IIM INDORE

FINANCE PROJECTMAHINDRA & MAHINDRA LTD.

GROUP 9 SECTION D

3/28/2010

ROHIT RAJ| JASPREET SINGH | UBAINTHARAN| V ARUN KUMAR | SANTOSH KUMAR GUPTA

TABLE OF CONTENTS

TABLE OF CONTENTS............................................................................................................................2

CORPORATE GOVERNANCE ANALYSIS.............................................................................................4

STOCKHOLDER ANALYSIS...................................................................................................................7

Calculation of top down beta...................................................................................................................8

Calculation of cost of debt.....................................................................................................................10

wacc......................................................................................................................................................11

MEASURING INVESTMENT RETURNS..............................................................................................12

CAPITAL STRUCUTURE CHOICES.....................................................................................................14

BENEFIT OF DEBT.............................................................................................................................15

COST OF DEBT...................................................................................................................................15

OPTIMAL CAPITAL STRUCTURE.......................................................................................................18

OPTIMAL CAPITAL STRUCTRUE....................................................................................................18

OPTIMAL CAPITAL STRUCTURE AT CONSTRAINED CREDIT RATING..................................20

OPTIMAL CAPITAL STRUCTURE AT NORMALISED OPERATING INCOME...........................21

RELATIVE ANALYSIS.......................................................................................................................21

MECHNANICS OF MOVING TO THE OPTIMAL................................................................................22

THE IMMEDIACY QUESTION..........................................................................................................22

AFTER FINANCING MIX OR TAKE PROJECTS.............................................................................23

TAXATION ON DIVIDEND AND CAPITAL GAINS.......................................................................23

COMPANY CASH FLOW...................................................................................................................23

CHOICE OF MECHANICS OF MOVING TO THE OPTIMALS.......................................................24

REGRESSION OF MARKET VALUE OF FIRM WITH MACROECONOMIC FACTORS..............24

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REGRESSION OF OPERATING INCOME OF THE FIRM WITH MACROECONOMIC VARIABLES........................................................................................................................................25

DIVIDEND POLICY................................................................................................................................25

Dividend declared in the past years.......................................................................................................25

FRAMEWORK FOR ANALYZING DIVIDENDS..................................................................................29

VALUATION...........................................................................................................................................31

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CORPORATE GOVERNANCE ANALYSISIs this a company where there is a separation between management and ownership? If so how responsive management is to ownership?

No there is not separation between ownership and management of the company. The control of the firm is in the hands of Mahindra family. Keshabh Mahindra the current chairman of the company has been the Chairman since 1963. The company itself was founded by his Father K.C. Mahindra in 1945. K.C Mahindra grandson, Anand Mahindra has also joined Mahindra group after management education at Harvard Business School. He is presently managing director of Mahindra and Mahindra ltd and also the vice chairman of the company. The company board of director consists of the following people.

Name Position Member since1 Keshab Mahindra Chairman 19632 Mr. Anand G. Mahindra Vice Chairman and Managing Director 19913 Deepak Shantilal Parekh Director 19904 Nadir Burjorji Godrej Director 19925 M. M. Murugappan Director 19926 Bharat Narotam Doshi Executive Director & Group Chief Financial Officer (Group CFO) 19927 Arun Kumar Nanda Executive Director 19928 Narayanan Vaghul Director 19969 Dr. Ashok Sekhar Ganguly Director 1997

10 R. K. Kulkarni Director 197711 Anupam Pradip Puri Director 200112 Arun Kanti Dasgupta Nominee of LIC 2007

Fig 1: Board of Directors 1

Although the ownership of the company is in the hands of family, clearly they have strong/impartial board of Directors in place. Out of the 13 board of Directors many are from different industries and many people have their independent reputation which lends credibility to the board. For example Deepak Parekh has been chairman of HDFC pvt. Ltd. He has also been member of various committee set up by government of India. Nadir B Godrej has been director of several Godrej companies since 1977. A.S Ganguly has been Chairman of Hindustan Unilever Ltd. from 1980 to 1990.

How committed management can also be seen from compensation given to Board of Directors. Mahindra and Mahindra has separate remuneration committee. The committee considers the performance of the company, the current trends in the industry, the qualification of the appointee, their experience, past performance and other relevant factors while deciding the remuneration of the directors. It also keeps track of market trends in terms of compensation level and practices in relevant industries through participation in structured surveys.

How firm interact with financial markets? How do markets get information on the firm?

The firm is listed in BSE 30 index of Bombay stock exchange. So there is lot of financial analysts following the firm.

MeansofCommunication

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• The half‐yearly/quarterly results are published in the newspapers (Mumbai edition) andarebeingsenttoeachhouseholdofshareholders.•Theresultsareusuallypublishedinthefollowingnewspapers: i. The Economic Times ii. Navbharat Times iii. The Financial Express iv. Business Standard v. The Hindu Business Line vi. Mint• The annual/half‐yearly/quarterly results, other official news releases and presentationsaredisplayedonthewebsiteoftheCompany‐www.mahindra.com•TheManagementDiscussionandAnalysisReportformspartoftheDirectors’Report.

How does the firm view it social obligations and manage its impact in society?

Mahindra and Mahindra ltd is one of the oldest companies of India. It was founded in 1945 before the partition. The firm enjoys a particularly good reputation as a corporate citizen. It has acquired its reputation over the years by several initiatives that it takes in the following areas :

1 Health, Safety and Environmental Concern: Company has demonstrated strong commitment and responsibility towards safety, occupational health and environment of the company which stems from the vision of the company to sustain business growth with deep commitment towards safety, occupational health and environment. The company has well established safety, health & Environmental Policy (SH&E) which is revised under EMS & OHSMS Standard for all the locations of the Automotive Sector. The SH&E Policy inter alia ensures safety of public, employees, plant, equipment and business associates, ensuring compliance with all statutory rules and regulations on a monthly basis, imparting training to its employees and business associates as per the Training Calendar. All Plants of the automotive sector have been certified with the amended standard for Environmental Management System ISO 14001: 2004. Keeping Safety as a key factor, the Central Safety Committee of the Mahindra Group was formed by the Mahindra Group Management Board. Mahindra Manufacturing Excellence Award for Safety, Health & Environmental activities for the year 2008-09 has been assessed by an external agency to confirm the rating of each Plant and the Company’s best safety practices and systems are shared and implemented for horizontal deployment.

2) Corporate Social Responsibility: Keeping with the Company’s core value of Good Corporate Citizenship, the Mahindra Group continues to display its social responsibility by directing 1% of its profit after tax (“PAT”) to Corporate Social Responsibility (“CSR”) initiatives which would benefit the socially and economically disadvantaged sections of society. Following are some of major of corporate social responsibility initiatives of the company.

a) Mahindra Pride School: The Mahindra Pride School at Chinchwad near Pune, within plant premises provides livelihood and skills training to youth from socially disadvantaged communities (comprising mainly of Scheduled Caste/Scheduled Tribe youth). Since its establishment on 23rd March, 2007, 1,202 students have been imparted with “employable” skills through a training course of 3 months duration. The School provides training in four faculties i.e. Hospitality Craft, Customer Relationship urban, rural and tribal parts of India by providing academic Management, Hardware and Networking and Call Centre Training.

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b) Mid Day Meal Kitchen: Company has established Mid Day Meal Kitchen at Govindgarh Block, Jaipur District, and Rajasthan under a unique tripartite agreement between the Company, Government of Rajasthan and Naandi Foundation with the prime objective being “to fight hunger in Schools”. This centralised Mid Day Meal Kitchen ensures that high quality, hygienically prepared Mid Day Meals containing a minimum of 450 calories are served to the children. The Company has spent Rs.1 crore, for setting lower up of this central kitchen, which today feeds over 25,000 school children from Class 1 to 5, covering 314 schools in two blocks of Chomu and Govindgarh, thereby schooling and learning a complete experience.

c) Mahindra All India Talent Scholarships (MAITS): During the year 510 students all over India were awarded were awarded the MAITS which enabled them to pursue job oriented diplomas at a recognized government polytechnic in India. The scholarship is awarded for 3 year period. Till date 4260 students have been awarded the MAITS with majority of them belonging to very poor families where average income of the families ranges from Rs 1500 to Rs 2000 per month.

3) Sustainability initiatives: In Oct 2008 first Mahindra group sustainability report was released setting out its triple bottom line performance i.e performance towards the environmental, social as well as economic aspects towards creating sustainable value towards all its stakeholders. This was in accordance with latest guidelines of internationally accepted global reporting initiatives. The report was essentially the first step which will take the company on a sustainability journey and enabling it to make conscious plans, to reduce GHG emissions and waste as well as conserve water, biodiversity and natural resources, as a part of its growth strategy.

STOCKHOLDER ANALYSISShareholding Pattern of Mahindra and Mahindra

Share holding pattern as on : 31/12/2009Face value 10

No. Of Shares % Holding

Promoter's holdingIndian Promoters 69063784 24.68Foreign Promoters 7127304 2.55Sub total 76191088 27.23

Non promoter's holdingInstitutional investorsBanks Fin. Inst. and Insurance 59592156 21.3FII's 64064714 22.89Sub total 139908653 50

Other investors

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Private Corporate Bodies 21273737 7.6NRI's/OCB's/Foreign Others 1645395 0.59Govt 221416 0.08Others 16060852 5.74Sub total 39201200 14.01

General public 24520124 8.76Grand total 279821065 100

STOCKHOLDER PATTERN 1

Majority of the stock is held by institutional investors i.e Banks Fin Inst and Foreign Institutional Investors. So Institutional investors are the marginal investors of the firm, they are also the average investor of the Firm.

RISK AND RETURN

Calculation of top down betaWe have done regression of daily return of Mahindra stock price against daily return of BSE index. Then we have determined the slope and coefficient of regression coefficient. The slope of the regression line gives the beta of the stock. We have also determined arithmetic mean of daily returns of Mahindra stock and stock of Mahindra counterparts.

Then using the formula given below we have determined r square of the regression. R-square of the regression tells us how much variation of dependent variable can be explained by variation of independent variables. In our case since independent variable is BSE 100 index return while dependent variable is stock return of Mahindra, r square gives the portion of systematic risk in the stock compared to

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total risk of the stock, while the rest is unsystematic risk of the stock. We have used the following formulas for calculations

y = β0 + β1 x

Where β1 = beta of the stock

R-square = 1 – SSE/SSyy

Proceeding in this way we have found systematic risk and unsystematic risk of Mahindra and its peers.

M&M Tata Motors Force Motors Eicher Motors Swaraj Mazda

BSE 100

Return (Average) 2.14% 1.93% 1.30% 1.83% 0.43% 1.95%Risk (SD) 14.04% 15.84% 17.43% 13.92% 14.29% 9.44%Sharpe Ratio (Avg / SD)

0.15237072 0.121964303 0.074396613 0.13142186 0.02989 0.20624

Beta 0.93612631 1.337041402 1.036020498 0.873926498 0.53220 1Rsquare 39.57% 63.48% 31.48% 35.11% 12.36% 100.00%Systematic Risk 5.56% 10.05% 5.49% 4.89% 1.77% 9.44%Unsystematic Risk

8.49% 5.78% 11.94% 9.03% 12.52% 0.00%

Annual Returns 28.93% 25.81% 16.72% 24.30% 5.25% 26.03%TOP DOWN BETA CALCULATION 1

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RELATIVE COMPARISON OF TOP DOWN BETA 1

CALCULATION OF BOTTOM UP BETA

Bottom up beta is found by taking weighted average of beta of firms sectors. Whereas top down beta is found by regressing firm’s stock return against market index. Hence bottom up beta is better measure of the risk of the firm as it takes into account difference in risks in different business of the firm.

After calculating top down beta and systematic and unsystematic risk for Mahindra we have found bottom up beta for Mahindra and Mahindra and Mahindra. For calculating bottom up beta we have identified the sectors in which Mahindra and Mahindra operates. Then we have identified the firms in those sectors. Regression of their stock return was done against market return to find top down beta for

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the stocks. Then using Debt to equity ratio of these stocks we have found unlevered beta for the firms. Then using revenues of these firms we have found weighted unlevered beta for both the sectors.

Equity Beta

D/E Revenue Unlevered Beta

Weigted Unlevered Beta

Utility Vehicles: Force Motors 1.0360205 0.88138

31237.88 0.654999146 0.011157197

Tata Motors 1.3370414 0.990414

71433.63

0.808528325 0.794755926

Sector Beta 0.805913123Light Commercial Vehicles:Tata Motors 1.3370414 0.99041

471433.6

30.808528325 0.768482145

Eicher Motors 0.8739265 0.150051

1919.51 0.795177099 0.020309071

Force Motors 1.0360205 0.881383

1237.88 0.654999146 0.010788352

Swaraj Mazda 0.53220313

2.282325

565.07 0.212343222 0.001596528

Sector Beta 0.801176096

Tax Rate (M&M) 26%M&M Debt 4,052.76M&M Equity 30,975.1

0D/E 0.13083

9Financial Leverage 1.09682

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Unlevered Beta Levered Beta Sales WeightUtility Vehicles: 0.805913123 0.883942496 7,646.72 0.63827Light Commercial Vehicles:

0.801176096 0.878746824 4,333.56 0.36172

After getting weighted unlevered beta for both the sectors of Mahindra and Mahindra we found bottom up beta for Mahindra using its sales in both the sectors as weights. So finally we found bottom up beta of

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Weigted Unleverd Beta 0.8042Weighted Levered Beta: Bottom Up Beta

0.88206

BOTTOM UP BETA 1

Mahindra as 0.86.158. We used bottom up beta in our later calculations instead of using bottom up beta because it is deemed to be more correct.

Calculation of cost of debt

Interst Coverage Ratio( ICR ) Rating Debt Spread>12.5 AAA 0.00750009.5 to 12.5 AA+ 0.01000007.5 to 9.5 A+ 0.01500006 to 7.5 A 0.01800004.5 to 6 A- 0.02000003.5 to 4.5 BBB 0.02250003 to 3.5 BB 0.03500002.5 to 3 B+ 0.04750002 to 2.5 B 0.06500001.5 to 2 B- 0.08000001.25 to 1.5 CCC 0.1000000.8 to 1..25 CC1 0.1150000.5 to .8 C 0.1270000< .5 D 0.1400000

Calculating cost of debtYield on 20 year government bonds 8.27%Credit rating of the firm AADefault spread 1%Pre tax cost of debt for the firm 9.27%Marginal tax rate 26%Post tax cost of debt 6.9%

COST OF DEBT

We used credit rating given by Crisil for Mahindra as credit rating of Mahindra. CRISIL has recently rated Mahindra as AA. Then we used the above table given by Ashwath Damodaran for determining debt spread for this rating. Then for risk free rate we have taken yield on 20 year Indian government bonds. This gives cost of debt of Mahindra as 9.27%.

WACC

Value %M&M Debt 4,052.76 11.6%M&M Equity (Market Value) 30,975.10 88.4%Preferrence Capital 0 0%

Bottom Up Beta Top Down BetaLong Term Short Term Long Short

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Term Term`

Cost of debt 9.3% 9.3% 9.3% 9.3%Marginal Tax Rate 26% 26% 26% 26%

Rf 8.27% 5.12% 8.27% 5.12%Rm 26.03% 26.03% 26.03% 26.03%Rm-Rf 17.76% 20.91% 17.76% 20.91%Beta 0.86 0.86 0.93 0.93612

Preferrence Capital 0% 0% 0% 0%After-tax cost of debt 6.9% 6.9% 6.9% 6.9%Cost of equity 23.6% 23.1% 24.9% 24.7%Weighted average cost of capital 21.64% 21.3% 22.81% 22.6%

WACC

We have determined here cost of capital both for short term using both bottom up beta. For long term we have taken yield on 20 year government bonds as risk free rate. And for short term we have taken average yield on 364 days treasury bills

MEASURING INVESTMENT RETURNS

2009 2008 2007 2006 2005 2004 2003 2002NOPAT 1,405.41 1,571.12 1,497.15 1,269.72 681.54 425.61 141.71 89.95 Total Shareholders Funds 7,042.46 6,164.77 4,854.75 3,721.63 2,384.98 2,013.22 1,780.52 1,759.09Equity EVA -254.47 144.97 288.64 350.77 681.54 425.61 141.71 89.95Equity EVA as % of Equity -3.61% 2.35% 5.95% 9.43% 28.58% 21.14% 7.96% 5.11%Capital Invested 9296.73 6937.13 5188.9 3792.26 3064.88 2504.85 2709.65 2881.09EVA -606.06 70.18 374.47 449.22 18.41 -116.35 -444.56 -533.41EVA as % of Capital -6.52% 1.01% 7.22% 11.85% 0.60% -4.64% -16.41% -18.51%ROE 0.199562369 0.254855 0.308389 0.341173 0.285763 0.211408 0.079589 0.051134ROCE 0.151172509 0.22648 0.288529 0.334819 0.222371 0.169914 0.052298 0.031221

Average ROCE for past 7 years 0.184600603Stdev(ROCE) 0.106173408Averaage ROE for past 7 yr 0.216484156Stdev(ROE) 0.104648114

Firm’s current return on capital employed is well below cost of capital employed for the firm. And its current return on equity is also well below the cost of equity. As a result firm has negative economic value added presently.

Do you think accounting return is a fair measure of returns that a firm is making on existing projects? If not how would you modify the return to make it a fairer measure?

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Though ROIC is not perfect. It is subject to the vagaries of asset values shown on the balance sheet. These depend on depreciation policies and the age of a company's assets. ROIC does nonetheless give investors a useful way of assessing how well a company has been run, besides that market value of equity is considerably different from book value of equity, so real return for shareholders can be considerably different from ROE. To get better idea of company’s return we can use market value of debt and equity.

We have plotted bar graph of ROC and ROE of the firm over 7 years. On the basis of that we have predicted Return on capital employed for future years. The trend line for return on capital is

Y = -0.025x + 0.301

This shows that return on capital of the firm is decreasing with time The trend line for return on equity is Y = -0.026x + 0.337 This shows that return on equity is decreasing with time.

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Then we have also drawn the bar graph for equity EVA as % of equity and EVA as % of capital versus timeline. We can see that firm equity EVA was positive 2 years back consistently for 5 years but now it has turned negative, whereas firm EVA as % of capital has been consistently negative over the years. The trend line for equity EVA as % of equity is

Y = -0.025x + 0.085

The trend line for EVA as % of capital is

Y = 0.018x +0.013

Firm EVA as % of capital is improving over time, but firm equity EVA as % of equity is worsening over time. This is happening because ratio of book value of equity to book value of debt has changed in this period.

Why might a comparison based upon economic value added lead you to different conclusions than one based upon the return differences in the earlier section?

Economic value added also takes into account cost of capital employed. For equity EVA we use cost of equity and for EVA for capital we use cost of capital. Both cost of equity and cost of capital are very different from each other. So comparison of ROC and ROE with EVA can yield contrasting results.

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CAPITAL STRUCUTURE CHOICES

BENEFIT OF DEBTCURRENT FINANCING MIX :

Mahindra and Mahindra has 3 times more unsecured loans compared to secured loans.

BENEFITS OF DEBT: Firms faces following tax advantages

1) Firm has depreciation by book value ratio of 0.06 which means there is less depreciation to reduce tax bite.

2) Firms has made investments in tax free US 64 bonds

3) Provision for current tax, fringe benefit tax and deferred tax for the current year as percentage of profit before tax has been lower due to higher tax free income

4) Increased profit in new plant eligible for deduction under section 80ic of Income Tax Act, 1961

MARGINAL TAX STRUCTURE

Company Marginal taxMahindra 0.26Maruti 0.02Force 0.29Swaraz 0.34Eicher 0.13tata motors 0.15

Mahindra and Mahindra faces marginal tax rate of 26 % which is high compared to other firms in the industry so it gets more tax advantage from debt

COST OF DEBT

Market Value of Equity 30975.10MarginalTax Rate 0.26Book Value of Firm 5245.84Debt/Equity Ratio 0.13CurrentDepreciation 292.00CurrentDepreciation/BVofFirm 0.06EBITDA 1383.00MarketValueof Debt 4026.00

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MarketValueofFirm 35001.10EBITDA/MVofFirm 0.04FreeCashFlow 940.41ICR 9.76

Ratio of EBITDA to Market Value of firm is also very low which reduces the capability of the firm to handle debt

Free Cash Flow

Here we calculate using the firm value and EBITDA.

 Year Mar 09(12) 

Mar 08(12) 

Mar 07(12) 

Mar 06(12) 

Mar 05(12) 

EBIT 1,462.10 1,733.61 1,667.40 1,326.75 928.61EBIT(1-T) 1081.954 1282.8714 1233.876 981.795 687.1714Net block 2567.6 1,710.96 1,541.45 1,348.98 1,340.95Cap exp 856.64 169.51 192.47 8.03 7.22NWC 347.64 1062.74 550.67 375.83 -7.55Change in NWC

-715.1 512.07 174.84 383.38 -349.14

FCFF 940.414 601.2914 866.566 590.385 1029.0914FCFF

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FCFF Diagram

Fig: Free Cash Flow Diagram

Average FCFF 805.54956STD FCFF 199.93721

Firm has very stable positive cash flows over the last 5 years which increases its ability to take debt

INTANGIBLE ASSET

Company has following intangible assets in its books

1) Technical knowhow: The expenditure incurred is amortised over the estimated period of benefit, not exceeding six years commencing with the year of purchase of the technology.

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2) Development expenditure: The expenditure incurred on technical services and other project/product related expenses are amortised over the estimated period of benefit, not exceeding five years.

3) Software expenditure: The expenditure incurred is amortised over three financial years equally commencing from the year in which the expenditure is incurred.

So the company has much less proportion of intangible assets as compared to tangible assets in its books. As Mahindra owns most of its expertise in process rather than huge technical niche, bondholders can easily observe what equity investors are doing.

OPERATING INCOME

OPERATING INCOME FOR LAST 5 YEARS (in crores)Mean 1423.69

Standard Deviation 320.71

Firms operating income have been very volatile in last 5 years. This increases the cost of debt for the firm.

BANKRUPTCY RISK AGENCY COST FUTURE FLEXIBILITY

Mahindra and Mahindra Mahindra and Mahindra is part of very large conglomerate Mahindra group which has operations in large number of businesses. Hence bankruptcy risk is small

Mahindra group is owned by family. So increase in debt will ensure that firm is not making negative NPV decisions.

Mahindra and Mahindra ltd. is the flagship company of Mahindra group. It is presently in automotive industry is cut throat. Lot of foreign companies are introducing new models in new future. So M &M ltd. needs flexibility to make future investments.

OPTIMAL CAPITAL STRUCTURECURRENTT CAPITAL STRUCTURE OF THE FIRM

Risk Premium 17.76% Cost of Equity 0.23569 D/D+E 0.11570Risk Free Rate 8.27% Cost of Debt 0.0927 E/D+E 0.88429Beta 0.86 EBITDA 1383.00Market Value of 30,975.1 Depreciation 292.00

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Equity EBIT 1091.00Market Value of firm

4,052.76 WACC 21.64%

DebtTotal Market Value 35,027.8

OPTIMAL CAPITAL STRUCTRUE

Debt Ke Interest coverage ratio

credit rating

Kd wacc MV-firm

0.0000 0.119693 - 0 0.119693 34224.70.0500 0.121056 25.24873 AAA 0.0902 0.118341 34615.850.1000 0.12257 12.62437 AAA 0.0902 0.116988 35016.050.1500 0.124263 8.416244 A+ 0.0977 0.116468 35172.380.2000 0.126167 6.312183 A 0.1007 0.115837 35363.980.2500 0.128325 5.049746 A- 0.1027 0.115243 35546.250.3000 0.130791 4.208122 BBB 0.1052 0.114908 35649.880.3500 0.133637 3.606962 BBB 0.1052 0.114111 35877.030.4000 0.136957 3.156091 BB 0.1177 0.117013 35008.560.4500 0.14088 2.805415 B+ 0.1302 0.120841 33899.70.5000 0.145588 2.524873 B+ 0.1302 0.120968 33863.970.5500 0.151343 2.295339 B 0.1477 0.128218 31949.160.6000 0.158536 2.104061 B 0.1477 0.128993 31757.20.6500 0.167784 1.94221 B- 0.1627 0.136983 29904.86

0.7000 0.180115 1.803481 B- 0.1627 0.138313 29617.30.7500 0.197379 1.683249 B- 0.1627 0.139643 29335.210.8000 0.223274 1.578046 B- 0.1627 0.140973 29058.450.8500 0.266433 1.485219 CCC 0.1827 0.154883 26448.720.9000 0.35275 1.402707 CCC 0.1827 0.156953 26099.90.9500 0.611703 1.328881 CCC 0.1827 0.159023 25760.16

We have plotted WACC, Ke and Kd against debt ratio. Both cost of debt and cost of equity increases with debt ratio. While WACC initially decreases with increase in debt to equity ratio then it starts decreasing. Lowest WACC is attained at D/E ratio of 0.5385 or debt to value ratio of 0.35. Optimal WACC is 11.41%.

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WACC VS D/V

Then we have found what will happen to firm value when firm moves to the optimal with the help of following formulaNew Value of firm = Old value of firm *( 1 + ( Old WACC- New WACC)/Old WACC)

Then we have plotted the firm value against debt to value ratio. Optimal firm value comes out to be 35877.03 crores.

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MARKET VALUE OF FIRM VS D/V

So we get the following final results

At Optimal D/E ratio 0.5385D/V 0.35WACC 11.41%Market Value of firm 35877.89135Market Value of debt 12557.26197Market Value of equity 23320.62938No. of Shares 279,821,265.00Share price 833.4116201

OPTIMAL CAPITAL STRUCTURE AT CONSTRAINED CREDIT RATINGThe company credit rating at optimal debt to equity ratio is BBB. If we constrain the credit rating of the firm at AAA, then optimal debt to equity ratio of the firm is 0.1111.

Constrained Credit rating A Optimal D/E ratio 0.25Market Value of firm 35360

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Market Value of debt 7072Market Value of equity 28288No. of Shares 279,821,265.0Share price 1010.93

OPTIMAL CAPITAL STRUCTURE AT NORMALISED OPERATING INCOMEIf we normalize the operating income of the firm we get the following

2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2008.0 2009.0Operating Income 344.9 483.2 692.4 928.6 1326.8 1667.4 1733.6 1462.1Net Sales 3934.5 4498.3 5887.1 7649.5 9273.1 11232.

012894.

914713.

0Sales as % of This yr Sales

26.7 30.6 40.0 52.0 63.0 76.3 87.6 100.0

Standardized Operating Income

1289.6 1580.6 1730.4 1786.1 2105.1 2184.2 1978.0 1462.1

Normalized Income 1764.5

Using this normalized operating income for the firm we get the following result for the capital structure of the firm

At Optimal D/V ratio 40%D/E 0.6667WACC 11.33%Market Value of firm 36151.68956Market Value of debt 14460.67582Market Value of equity 21691.01374

Nor of shares 279,821,265.00

Share Price 775.1738859

RELATIVE ANALYSISWe have found debt and equity of firms in the same sector as Mahindra and Mahindra and find the values of factors affecting debt capacity of the firm for them and Mahindra and Mahindra and Mahindra

Company debt/mv effective tax rate

Average OI Std (OI) EBITDA/mv

Mahindra 0.12 0.29 1423.69 320.71 0.05

Maruti 0.02 0.02 2446.18 516.24 0.06

Force 0.47 0.29 43.72 91.82 0.27

Swaraz 0.70 0.34 39.83 9.61 0.09

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Eicher 0.13 0.13 179.70 70.67 0.20

tata motors 0.50 0.15 3516.94 988.19 0.04

Then we have done regression with ratio of debt to market value of firm as dependent variable. And we have taken effective tax rate of the firms, their mean operating income, standard deviation of their operating income and ebitda to market value of the firm as independent variables.

SUMMARY OUTPUTRegression Statistics

Multiple R 0.86484R Square 0.74794Adjusted R Square -0.2603Standard Error 0.29007Observations 6

ANOVAdf SS MS F Significance

FRegression 4.000 0.250 0.062 0.742 0.690Residual 1.000 0.084 0.084Total 5.000 0.334

Coefficients Standard Error

t Stat P-value

Lower 95% Upper 95%

Lower 95.0%

Upper 95.0%

Intercept -0.26 1.02 -0.25 0.84 -13.25 12.73 -13.25 12.73effective tax rate

2.83 2.31 1.23 0.44 -26.53 32.20 -26.53 32.20

Average OI 0.00 0.00 0.55 0.68 -0.01 0.01 -0.01 0.01Std (OI) 0.00 0.00 -0.62 0.65 -0.03 0.03 -0.03 0.03EBITDA/MV -0.01 3.22 0.00 1.00 -40.95 40.93 -40.95 40.93

Predicted Value of Debt/Market Value of Mahindra and Mahindra by this regression is 0.34 whereas present debt to market value ratio of company is 0.11. Hence Mahindra and Mahindra is underleveraged compared to industry.

MECHNANICS OF MOVING TO THE OPTIMAL

THE IMMEDIACY QUESTIONName Market Value

(crores)ROCE P/E per share Percentage of

insider holdings

Mahindra 35027.86 14.83% 15.52 24.68%

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Force Motors 631.16 -18.88% 3.78 51%

Swaraj Mazda 550.5 8.38% 21.24 53.425%Eicher Motors 1671.7 6.03% 44.52 55.90%

Tata Motors 55895.4 6.88% 19.08 38.07%

In Mahindra and Mahindra ltd. insider holdings is quite small which makes it a take over target. And its price to earnings ratio at 15.52 is not large compared to its peer group. But its market value of 35027 crores act as deterrent against hostile takeover.

AFTER FINANCING MIX OR TAKE PROJECTS

Year End

Dividend Dividend(%) Div Yield(%)

200903 278.83 100 2.61200803 282.61 115 1.65200703 282.23 115 1.47200603 243.97 100 1.59200503 150.81 130 5.23200403 104.41 90 3.87200303 63.81 55 11.06200203 56.21 50 8.8

Mahindra has been paying dividend regularly over the last 10 years. So its shareholders consist of clientele of investors who have come to expect dividends.

TAXATION ON DIVIDEND AND CAPITAL GAINSAs of 2008, equities are considered long term capital if the holding period is one year or more.

Long term capital gains from equities are not taxed if shares are sold through recognised stock exchange and STT is paid on the sale. However short term capital gain from equities held for less than one year, is taxed at 10% (As on Budget 2009-10) (plus surcharge and education cess). This is applicable only for transactions that attract Securities Transaction Tax (STT)

At present the dividend distribution tax is 15%, according to the Union Budget 2007, India.As per existing tax provisions, income from dividends is tax free in the hands of the investor. However, this is not to say that there is no tax levied at all. On the contrary, there is a levy of 15% of the dividend declared as distribution tax. This tax is paid out of the profits/reserves of the company declaring the dividend.

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COMPANY CASH FLOW

Mar 09 Mar 08 Mar 07 Mar 06 Mar 05Cash Flow SummaryCash and Cash Equivalents at Beginning of the year

923.88 1361.79

725.16 630.69 233.33

Net Cash from Operating Activities 1631.3 825.83 1168.95

686.9 414.04

Net Cash Used in Investing Activities -1690.2

6

-2075.0

8

-950.4 -502.66 -209.13

Net Cash Used in Financing Activities 696.91 811.34 418.08 -89.78 192.45Net Inc/(Dec) in Cash and Cash Equivalent 637.95 -437.91 636.63 94.46 397.36Cash and Cash Equivalents at End of the year 1561.8

3923.88 1361.7

9725.15 630.69

CHOICE OF MECHANICS OF MOVING TO THE OPTIMALSFirm is not in danger of hostile takeover bid. So it does not need to move fast to its optimal

capital structure but it can move gradually towards its optimal capital structure. Firm can do this in 2 ways either it can increase dividends or it can take up projects which slowly moves its capital structure towards optimal. Mahindra and Mahindra has last year decreased its payout ratio of dividends by 15%. And there is no sign in long run profitability of the firm. World economy is still not completely out of recession yet. In such a situation it is not advisable to increase dividends, moreover in India long term capital gains tax rate is zero for shareholder who had paid their securities transaction tax. But Dividend is taxed at 15% in India.

But is there is a choice between paying dividends or stock buybacks to return cash to share holders. Then we will prefer dividends, because Mahindra cash flows have been stable but its not cash balance is not large enough to return enough cash that is required to move towards optimal capital structure.

REGRESSION OF MARKET VALUE OF FIRM WITH MACROECONOMIC FACTORSSUMMARY OUTPUT

Regression StatisticsMultiple R 0.760050532R Square 0.552525268Adjusted R Square 0.594345288Standard Error 8603.22811Observations 60

ANOVA

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df SS MS F Significance FRegression 4 271507330 67876833 3.91706 0.890647222Residual 55 4070854366 74015534Total 59 4342361696

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Market Value 22280.74104 1135.88206 19.61536 1.7E-26 20004.38253 24557.09954Change in forex -4142.065561 2544.82756 -1.62764 0.10932 -9242.013915 957.8827923change in bond yield 1007.17965 805.203988 1.501005 0.06188 -3026.982452 5041.341752change in gdp 6.686614371 1.54210354 2.168017 0.08328 -6.054457755 12.53035325change in inflation 43.66474906 5.23108871 2.22591 0.05801 37.86176348 50.22869714

REGRESSION OF OPERATING INCOME OF THE FIRM WITH MACROECONOMIC VARIABLES

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.86R Square 0.67Adjusted R Square 0.79Standard Error 8603.23Observations 60.00

ANOVA

df SS MS F Significance FRegression 4.00 271507330.25 67876832.56 4.92 0.94Residual 55.00 4070854365.51 74015533.92Total 59.00 4342361695.76

Coefficients Standard Error t Stat P-value Lower 95%15914.82 1135.88 29.62 0.00 18186.58

Change in forex -3313.65 2035.86 -0.63 0.12 758.07change in bond yield

1119.09 838.75 1.65 0.04 2796.60

change in gdp 6.69 1.40 2.56 0.07 9.49change in inflation 39.70 4.62 2.62 0.06 48.93

After doing multiple regression of firm’s market value and operating income against macroeconomic variables. We find that variation in operating income of the firm is explained by macro economic variables. Its multiple r square is 0.86 which shows that 86 % of variation is explained. Predictability of

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market value of firm by macroeconomic variables is also good. Multiple r square of the model is 0.76 which means 76 % of variation in market value of firm is explained by the model.

DIVIDEND POLICY

Dividend declared in the past yearsYear End Dividend Dividend(%) Div Yield(%)

2009-03 278.83 100 2.612008-03 282.61 115 1.652007-03 282.23 115 1.472006-03 243.97 100 1.592005-03 150.81 130 5.232004-03 104.41 90 3.872003-03 63.81 55 11.062002-03 56.21 50 8.82001-03 60.77 55 9.152000-03 60.77 55 3.42

Firm has been consistently paying dividends since several years. Firm reduced its dividend in last year.

Dividend yield of Mahindra and Mahindra reached its peak in 2003. Then it started falling. But in last year it improved it a little bit.

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Year End

Dividend

Dividend(%)

Div Yield(%)

Stock Buyback

Net Cash to Shareholders

EPS (annualised) (Unit Curr)

Payout (%)

  Reported Net Profit

2009-03

278.83 100 2.61 0 278.83 30.6 33.42 867.51

2008-03

282.61 115 1.65 0 282.61 44.54 26.54 1,103.37

2007-03

282.23 115 1.47 0 282.23 43.1 27.51 1,068.39

2006-03

243.97 100 1.59 0 243.97 35.26 29.65 857.1

2005-03

150.81 130 5.23 0 150.81 44.02 30.68 512.67

2004-03

104.41 90 3.87 0 104.41 28.89 31.15 348.54

2003-03

63.81 55 11.06 0 63.81 11.84 46.45 145.54

2002-03

56.21 50 8.8 0 56.21 8.85 54.74 102.69

2001-03

60.77 55 9.15 0 60.77 10.35 53.14 120.56

2000-03

60.77 55 3.42 0 60.77 23.24 23.66 263.48

Average

4.885

Dividend Payout is near 30% from last 5 years.Net increase in dividend from last 5 years (2005) is Rs. 138 Cr which is increase of 92% from last 5 years. Mahindra and Mahindra net profit decreased last year.

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Year 2009 Dividend(Rs in Crores)

Dividend %

Dividend

Yield(%)

M&M 278.83 100 2.61Tata Motors 311.61 60 3.33Force Motors 0 0 0

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Eicher Motors 0 0 0Swaraj Mazda 1.57 15 1.37

1.462Many competitors are not paying dividend

No of Shares % Share Holding

Share Holder

Foreign (Promoter & Group) 7,127,304.00 2.5471 2Indian (Promoter & Group) 69,063,784.0

024.6814 58

Total of Promoter 76191088 27.2285 60Non Promoter (Institution) 140130069 50.0784 715Non Promoter (Non-Institution) 47665482 17.0343 138374Total Non Promoter 187795551 67.1127 139089Total Promoter & Non Promoter 263986639 94.3412 139149Custodians(Against Depository Receipts) 15834626 5.6588 3Grand Total 279821265 100 139152

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FRAMEWORK FOR ANALYZING DIVIDENDS

 Year Mar 09(12)  Mar 08(12)  Mar 07(12)  Mar 06(12)  Mar 05(12) 

Dividend 278.83 282.61 282.23 243.97 150.81FCFF 940.414 601.2914 866.566 590.385 1029.09

1Total Debt 4,052.76 2,587.06 1,636.00 883.38 1,052.62Change in Debt 1,465.70 951.06 752.62 -169.24 322.81FCFE 2,406.11 1,552.35 1,619.19 421.15 1,351.90Div/FCFE 0.115883952 0.182052852 0.174303632 0.579301666 0.11155

4FCFE-Dividend 2,127.28 1,269.74 1,336.96 177.18 1,201.09 Cash and Bank 1,574.43 861.23 1,326.07 730.31 623.98

They have enough money to give dividend but they need money to reinvest. Recently they are going for scooter segment and so they need money to invest in other high potential projects. Despite the recession firm has been consistently distributing cash among the shareholders in the form of dividends

Year End

2009-03 2008-03 2007-03 2006-03 2005-03 2004-03 2003-03 2002-03

Payout 33.42 26.54 27.51 29.65 30.68 31.15 46.45 54.74

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(%)ROE 0.19956

20.25485

50.30838

90.34117

30.28576

30.21140

80.07958

90.05113

4ROE(%) 19.9562

425.4854

630.8388

734.1173

128.5763

421.1407

67.95891

15.11343

9

Here we can see that the firm had increasing ROE from 2003 to 2006 and started decreasing after that. Firm is having a very high ROE, this implies that they have been making good investments in the recent past. So, the company can think of retaining the earnings with themselves and can invest in some good projects rather than paying the payout almost equal to ROE. In this case investors can earn a decent return on their invested capital.

VALUATION

2009 2010 2011 2012 2013Net Profit 1383.551 2074.552 2667.776 3144.636 3233.617  Depreciation+ 343.775 376.355 408.935 441.515 474.095Operating Cash Flows 1727.326 2450.907 3076.711 3586.151 3707.712  Gross Block + 4498.722 4827.124 5155.527 5483.93 5812.332Capital Expenditure -395.168 328.4026 428.4026 458.4026 528.4026Working Capital 522.6504 541.6257 560.6011 579.5764 598.5518Working Capital Change 239.2104 18.97536 28.97536 35.97536 38.97536FCFF 1477.348 1379.948 1993.529 2582.333 3018.773

Discount Rate 0.116949

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Terminal Growth Rate 0.04Present Value of Firm 28266.75No. of Shares 2.8E+08Price per share 1010.172Terminal Value 40800.21PV Terminal Value 23469.08

33