Capital Structure

Sunday, March 02, 2014

Presented by Amit Kumar Deepak Nauriyal Jagdish Agarwal Karthik Srinivas Madhu Prasad

Agenda
Introduction Cement Industry-Ultratech Pharma Industry-GlenMark IT Industry-HCL Conclusion

Agenda
Introduction Cement Industry-Ultratech Pharma Industry-GlenMark IT Industry-HCL Conclusion

Introduction: Calculation of WACC

Cost of Capital: The opportunity cost of all capital invested in an enterprise. Calculation of WACC: 3 step process Step 1:Cost of capital components. First, we calculate or infer the cost of each kind of capital that the enterprise uses, namely debt and equity. Debt Capital: The cost of debt capital is equivalent to actual or imputed interest rate on the company's debt, adjusted for the tax-deductibility of interest expenses. Equity Capital: Opportunity cost of equity capital. Calculated

using CAPM model. Cost of capital= Risk-Free Rate +Beta * Market Risk Premium Beta is calculated using Hamada Equation. Beta(levered)=Beta(unlevered)*(1+(1-tax rate)*(Debt/Equity).

Introduction Continues..

Step2: Capital structure. Next, we calculate the proportion that debt and equity capital contribute to the entire enterprise, using the market values of total debt and equity to reflect the investments on which those investors expect to earn a minimum return. Step3: Weighting the components. Finally, we weight the cost of each kind of capital by the proportion that each contributes to the entire capital structure. This gives us the Weighted Average Cost of Capital (WACC), the average cost of each dollar of cash employed in the business. V=Debt(D)+Equity(E).

Cost of Capital Estimation

Estimate the Cost of Equity at different levels of debt: Equity will become riskier -> Beta will increase -> Cost of Equity will increase. Estimation will use levered beta calculation 2. Estimate the Cost of Debt at different levels of debt: Default risk will go up and firm ratings will go down as debt goes up -> Cost of Debt will increase. To estimating firm ratings, we will use the interest coverage ratio (EBIT/Interest expense) 3. Estimate the Cost of Capital at different levels of debt 4. Calculate the effect on Firm Value.
1.

Assumptions and Approach

Agenda
Introduction Cement Industry- Ultratech Pharma Industry-GlenMark IT Industry-HCL Conclusion

UltraTech- Cost of Capital Estimate

Cost of Capital Estimate with different Debt Equity Mix Interest D/E Estimate Cost of Coverage Ratio d Beta Equity Ratio 122.27 No debt 0.87 0.66 10.2% 9.8%

Capital

Debt

Equity

Cost of Debt

Cost of Capital

2,16,034.2 63,686.0 1,52,348.2 41.8% 2,16,034.2 0.0 2,16,034.2 0.0%

5.18% 4.00%

8.30% 9.80%

2,16,034.2 20,000.0 1,96,034.2 10.2%

2,16,034.2 40,000.0 1,76,034.2 22.7% 2,16,034.2 50,000.0 1,66,034.2 30.1%

474.71
224.17 161.40

0.71
0.78 0.81

9.9%
10.0% 10.1%

4.25%
4.50% 5.00%

9.26%
8.76% 8.59%

2,16,034.2 60,000.0 1,56,034.2 38.5%

2,16,034.2 80,000.0 1,36,034.2 58.8%

103.46
63.05

0.85
0.95

10.1%
10.3%

6.50%
8.00%

8.65%
8.68%

Ultratech-Cost of Debt,Equity & Capital

Ultratech getting Optimal WACC at Debt Ratio of 30.1%

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Agenda
Introduction Cement Industry-Ultratech Pharma Industry- GlenMark IT Industry-HCL Conclusion

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GlenMark- Cost of Capital Estimate

Cost of Capital Estimate with different Debt Equity Mix Interest Estimated Cost of Coverag Beta Equity e Ratio 10.27 No debt 12.82 8.84 6.65 5.61 2.72 0.37 0.31 0.36 0.38 0.41 0.43 0.55 9.3% 9.2% 9.2% 9.3% 9.3% 9.4% 9.6%

Capital

Debt

Equity

D/E Ratio

Cost of Debt

Cost of Capital

31,038.3 31,038.3 31,038.3 31,038.3 31,038.3

5,806.5 25,231.8 0.0 31,038.3

23.0% 0.0% 19.2% 29.1% 40.8% 47.5% 93.5%

7.52% 6.00% 7.00% 7.25% 7.50% 8.00% 11.00%

8.69% 9.15% 8.69% 8.55% 8.43% 8.48% 10.27%

5,000.0 26,038.3 7,000.0 24,038.3 9,000.0 22,038.3

31,038.3 10,000.0 21,038.3 31,038.3 15,000.0 16,038.3

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Glenmark-Cost of Debt,Equity& Capital

Glenmark getting Optimal WACC at Debt Ratio of 40.8%

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Agenda
Introduction Cement Industry-Ultratech Pharma Industry-GlenMark IT Industry-HCL Conclusion

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HCL- Cost of Capital Estimate

Cost of Capital Estimate with different Debt Equity Mix Interest D/E Estimated Cost of Coverag Ratio Beta Equity e Ratio 66.22 No debt 126.58 42.19 19.47 7.23 4.99 0.42 0.40 0.42 0.44 0.48 0.68 0.99 9.4% 9.3% 9.3% 9.4% 9.5% 9.8% 10.4%

Capital

Debt

Equity

Cost of Debt

Cost of Capital

1,08,643.2 6,265.8 1,02,377.4 6.1% 1,08,643.2 0.0 1,08,643.2 0.0%

12.20% 6.00% 10.00% 12.00% 13.00% 14.00% 14.50%

9.39% 9.33% 9.30% 9.41% 9.63% 10.46% 11.16%

1,08,643.2 4,000.0 1,04,643.2 3.8% 1,08,643.2 10,000.0 98,643.2 1,08,643.2 20,000.0 88,643.2 1,08,643.2 50,000.0 58,643.2 10.1% 22.6% 85.3%

1,08,643.2 70,000.0 38,643.2 181.1%

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HCL-Cost of Debt,Equity & Capital

HCL getting Optimal WACC at Debt Ratio of 3.8%

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Agenda
Introduction Cement Industry-Ultratech Pharma Industry-GlenMark IT Industry-HCL Conclusion

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Comparing the Industry Average

Industry Analysis: Debt/Equity Ratio Pharma Industry Sun Pharma Glenmark Cipla Dr. Reddy RanbaxyDec 122 Optimum Glenmark

0.35

0.01

0.23

0.06

0.25

2.38

0.41

Cement

Industry 0.44

Ambuja 0.01

Ultratech 0.34

Birla 0.5

JK 0.9

Prism 1.3

Optimum Ultra 0.3

Infy/MS/TCS/ Industry Cognizent/HP IT/Capeg. Software 0.11 0

HCL 0.1

Wipro 0.23

IBM 0.25

Tech Optimum Mahindra HCL 0.33 0.038

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Conclusion
Framework for getting to the Optimal
Is the actual debt ratio greater than or lesser than the optimal debt ratio?

Actual > Optimal Overlevered Is the firm under bankruptcy threat? Yes Reduce Debt quickly 1. Equity for Debt swap 2. Sell Assets; use cash to pay off debt 3. Renegotiate with lenders No Does the firm have good projects? ROE > Cost of Equity ROC > Cost of Capital

Actual < Optimal Underlevered Is the firm a takeover target? Yes Increase leverage quickly 1. Debt/Equity swaps 2. Borrow money& buy shares. No Does the firm have good projects? ROE > Cost of Equity ROC > Cost of Capital

Yes No Take good projects with 1. Pay off debt with retained new equity or with retained earnings. earnings. 2. Reduce or eliminate dividends. 3. Issue new equity and pay off debt.

Yes Take good projects with debt.

No Do your stockholders like dividends?

Yes Pay Dividends

No Buy back stock

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Thank you

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