UNIT - II

Equity (finance):

The value of an ownership interest in property, including shareholders' equity in a

business.

In finance, equity is the ownership in any asset after all debts associated with
that asset are paid off. It is total assets minus total liabilities; here also called
shareholder's equity or net worth or book value.
Capital:

An accumulated fund of investible resources. Usually used for ‘active’

funds, i.e., funds that are not just being hoarded or saved, but are being held for
investment. Capital seeks to grow, to add to itself – this is the process of
accumulation.
Labour Intensive Projects versus Capital Intensive Projects:
Labour Intensive Projects versus Capital Intensive Projects:

• Labour intensive means use of manpower in production with little of

technology.

• while capital intensive means use of technology with little manpower in

production.

Labour Technology Technology Labour

Labour intensive Project Capital intensive Project

Labour Intensive Projects versus Capital Intensive Projects:

• Labour-intensive Industry or project is where a larger portion of total costs is

due to labour as compared with the portion for costs incurred in
purchase, maintenance, and depreciation of capital equipment.
Agriculture, construction, and coal-mining industries are examples of labour
intensive industries.

• Capital-intensive Industry is one which requires large sums of investment in

purchase, maintenance, and amortization of capital equipment, such as
automotive, petroleum, and steel industry.

Purchase
Maintenance
depreciation

Capital investment
Labour Intensive Projects versus Capital Intensive Projects:

• Capital intensive industries need a high volume of production, a high margin

of profit, and low interest rates to be able to provide adequate returns on
investment.

• It is important to distinguish between capital-intensive and labour-intensive

methods of production.

Capital High margin of

intensive profit

Low interest High volume

rate of production
Capital-intensive

A business is capital intensive if it requires heavy capital investment in buying

assets relative to the level of sales or profits that those assets can generate. A
capital intensive business will typically have some mixture of the following
characteristics:

• High depreciation costs

• High barriers to entry
• Large amounts of fixed assets on the balance sheet.
Some features of these projects or processes are:

• ‘Capital’ refers to equipment, machinery, vehicles, etc that a business uses to

make its product or service.

• Capital-intensive processes require a relatively high level of capital

investment compared to the labour cost.

• These processes are more likely to be highly automated and to be used to

produce on a large scale.

• Capital-intensive production is more likely to be associated with expensive

equipment.

• Capital is a long-term investment for most businesses, and the costs of

financing, maintaining and depreciating this equipment represents a
substantial overhead.

• In order to maximise efficiency, firms want their capital investment to be fully

utilised.
Some features of these projects or processes are:

• In a capital-intensive process, it can be costly and time-consuming to increase

or decrease scale of production.
Labour-intensive :

• A labour intensive business is one in which the main cost is that of labour, and
it is high compared to sales or value added.

• As the capital intensive business may attempt to reduce operational costs

by, for example, leasing or renting assets, a labour intensive one may try to
reduce operational costs by outsourcing or automation.
• ‘Labour’ refers to the people required to carry out a process in a business.

• Labour-intensive processes require a relatively high level of labour compared

to capital investment.

• These processes are likely to be used to produce individual/personalised

products, or to produce on small scale .

• The costs of labour are: wages and other benefits, recruitment, training and
so on.

Wages and other benefit

training

recruitment
• Some flexibility in capacity may be available by use of overtime and
temporary staff, or by laying-off workers.

• Long-term growth depends on being able to recruit sufficient suitable staff.

• Labour intensive processes are more likely to be seen in Job production and
in smaller-scale enterprises.

Flexibility

Temporary Laying-off
overtime
staff workers
• In under developed countries, due to chronic unemployment or cheap
labour, labour-intensive methods are preferred to capital-intensive.

• The most efficient use of resources in less developed countries will tend to
favour labour intensive methods.

• For innovations, it would also follow the Capital Saving and Labour – using
innovations, it would be preferred. However, It may be profitable to adopt
capital-intensive techniques to increase productivity.

• For example, In India, Labour force is available in plenty. This is the reason
most of the building industry is Labour Intensive including both skilled and
unskilled labour.

• Only certain prestigious projects are handled by Reputed Building agencies

like L&T, Raheja Builders etc who employ only skilled labour force handled by
all professionals like Architects, Engineers, project Managers, etc and they
handle construction using precast building elements and heavy equipment
and machines.
General economies of the basic inputs into building construction:
Land, Labour, Capital and Material:

The factors of production are the inputs used to produce goods and services.
Labour, land, capital and material are the four most important factors of
production.

Factors of production

Labour
Material

Land
Capital
Labour Market:

• Labor markets, like other markets in the economy, are governed by the forces
of supply and demand.

• Labor markets are different from most other markets because labour demand
is a derived demand.

• Most labor services, rather than being final goods ready to be enjoyed by
consumers, are inputs into the production of other goods.
The Production Function and the Marginal Product of Labour:

• The marginal product of labour is the increase in the amount of output from
an additional unit of labor.

• The production function is the relationship between the inputs into

production, i.e. labour, and the output from production. As the quantity of
the input (no. of labour) increases, the production function gets
flatter, reflecting the property of diminishing marginal product.

Input of labour

Input of labour

Production Production

Marginal Production
Production Production
The Value of the Marginal Product and the Demand for Labor:

• To find the labourer’s contribution to revenue, the marginal product of labour

should be multiplied by the value or market price of the marginal product.

• Because the market price is constant for a competitive firm, the value of the
marginal product diminishes as the number of workers rises.

• To maximize profit, the firm hires workers up to the point where the value of
the marginal product exceeds the wage, so hiring another labour would
increase profit. Above this number of labourers, the value of the marginal
product is less than the wage, so the marginal worker is unprofitable

labourer’s contribution = Marginal Product X Market price of marginal

product

No marginal production = No hiring

Factors that causes the Labour Demand Curve to Shift:

The Output Price:

• The value of the marginal product increases when the output price for that
product is increased.

• Thus, when the output price changes, the value of the marginal product
changes, and the labour demand curve shifts.

• An increase in the output prices raises the value of the marginal product of
each worker, and, therefore, increases labour demand from the firms
producing similar product. Conversely, a decrease in the output prices
reduces the value of the marginal product and decreases labor demand.
 Output
price

Value of
marginal
product

Labour demnd

Labour demand depend upon the output price

Technological advance:

It raises the marginal product of labour, which in turn increases the demand for
labour.

Supply of other Factors:

Quantity available of one factor of production can affect the marginal product of
other factors.
The Tradeoff between Work and Leisure:

• The tradeoff between labour and leisure lies behind the labor supply curve.

• The opportunity cost of an hour of leisure for a labour is his wage for that one
hour.

• The labour supply curve reflects how workers’ decisions about the labour–
leisure tradeoff respond to a change in that opportunity cost.

• An upward-sloping labor supply curve means that, an increase in the wage

induces workers to increase the quantity of labour they supply, foregoing
their leisure.

• Since time is limited, if more hours of work is offered, it means labour are
enjoying less leisure
Labour supply curve Shifting of Labour supply curve
Factors that Causes the Labor Supply Curve to Shift:

The labor supply curve shifts whenever people change the amount of labour they
want to work at a given wage.

• Changes in Tastes: Now a days, more female population is choosing to

work, thereby increasing the supply of labour.

• Changes in Alternative Opportunities: The supply of labor in any one labour

market depends on the opportunities available in other labour markets.

• Immigration: Movements of workers from region to region, is often an

important source of shifts in labor supply
Land and Capital:

• While the firms are deciding how much labour to hire, they are also deciding
about other inputs of production, i.e. land, capital and material.

• The term ‘capital’ refers to the stock of equipment and structures used to
produce new goods and services.

• The ‘purchase price of land or capital’ is the price a person pays to own that
factor of production indefinitely.

• The ‘rental price’ is the price a person pays to use that factor for a limited
period of time. The ‘wage’ is the rental price of labour.
• The rental price of land, and the rental price of capital are determined by
supply and demand.

• For both land and capital, the firm increases the quantity hired until the value
of the factor’s marginal product equals the factor’s price.

• As long as the firms are using the factors of production that are competitive
and profit-maximizing, each factor’s rental price must equal the value of the
marginal product for that factor.

• Considering the purchase price of land or capital, Buyers would be willing to

pay more to buy a piece of land or capital if it produces a valuable stream of
rental income.

• The equilibrium purchase price of a piece of land or capital depends on both

the current value of the marginal product and the value of the marginal
product expected to prevail in the future.
Linkages among the Factors of Production:

When the supply of any factor of production changes, the resulting effects are not
limited to the market for that factor. In most situations, factors of production are
used together in a way that makes the productivity of each factor dependent on
the quantities of the other factors available to be used in the production process.
As a result, a change in the supply of any one factor alters the earnings of all the
factors.

Labour

Land Production Material

Capital
Financing of Projects:

• Is known as a Loan arrangement in which the repayment is derived primarily

from the project’s cash flow on completion, and where the project's
assets, rights, and interests are held as collateral/guarantee.

• It is financing of a sole subject established for the purpose of project

realization usually termed as “SPV” (Special Purpose Vehicle). During the
project financing, the creditor/lender believes in cash flow and incomes of
such SPV as sources through which the loan will be re-paid, and the assets of
such SPV are held as security for the loan.

• Project financing sets up the project so the risks and gains related to the
project would be justifiably divided among all project
parties, namely, sponsors, shareholders, subscribers, suppliers or operators
bearing a particular part of risk.
Sources of Capital:

Business firms can meet their demand for capital from various sources, such as:

• Share capital,

• Term loans,

• Debenture capital,

• Incentive sources,

• Deferred credit,

• Miscellaneous sources
Share capital

There are two types of share capital :

• Equity capital and

• Preference capital.

‘Equity capital’ represents the contribution made by the owners of the

business, the equity shareholders, who enjoy the rewards and bear the risks of
ownership. Equity capital being risk capital carries no fixed rate of dividend.

‘Preference Capital’ represents the contribution made by preference shareholders

and the dividend paid on it is generally fixed.
Term Loans

Provided by financial institutions and commercial banks, ‘term loans’ represent

secured borrowings which are a very important source (and often the major
source) for financing new projects, and expansion, modernization and renovation
schemes of existing firms.

Term loans are provided in Indian Rupee as well as Foreign Currency, depending
upon the need.
Debenture capital

Akin (similar) to promissory notes, debentures are instruments for raising debt
capital.

They are two types:

• Non-convertible debentures and

• Convertible debentures.

Non-convertible debentures are straight debt instruments. Typically, they carry a

fixed rate of interest and have a maturity period of 5 to 9 years.

Convertible debentures, which are convertible to equity shares, wholly or partly.

Cost of Capital:

A firm’s cost of capital is the rate of return it must earn on its investments for the
market value of the firm to remain unaffected. It can also be regarded as the rate
of return required by the investors on capital provided by them.

• Capital is a scarce and productive commodity. Since every scarce and useful
commodity has a price, capital too has a price, known as ‘Cost of Capital’.

• The cost of capital can be ‘explicit’, i.e. interest paid on it, or ‘implicit’, i.e.
opportunity cost of that capital.

• The cost of capital plays an important role in the financing of projects. Since
capital is available at a cost, it demands the best possible use of available
funds, to assure acceptable return on the invested capital.
Different concepts of cost are presented below to estimate the cost of
capital:

Cost of Debt-Capital: it refers to the funds directly borrowed from the market
through public deposits, bonds and debentures. The cost of debt capital may be
defined as the rate of return that must be earned on the borrowed capital to keep
the earning of common stockholders unchanged.

Cost of Preferred Stock: it is similar to the cost of debt-capital. It is defined as the

rate of return on preferred stock that must be earned to keep the earning
available to the stockholders unchanged.

Cost of Equity Capital (Common Stock): it may be defined as the minimum rate of
return on the projects financed through the sale of common stocks that can keep
the market value of issues unchanged. The opportunity cost of stocks issued
earlier must be equal to the rate of return on them.
Agencies and Institutions directly and indirectly influencing economic
aspects of projects:

Since independence, a number of financial institutions, some operating on an all-

India basis and others functioning within their respective states, have been
established. They provide the bulk of long-term project finance, lay emphasis on
development of backward regions, encourage competent new
entrepreneurs, support modernization efforts, and engage in promotional
activities.

The structure of financial institutions in India is as follows:

1. All India Institutions

a. Industrial Finance Corporation of India
b. Industrial Credit and Investment Corporation of India
c. Industrial Development Bank of India
d. Other All-India Institutions.
2. State-level Institutions
a. State Finance Corporations
b. State Industrial Development Corporations
Industrial Finance Corporation of India (IFCI): set up with the primary objective of
providing medium and long-term credit to industry.

Industrial Credit and Investment Corporation of India (ICICI): it is owned and

financed mainly by the private sector. It provides assistance to industries in the
private sector, particularly to meet their foreign exchange requirements.

Industrial Development Bank of India (IDBI): it is a subsidiary of Reserve Bank of

India, and is the principle financial institution of the country, working in
conformity with the national priorities.

Life Insurance Corporation of India (LIC): it is an important all-India financial

institution which provides substantial financial support to the industry. Its primary
business is life insurance. LIC is one of the two largest institutional investors in the
country.
General Insurance Corporation (GIC): it substantially invests in ‘socially oriented’
sectors/projects, and provides term-loans to industrial projects.

Unit Trust of India: it was set up with the principle objective of mobilizing public
savings and channeling them into productive corporate investments. It has
emerged into one of the two largest institutional investors in India.

Industrial Reconstruction Bank of India (IRBI): it is primarily an agency to help the

reconstruction and rehabilitation of industrial units which have been closed down
or which face the risk of closure.
State Level Institutions:

State Financial Corporations (SFCs): they render assistance to medium and small
scale industries in their respective states. Respective state governments are one of
the shareholders in these financial institutions.

State Industrial Development Corporations (SIDCs): They serve as catalytic agents

in the industrialization process of their respective states. They sponsor joint sector
projects with the participation of private entrepreneur.