than firms with less growth opportunities, but it is suggest that this is not necessarily the

case. This will typically occur when assets whose values have increased over time have

been fully depreciated, as well as when assets with high value are not accounted for in the

balance sheet. They find a negative relationship between growth opportunities and

leverage. They suggest that this may be due to firms issuing equity when stock prices are

high. As mentioned by them, large stock price increases are usually associated with

improved growth opportunities, leading to a lower debt ratio.

Size:

Auto companies tend to be more diversified, and hence their cash flows are less volatile.

Size may then be inversely related to the probability of bankruptcy. They suggest that

large firms have easier access to the markets and can borrow at better conditions. For

small firms, the conflicts between creditors and shareholders are more severe because the

managers of such firms tend to be large shareholders and are better able to switch from

one investment project to another. However, this problem may be mitigated with the use

of short term debt, convertible bonds, as well as long term bank financing. Most

empirical studies report indeed a positive sign for the relationship between size and

leverage. Less conclusive results are reported by other authors. For India, however, they

find that a negative relationship exists. They confirm the finding of them for company

and argue that the negative relationship is not due to asymmetrical information, but rather

to the characteristics of the bankruptcy law and the system which offer better protection

to creditors than is the case in other countries.

Profitability:

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One of the main theoretical controversies concerns the relationship between leverage and

profitability of the firm. According to the pecking order theory, firms prefer using

internal sources of financing first, then debt and finally external equity obtained by stock

issues. All things being equal, the more profitable the firms are, the more internal

financing they will have, and therefore we should expect a negative relationship between

leverage and profitability. This relationship is one of the most systematic findings in the

empirical literature In a trade-off theory framework, an opposite conclusion is expected.

When firms are profitable, they should prefer debt to benefit from the tax shield. In

addition, if past profitability is a good proxy for future profitability, profitable firms can

borrow more as the likelihood of paying back the loans is greater. Dynamic theoretical

models based on the existence of a target debt-to-equity ratio show (1) that there are

adjustment costs to raise the debt-to-equity ratio towards the target and (2) that debt can

easily be reimbursed with excess cash provided by internal sources. This leads firms to

have a pecking order behavior in the short term, despite the fact that they aim at

increasing their debt-to-equity ratio.

Collaterals:

Tangible assets are likely to have an impact on the borrowing decisions of a firm because

they are less subject to informational asymmetries and usually they have a greater value

than intangible assets in case of bankruptcy. Additionally, the moral hazard risks are

reduced when the firm offers tangible assets as collateral, because this constitutes a

positive signal to the creditors who can request the selling of these assets in the case of

default. As such, tangible assets constitute good collateral for loans. According to them, a

firm can increase the value of equity by issuing collateralized debt when the current

creditors do not have such guarantee. Hence, firms have an incentive to do so, and one

would expect a positive relation between the importance of tangible assets and the degree

of leverage. Based on the agency problems between managers and shareholders, they

suggest that firms with more tangible assets should take more debt. This is due to the

behavior of managers who refuse to liquidate the firm even when the liquidation value is

higher than the value of the firm as a going concern. Indeed, by increasing the leverage,

the probability of default will increase which is to the benefit of the shareholders. In an

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agency theory framework, debt can have another disciplinary role: by increasing the debt

level, the free cash flow will decrease. As opposed to the former, this disciplinary role of

debt should mainly occur in firms with few tangible assets, because in such a case it is

very difficult to monitor the excessive expenses of managers. From a pecking order

theory perspective, firms with few tangible assets are more sensitive to informational

asymmetries. These firms will thus issue debt rather than equity when they need external

financing, leading to an expected negative relation between the importance of intangible

assets and leverage. Most empirical studies conclude to a positive relation between

collaterals and the level of debt. Inconclusive results are reported for instance by them.

Operating Risk:

Many authors have included a measure of risk as an explanatory variable of the debt

level. Leverage increases the volatility of the net profit. Firms that have high operating

risk can lower the volatility of the net profit by reducing the level of debt. By so doing,

bankruptcy risk will decrease, and the probability of fully benefiting from the tax shield

will increase. A negative relation between operating risk and leverage is also expected

from a pecking order theory perspective: firms with high volatility of results try to

accumulate cash during good years, to avoid under investment issues in the future.

Taxes:

The impact of taxation on leverage is twofold. On the one hand, companies have an

incentive to take debt because they can benefit from the tax shield. On the other hand,

since revenues from debt are taxed more heavily than revenues from equity, firms also

have an incentive to use equity rather than debt. As suggested by them, the financial

structure decisions are irrelevant given that bankruptcy costs can be neglected in

equilibrium. They show that if non-debt tax shields exist, then firms are likely not to use

fully debt tax shields. In other words, firms with large non-debt tax shields have a lower

incentive to use debt from a tax shield point of view, and thus may use less debt.

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Empirically, this substitution effect is difficult to measure as finding an accurate proxy

for the tax reduction that excludes the effect of economic depreciation and expenses is

tedious. According to them, the tax shield accounts on average to 4.3% of the firm value

when both corporate and personal taxes are considered.

A capital structure is the mix of a company's financing which is used to fund its day-to-

day operations. This source of funds can originate from equity, debt and hybrid

securities. The equity will come in the form of common and preferred stocks. The debt

is broken out into long-term and short-term debts. Lastly hybrid securities are a group of

securities that are a combination of debt and equity. When analyzing a company it is

important to note their mix of debt and equity, because it gives a firm picture of the

financial health of the company.

If capital structure is irrelevant in a perfect market, then imperfections which exist in the

real world must be the cause of its relevance. The theories below try to address some of

these imperfections, by relaxing assumptions made in the M&M model.

Trade-off theory:

Trade-off theory allows the bankruptcy cost to exist. It states that there is an advantage tofinancing with debt (namely, the tax benefit of debts) and that there is a cost of financing

with debt (the bankruptcy costs of debt). The marginal benefit of further increases in debt

declines as debt increases, while the marginal cost increases, so that a firm that is

optimizing its overall value will focus on this trade-off when choosing how much debt

and equity to use for financing. Empirically, this theory may explain differences in D/E

ratios between industries, but it doesn't explain differences within the same industry.

Pecking order theory:

Pecking Order theory tries to capture the costs of asymmetric information. It states that

companies prioritize their sources of financing (from internal financing to equity)

according to the law of least effort, or of least resistance, preferring to raise equity as a

financing means of last resort. Hence: internal financing is used first; when that is

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depleted, then debt is issued; and when it is no longer sensible to issue any more debt,

equity is issued. This theory maintains that businesses adhere to a hierarchy of financing

sources and prefer internal financing when available, and debt is preferred over equity if

external financing is required (equity would mean issuing shares which meant 'bringing

external ownership' into the company. Thus, the form of debt a firm chooses can act as a

signal of its need for external finance. The pecking order theory is popularized by Myers

(1984) when he argues that equity is a less preferred means to raise capital because when

managers (who are assumed to know better about true condition of the firm than

investors) issue new equity, investors believe that managers think that the firm is

overvalued and managers are taking advantage of this over-valuation. As a result,

investors will place a lower value to the new equity issuance.

Agency Costs:

There are three types of agency costs which can help explain the relevance of capital

structure.

Asset substitution effect: As D/E increases, management has an increased

incentive to undertake risky (even negative NPV) projects. This is because if the

project is successful, share holders get all the upside, whereas if it is unsuccessful,

debt holders get all the downside. If the projects are undertaken, there is a chance

of firm value decreasing and a wealth transfer from debt holders to share holders.

Underinvestment problem: If debt is risky (e.g., in a growth company), the gain

from the project will accrue to debt holders rather than shareholders. Thus,

management have an incentive to reject positive NPV projects, even though they

have the potential to increase firm value.

Free cash flow: unless free cash flow is given back to investors, management has

an incentive to destroy firm value through empire building and perks etc.

Increasing leverage imposes financial discipline on management.

Other:

The neutral mutation hypothesisfirms fall into various habits of financing,

which do not impact on value.

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Market timing hypothesiscapital structure is the outcome of the historical

cumulative timing of the market by managers.

Accelerated investment effecteven in absence of agency costs, levered firms

use to invest faster because of the existence of default risk.

Following Modigliani and Miller's pioneering work on capital structure, we are left with

the question, "Is there such a thing as an optimal capital structure for a company? In

other words, is there a best way to finance the company: an optimal debt/equity ratio?"

According to the trade-off theory, the answer is yes - in fact, you might even say that

there is an optimal range. There is a specific debt/equity ratio that will minimize a

company's cost of capital. (This is also the point at which the value of the company will

be maximized.) However, because the cost of capital curve is fairly shallow (like thebottom of a bowl), you can deviate from this optimal debt/equity ratio without

appreciably increasing the cost of capital This creates a range in the bottom portion of

the curve where the cost of capital is essentially the same throughout the range. There is a

danger of getting outside of this range however. The cost of capital will increase rapidly

once you get outside the range, as shown by the blue Average Cost of Capital line in the

graph below.

The Trade-off View of the Cost of Capital

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A company's overall cost of capital is a weighted average of the cost of debt and the cost

of equity. For example, if a company's debt/equity ratio is 30/70 and the after-tax cost of

debt is 4% and the cost of equity is 10.5%, the company's overall cost of capital is 0.30 *

4% plus 0.70 * 10.5%, or 8.55%.

Let's take a company from its inception:

1. When a company is new, it will likely be financed entirely with equity, so its

average cost of capital is the same as its cost of equity (10% in the graph above

for a 0/100 debt/equity ratio).

2. As the company grows, it establishes a track record and attracts the confidence of

lenders. As the company increases its use of debt, the company's debt/equity ratio

increases and the average cost of capital decreases. In essence, the company is

substituting the cheaper debt for the more expensive equity, thereby decreasing its

overall cost. (It might be useful to think of the company borrowing money, then

using that borrowed money to buy back some of its common stock. The debt goes

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up, the equity goes down, and the company's average cost of capital decreases

because the company has substituted the cheaper debt for the more expensive

equity.)

3. Eventually, as the company's debt/equity ratio increases, the cost of debt and the

cost of equity will increase. Lenders will become more concerned about the risk

of the loan and will increase the interest rate on its loans. Common shareholders

will become more concerned about default on the loans (and, in bankruptcy,

losing all of their investment) and will insist on receiving a higher rate of return to

compensate them for the higher risk. Since both the cost of debt and equity

increases, the average cost of capital will also increase.

4. This results in a minimum point on the cost of capital curve. However, the curve

(for most industries) is relatively shallow. This means that the financial manager

has considerable flexibility in choosing a debt/equity ratio. He or she wants to

move to the shallow portion of the curve and, once there, remain there. However,

there is a range of debt/equity ratios that will allow the company to stay in this

shallow portion of the curve.

Just remember that there is a danger in getting outside of this range.

If you move too far to the left-hand side of the curve, you are paying too much to

raise money - you would be better off borrowing money (at a relatively low after-

tax interest rate) and buying back some of the more expensive equity. (The cost

of financing with debt is always considerably lower than financing with equity.)

If you move too far to the right-hand side of the curve, you are paying too much

to raise money - lenders and stockholders perceive your company as being toorisky. You should either pay down the debt or issue new equity in the next round

of financing in order to reduce the risk and to move back into the shallow portion

of the curve.

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Pecking Order Theory:

There is a competing theory to the trade-off view. It is based more on observations of

how managers take short-cuts rather than a repudiation of the trade-off view. The

pecking order theory says that companies tend to finance investments with internal funds

when possible and also issue debt whenever possible. Since internal funds (profits that

are retained in the company) are a form of equity and have a very high cost, managers are

obviously not always following the recommendations of the trade-off view.

The pecking order theory says that companies finance investments by raising funds in

this order: (1) internal funds (retained earnings), (2) debt, and (3) sale of new common

stock (the most expensive form of financing). Much of this may have to do with

convenience - the pecking order corresponds to the easiest and most convenient ways to

raise money.

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5. FINDINGS AND ANALYSIS

Moving Average for 2001/02 to 2005/06

Company Return (2006-07) Debt-Equity Dividend Payout Retention Ratio

Tata Motors -0.11 1.39 0.66 0.14

Hyundai 0.23 0.16 0.17 0.83

Maruti Udyog -0.3 0.05 0.15 0.85

Toyota -0.16 0.31 0.16 0.84

Hindustan Motors 0.14 0.83 0.29 0.71

Skoda -0.22 0.92 0.4 0.6

Mahindra &

Mahindra -0.47 0.27 0.32 0.68



Tata Motors 0.81 1.44 0.41 0.39Hyundai 1.58 0.13 0.2 0.8

Maruti Udyog 0.62 0.05 0.18 0.82

Toyota 0.06 0.27 0.13 0.87

Hindustan Motors 2.18 0.78 0.3 0.7

Skoda 0.8 0.94 0.43 0.57

Mahindra &

Mahindra 1.56 0.19 0.43 0.57



Tata Motors 0.37 1.39 0.49 0.51

Hyundai 0.2 0.13 0.21 0.79

Maruti Udyog 0.09 0.06 0.2 0.8

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Final Thesis Tata Motor Capital Structure 03 Feb 2012 Correction Final