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DEHRADUN
Methods used:
1. Dividend-Yield-plus-Growth-Rate, or Discounted Cash Flow (DCF) approach to find
out the cost of equity
2. Retention Growth Model to estimate the Growth for DCF
3. Weighted Average Cost of Capital (WACC) for cost of capital
4. Ratio analysis to comment on the capital structure of the capital
When we look at the Balance Sheets of the company over the past 5 years, we see that there
has been no capital issue by the company during the period and the amount of the unsecured
loans has increased slightly in the year 2006. The amount of the secured loans has increased
over the period and has also decreased.
Capital Mix:
1. Debt-equity: The debt-equity ratio is calculated to measure the extent to which debt
financing has been used in a business. It has an important implication from the view
point of the creditors, owners and the firm itself. A high ratio shows large share of
financing by the creditors of the firm, a low ratio implies a smaller claim. For a high
ratio the creditor’s risk is high as owner’s funds are less in assets and they may
behave irresponsibly. Moreover, a high ratio is also not good for the firm as the
creditors will interfere in the activities of the business and more interest has to be
paid.
Currently the debt and equity ratio of Capital Structure of Asian Paints Ltd
the company is 0.0597 (Annexure 2)
8.27
which is very small. Because the 5.63
company is having very small Equity
amount of loan in its capital mix and Debt
almost all its capital has been raised Reserves and
Surplus
through the equity issue.
One more thing to be noticed is that the 86.10
company has issued 93989940 shares as
bonus shares. So the company has actually used its high earnings to give bonus shares to the
shareholders through its reserves and surplus.
2. Debt: The debt that has been raised by the company is all interest free as we can see
in the schedules of the company’s financial statements (Annexure 3) that the loans are
part of state government’s Sales Tax Deferment Schemes and the trade deposits are
also interest free. Thus if we talk about the cost of debt it will be zero.
3. Reserves and Surplus: The general reserves of the company have been increasing
significantly over the past couple of years. This is because of the high profit earning
ratios of the company. When we see the Annexure 4, which comprises all the
financial ratios of the company, the operating profit ratio, the net operating profit
ratio, the free reserves per share has been increasing very significantly. This talks
about the strong financial position for the future prospects of the company. The
reserves and surplus forms 86.10% of the total capital structure of the company.
Debt-Equity
Net Worth Debt Ratio
Asian Paints 1094.47 65.29 0.059654
Kansai Nerolac 654.45 93.62 0.143051
ICI India 971.07 0 0
Berger Paints 425.13 78.06 0.183614
Shalimar Paints 39.09 60.4 1.545152
The average debt-equity ratio of the industry is 0.143 (taking the median of all the
major players of the industry because the mean is deflected by the critical values, so
to avoid that median is taken). The debt equity ratio of Asian Paints is very small as
compared to that of the industry.
Asian Paints can increase its loan and can start trading on equity which will help it to
further increase the earning per share. As we can see that over the period of past 5
years the net profit margin and other profitability ratios are declining (Annexure 4)
Cost of equity: The cost of equity can be calculated by many methods. But in this case the
Discounted Cash Flow method suits the most because there are a lot of shares issued as bonus
shares. Actual issue made by the company in only 12.44 crores worth. Rest all are issued as
bonus shares out of 95.92 crores of total share capital. (Annexure 6.1 & 6.2)
Assumptions made:
D1
r s= +g
P0
Where, r s is the cost of equity
D1 Is the expected dividend for the next year which is calculated by taking average of all the
dividends paid by the company over past 14 years and multiplying it with the expected
growth factor that is 1.1556
P0 is the average market price of the equity at the beginning of the years over past 14 years.
Here we have to add the dividend tax amount also to the cost of equity because in the profit
and loss account of the company it is given that it has to pay dividend tax at the rate of 17%.
Thus, the new formula will become
D 1(1+t )
r s= +g
P0
D1=¿ D 0 (1+g)
Where D0 is the average dividend declared by the company over past 14 years. As per table
1.
P0=477.8 4
Close Dividend
Date Price Year %
3/31/19
95 580 Mar 1995 65
3/29/19
96 343 Mar 1996 65
3/31/19
97 279.35 Mar 1997 75
3/31/19
98 305.95 Mar 1998 75
3/31/19
99 245 Mar 1999 80
3/31/20
00 423.2 Mar 2000 100
3/30/20
01 245.45 Mar 2001 70
3/28/20
02 327.3 Mar 2002 90
3/31/20
03 330 Mar 2003 110
3/31/20
04 301.5 Mar 2004 85
3/31/20
05 391.95 Mar 2005 95
3/31/20
06 646.05 Mar 2006 125
3/30/20
07 762.6 Mar 2007 130
3/31/20
08 1199.9 Mar 2008 170
3/31/20
09 786.35 Mar 2009 175
NSE Database Prowess Database
Averag 100.66666
e 477.84 Average 67
Table 1
But we have to take into consideration the bonus shares also.
Thus (Annexure 6.1 & 6.2), we have to find out the ratio of the actual share issued and the
bonus shares issued over the period by the company on the equity shares.
We observe that for the 99.28% of the total equity shares, the bonus shares to the actual
shares issued is 6.68:1 and for the rest 0.72% of the total equity shares, which are being
issued as consideration other than cash, the ratio is 1.4:1.
((
11.678 ( 1.17 ) (7 .68)
477.84 ) 99.28% + (
11.678 ( 1.17 ) (2 .4)
477.84 ) 0.72%) + 0.1556
=37.41% cost of equity
The cost of equity for the company is very high that is because of the high bonus shares issue
rates of the company. They have actually raised only 12.44 crores through actual share
selling, rest all has been issued as bonus shares.
Cost of reserves and surplus: The reserves and surplus belong to the shareholders. Therefore
the cost of equity is equal to the cost of reserves and surplus.
Cost of debt: The Company is having the debts raised through some sources and the ratio is very
small. But as per the balance sheet and profit and loss account of the company the loans are all
interest free and there is no interest cost to the debts as per the profit and loss account of the company
also. Therefore, the cost of debt is 0.
The weighted average cost of capital can be computed by giving the weights to the different costs
computed above. The weights given are according to the book values.
Thus:
Where,
k d is the cost of debt (here it is zero because all the loans are interest free)
Or 94.37% of 37.41
The cost of capital will be 35.30%
Assuming that there is no floatation cost for the equity shares.
References:
1. www.moneycontrol.com
2. Prowess Database
3. http://asianpaints.com
4. Financial Reports of Asian Paints ltd.
5. Religare technova
6. Corporate Finance, A Focused Approach by Bringham
7. Financial Management by ICFAI University Press