Cost of Capital Project

A Project Report On: ‘Cost of Capital’ of Shree Cement Ltd.

A Report submitted towards the partial fulfilment of the requirements of two year full time in Master of  Business Administration

UNDER GUIDANCE OF:

Submitted By:

Mr. N.C. JAIN

SAGAR SHARMA MBA 3rd Sem.

(Asst. Vice President Finance)

(2008-2010)

Management and Commerce Institute of Global Synergy, Ajmer. 1

ACKNOWLEDGEMENT A large number of individual has contributed to this project. I am thankful to all of them for  their help and encouragement. Like other reports, this report is also drawn from the work of  large number of researchers and author in the field of finance.

I would like to express my gratitude to Mr. N.C. Jain S.G.M. (finance) for giving me the opportunity and enough of support to undergo training in their organization, SHREE CEMENT LTD, BEAWER (RAJ)

I shall like to thanks SHREE’S finance department for their able guidance, support, supervision and care during the whole training programme and to whom words can never  express my feeling of gratitude and reverence. I would like to give my sincere thanks to officers, managers and employees of SHREE CEMENT LTD, BEAWER (RAJ) for providing providing valuable information information,, reports reports and data that were require for the study. The successful completion of my project has been carried out under the able guidance of Mr. Mr. N.C N.C Jain Jain S.G.M .G.M (fin (finan ance ce). ). I take take upon upon this this oppo opport rtun unit ity y to than thank k them them for  for  encouragement and guidance in completion of project. Their knowledge and expertise was of  great help for the project study. Last but not least, I would like to express my deep sense of gratitude to my parents and friends for their unflinching moral support. Their towering presence instilled in me the carving to the work harder and completes this daunting task timely with a sufficient degree of  in depth study. I have tried to give credit to all sources form where I have drawn material in this project still I fell obliged if they are brought to my notice.

(SAGAR SHARMA) 2

ACKNOWLEDGEMENT A large number of individual has contributed to this project. I am thankful to all of them for  their help and encouragement. Like other reports, this report is also drawn from the work of  large number of researchers and author in the field of finance.

I would like to express my gratitude to Mr. N.C. Jain S.G.M. (finance) for giving me the opportunity and enough of support to undergo training in their organization, SHREE CEMENT LTD, BEAWER (RAJ)

I shall like to thanks SHREE’S finance department for their able guidance, support, supervision and care during the whole training programme and to whom words can never  express my feeling of gratitude and reverence. I would like to give my sincere thanks to officers, managers and employees of SHREE CEMENT LTD, BEAWER (RAJ) for providing providing valuable information information,, reports reports and data that were require for the study. The successful completion of my project has been carried out under the able guidance of Mr. Mr. N.C N.C Jain Jain S.G.M .G.M (fin (finan ance ce). ). I take take upon upon this this oppo opport rtun unit ity y to than thank k them them for  for  encouragement and guidance in completion of project. Their knowledge and expertise was of  great help for the project study. Last but not least, I would like to express my deep sense of gratitude to my parents and friends for their unflinching moral support. Their towering presence instilled in me the carving to the work harder and completes this daunting task timely with a sufficient degree of  in depth study. I have tried to give credit to all sources form where I have drawn material in this project still I fell obliged if they are brought to my notice.

(SAGAR SHARMA) 2

PREFACE

About three decade ago, the scope of financial management was confined to the raising of  funds, whenever needed and little significance used to be attached to financial decisionmaking and problem solving. As a consequence, the traditional finance texts were structured around this theme and contained description of the instruments and institutions of raising funds and of the major events, such as promotion, reorganization, Readjustment, merger, consolidation etc. When funds were raised. In the mid fifties, the emphasis shifted to the judicious utilization of funds. The modern thinking in financial management accords a far greater importance to management decision-making and policy. Today, financial management donot perform the passive role of scorekeepers of financial data and information, and arranging funds, whenever directed to do so. Rather, they occupy the key position in top management areas and play a dynamic role in solving complex management problems. They are now responsible for the fortune of the enterprises and are involved in the most vital management decision of allocation of capital. It is their duty to insure the funds are raised most economically and used in the most efficient and effective manner. Because of this change in emphasis, the descriptive treatment of the subject of  financial management is being replaced by growing analytical content and sound theoretical underpinnings.

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INDEX

S.NO.

PARTICULARS

PAGE NO.

1.

Cement Industry Overview

5.

2.

Introduction of Shree Cement

6.

3.

The The Cem Cement ent Ind Indust ustry Stru Struct ctu ure

12. 12.

4.

Maj Major Playe ayers of the Industry try

14.

5

Policies

16.

6.

SWOT Analysis

20.

7.

Cement Manufacture

25.

8.

Research Methodology

28.

9.

Cost of Capital

30.

10.

Cost of Debts

35.

11.

Cost of Equity

37.

12. 12.

Weig We ight hted ed Aver Averag agee Cost Cost of Capi Capita tall

40. 40.

13. 13.

Conc Conclu lusi sion on and and Reco Recomm mmen enda dati tion on

49. 49.

14.

Bibliography

49.

4

Cement Industry Overview The Indian Cement industry dates back to 1914, with first unit was set-up at Porbandar with a capacity of 1000 tones. Currently The Indian cement industry with a total capacity of about 170 m tones (excluding mini plants) in FY07-08, has surpassed developed nations like USA and Japan and has emerged as the second largest market after China . Although consolidation has taken place in the Indian cement industry with the top five players controlling almost 50% of the capacity, the remaining 50% of the capacity remains pretty fragmented. Per capita consumption has increased from 28 kg in 1980-81 to 115 kg in 2005. In relative terms, India’s average consumption is still low and the process of  catching up with international averages will drive future growth. Infrastructure spending (particularly on roads, roads, ports ports and airport airports), s), a spurt spurt in housin housing g constr construct uction ion and expans expansion ion in corpor corporate ate produc productio tion n facilities is likely to spur growth in this area. South-East Asia and the Middle East are potential export market markets. s. Low cost cost techno technolog logy y and extens extensive ive restruc restructur turing ing have have made made some some of the Indian Indian cement cement companies the most efficient across global majors. Despite some consolidation, the industry remains

5

somewhat fragmented and merger and acquisition possibilities are strong. Investment norms including guidelines for foreign direct investment (FDI) are investor-friendly. All these factors present a strong case for investing in the Indian market.

 Now, the Indian cement industry is on a roll. Riding on increased activity in real estate, cement  production has registered a growth of 9.28 per cent in April, 2008, at 14 million tones as against 11.41 million tones in the corresponding period a year ago. The growth trend has been on for some time now. If these trends are anything to go by, it will not be long before the sector will match the demand supply gap. During the Tenth Plan, the industry, which is ranked second in the world in terms of production, is expected to grow at 10 per cent per annum adding a capacity of 40-52 million tones, according to the annual report of the Department of Industrial Policy and Promotion (DIPP). The report reveals that this growth trend is being driven mainly by the expansion of existing plants and using more fly ash in the  production of cement.

INTRODUCTION ABOUT THE ORGANISATION

Shree Cement Limited is a Beawar based company, located in Rajasthan. The Company is a part of  the Bangur Group and was incorporated on 25th October1979, at Jaipur with a Vision: “To register strong consumer surplus through a superior cement quality at affordable price.” Commercial

  production commenced from 1st May1985 with a installed capacity of 6 lacs tones per annum in Beawar dist. Ajmer, the capacity of this plant was upgraded to 7.6 lacs tones per annum during 1994-95 by a modernization and up gradation programme. In 1995 - The Company undertook the implementation of new unit of 1.24 MT capacity per annum named "Raj Cement”. In 1997 The Company commissioned its second cement plant - Raj Cement with a capacity of 12.4 lacs tones  per annum adjacent to its existing plant in order to take full advantage of its existing infrastructure and already developed captive mining lease enough to sustain a new cement plan. The cumulative capacity was enhanced by de-bottlenecking and balancing equipment in December 2001 to 2.6 6

MTPA. A product called “Tuff Cemento” has also launched by the company in April 2007. At   present company is producing over 100% capacity utilization, it is the largest single location cement producer in north India (sixth in country).

C OM PA NY

P RO FI LE

COMPANY

SHREE CEMENT LTD.®

INCORPORATION YEAR 

1979

REGISTERED OFFICE

BANGUR NAGAR, BEAWAR, AJMER  (RAJASTHAN)

CORPORATE OFFICE

21, STRAND ROAD, KOLKATA  

INDUSTRY

CEMENT MANUFACTURING

CHAIRMAN

B.G. BANGUR  

MANAGING DIRECTOR

H.M. BANGUR  

EXECUTIVE DIRECTOR

M.K. SINGHI

EQUITY CAPITAL

34.84 CRORES

FACE VALUE OF SHARE

10

EQUITY CAPITAL

34.84 CRORES

FACE VALUE OF SHARE

10

Shree Cement Limited is one of the fastest growing Cement Companies in India. Presently

Shree Cement has 9.1 MTPA capacity in three plants (Shree in Beawar 2.6 MTPA, Ras in Pali District 3 M T a nd K hushkhera capacit y is 3.5 MTPA) The organization has performed 7

exceptionally well in the year 2007-08 increasing the PBT by 95% the reasons for this remarkable achievement and key strengths of the company are discussed in the report. For the last 18 years, it has been consistently producing many notches above the nameplate capacity. The company retains its position as north India’s largest single-location manufacturer. Shree’s principal cement consuming markets comprise Rajasthan, Delhi, Haryana, Punjab, Uttar Pradesh and Uttranchal. Shree manufactures Ordinary Portland Cement (OPC) and Portland Pozzolana Cement (PPC). It has three brands under its portfolio viz., Shree Ultra Jung Rodhak Cement, Bangur Cement and Tuff  Cemento. The Shree Vision – 

To be one of the India’s most respected enterprise through “best-in-class performance” and leading by “low carbon” philosophy making it a progressive organization that all stakeholders proud to deal with.

The Shree Mission – 

The company continues to be one of the most operationally efficient and energy conserving cements  producers in the world. Its mission statement is •

To harness sustainability through low-carbon philosophy

•

To sustain its reputation as one of the most efficient manufacture globally.

•

To continually have most engaged team.

•

To continually add value to its products and operation meeting expectations of all its stakeholders.

•

To continually build and upgrade skills and competencies of its human resource for growth

•

To be a responsible corporate citizen with total commitment to communities in which it operates and society at large.

Origin of the Company

Promoted by the Bangur Group, Shree Cements is the largest cement producer in Rajasthan. The company has a total installed capacity of 6.825 million tonne (opc basis)The plants are strategically located in central Rajasthan, from where it can cater to the entire Rajasthan market as well as Delhi and Haryana. The company has about 100 sales offices spread across the states of Rajasthan, Uttar  Pradesh, Uttaranchal, Delhi, Haryana, Punjab and Jammu & Kashmir. Its cement is marketed under  the brand name of “Shree Ultra Cement” with different grades like 33, 43 and 53 and sub-brand names like "red oxide cement", "Jung Rodhak Cement", etc.

8

Shree Cement Ltd (SCL) is located at Beawer, Rajasthan, India’s largest cement producing state. It was incorporated in 1979. Commercial production at its 0.6 million tones per annum (mtpa) cement  plant in Rajasthan commenced in May 1985. Three companies of the Bangur group promoted SCL. These companies are Shree Digvijay Company Ltd, Graphite India Ltd and Fort Gloster Industries Ltd. Over the years, SCL's capacity rose and touched 2 mtpa by 1997-98. Its current cumulative installed capacity stands at 2.6 mtpa & in 2003-04 the company produced 2.84 million tones of  cement making it the largest single location cement producer in north India. It is operating at over  100% capacity utilization. Shree caters to cement demand arising in Rajasthan, Delhi, Haryana, UP and Punjab. What is strategic for SCL is that it is located in central Rajasthan so it can cater to the entire Rajasthan market with the most economic logistics cost. Also, Shree Cement is the closest plant to Delhi and Haryana among all cement manufacturers in its state and proximity to these profitable cement markets renders the company an edge over other cement companies of the company in terms of lower freight costs. Shree’s total captive power plant capacity today stands at 101.5 MW. In 2000-01, the company has succeeded in substituting conventional coke with 100 per cent pet coke, a waste from refineries, as  primary fuel resulting in lower inventory and input costs. In the past two years the price of coal has gone up. Earlier dependent on good quality imported coal, the company's switch to pet coke could not have come at a better time. The company also replaced indigenous refractory bricks with imported substitutes, reducing its consumption per tonne of clinker. The company has one of the most energy efficient plants in the world. The captive plant generates power at a cost of Rs 4.5 per  unit (excluding interest and depreciation) as compared to over Rs 5 per unit from the grid. In appreciation of its achievements in Energy sector, the Company has been awarded the prestigious 'National Energy Conservation Award" for the year 1997. Shree is rated best by Whitehopleman, an international agency specializing in the rating of cement plants. MULTIPLE COMPETITIVE BRANDS

Incisive execution of Shree’s multiple competitive brand strategy has been delivering results along anticipated lines. Consistency in brand strategy is helping Shree to sustain its brands having lasting impression among its consumers. The steady growth in Shree’e volume especially year-on –year in the last two fiscals, testifies to the effectiveness of its multi brand marketing strategy. SHREE ULTRA

Launched in 2002, Shree Ultra was the company’s first brand, the first manifestation of Shree’s strategic move from commodity to brand marketing.

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Its generic OPC version has been joined by a variant, Shree Ultra Jung Rodhak, on the functional differentiator of rust prevention. Together the two variance have made Shree Ultra the flagship brand of the company, contributing half of the Shree’s total sales. The brand was launched with powerful media and promotional support, the imaginative advertising and the momentum has clearly sustained it’s growth over time. Today it is present all of Shree Cement’s market territories. In 07-08 it chalked up its highest volumes in the home market of Rajasthan, and in the NCR, the main focus of the construction boom in north India. Overall, Shree Ultra volumes reflects its acceptance by professional influencers. Which in turn facilities acceptance by domestic consumers. Their support, as well as sustained local promotions, has helped to improve brand recall, and prepared the ground for fresh initiatives in the market place. BANGUR CEMENT

Bangur Cement was launched in 2006 as a premium brand, competitive with best in the market designed to full fill user aspiration for high quality construction, the brand tagline reflects its  promise of top-of-market value: “Sasta Nahi, Sabse Achcha”. Given the premium profile design for it the brand is supported by a matching network of business  partners and business associates carefully selected for the track record in selling to high end market segment. Its early successes are founded on a two tier marketing and distribution programme. At one level Shree’s field forts takes the trades in to the confident with transparent terms and tested and proven  promotional offrings. On a more exclusive level, it deploys special teams of highly professional technical sales experts t conduct direct, one on one interaction with opinion builders and influencers if high standing among the fraternity of respected construction space list. Bangur Cement has achieved 95% of its total sales in the trade segment. It has made selective  penetration in both urban and rural markets. Bangur cement maintained its zero outstandings status in this year as well.

TUFF CEMENTO

This is the latest brand offering from Shree Cement, directed at a highly competitive niche market, with aggressive and establish competitors. It has been position as rock strong- on the promise of high performance, able to withstand exceptionally harsh environmental conditions. Launched in the first month of the year under review, Tuff Cemento was able to secure a network of  the 1000 dynamic and resourceful dealers in a record time of about four months. The brand is consolidated its position in the market, and the making further headway in Rajasthan, Delhi, Haryana, parts of south Punjab and Western U.P. While its current status would otherwise be regarded as reasonable. Tuff Cemento has an altogether  more ambitious agenda: to be aggressively competitive and become a leading brand in the coming months, and to enable Shree Cement to achieve the maximum possible combined market share in its market.

10

CEMENT Cements are of two basic types- gray cement and white cement. Grey cement is used only for  construction purposes while white cement can be put to a variety of uses. It is used for mosaic and terrazzo flooring and certain cements paints. It is used as a primer for paints besides has a variety of  architectural uses. The cost of white cement is approximately three times that of gray cement. White cement is more expensive because its production cost is more and excise duty on white cement is also higher. Shree cement does not manufacture white cement at present.

CEMENT

GREY

Portland Pozzolona Cement

WHITE

Ordinary Portland cement

Pozzolona used in the manufacture of Portland cement is burnt clay of fly ash generated at thermal power plants. PPC is hydraulic cement. PPC differs from OPC on a number of counts. 11

Pozzolona during manufacturing consumes lot of hydration heat and forms ‘cementious gel’. Reduced heat of hydration leads to lesser shrinkage cracks. An additional gel formation leads to lesser pores in concrete or mortar. It also minimizes problem of leaching and efflorescence.

The Cement Industry Structure Presently the total installed capacity of Indian Cement Industry is more than 175 mn tones per annum, with a production around 168 mn tones . The whole cement industry can be divided into Major cement  plants and Mini cement plants.

Major Cement Plants: •

Plants : 140

•

Typical installed capacity

•

Per plant : Above 1.5 mntpa

•

Total installed capacity : 170 mntpa

•

Production 07-08: 161 mntpa

•

All India reach through multiple plants

•

Export to Bangladesh, Nepal, Sri Lanka, UAE and Mauritius

•

Strong marketing network, tie-ups with customers, contractors

•

Wide spread distribution network .

•

Sales primarily through the dealer channel

12

Mini Cement Plants: •

Nearly 300 plants & Located in Gujarat, Rajasthan, MP mainly

•

Typical capacity < 200 tpd

•

Installed capacity around 9 mn. Tones

•

Production around : 6.2 mn tones

•

Mini plants were meant to tap scattered limestone reserves. However most set up in AP

•

Most use vertical kiln technology

•

Production cost / tonne - Rs. 1,000 to 1,400

•

Presence of these plants limited to the state

•

Infrastructural facilities not the best

Regional division

The Indian cement industry has to be viewed in terms of five regions:-

•

 North (Punjab, Delhi, Haryana, Himachal Pradesh, Rajasthan, Chandigarh, J&K and Uttranchal);

•

West (Maharashtra and Gujarat);

•

South (Tamil Nadu, Andhra Pradesh, Karnataka, Kerala, Pondicherry, Andaman & Nicobar and Goa);

•

East (Bihar, Orissa, West Bengal, Assam, Meghalaya, Jharkhand and Chhattisgarh); and

•

Central (Uttar Pradesh and Madhya Pradesh).

13

Regionwise Cement Production

Centeal 16% South 33% Est 16%

West 17%

North 18%

Major Players in Cement Industry Shree

Shree Cements Ltd. is a Rajasthan based company, located at Beawer. The company has installed capacity of 6.825 mn tones per annum( opc basis )in Rajasthan. For the last 18 years, it has been consistently producing many notches above the name plate capacity. The company retains its  position as north India’s largest single-location manufacturer. Shree’s principal cement consuming markets comprise Rajasthan, Delhi, Haryana, Punjab, Uttar Pradesh and Uttranchal. Shree manufactures Ordinary Portland Cement (OPC) and Portland Pozzolana Cement (PPC). Its output is marketed under the Shree Ultra Ordinary Portland Cement’ and ‘Shree Ultra Red Oxide Jung Rodhak Cement’ brand names. 14

Ambuja

GACL was set up in 1986 with 0.7 million tones. The capacity has grown 25 times since then to 18.5 million tones. GACL exports as much as 15 percent of its production. Thirty five per cent of the company’s products transported are by sea which is the cheapest mode. It has earned the reputation of being the lowest cost producer in the cement industry. Ambuja cement one of GACL’s well established brands. The company plans to increase capacity by 3-4 million tones in the near future.

ACC

Being formed in 1936, ACC has a capacity of 22.40 million ( including 0.53 million tones of  Damodar Cement and Slag and 0.96 million tones of Bargarh Cement ). ACC Super is one of the company’s well established brands. It is planning to expand the capacity of its wholly-owned subsidiary Damodar cement and Slag at Purulia in West Bengal. This is aimed at increasing its  presence in the eastern region. As on FY’07, ACC was the largest player with a capacity of 22.4 million tones per annum (including 0.525 mn tones per annum of its subsidiary Damodar Cement).

The Aditya Birla Group

The Aditya Birla Group is the world’s eighth largest cement producer. The first cement plant of  Grasim, the flagship of the Aditya Birla Group, at Jawad in Madhya Pradesh went on Stream in 1985. In total, Grasim has five integrated grey cement

 plants and six ready-mix concrete plants. The company is India’s largest white cement producer with a capacity of 4 lakh tones. It has one of the world’s largest white cement plant at Kharia Khangar  (Raj.) Shree Digvijay Cement, a subsidiary of Grasim, which was acquired in 1998, has its integrated grey cement plant at Sikka (Gujrat). Finally Grasim acquired controlling stake in Ultra Tech Cement Limited (Ultra Tech), the demerged cement business of L&T. Grasim has a total capacity of 31 million tones and eyeing to increase it to 48 MT by FY 09. Grasim has a portfolio of national brands which include Birla Supar, Birla Plus, Birla White and Birla Ready mix and also regional brands like Vikram Cement and Rajshree Cement.

Binani

A fierce competitor with a 2.2 MTPA plant is located at Binanigram, Pindwara, a village in Sirohi in the state of Rajasthan. It’s a tough nut player which is outside CMA (Cement Manufacturer’s Association) and is prime reason for driving prices low in market. Offers a good quality product at 15

cheap rates and has very good brand image. Sales are focused in the North India, Gujarat and Rajasthan markets. Holds around 14% of Rajasthan market.

JK 

An entrenched competitor that has brands across the price spectrum with JK Nembahera leading the  pack. Also operates in the white cement market with Birla as its only competitor. It lost significant market when Ambuja came to Rajasthan.

Others

Other players like Shriram have insignificant share and are highly localized. Shriram has a small   presence and that too largely in southern Rajasthan. There are various mini plants operating too which supply cheap cement which has no ISI certification and does not confirm BIS standards. Quite often they are supplied in other established brand’s cement bags. L&T is a strong player nationally and regarded as quality product. It has a footprint but not a foothold in Rajasthan market

POLICIES Quality Policy: •

‘To provide products conforming to national standards and meeting customers requirements to their  total satisfaction.

•

To continually improve performance and effectiveness of quality management system by setting and reviewing quality objectives for:

•

Customer Satisfaction

•

Cost EffectivenessSs

16

Energy Policy: •

‘To reduce to the maximum extent possible the consumption of energy without imparting  productivity which should help in:

•

Increase in the profitability of the company

•

Conservation of Energy

•

Reduction in Environmental pollution at energy producing areas Since Energy is Blood of Industry, It is the responsibility of all of us to utilize energy effectively and efficiently’

Environment Policy:

‘To ensure : •

Clean, green and healthy environment

•

Efficient use of natural resources, energy, plant and equipment

•

Reduction in emissions, noise, waste and greenhouse gases

•

Continual improvement in environment management

•

Compliance of relevant environmental legislation

Water Policy: •

To provide sufficient and safe water to people & plant as well as to conserve water, we are committed to efficient water management practices viz,

•

Develop means & methods for water harvesting

•

Treatment of waste discharge water for reuse

•

Educate people for effective utilization and conservation of water 

•

Water audit & regular monitoring of water consumption

Health & Safety Policy: •

‘To ensure good health and safe environment for all concerned by:

•

Promoting awareness on sound health and safe working practices

•

Continually improving health and safety performance by regularly setting and reviewing objectives & Targets

•

Identifying and minimizing injury and health hazards by effective risk control measures

•

Complying with all applicable legislations and regulations’

Human Resource Policy:

17

•

‘We at Shree Cement are committed to

•

Empower People

•

Honour individuality

•

 Non discrimination in recruitment process

•

Develop Competency

•

Employees shall be given enough opportunity for betterment

•

 None of the person below the age of 18 years shall be engaged to work 

•

Incidence of Sexual Harassment shall be viewed seriously

•

Statute enacted shall be honoured in letter & spirit & standard Labour Practices shall be followed. Every employee shall be accountable to the law of the land & is expected to follow the same without any deviation

•

Management will appreciate observance of Business ethics & professional code of conduct

•

To follow safety & Health. Quality, Environment, Energy Policy’

IT Policy:

‘To provide a robust IT platform suitable to the business processes and integrated management  practices of the company, resulting into better speed, efficiency, transparency, internal controls and  profitability of business’

Trade and Non-Trade Networks There are two types of Networks: Trade and Non-trade

a) Non-trade Network  Non-trade Network:

18

Govt. Non-trade

-

for govt infrastructure  building - Govt. Housing Projects - Railways - Airports - Cement Roads - Bridges - Dams - Canals These are all bulk requirements

Private Non-trade

-

for Group housing / retail housing contractor’s projects on  behalf of govt. Any industrial projects taken up by the private sector like bridges, roads etc.

b) Trade Network  Company

Handling Agent

Stockiest

Retailers

Consumers

Advertising Need for Advertising 



Cement has evolved into a highly commoditized product category. Due to competitive pricing

within the industry, there was not much differentiation among the various brands on offer.



People too did not pay much attention to this product unless there was a need. Hence people

who were currently making their houses or were soon to embark on such a project became the target market.

19



Because of the product being commoditized , there was a need for differentiation for which

there was made some changes in the form of the product . Shree Cement ltd. was not advertising its products past few years but looking at the competitive market and opportunities ahead it introduced a new ad campaign which was targeted to differentiate its product from other cement brands. It introduced an ad campaign showing the anti rusting capability of the Red Oxide Cement of the company. But still the presence of the company has not  been so intense as other brands have like Ambuja and Grasim etc.

SWOT Analysis for Shree Cements

Strengths 

Focused strategy



Lowest cost producer of cement in north India



A secure source of raw materials



High penetration in Govt. projects 20



Largest single plant capacity in India



Shree power plant , which is producing electricity enough for Ras plant

Weaknesses 

Less dealer incentives as compared to its competitors



Color of the cement has not been perceived greatly, green color was preferred the most



Poor advertising and brand promotion

Opportunities 

Real estate boom will lead to increased demand



International expansion



Demand from Pakistan side



Reduction in customs duties



Government’s thrust on infrastructure and tax incentives on housing loans

Threats 

Increased competition from domestic as well as international players



Rising input (oil) prices



Sales highly dependent on monsoons



Growth of counterfeits

Creating Multiple Brands to Increase Market Share

Company wanted to increase it’s share in the more remunerative markets. Rajasthan and Haryana are the markets where Shree have high realisation. They realized that a single brand has limited potential for faster increase in market share in these markets. This because there are limits to the volume that a distribution and retail network could handle. Thus there was a requirement for increasing distribution

21

network in these markets. To alleviate this, they studied the brand strategy of a fast moving Consumer Goods Company. This company had multiple brands for soaps. Each brand had a unique  products differentiation property. All bands were competing with each other. The marketing teams, distribution channel and logistics were all different for each brand. They found the same model could  be applied in cement business as well. They realized that they can also achieve their objective by introducing another brand in the market. The new brand would have its own marketing strategy, distribution network and penetration. It required deployment of almost twice the quantum of resources to sustain two brands in the markets. An altogether new marketing team, additional advertising cost, another set of storage and distribution logistics like godowns and offices, thus all such costs were doubling. Yet, Shree Cement chose to go ahead and launched Bangur Cement in 2006. The result, market share in Rajasthan almost doubled in  just one year. In Haryana it rose by almost 50 percent. Encouraged by the success of having two brands, we decided to launch a third brand-Tuff Cemento. With three brands we have further consolidated our position in the market. Today Shree have three  brands in the same market: Shree Ultra, Bangur Cement and Tuff Cemento. Each of these brands has been built on a unique product promise. As a result of multiple brand strategy Company’s market shares have shown appreciable growth, as demonstrated below:

Market share in different states STATE RAJASTHAN HARYANA DELHI PUNJAB U.P. UTTARANCHAL

2006-07 11.77% 16.15% 17.67% 5.36% 2.60% 7.32%

2007-08 20.36% 19.03% 17.94% 7.32% 3.98% 7.96%

2008-09 22.17% 23.91% 17.97% 8.29% 4.86% 10.13%

Efforts made to maintain three brands •

Independent marketing team

•

Separate distribution and retail network 

•

Separate storage and logistics supports

•

Higher advertisement cost

Achievements by maintaining three brands •

Higher Dealer Density

•

Higher market share

22

•

Better Realisation

•

Lower logistics cost

Risi 30 25

SUCCESS DRIVERS AT SHREE PEOPLE AS PROGRESS DRIVERS

Shree believes that what is present in the minds of people is more valuable than the assets on the shop floor. All the company’s initiatives are directed to leverage the value of this growing asset.

Market Share 2005-06 23

TEAMWORK 

Shree leverages effective team working to generate a sustainable improvement.

LEADERS AT EVERY LEVEL

Shree believes in creating leaders -not just at the organizational apex but at every level, resulting in a strong sense of emotional ownership.

CULTURE OF INNOVATION

Shree believes that what is good can be made better -across the organization.

CUSTOMER FOCUS

Shree is committed to deliver a superior quality of cement at attractively affordable prices.

SHAREHOLDER VALUE

Shree is focused on the enhancement of value through a number of strategic and business initiatives that generate larger and a better quality of earnings.

COMMUNITY AND ENVIRONMENT

Shree’s community concern extends from direct assistance to safe and dependable operations for its members and the environment.

LOWEST COST OF PRODUCTION

Its cost of production is around Rs.860 per ton, making it the lowest cost cement producer in India.

ENERGY EFFICIENT PRODUCER 

Shree Cement is one of the most power efficient units in the country with a power consumption of 75 units per ton. The Company sources 100% of power requirement from its captive power plants. The company has existing power plant capacity of 42 MW. The company is installing additional power   plant of 18 MW capacity, which would supply power to its new cement units, thus ensuring selfsufficiency.

ALTERNATE FUEL IN PET COKE

The Company’s captive power plant as well as cement plants runs on alternate fuel, i.e., pet coke, the first in India to do so. Until recently, it was obtaining pet coke domestically from Reliance Industries

24

Ltd., Jamnagar refinery. Imported pet coke and the future plan to source it from Panipat refinery of  IOCL will further bring down costs by around Rs.300 per tonne.

INCREASED BLENDING

SCL is continuously trying to improve the ratio of sale of blended cement (ROC) to 50:50 very soon. Although cost of production is lower because of addition of cheap fly-ash, it commands higher prices due to rust-retarding properties.

CEMENT MANUFACTURING Raw Material Preparation

25

Limestone of differing chemical composition is freely available in the quarries. This limestone is carefully blended before being crushed. Red mineral is added to the limestone at the crushing stage to provide consistent chemical composition of the raw materials. Once these materials have been crushed and subjected to online chemical analysis they are blended in a homogenized

Fig 2: Limestone Extraction

stockpile. A bucket wheel reclaimer is used to recover and further blend this raw material mix before transfer to the raw material grinding mills. Raw Mill

Transport belt conveyor transfers the blended raw materials to   ball mills where it is ground. The chemical analysis is again checked to ensure excellent quality control of the product. The resulting ground and dried raw meal is sent to a homogenizing and storage silo for further blending before being burnt in the kilns.

Fig 3: Kiln

Fig 3: Kiln

Fuels

The heat required to produce temperatures of 1,800°C at the flame is supplied by ground and dried petroleum coke and/or fuel oil. The Petcoke is imported via the companies' internal wharf, stored and then ground in dedicated mills. Careful control of the mills ensures optimum fineness of the Petcoke and excellent combustion conditions within the kilns system. Fig 4: Inside of Kiln

Burning

The raw meal is fed into the top of a pre-heater tower equipped with four cyclone stages. As it falls, the meal is heated up by the rising hot gases and reaches 800°C. At this temperature, the meal dehydrates and partially decarbonizes. The meal then enters a sloping rotary kiln, which is heated by a 1,800°C flame, which completes the  burning process of the meal. The meal is heated to a temperature of at least 1,450°C. At

this

temperature the chemical changes required to produce cement clinker are achieved. The dry process

Fig 5: Central Control Room

26

kiln is shorter than the wet process kiln and is the most fuel-efficient method of cement production available. Cooler Units

The clinker discharging from the kiln is cooled by air to a temperature of 70°C above ambient temperature and heat is recovered for the process to improve fuel efficiency. Some of the air from the cooler is de-dusted and supplied to the coal grinding Plant. The remaining air is used as preheated secondary air for  the main combustion burner in the kiln. Clinker is analyzed to

Fig 6: Cement Plant

ensure consistent product quality as it leaves the cooler. Metal conveyors transport the clinker to closed storage areas.

Filters Dedicated electrostatic precipitators dedust the air and gases used in the Clinker Production Line Process. In this way, 99.9% of the dust is collected before venting to the atmosphere. All dust collected is returned to the process.

Constituents Different types of cement are produced by mixing and weighing proportionally the following constituents: •

Clinker 

•

Gypsum

•

Limestone addition

•

Blast Furnace Slag

27

Fig 7: Cement manufacturing from the quarrying of limestone to the bagging of cement.

28

RESEARCH METHODOLOGY

Data Sources

- Primary Data, - Secondary Data

Data sources: Primary Data Primary data is a data that is collected for the first time in the processing of the analysis. The researchers have adopted the contact through telephone for the purpose of collecting Primary data. The researchers discuss with Team Manager and employees of the company to get information about competitors of SHREE.

Secondary Data Under Secondary sources, we tapped information from internal & external sources. We made use of  Internet (such as search engine www.google.com),

www.shreecementltd.com

And miscellaneous sources (such as brochures, pamphlets) under external sources.

Analysis To make our research project most effective in a given time period of 40 days surveyed the information of the competitors. We undertook both Explorative as well as Conclusive Research Design. The data has been collected from both Primary as well as Secondary sources and we also did the fieldwork for which utmost care has been taken to keep project unbiased from personal opinion.

Objectives •

To understand the theory of capital and its implication in business structure

•

To know about the various sources of funds in the company

•

To find out the cost of various components of capital and how to minimize it

•

To get a good insight of the cement industry

29

Focus of the Project The project is structured for the purpose of getting good insight of, Capital Structure and Cost of Capital, theory and its implication. The Projects Focus On Cost Of Different Component Of Capital And Optimal Capital Structure For Minimizing The Cost And Risk. It also discusses the different sources of funds, different approaches of cost of capital.

The project is being made as a part of summer training and gives good insight of the topic covered under it.

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COST OF CAPITAL The main objective of a business firm is to maximize the wealth of its shareholders in the long-run, the Management Should only invest in those projects which give a return in excess of cost of fund invested in the project of the business. The difficulty will arise in determination of cost of funds, if is raised from different sources and different quantum. The various sources of funds to the company are in the form of equity and debt. The cost of capital is the rate of return the company has to pay to various suppliers of fund in the company. There are main two sources of capital for a company –  shareholder and lender. The cost of equity and cost of debt are the rate of return that need to be offered to those two groups of suppliers of the of capital in order to attract funds from them.

The primary function of every financial manager is to arrange adequate capital for the firm. A   business firm can raise capital from various sources such as equity and or preference shares, debentures, retain earning etc. This capital is invested in different projects of the firm for generating revenue. On the other hand, it is necessary for the firm to pay a minimum return to each source of  capital. Therefore, each project must earn so much of the income that a minimum return can be paid to these sources or supplier of capital. What should be this minimum return? The concept used to determine this minimum return is called Cost of Capital. On the basis of it the management evaluates alternative sources of finance and select the optimal one. In this chapter, concepts and implications of  firms cast of capital, determination of cast of difference sources of capital and overall cost of capital are being discussed.

CONCEPT OF COST OF CAPITAL

Cost of capital is the measurement of the sacrifice made by investors in order to invest with a view to get a fair return in future on his investments as a reward for the postponement of his present needs. On the other hand form the point of view of the firm using the capital, cast of capital is the  price paid to the investor for the use of capital provided by him. Thus, cost of capital is reward for  the use of capital. Author Lutz has called it”BORROWING AND LANDING RATES”. The  borrowing rates means the rate of interest which must be paid to obtained and use the capital. Similarly, landing rate is the rate at which the firn discounts its profits.It may also the opportunity cost of the funds to the firm i.e. what the firm would earn by investing these funds elsewhere. In  practice the borrowing rates used indicate the cost of capital in preference to landing rates.

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Technically and Operationally, the cost of capital define as the minimum rate of return a firm must earn on its investment in order to satisfy investors and to maintain its market value. I.e. it is the investors required rate of return. Cost of capital also refers to the discount rate which is used while determining the present value of estimated future cash flows. In the other word of John J. Hampton, “The cost of capital is the rate of return in the firm requires from investment in order to increase the value of firm in the market place” . For example if a firm borrows Rs. 5 crore at an

interest of 11% P.A., then the cost of capital is 11%. Hear it’s the essential for the firm to invest these Rs. 5 Crore in such a way that it earn at least Rs. 55 lacks i.e. rate of return at 11%. If the return less then this, then the rate of dividend which the share holder are receiving till now will go down resulting in a decline in its market value thus the cost of capital is the reward for the use capital. Solomon Ezra, has called “It the minimum required rate of return or the cut of rate for capital

expenditure.”

FEATURES OF COST OF CAPITAL

It is not a cost in reality the cost of capital is not a cost as such, but its rate of return which it requires on the projects.

MINIMUM RATE OF RETURN

Cost of capital is the minimum rate of return a firm is required in order to maintain the market value of its equity shares.

REWARDS FOR RISKS

Cost of capital is the reward for the business and financial risk. Business risks is the measurement of  variability in profits due to changes un sales, while financial risks depends on the capital structure i.e. that equity mix of the firm.

SIGNIFICANCE OF CONCEPT OF COST OF CAPITAL

The cost of capital is very important concept in the financial decision making. The progressive management always likes to consider the cost of capital while taking financial decisions as it’s very relevant in the following spheres...

1. Designing the capital structure: the cost of capital is the significant factor in designing a balanced an optimal capital structure of a firm. While designing it, the management has to consider the objective of maximizing the value of the firm and minimising cost of capita. I comparing the various specific 32

costs of different sources of capital, the financial manager can select the best and the most economical source of finance and can designed a sound and balanced capital structure. 2. Capital budgeting decisions: the cost of capital sources as a very useful tool in the process of making capital budgeting decisions. Acceptance or rejection of any investment proposal depends upon the cost of capital. A proposal shall not be accepted till its rate of return is greater then the cost of  capital. In various methods of discounted cash flows of capital budgeting, cost of capital measured the financial performance and determines acceptability of all investment proposals by discounting the cash flows.

3. Comparative study of sources of financing: there are various sources of financing a project. Out of  these, which source should be used at a particular point of time is to be decided by comparing cost of  different sources of financing. The source which bears the minimum cost of capital would be selected. Although cost of capital is an important factor in such decisions, but equally important are the considerations of retaining control and of avoiding risks.

4. Evaluations of financial performance of top management: cost of capital can be used to evaluate the financial performance of the top executives. Such as evaluations can be done by comparing actual  profitability of the project undertaken with the actual cost of capital of funds raise o finance the   project. If the actual profitability of the project is more then the actual cost of capital, the  performance can be evaluated as satisfactory.

5. Knowledge of firms expected income and inherent risks: investors can know the firms expected income and risks inherent there in by cost of capital. If a firms cost of capital is high, it means the firms present rate of earnings is less, risk is more and capital structure is imbalanced, in such situations, investors expect higher rate of return.

6. Financing and Dividend Decisions: the concept of capital can be conveniently employed as a tool in making other important financial decisions. On the basis, decisions can be taken regarding dividend  policy, capitalization of profits and selections of sources of working capital.

33

CLASSIFICATION OF COST OF CAPITAL

1. Historical Cost and future Cost

Historical Cost represents the cost which has already been incurred for financing a project. It is calculated on the basis of the past data. Future cost refers to the expected cost of funds to be raised for financing a project. Historical costs help in predicting the future costs and provide an evaluation of the past performance when compared with standard costs. In financial decisions future costs are more relevant than historical costs.

2. Specific Costs and Composite Cost

Specific costs refer to the cost of a specific source of capital such as equity share. Preference share, debenture, retain earnings etc. Composite cost of capital refers to the combined cost of various sources of finance. In other words, it is a weighted average cost of capita. It is also termed as ‘overall costs of capital’. While evaluating a capital expenditure proposal, the composite cost of capital should be as an acceptance/ rejection criterion. When capital from more than one source is employed in the business, it is the composite cost which should be considered for decision-making and not the specific cost. But where capital from only one source is employed in the business, the specific cost of  those sources of capital alone must be considered.

3. Average Cost and Marginal Cost

Average cost of capital refers to the weighted average cost of capital calculated on the basis of cost of each source of capital and weights are assigned to the ratio of their share to total capital funds. Marginal cost of capital may be defined as the ‘Cost of obtaining another rupee of new capital.’ When a firm raises additional capital from only one sources (not different sources), than marginal cost is the specific or explicit cost. Marginal cost is considered more important in capital budgeting and financing decisions. Marginal cost tends to increase proportionately as the amount of debt increase.

4. Explicit Cost and Implicit Cost

Explicit cost refers to the discount rate which equates the present value of cash outflows or value of  investment. Thus, the explicit cost of capital is the internal rate of return which a firm pays for   procuring the finances. If a firm takes interest free loan, its explicit cost will be zero percent as no cash outflow in the form of interest are involved. On the other hand, the implicit cost represents the rate of return which can be earned by investing the funds in the alternative investments. In other  words, the opportunity cost of the funds is the implicit cost. Port field has defined the implicit cost as 34

“the rate of return with the best investment opportunity for the firm and its shareholders that will be forgone if the project presently under consideration by the firm were accepted.” Thus implicit cost arises only when funds are invested somewhere, otherwise not. For example, the implicit cost of  retained earnings is the rate of return which the shareholder could have earn by investing these funds, if the company would have distributed these earning to them as dividends. Therefore, explicit cost will arise only when funds are raised whereas implicit cost arises when they are used.

Assumption of Cost of Capital

While computing the cost of capital, the following assumptions are made:

•

The cost can be either explicit or implicit.

•

The financial and business risks are not affected by investing in new investment  proposals.

•

The firm’s capital structure remains unchanged.

•

Cost of each source of capital is determined on an after tax basis.

•

Costs of previously obtained capital are not relevant for computing the cost of capital to be raised from specific source.

Computation of specific costs

A firm can raise funds from different sources such as loan, equity shares, preference shares, retained earnings etc. All these sources are called components of capital. The cost of capital of these different sources is called specific cost of capital. Computation of specific cost of capital helps in determining the overall cost of capital for the firm and in evaluating the decision to raise funds from a particular  source. The computation procedure of specific costs is explained in the pages that follow – 

35

COST OF DEBT CAPITAL Cost of Debt is the effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. This is one part of the company's capital structure, which also includes the cost of  equity. Much theoretical work characterizes the choice between debt and equity, in a trade-off context: Firms choose their optimal debt ratio by balancing the benefits and costs. Traditionally, tax savings that occur because interest is deductible while equity payout is not have been modeled as a primary benefit of debt. Large firms with tangible assets and few growth options tend to use a relatively large amount of  debt. Firms with high corporate tax rates also tend to have higher debt ratios and use more debt incrementally. A company will use various bonds, loans and other forms of debt, so this measure is useful for giving an idea as to the overall rate being paid by the company to use debt financing. The measure can also give investors an idea as to the riskiness of the company compared to others, because riskier companies generally have a higher cost of debt.

Example-: If a company issues 12% debentures worth Rs. 5 lacs of Rs. 100 each at par, then it must be earn at least Rs.60000(12% of Rs. 5 lacs) per year on this investment to maintain the income available to the shareholders unchanged. If the company earnws less than this interest rate (12%) than the income available to the shareholders will be redused and the market value of the share will go down. Therefore, the cost of debt capital is the contractual interest rate adjusted further for the tax liability of the firm. But, to know the real cost of debt, the relation of the interest rate is to be established with the actual amount realised or net proceeds from the issue of debentures.

To get the after-tax rate, you simply multiply the before-tax rate by one minus the marginal tax rate. Cost of Debt = (before-tax rate x (1-marginal tax)) The before tax rate of interest can be calculated as below: =

Interest Expense of the company ---------------------------------------Total Debt

100 X

 Net Proceeds: 1.

At par

= Par value – Floatation cost

2.

At premium

= Par value + Premium – Floatation cost

3.

At Discount

= Par value – Discount – Floatation cost

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COST OF PREFERENCE SHARE CAPITAL Preference share is another source of Capital for a company. Preference Shares are the shares that have a preferential right over the dividends of the company over the common shares. A preference shareholder enjoys priority in terms of repayment vis-à-vis equity shares in case a company goes into liquidation. Preference shareholders, however, do not have ownership rights in the company. In the companies under observation only India Cement has preference shares issued. Cost of Preference Capital = Preference Dividend/Market Value of Preference Shree Cement has not paid any dividend to the Preference Shareholders. Thus the Cost of Preference Capital is 0 (Zero).

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COST OF EQUITY SHARE CAPITAL The computation of cost of euity share capital is relatively diffiult because nether the rate of  dividend is predetermind nor the payment of dividend is legally binding, therefore, some financial experts hold the opinion the p.s capital does not carry any cost but this is not true. When additional equity shares are issued, the new equity share holders get propranate share in future dividend and undistributed profits of the company. If reduces the earning per shares of excisting share holders resulting in a fall in marker price of shares. Therefore, at the time of issue of new equity shares, it is the duty of the management to see that the company must earn atleast so much income that the market price of its ecisting share remains unchanged. This expected minimum rate of return is the cast o equity share capital. Thus, cost of equity sahre capital may be define as the minimum rate of return that a firm must earn on the equity financed portion of a investment- project in order to leave unchanged the market  price of its shares. The cost of equity can be computed by any of the following method:

1. Dividend yield method: Ke = DPS\mP*100 Ke= cost of equity capital Dps= current cash dividend per share Mp=current market price per share

2. Earning yield method: Ke= EPS\mp*100 Eps= earning per share

3. Divideng yield plus growth in dividend method: While computing cost of capital under dividend yield(d\p ratio)method, it had been asumend that present rate of dividend will remail the same in future also. But, if the management astimates that companies prestnet dividend will increased continuisly for the year to come, then adjustment for this increase is essential to compute the cost of capital. The growth rate in dividend is assumed to be equal to the growth rate in earning per share. For example if the EPS increase at the rate of 10% per year, the DPS and market price per  share would show an increase at the rate of 10%. Therefore, under this method, cost of equity

38

capital is computed by adjusting the present rate of dividend on the basis of expected future increase in company’s earning.

Ke= DPS\MP*100+G G= Growth rate in dividend. 4. Realised yield methd: In case where future dividend and market price are uncertain, it is very difficult to estimate the rate of  return on investment. In order to overcome this difficulty, the average rate of return actually relise in the past few year by the investors is used to determine the cost of capital. Unddr this method, the realised yield is discounted at the present value factor, and then compare with value of investment this method is based on these assumptions. The company’s risk doe not change i.e. dividend and growth rate are stable. The alternative investment opportuinities, elsewhere for the investor, yield the return wshich is equal to realised yiels in the company, and The market of equity share of the company does not fluctuate widly.

Cost of newly issued equity shares

when new equityshare are issued by a company, it is not possible to realise the marlet price per share,  because the company has to incur some expenses on new issue, including underwriting commission,  brokerage etc. so, the amount of net proceeds is calculated by deducting the issue expenses form the expected marlet value or issue price. To acertain the cost of capital, dividend per share or EPS is divided by the amount of net proceeds. Any of the following formulae may be used for this purpose:

Ke= DPS\NP*100 Or  Ke= EPS\NP*100 Or  Ke=DPS\NP*100+G

COST OF RETAIN EARNINGS OR INTERNAL EQUITY

Generally, compnay’s do not distribute the entire profits by way of dividend among their  share holders. A part of such profit is reatianed for future expantion and development. Thus year by year, companies create sufficiat fund fior the fianancing thrugh internal sources. But , nether the company 39

 pays any cost nor incur any expenditure for such funds. Therefore, it is assumed to cost free capital that is not true. Though ratain earnings like retained earnings like equity funds have no explicit cost but do have opportunity cost. The opportunity cost iof retained earnings is the income forgone by the share holders. It is equal to the income what a share holders culd have earn otherwise by investing the same in an alternative investment, If the company would have distributed the earnings by way of dividend instead of retaining in the busieness. Therefore , every share holders expects from the company that much of income on ratined earnings for which he is deprived of the income arising o its alternative investment. Thus, income forgone or sacrifised is the cost of retain earnings which the share holders expects from the company.

40

WEIGHTED AVERAGE COST OF CAPITAL Once the specific cost of capital of the long-term sources i.e. the debt, the preference share capital, the equity share capital and the retained earnings have been ascertained, the next step is to calculate the overall cost of capital of the firm. The capital raised from various sources is invested in different  projects. The profitability of these projets is evaluated by comparing the exprcted rate of return with overall cost of apital of the firm. The overall cost of capital is the weighted average of the costs of the various sources of the funds, weights being the proportion of each sources of funds in the total capital structure. Thus, weighted average as the name implies, is an average of the cost of specific sources of capital employed in the business properly weighted by the proportion they held in firm’s capital structure. It is also termed as ‘Composite Cost of Capital’ or ‘Overall Cost of Capital’ or ‘Average Cost

of Capital’.

WEIGHTED AVERAGE, How to calculate?

Though, the concept of weighted average cost of capital is very simple. Yet there are many  problems in its calculation. Its computation requires :

1. Assignment of Weights : First of all, weights have to be assigned to each source of capital for  calculating the weighted average cost of capital. Weight can be either ‘book value weight’ or ‘market value weight’. Book value weights are the relative proportion of various sources of capital to the total capital structure of a firm. The book value weight can be easily calculated by taking the relevant information from the capital structure as given in the balance sheet of the firm. Market value weights may be calculated on the basic on the market value of different sources of capital i.e. the proportion of each source at its market value. In order to calculate the market value weights, the firm has to find out the current market price of each security in each category. Theoretically, the use of market value weights for calculating the weighted average cost of capital is more appealing due to the following reasons:

•

The market value of securities is closely approximate to the actual amount to be received from the proceeds of such securities.

•

The cost of each specific source of finance is calculated according to the prevailing market  price.

But, the assignment of the weight on the basic of market value is operationally inconvenient as the market value of securities may frequently fluctuate. Moreover, sometimes, no market value is

41

available for the particular type of security, especially in case of retained earnings can indirectly be estimated by Gitman’s method. According to him, retained earnings are treated as equity capital for  calculating cost of specific sources of funds. The market value of equity share may be considered as the combined market value of both equity shares and retained earnings or individual market value (equity shares and retained earnings) may also be determined by allocating each of percentage share of the total market value to their respective percentage share of the total values.

For example:- the capital structure of a company consists of 40,000 equity shares of Rs. 10 each ad

retained earning of Rs. 1,00,000. if the market price of company’s equity share is Rs. 18, than total market value of equity shares and retained earnings would be Rs. 7,20,000 (40,000* 18) which can  be allocated between equity capital and retained earnings as follows-

Market Value of Equity Capital = 7,20,000*4,00,000/5,00,000 =Rs. 5,76,000.

Market Value of Retained Earnings= 7,20,000*1,00,000/5,00,000 =Rs. 1,44,000.

2. Computation of Specific Cost of Each Source :

After assigning the weight; specific costs of each source of capital, as explained earlier, are to be calculated. In financial decisions, all costs are ‘after tax’ costs. Therefore, if any source has ‘before tax’ cost, it has to be converted in to ‘after tax’ cost.

3. Computation of Weighted Cost of Capital :

After ascertaining the weights and cost of each source of capital, the weighted average cost is calculated by multiplying the cost of each source by its appropriate weights and weighted cost of all the sources is added. This total of weighted costs is the weighted average cost of capital. The following formula may be used for this purpose : Kw = ∑XW/∑W Here; Kw = Weighted average cost of capital X = After tax cost of different sources of capital W = Weights assigned to a particular source of capital

Example: Following information is available with regard to the capital structure of ABC Limited :

Sources of Funds

Amount(Rs.)

After tax cost of Capital 42

E.S. Capital

3,50,000

.12

Retained Earning

2,00,000

.10

P.S. Capital

1,50,000

.13

Debentures

3,00,000

.09

You are required to calculate the weighted average cost of capital.

Computation of Weighted Average Cost of Capital Source

Amount

Weights

Rs.

After

tax

Cost

(1) (2) (3) E.S. Capital 3,50,000 .35 Retained Earning 2,00,000 .20 P.S. Capital 1,50,000 .10 Debentures 3,00,000 .09 Total 10,00,000 1.00 Weighted Average Cost of Capital (WACC)

(4) .12 .10 .13 .09 -

Weighted Cost

(5)= (3) * (4) .0420 .0200 .0195 .0270 .1085 .10850 or 10.85%

CALCULATION OF COST OF CAPITAL OF SHREE CEMENT LTD.

Cost of Debt Capital:

For the year 2008-09:

Total Debt Capital = Term loan from Banks + Debts = 112573.18 + 800 = 113373.18 lacs Total Interest Paid = 9636.72 lacs Tax Rate

= 30%

Interest Expense of the company Kd (before tax)

=

--------------------------------------------

X

100

Total Debt 9636.72

=

Kd (before tax)

----------------------

X

100

=

8.50%

113373.18

Kd (after tax)

=

Interest Rate Before Tax – Tax Rate ( 30%.)

43

Kd (after tax)

=

8.50% - 30%

= 5.95%

For the year 2007-08

Total Debt Capital = Term loan from Banks + Debts = 83427.02+1400 = 84827.02lacs Total Interest Paid = 6573.02 lacs Tax Rate

= 30% 6573.02

=

Kd (before tax)

----------------------

X

100

=

7.75%

100

=

7%

84827.02

Kd (after tax)

=

7.75% - 30%

= 5.42%

For the year 2006-07

Total Debt Capital = Term loan from Banks + Debts = 28617.33+2000= 30617.33lacs Total Interest Paid = 2143.21lacs Tax Rate

= 30%

2143.21 Kd (before tax)

=

----------------------

X

30617.33

Kd (after tax)

=

7% - 30%

= 4.90%

COMPARATIVE CALCULATION OF Kd FOR THREE YEAR 

44

Particular

2008-09

2007-08

2006-07

Total Debts (Term loan from 112573.18+

83427.02+1

28617.33+2

Bank+Debts)

800

400

000

Total Interest paid

=113373.18 9636.72

=84824.02 6573.86

=30617.33 2143.21

Interest Rate (Before Tax)

8.50%

7.75%

7%

Interest Rate (After Tax)= Interest 5.95%

5.42%

4.90%

Rate Before Tax – Tax Rate 30%.

COST OF EQUITY CAPITAL:

EQUITY SHARE CAPITAL Particular 2008-09 No. of Shares (In lacs) 348.37 DPS Given 8 Market Price (at the end of  1079.40

2007-08 348.73 6 921.85

2006-07 348.73 5 893.50

March) Earning per equity share 74.74

50.81

NA

of rs. 10(in Rs.) Proposed final dividend 2786.98

Not given

NA

on equity share (in lacs) Market Capitalisation (in 376033.01

321146.96

311270.61

Lacs)

1. Dividend yield plus growth in dividend method:-

Ke = DPS\mP*100 + G

45

Dps = Current cash dividend per share

= 8 Rs.

Mp = Current market price per share

= 1079.40 Rs.

G

= 10%

= Growth rate 8

Ke

=

--------------------

X

100 + 10%

=

10.74%

X

100

=

6.92%

1079.40 2. Earning yield method:Ke= EPS\mp*100

Eps = earning per share = 74.74 Rs. Mp = Market prise

= 1079.40 Rs.

74.74 Ke

=

-------------------1079.40

3. Dividend per share method:-

Ke = Proposed final dividend on Equity Share / No. of Equity Share

Proposed final dividend on Equity Share = 2786.98 Lacs  No. of Equity Share = 348.37 Lacs 2786.98 Ke

=

--------------------

=

8

348.37

COST OF EQUITY SHARE CAPITAL (KE)

Particular Dividend Per share method Earning Yeild Method Dividend yield plus growth method

2008-09 8 6.92 10.74

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WEIGHTED AVERAGE COST OF CAPITAL (WACC)

WACC = (We * Ke) + (Wd * Kd)

Where………...

We = Weight of equity

Wd = Weight of Debt. Ke = Cost of Equity Share capital Kd = Cost of Debt. capital

WACC = ( 0.768 * 10.74) +( 0.232 *5.95 )= 9.628%

WACC OF SHREE CEMENT LIMITED

Source

(1)

Amount

Weight

After

Weighted

Rs.

s

tax

Cost

Cost

(5)= (3) *

(4) 10.74

(4) 8.248

5.95

1.379

(2)

E.S.

376033.0

(3) .768

Capital Debentures

1 113373.1

.232

Total

8 489406.1

1.00

9 Weighted Average Cost of Capital (WACC)

9.628 9.628%

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MERITS OF WEIGHTED AVERAGE COST OF CAPITAL

The WACC is widely used approach in determining the required return on a firm’s investments. It offers a number of advantages including the followings1. Straight forward and logical : It is the straightforward and logical approach to a difficult problem. It depicts the overall cost of capital as the some of the cost of the individual components of the capital structure. It employs a direct and reasonable methodology and is easily calculated and understood. 2. Responsiveness to Changing Condition : Since, it is based upon individual debt and equity components, the weighted average cost of capital reflects each element in the capital structure. Small changes in the capital structure of the firm will be noted by small changes in overall cost of capital of  the firm. 3. Accurate when Profits are Normal : During the period of normal profits, the weighted a verage cost of capital is more accurate as a cut-off rate in selecting the capital budgeting proposals. It is because the weighted average cost recognises the relatively low debt cost and the need to continue to achieve the higher return on the equity financed assets. 4. Ideal Creation for Capital Expenditure Proposals : With the help of weighted average cost of  capital, the finance manager decides the cut-off rate for taking decisions relating to capital expenditure proposals. This cut-off rate determines the miimum limit for accepting an investment  proposal. If an investment proposal is accepted below this limit, the firm incur a loss. Therefore, this cut-off rate is always decided above the weighted average cost of capital.

LIMITATION OF WEIGHTED AVERAGE COST OF CAPITAL

The weighted Average cost approach also has some weaknesses, important among them are as follows :

1. Unsuitable in case of Excessive Low-cost Debts : Short term loan can represent an important sources of fund for firm experiencing financial difficulties. When a firm relies on Zero cost (in the form of payables) or low cost short term debt, the inclusion of such debts in the calculation of cost of  capital will result in a low WACC. If the firm accepts low-return projects on the basic of this low WACC, the firm will be in a high financing risk. 48

2.

Unsuitable in Case of Low Profits : If a firm is experiencing a period of low profits, not earning

 profit as compared to other firms in the industry, WACC will be inaccurate and of limited value. 3. Difficulty in Assigning Weights : The main difficulty in calculating the WACC is to assign weight to different components of capital structure. Normally, there are two type of weights- (i) book value weights and (ii) market value weight. These two type of weights give different results. Hence, the  problem is which type of weight should be assigned. Though, market value is more appropriate than  book value, but the market value of each component of capital of a company is not readily available. When the securities of the company are unlisted, the problem becomes more intricate. 4. Selection of Capital Structure : The selection of capital structure to be used for determining the WACC is also not easy job. Three types of capital structure are there i.e. current capital structure, marginal capital structure and optimal capital structure. Which of these capital structure be selected. Generally, current capital structure is regarded as the optimal structure, but it is not always correct.

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