AN ANALYSIS OF CAPITAL STRUCTURE FOR HINDUSTAN UNILEVER LIMITED, VADAMANGALAM PUDUCHERRY.

SUMMER PROJECT REPORT Submitted by BAIG MANSUR IBRAHIM REGISTER NO: 26348005 Under the Guidance of Mrs. S. JANAKI RAMA M.B.A.,P.G.D.C.A, Faculty, Department of Management Studies
in partial fulfillment for the award of the degree of

MASTER OF BUSINESS ADMINISTRATION

DEPARTMENT OF MANAGEMENT STUDIES

SRI MANAKULA VINAYAGAR ENGINEERING COLLEGE PONDICHERRY UNIVERSITY PUDUCHERRY, INDIA

OCTOBER 2007

SRI MANAKULA VINAYAGAR ENGINEERING COLLEGE PONDICHERRY UNIVERSITY

DEPARTMENT OF MANAGEMENT STUDIES
BONAFIDE CERTIFICATE

This to certify that the project work entitled AN ANALYSIS OF CAPTAL STRUCTURE FOR HINDUSTAN UNILEVER LIMITED, VADAMANGALAM PUDUCHERRY is a bonafide work done by BAIG MANSUR IBRAHIM [ REGISTER NO: 26348005] in partial fulfillment of the requirement for the award of Master of Business Administration by Pondicherry University during the academic year 2006 2007.

GUIDE

HEAD OF DEPARTMENT

Submitted for Viva-Voce Examination held on

EXTERNAL EXAMINER

TABLE OF CONTENTS
CHAPTER
ACKNOWLEDGEMENT ABSTRACT LIST OF TABLES LIST OF CHARTS

TITLE

PAGE NO

ii iii v vi

INTRODUCTION I 1.1 Corporate Profile 1.2 Need for the Study 1 10

II III IV V VI VII VIII

REVIEW OF LITERATURE OBJECTIVES OF THE STUDY RESEARCH METHODOLOGY DATA ANALYSIS AND INTERPRETATION FINDINGS OF THE STUDY SUGGESTIONS, RECOMMENDATIONS & CONCLUSION LIMITATIONS & SCOPE FOR THE FURTHER STUDY ANNEXURE

11 27 28 30 51 53 55

ACKNOWLEDGEMENT
I express my sincere thanks and deep sense of gratitude to the MANAGEMENT OF SRI MANAKULA VINAYAGAR ENGINEERING COLLEGE, Puducherry, for providing me the necessary and essential facilities to do this project report. I am extremely grateful to Our Principal Dr. V.S.K. VENGATACHALAPATHY for providing necessary and essential facilities to do this project report. I express my sincere thanks and deep sense of gratitude to our Head of Department Mr.S. JAYAKUMAR and my guide Mrs.M. JANAKI RAMA, Department of Management Studies for providing me an opportunity to carry on this study and for the guidance to complete this project successfully. I convey my heartiest thanks to Mr. VIJAYAKUMAR, Executive - HR, Hindustan Unilever Limited, Soap & Detergent Division, Puducherry, who kindly granted permission to do this project in his esteemed organization. I express my sincere thanks to Mr. R.T. SHANKAR, Safety Officer, Hindustan Unilever Limited, Pondicherry, for guiding me in all the ways to do this project I express my sincere thanks and deep sense of gratitude to my friend MARIA JOSEPHINE VIDHYA RADHIKA, who encouraged me in all possible ways. Finally, I thank my brother MR.NAZIR without whose support this project report would not have been completed successfully

ABSTRACT
Finance is an important integral part of modern economic life. Financing decision plays a vital role. It involves raising funds for the company. It is concerned with the designing of capital structure. The financial decision should be shaped in such a way it should support the companys capital structure. Capital structure should be examined from the viewpoint of its impact on the value of the firm. The firm should select the financing mix in such a way that it maximizes the shareholders wealth. The combination of debt and equity determines it. . This project deals with an analysis of capital structure for Hindustan Unilever Limited, Detergent division, Vadamangalam, Puducherry. The main objective of the project is to analyze the capital structure of the company and its secondary objectives are to determine the optimal debt-equity mix for the company,to determine the firms combined effect of the leverages,to identify the value of the firm {overall cost of capital (KO)} by applying various capital structure theories,to apply the related ratios in order to analyze the capital structure of the company and to suggest suitable suggestions for framing effective capital structure to meet the requirement of the company.

For analyzing the capital structure of, secondary data such as balance sheet, the financial statements of the company are collected and the tools such as leverage analysis, ratio analysis, cost of capital and the theories of the capital structure have been applied.

finally, from the analysis and interpretation of the study, it has been concluded that Leverage analysis of the company states that both financial and operating risk associated with the company is less and they are very efficient in using the operating cost. Cost of capital analysis of the company states that the company had taken steps to minimize their cost of capital and they were able to minimize it. It shows how effectively they had used the capital. The financial performance of the company is also good and they are maintaining it. Capital structure decisions are dynamic for every year. Overall, the companys capital structure is optimum. The study suggests that the company can maintain the same level of capital structure decisions to maximize its earning for the forth coming years.

LIST OF TABLES

Table No 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 5.13 5.14 5.15 5.16 5.17 Financial Leverage Operating Leverage Combined Leverage Cost of Equity Cost of Debt

TABLE NAME

Page No 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46

Composite Cost of Capital Debt Equity Ratio Capital Gearing Ratio Interest Coverage Ratio Ratio of Fixed Assets To Funded Debt Ratio of Current Liability To Proprietors Fund Proprietory Ratio Fixed Assets Turnover Ratio Ratio of Reserves To Equity Capital Capital Structure of HUL Price Earnings Ratio/Earnings Yield Ratio Return On Share Holders Investment Or Net Worth

CHAPTER I

INTRODUCTION 1.1 CORPORATE PROFILE

Hindustan Unilever Limited (HUL) is India's largest fast moving consumer goods company, with leadership in Home & Personal Care Products and Foods & Beverages. HUL's brands, spread across 20 distinct consumer categories, touch the lives of two out of three Indians. They endow the company with a scale of combined volumes of about 4 million tones and sales of Rs.10,000 crores. The mission that inspires HUL's over 15,000 employees is to "add vitality to life". With 35 Power Brands, HUL meets everyday needs for nutrition, hygiene, and personal care with brands that help people feel good, look good and get more out of life. It is a mission HUL shares with its parent company, Unilever, which holds 51.55% of the equity. A Fortune 500 transnational, Unilever sells Foods and Home and Personal Care brands in about 100 countries worldwide 1.1.1 CORPORATE PURPOSE HUL purpose in Unilever is to meet the everyday needs of people everywhere to anticipate the aspirations of companys consumers and customers and to respond creatively and competitively with branded products and services which raise the quality of life. HULs deep roots in local cultures and markets around the world are unparalleled inheritance and the foundation for corporate future growth. HUL will bring wealth of knowledge and international expertise to the service of local customers - a truly multi-local multinational. HUL has long term success requires a total commitment to exceptional standards of performance and productivity, to working together effectively and to a willingness to embrace new ideas and learn continuously. HUL believe that to succeed requires the highest standards of corporate behaviour towards employees, consumers and the societies and world in which we live. This is Unilevers road to sustainable, profitable growth for companys business and long term value creation for firms shareholders and employees. 1.1.2 FAST FACTS Indias largest fast moving consumer goods company

8 Touches the lives of 2 out of 3 Indians 30 Power Brands Combined volume 4 million tonnes Leadership in home and personal care, foods and beverages Covers 1 million retail outlets, 50,000 villages About 40,000 employees (including group companies) Golden Super-Star Trading House; Net foreign exchange earner 1.1.3 HISTORY 1888: Sunlight introduced in India 1918: Vanaspati launched through imports 1931: Unilever registers company in India Hindustan Vanaspati Manufacturing Company 1933: Lever Brothers India Limited incorporated to manufacture soaps 1935: United Traders Limited incorporated in India to market personal products 1956: HVM, LBIL, UTL merge to form HLL 1958: HLRC starts functioning 1979: Chemicals complex commissioned in Haldia 1993: TOMCO merges with HLL 1994: JV, Kimberley-Clark Lever 1995: Lakme Lever formed 1996: HLL and BBLIL merge Ponds India Ltd merges with HLL and HLL acquires Lakme 2000: HLL acquires Modern Foods 2001: (i). Project Shakti, HLLs partnership with rural Self Help Groups (ii). Launch of HLLs e-tailing service- Sangam (iii).Max confectioneries launched 2002: Lever Ayush launched 2003: Launch of Hindustan Lever Network 2007: Name changed as Hindustan Unilever Limited.

1.1.4 FINANCIAL OVERVIEW

9 Financial performance in 2002 Gross turnover Net profit Earnings per share Dividend per share Rs 10952 crores Rs 1756 crores Rs 7.98 Rs 5.50

1.1.5 THE INDIAN MARKET PLACE

Urban Rural

Cities / Towns Outlets Villages Outlets

3700 1.5 million 627000 3.3 million

1.1.6 THE REACH 7000 redistribution stockists Direct coverage of 1 million of Indias 4.8 million retailers 50,000 villages

1.1.7 CATEGORIES & BRANDS

10 Soaps - Lifebuoy, Lux, Liril, Breeze, Hamam Detergents - Wheel, Rin, Surf Household Care - Vim, Domex Oral Care - Close-up, Pepsodent Skin Care - Fair & Lovely, Lakme, Ponds, Vaseline, Pears Hair Care - Sunsilk, Clinic, Nihar Deodorants - Axe, Rexona, Denim, Ponds Colours - Lakme, Elle 18 Beverages - Taj Mahal, Lipton Yellow Label, Lipton Ice Tea,3 Roses,Red Label, Taaza, A1, Bru, Green Label Foods - Knorr Annapurna, Kissan Cooking Oils - Dalda Ice Creams - Kwality Walls Healthcare - Lever Ayush Confectioneries - Max Network Marketing - Hindustan Lever Network 1.1.8 CHANGING FACE OF THE INDIAN CONSUMER More aware and selective Has faster changing needs and habits Increased ability to spend on a wide range of products Availability and willingness to use credit Quality conscious Rural consumers arespecially price sensitive 1.1.9 CHALLENGE OF THE RURAL MARKETS Indirect Coverage Cinema Van Operations Operation Streamline Project Shak

1.1.10 THE CONTEMPORARY DISTRIBUTION NETWORK

11

Factories / 3 P

Carrying & Forwarding Agents

Redistribution Stockiest

Wholesalers

Rural Retailers

Urban Retailers

Consumers

12 1.1.11 MANUFACTURING LOCATIONS 1.1.12 World Class Facilities Over 100 units across the country TPM in all key factories About 28 factories in backward areas About 2000 suppliers Sick companies turned Around 1.1.13 Best-in-Class Employees Systematic training ensures best-in-class employees Harmonious and cordial industrial relations at factories Production and productivity rates among the best in the Unilever world 1.1.14 DEVELOPING & USING RELEVANT TECHNOLOGY 1.1.15 Building the Base Largest private sector research facility Two Research Centres - Mumbai & Bangalore Over 200 highly-qualified scientists 1.1.16 BENEFITS OF RESEARCH HUL has found that research can be applied with enormous benefit across every one of our businesses, ranging from seemingly simple consumer products to industrial chemicals and machinery. It is a mistaken belief that research is only relevant to what seem to be high tech areas; there are always opportunities to use research to reduce costs, improve performance and provide new products and benefits. 1.1.17Key Successes Import substitution - Non-conventional oils for soap making. Estimated savings of US$1.2 billion. Reducing time & water consumption by 50% in Laundry Fair & Lovely - A global mega brand Iodine Intact salt Eutectics for cold chain Using R&D for manufacturing excellence

13 1.1.18 TRAINING & DEVELOPMENT A Peoples Company I believe that people make all the difference. I learnt this very early in my career, when, as a sales manager, I traveled from one territory to another. . People do make all the difference - CEO, HUL. The Philosophy Provides people the thrill of business and diversity of experience Inculcating diversity HLL managers hold key positions across Unilever world

Nurturing Top Talent, Encouraging Teamwork Commitment to attract, develop and retain the highest quality of talent Process in place to identify & develop potential early in peoples career Smaller, independent business units to ensure entrepreneurial teamwork

14 1.1.19 COMMITMENT TO SOCIETY 1.1.20 Proactive Social Development - Rural Development - Basic Education - Care and education for abandoned, special children - Caring for HIV-positive patients - Reconstruction & relief post natural calamities Commitment to Society 1.1.21 Sustainable development - Energy Conservation - Water Conservation - Tree Plantation - Watershed Development Commitment to Society 1.1.22 Asha Daan Run by the Missionaries of Charity, and supported by HLL, Asha Daan has been home to over 20,000 infants, destitute men and women and HIV positive patients. 1.1.23 Ankur & Kappagam Centres for special children in Assam & Tamil Nadu, imparts special education and services to severely disabled children. 1.1.24 Project Shakti Micro enterprise opportunity for under-privileged rural women. They become HLLs directto-home distribution and in turn benefit through sustainable income. Already in 5000 villages. Vision to reach 100,000 villages. 1.1.25 Yashodadham A village in Gujarat, rebuilt and dedicated to its 1100 residents after the earthquake in 2001 Spread over 25 acres, it has 289 dwelling units, school, play ground for children, community centre, anganwadi and health centre.

15 1.1.26 MEDIA PERCEPTIONS - Indias Most respected What the media says. India's biggest wealth creator -Business Today, April 2003 Amongst worlds Finest Large Corporations - Forbes Global, April 2003 Amongst India's most respected companies - Business World, January 2003 India's most valuable company - Business Today - November 2002 Indias greatest wealth creator - Business Today, March 2001 Indias best household products company - Forbes Global, January 2000 Indias most valuable company - Business Today, October 2000 Indian Corporation to be emulated - Far Eastern Economic Review, 1996 1999

Hindustan Unilever Limited Meeting everyday needs of people everywhere

16

1.2 NEED FOR THE STUDY

The study is needed to analysis the capital structure of the company in a better manner. Through this study the company can use various capital structure theories to identify the value of the firm. It can also be needed for the management to apply the related ratios to analyze its structure in a better manner. It can also be helpful for the management to apply various financial tools such as financial leverage and cost of capital. The study is needed for identifying optimal debt-equity mix.

17

CHAPTER II
REVIEW OF LITERATURE
2.1 INTRODUCTION

Finance is an important integral part of modern economic life. Financing decision plays a vital role. It involves raising funds for the company. It is concerned with the designing of capital structure. The financial decision should be shaped in such a way it should support the companys capital structure. Capital structure should be examined from the viewpoint of its impact on the value of the firm. The firm should select the financing mix in such a way that it maximizes the shareholders wealth. The combination of debt and equity determines it. If the company opts for more debt, they may trigger off a high Interest burden, devour profits and depress earnings per share and, above all, endanger the very survival of the firm. On the other hand, a conservative policy may deprive the company of its advantage in terms of magnifying the rate of return to its equity owners as higher equity component results in low earnings per share. The finance manger should consider various factors while deciding the choice of debt and equity. Apart from risk return financial considerations, the financial manager also considers non- financial factors. When equity shareholders are more in numbers; they have access to control the company. But when debts Owings are more then equity, finance managers consideration is more on debt then equity. Financial crisis may arise in the firm due to two main reasons. They are Unexpected decline in operating profit. Requirement for increased funds. Non-payment of interest or principal amount to lenders at specified time will have to be recovered through liquidations in the company. At the same time the non use of debt prevents the firm from availing an opportunity to have the advantage on rate of return to its shareholders.

18 The financial manger would always try to maximize the wealth of shareholders. Hence the credit of the financial manger lies on how he settle Disputes, overcome difficulties with help of optimum mix of debts and equity, which would satisfy both the shareholders and creditors. He has to make a risk return transaction between these two sources in such a way that it earns maximum benefits to the company. When the finance manger, is not able to provide benefits to the company he needs to redefine capital structure. Meaning Capital structure refers to the way a corporation finances itself through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20bn dollars in equity and $80bn in debt is said to be 20% equity financed and 80% debt financed. The firm's ratio of debt to total financing, 80% in this example, is referred to as the firm's leverage. Definition The permanent long-term financing of a company, including long-term debt, common stock and preferred stock, and retained earnings. It differs from financial structure, which includes short-term debt and accounts payable The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, the value of a firm is unaffected by how that firm is financed. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs. These other reasons include bankruptcy costs, agency costs and asymmetric information. This analysis can then be extended to look at whether there is in fact an 'optimal' capital structure: the one which maximizes the value of the firm.

2.2 Features of capital structure

1. Return The capital structure of the company should be advantageous subjects to other considerations; it should generate maximum returns to the shareholders without adding additional cost to them. 2. Risk

19 The use of excessive debt threatens the solvency of the company. Debt can be used the point where there is no significance risk, it should be avoided. 3. Flexibility The capital structure should be flexible. It should be possible for the company to adapt its capital structure with a minimum cost and delay if warranted by a changed situation. It should also possible for the company to provide funds whenever needed to finance its profitable activities. 4. Capacity The capital structure should be determined within the debt capacity of the company, and the capacity should not be exceeded. The capacity depends on the ability to generate future cash flows. They should have enough cash to pay the creditors fixed charges and principal sum. 5. Control The capital structure should involve minimum risk of loss of control of the company. The owners of closely held companies are particularly concerned about dilution of control. For example, a company may give more importance to flexibility then control while another company may be more concerned about solvency than any other requirement; Further more the relative importance of the requirement may change with shifting conditions 2.3 DESIGNING A CAPITAL STRUCTURE The capital structure is said to be optimum when the marginal real cost (explicit as well as implicit) of each available source of financing is identical. With an optimum debt and equity mix, the cost of capital is minimum and the market price per share (o r total value of the firm) is maximum. The use of debt and capital structure or financial leverage has both benefits as well as costs. While the attraction of debt is the tax benefit, its cost is financial distress and reduced commercial profitability.

20 The term financial distress includes a broad spectrum of problem ranging from relatively minor liquidity shortages to bankruptcy. Given the objective of maximization of shareholders wealth, the need for an optimal capital structure cannot, therefore, be overemphasized. In operational terms, every firm should try to design such a capital structure. But the determination of an optimum capital structure is a formidable task. It should be clearly understood that identifying the precise percentage of debt that will maximize price per share is almost impossible. It is possible that, however, to determine the approximate proportion of debt to use in the financial plan in conformity with the objective of maximizing share prices.

2.4 CONCEPTS INVOLVED IN CAPITAL STRUCTURE

COST OF CAPITAL MEANING The cost of capital of a firm is the minimum rate of return expected by its investors. It is the weighted average cost of various sources of finance used by a firm. The concept of cost of capital is very important in the financial management. A decision to invest in a particular project depends upon the cost of capital of the firm. Generally higher the risk involved, higher is the cost of capital. DEFINITIONS A cut-off rate for the allocation of capital to investments of projects. It is the rate of return on a project that will leave unchanged the market the price of the stock JAMES C. VANHORNE

Cost of capital is the minimum required rate of earning or the cut off rate of capital expenditures. - SOLOMON EZRA Computation of overall cost of capital of a firm involves: a. Computation of cost of specific source of finance, and

21 b. Computation of weighted average cost of capital.

2.5 LEVERAGE MEANING Leverage refers to an increased means of accomplishing some purpose. In financial management the term leverage is used to increase the return to its owners i.e. Shareholders. DEFINITION The employment of an asset or source of funds for which the firm has to pay a fixed cost or fixed return. TYPES OF LEVERAGE Basically there are three types of leverages. Operating Leverage Financial Leverage Composite Leverage The leverage associated with the employment of fixed cost assets is referred to as operating leverage, while the leverage resulting from the use of fixed cost / return source of funds is knows as financial leverage. In addition to this two kind of leverages, one could always computer Composite leverage to determine the combined effect of the leverages.

22

2.6 CAPITAL STRUCTURE IN A PERFECT MARKET Main article: Modigliani-Miller theorem The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. The basic theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed.[1] It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, the Modigliani-Miller theorem is also often called the capital structure irrelevance principle. Merton Miller's analogy to illustrate the principle uses a pizza: cutting a pizza into more or less pieces does not change the underlying amount of pizza. Modigliani won the 1985 Nobel Prize in Economics for this and other contributions. Miller won the 1990 Nobel Prize in Economics, along with Harry Markowitz and William Sharpe, for their "work in the theory of financial economics," with Miller specifically cited for "fundamental contributions to the theory of corporate finance

23 Propositions The theorem was originally proved under the assumption of no taxes. It is made up of two propositions which can also be extended to a situation with taxes. Consider two firms which are identical except for their financial structures. The first (Firm U) is unlevered: that is, it is financed by equity only. The other (Firm L) is levered: it is financed partly by equity, and partly by debt. The Modigliani-Miller theorem states that the value of the two firms is the same Without taxes Proposition I: Vu = Vl where VU is the value of an unlevered firm = price of buying a firm composed only of equity, and VL is the value of a levered firm = price of buying a firm that is composed of some mix of debt and equity. To see why this should be true, suppose an investor is considering buying one of the two firms U or L. Instead of purchasing the shares of the levered firm L, he could purchase the shares of firm U and borrow the same amount of money B that firm L does. The eventual returns to either of these investments would be the same. Therefore the price of L must be the same as the price of U minus the money borrowed B, which is the value of L's debt. This discussion also clarifies the role of some of the theorem's assumptions. We have implicitly assumed that the investor's cost of borrowing money is the same as that of the firm, which need not be true in the presence of asymmetric information or in the absence of efficient

Proposition II:

24

Proposition II with risky debt. As leverage (D/E) increases, the WACC stays constant. 1. y is the required rate of return on equity, or cost of equity. 2. c0 is the cost of capital for an all equity firm. 3. b is the required rate of return on borrowings, or cost of debt. 4. D / E is the debt-to-equity ratio. This proposition states that the cost of equity is a linear function of the firm's debt to equity ratio. A higher debt-to-equity ratio leads to a higher required return on equity, because of the higher risk involved for equity-holders in a company with debt. The formula is derived from the theory of weighted average cost of capital. These propositions are true assuming the following assumptions: 1. no taxes exist 2. no transaction costs exist, and 3. Individuals and corporations borrow at the same rates. 4. These results might seem irrelevant (after all, none of the conditions are met in the real world), but the theorem is still taught and studied because it tells us something very important. That is, if capital structure matters, it is precisely because one or more of the assumptions is violated. It tells us where to look for determinants of optimal capital structure and how those factors might affect optimal capital structure

With taxes

25 Proposition I: Where VL= VU + TCD

VL is the value of a levered firm. VU is the value of an unlevered firm. TCD is the tax rate (TC) x the value of debt (D)

This means that there are advantages for firms to be levered, since corporations can deduct interest payments. Therefore leverage lowers tax payments. Dividend payments are nondeductible. Proposition II: Where Y= c0 + D / E (c0 b) (1- Tc )

Y is the required rate of return on equity, or cost of equity. c0 is the cost of capital for an all equity firm. b is the required rate of return on borrowings, or cost of debt. D / E is the debt-to-equity ratio. Tc is the tax rate.

The same relationship as earlier described stating that the cost of equity rises with leverage, because the risk to equity rises, still holds. The formula however has implications for the difference with the WACC. The following assumptions are made in the propositions with taxes:

corporations are taxed at the rate TC on earnings after interest, no transaction cost exist, and individuals and corporations borrow at the same rate

Miller and Modigliani published a number of follow-up papers discussing some of these issues. The theorem first appeared in: F. Modigliani and M. Miller, "The Cost of Capital, Corporation Finance and the Theory of Investment," American Economic Review (June 1958)

26 2.7 CAPITAL STRUCTURE IN A REAL WORLD If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of these imperfections, by relaxing assumptions made in the M&M model. Trade-off theory Trade-off theory allows bankruptcy costs to exist. It states that there is an advantage to financing with debt, the tax benefit of debt and there is a cost of financing with debt, the bankruptcy costs of debt. The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. Empirically, this theory may explain differences in D/E ratios between industries, however it doesn't explain differences within the same industry.

As the Debt equity ratio (ie leverage) increases, there is a trade-off between the interest tax shield and bankruptcy, causing an optimum captial structure, D/E* The Trade-Off Theory of Capital Structure is a theory in the realm of Financial Economics about the corporate finance choices of corporations. Its purpose is to explain the fact that firms or corporations usually are financed partly with debt and partly with equity. It states that there is an advantage to financing with debt, the Tax Benefit of Debt and there is a cost of financing with debt, the costs of financial distress including Bankruptcy Costs of debt and non-Bankruptcy costs (e.g. staff leaving, suppliers demanding disadvantageous payment

27 terms, bondholder/stockholder infighting, etc). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. Although the empirical success of the alternative theories is often dismal,[1][2] the relevance of this theory has often been questioned. Miller 1977 [3] for example metaphor speaks of the balance between those two as equivalent to the balance between horse and rabbit content in a stew of one horse and one rabbit. Other critics have suggested it is the mechanical change in asset prices that makes up for most of the variation in capital structure. Pecking order theory Main article: Pecking Order Theory Pecking Order theory tries to capture the costs of asymmetric information. It states that companies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means of last resort. Hence internal funds are used first, and when that is depleted debt is issued, and when it is not sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required. Thus, the form of debt a firm chooses can act as a signal of its need for external finance.

Agency Costs There are three types of agency costs which can help explain the relevance of capital structure.

Asset substitution effect: As D/E increases, management has an increased incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders.

Underinvestment problem: If debt is risky (eg in a growth company), the gain from the project will accrue to debtholders rather than shareholders. Thus, management

28 have an incentive to reject positive NPV projects, even though they have the potential to increase firm value.

Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management

2.8 Arbitrage In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, a risk-free profit. A person who engages in arbitrage is called an arbitrageur. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives, commodities and currencies. If the market prices do not allow for profitable arbitrage, the prices are said to constitute an arbitrage equilibrium or arbitrage free market. An arbitrage equilibrium is a precondition for a general economic equilibrium. Conditions for arbitrage Arbitrage is possible when one of three conditions is met: 1. The same asset does not trade at the same price on all markets ("the law of one price"). 2. Two assets with identical cash flows do not trade at the same price. 3. An asset with a known price in the future does not today trade at its future price discounted at the risk-free interest rate (or, the asset does not have negligible costs of storage; as such, for example, this condition holds for grain but not for securities). Arbitrage is not simply the act of buying a product in one market and selling it in another for a higher price at some later time. The transactions must occur simultaneously to avoid exposure to market risk, or the risk that prices may change on one market before both transactions are complete. In practical terms, this is generally only possible with securities and financial products which can be traded electronically.

29 In the most simple example, any good sold in one market should sell for the same price in another. Traders may, for example, find that the price of wheat is lower in agricultural regions than in cities, purchase the good, and transport it to another region to sell at a higher price. This type of price arbitrage is the most common, but this simple example ignores the cost of transport, storage, risk, and other factors. "True" arbitrage requires that there be no market risk involved. Where securities are traded on more than one exchange, arbitrage occurs by simultaneously buying in one and selling on the other. Types of arbitrage Merger arbitrage Also called risk arbitrage, merger arbitrage generally consists of buying the stock of a company that is the target of a takeover while shorting the stock of the acquiring company. Usually the market price of the target company is less than the price offered by the acquiring company. The spread between these two prices depends mainly on the probability and the timing of the takeover being completed as well as the prevailing level of interest rates. The bet in a merger arbitrage is that such a spread will eventually be zero, if and when the takeover is completed. The risk is that the deal "breaks" and the spread massively widens. Municipal bond arbitrage Also called municipal bond relative value arbitrage, municipal arbitrage, or just muni arb, this hedge fund strategy involves one of two approaches. Generally, managers seek relative value opportunities by being both long and short municipal bonds with a duration-neutral book. The relative value trades may be between different issuers, different bonds issued by the same entity, or capital structure trades referencing the same asset (in the case of revenue bonds). Managers aim to capture the inefficiencies arising from the heavy participation of non-economic investors (i.e., high income "buy and hold" investors seeking tax-exempt income) as well as the "crossover buying" arising from corporations' or individuals' changing income tax situations (i.e., insurers switching their munis for corporates after a large loss as they can capture a higher after-tax yield by offsetting the taxable corporate income with underwriting losses). There are additional inefficiencies arising from the highly fragmented nature of the municipal bond market which has two

30 million outstanding issues and 50,000 issuers in contrast to the Treasury market which has 400 issues and a single issuer. Second, managers construct leveraged portfolios of AAA- or AA-rated tax-exempt municipal bonds with the duration risk hedged by shorting the appropriate ratio of taxable corporate bonds. These corporate equivalents are typically interest rate swaps referencing Libor [1] or BMA (short for Bond Market Association [2]). The arbitrage manifests itself in the form of a relatively cheap longer maturity municipal bond, which is a municipal bond that yields significantly more than 65% of a corresponding taxable corporate bond. The steeper slope of the municipal yield curve allows participants to collect more after-tax income from the municipal bond portfolio than is spent on the interest rate swap; the carry is greater than the hedge expense. Positive, tax-free carry from muni arb can reach into the double digits. The bet in this municipal bond arbitrage is that, over a longer period of time, two similar instruments--municipal bonds and interest rate swaps--will correlate with each other; they are both very high quality credits, have the same maturity and are denominated in U.S. dollars. Credit risk and duration risk are largely eliminated in this strategy. However, basis risk arises from use of an imperfect hedge, which results in significant, but range-bound principal volatility. The end goal is to limit this principal volatility, eliminating its relevance over time as the high, consistent, tax-free cash flow accumulates. Since the inefficiency is related to government tax policy, and hence is structural in nature, it has not been arbitraged away. Convertible bond arbitrage A convertible bond is a bond that an investor can return to the issuing company in exchange for a predetermined number of shares in the company. A convertible bond can be thought of as a corporate bond with a stock call option attached to it. The price of a convertible bond is sensitive to three major factors:

interest rate. When rates move higher, the bond part of a convertible bond tends to move lower, but the call option part of a convertible bond moves higher (and the aggregate tends to move lower).

stock price. When the price of the stock the bond is convertible into moves higher, the price of the bond tends to rise.

31

credit spread. If the creditworthiness of the issuer deteriorates (e.g. rating downgrade) and its credit spread widens, the bond price tends to move lower, but, in many cases, the call option part of the convertible bond moves higher (since credit spread correlates with volatility).

Given the complexity of the calculations involved and the convoluted structure that a convertible bond can have, an arbitrageur often relies on sophisticated quantitative models in order to identify bonds that are trading cheap versus their theoretical value. Convertible arbitrage consists of buying a convertible bond and hedging two of the three factors in order to gain exposure to the third factor at a very attractive price. For instance an arbitrageur would first buy a convertible bond, then sell fixed income securities or interest rate futures (to hedge the interest rate exposure) and buy some credit protection (to hedge the risk of credit deterioration). Eventually what he'd be left with is something similar to a call option on the underlying stock, acquired at a very low price. He could then make money either selling some of the more expensive options that are openly traded in the market or delta hedging his exposure to the underlying shares. Depository receipts A depository receipt is a security that is offered as a "tracking stock" on another foreign market. For instance a Chinese company wishing to raise more money may issue a depository receipt on the New York Stock Exchange, as the amount of capital on the local exchanges is limited. These securities, known as ADRs (American Depositary Receipt) or GDRs (Global Depositary Receipt) depending on where they are issued, are typically considered "foreign" and therefore trade at a lower value when first released. However, they are exchangeable into the original security (known as fungibility) and actually have the same value. In this case there is a spread between the perceived value and real value, which can be extracted. Since the ADR is trading at a value lower than what it is worth, one can purchase the ADR and expect to make money as its value converges on the original. However there is a chance that the original stock will fall in value too, so by shorting it you can hedge that risk. Regulatory arbitrage Regulatory arbitrage is where a regulated institution takes advantage of the difference between its real (or economic) risk and the regulatory position. For example, if a bank,

32 operating under the Basel I accord, has to hold 8% capital against default risk, but the real risk of default is lower, it is profitable to securitise the loan, removing the low risk loan from its portfolio. On the other hand, if the real risk is higher than the regulatory risk then it is profitable to make that loan and hold on to it, provided it is priced appropriately. This process can increase the overall riskiness of institutions under a risk insensitive regulatory regime, as described by Alan Greenspan in his October 1998 speech on The Role of Capital in Optimal Banking Supervision and Regulation. In economics, regulatory arbitrage (sometimes, tax arbitrage) may be used to refer to situations when a company can choose a nominal place of business with a regulatory, legal or tax regime with lower costs. For example, an insurance company may choose to locate in Bermuda due to preferential tax rates and policies for insurance companies. This can occur particularly where the business transaction has no obvious physical location: in the case of many financial products, it may be unclear "where" the transaction occurs. Telecom arbitrage Telecom arbitrage companies like Action Telecom UK allow mobile phone users to make international calls for free through certain access numbers. The telecommunication arbitrage companies get paid an interconnect charge by the UK mobile networks and then buy international routes at a lower cost. The calls are seen as free by the UK contract mobile phone customers since they are using up their allocated monthly minutes rather than paying for additional calls. The end effect is telecom arbitrage. This is usually marketed as "free international calls". The profit margins are usually very small. However, with enough volume, enough money is made from the cost difference to turn a profit. This is very similar to Future Phone in the US.

33

CHAPTER III
OBJECTIVES OF THE STUDY

PRIMARY OBJECTIVE The primary objective of the study is to analyze the capital structure of Hindustan Unilever Limited. SECONDARY OBJECTIVES To determine the optimal debt-equity mix for the company. To determine the firms combined effect of the leverages. To identify the value of the firm {overall cost of capital (KO)} by applying various capital structure theories. To apply the related ratios in order to analyze the capital structure of the company, To suggest suitable suggestions for framing effective capital structure to meet the requirement of the company.

34

CHAPTER IV
RESEARCH METHODOLOGY

4.1 RESEARCH METHODOLOGY

Research methodology is a way through which systematically we solve the research problem. It is understood as a science of studying how research is dined scientifically. It is necessary for the researcher to know not only the research methods and techniques but also methodology.

4.2 RESEARCH DESIGN

Research design is the conceptual structure within which research is conducted. It constitutes the blue print for collection, measurement and analysis of data. The study aims at narration of existing facts and figures regarding financial position of the company. So the research design adopted in the study has been descriptive in nature.

35

4.3 AREA OF STUDY

The study was carried out in the finance department of HIINDUSTAN UNILEVER

LIMITED. 4.4 PERIOD TAKEN FOR STUDY

The time taken for the study is for two months

4.5 DATA COLLECTION

The study involves only secondary data.

4.6 SECONDARY DATA

Secondary data were collected through annual report and balance sheets, and manuals of the company.

4.7 TOOLS OF ANALYSIS In order to analyze the capital structure and dividend policy of the company the following statistical tools are used. Leverage analysis Cost of capital analysis Ratio analysis Theories of capital structure

36

CHAPTER V
DATA ANALYSIS AND INTERPRETATION

FINANCIAL LEVERAGE Each and every company has a legal binding to pay the interest. The rate of interest differs on each of financing. The use of fixed charges sources of funds, such as debt and preference capital along with owners capital in the capital structure is known as financial leverage. Here the owners equity is used as the base to raise debt and the supplier has limited participation in companys profits. Earnings before interest and tax Degree of financial leverage= -------------------------------------Profit before tax TABLE NO. 5.1 FINANCIAL LEVERAGE Year Earning before interest and tax (Rs.in.million) Profit before tax (Rs.in.million) Financial leverage

37 (Times) 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 492 471 425 529 445 349 358 309 455 402 1.41 1.32 1.38 1.16 1.11

SOURCE: SECONDARY DATA

INTERPRETATION It shows that the financial leverage was high in the year 2001-2002 with 1.41 times and low in the year 2005-2006 with 1.11 times. Thus it can be concluded that a low rate of financial leverage indicates a low interest outflow and consequently lower borrowings.

OPERATING LEVERAGE Operating leverage refers to the relationship between firms sales revenue and its earnings before interest and tax. Operating leverage results from the operating cost of a firms income. The operating cost may be fixed cost, variable cost, semi-variable or semi-fixed cost. The firm will employ assets in such a way that their revenues are sufficient to cover all fixed and variable cost. Where, contribution= sales-variable cost Contribution Degree of operating leverage = ------------------------------------------Earning before interest and tax

TABLE NO. 5.2 OPERATING LEVERAGE

38 Contribution (Rs.in.million) 1376.40 1934.20 1600.00 1480.28 1663.50 AVERAGE SOURCE: SECONDARY DATA Earning Before Interest and Tax (Rs.in.million) 492 471 425 529 445 Operating leverage (Times) 2.79 4.11 3.77 2.79 3.74 3.44

Year

2001 2002 2002 2003 2003 2004 2004 2005 2005 2006

INTEPRETATION It reveals that operating leverage it was high in the year 2000-2001 with 4.11 times and lower in the year 2001-2002 and 2004-2005 with 2.79 times. On an average operating leverage 3.44 times. COMBINED LEVERAGE The operating leverage and financial leverage constitutes combined leverage. The combined leverage represents the effects of a given in the sales revenue on EPS. It affects the total risk of the firm. To keep a risk with in manageable limit. The firm, which has high degree of operating leverage, should have low financial leverage and vice versa.

Combined leverage = operating leverage*financial leverage

TABLE NO. 5.3 COMBINED LEVERAGE Operating Financial leverage leverage 2.79 1.41 Combined leverage (Times) 3.93

Year 2001 2002

39 2002 2003 2003 2004 2004 2005 2005 2006 4.11 3.77 2.79 3.74 1.32 1.38 1.16 1.11 5.43 5.20 3.24 4.15

SOURCE: SECONDARY DATA

INTERPRETATION It shows that the combined leverage is high in 2002-2003 with 5.45 times and low in the year 2004-2005 with 3.24 times. Since the total risk is high in 2000-2001 the company can increase its equity to reduce the risk.

COST OF EQUITY Equity is the permanent capital for a firm. The company may raise equity capital both internally and externally. It can rise internally by retained earnings and externally by issuing new shares. When a company wants to raise funds by way of equity shares, their expectations have to be evaluated and for that cost of equity is calculated.

Dividend per share Cost of equity = ---------------------------------- * 100 Market price per share TABLE NO. 5.4 COST OF EQUITY Year Dividend per share Market per share (%) Cost of equity Capital

40 (%) 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 6.0 7.0 7.5 10.0 12.5 106 90 77 105 172 (%) 5.66 7.78 9.74 9.52 7.27

SOURCE: SECONDARY DATA

INTERPRETATION It reveals that the cost of equity capital was high in the year 2003-2004 with 9.74% and low in the year 2001-2002 with 5.66%. The market price was fluctuating for all the years. In 2004-2005 the market price had been drastically falling and hence the cost of equity was high. The decline in the market price was due to the recession in the Indian economy.

COST OF DEBT A company may raise debt in various ways. It may be in the form of debenture or loan borrowed from financial or public institutions for a certain period of time at a specific rate of interest. The debenture or bond may be issued at par, discount or premium. It forms the basis for calculating cost of debt. Cost of debt Interest = --------------------* 100 Total debt TABLE NO. 5.5 COST OF DEBT Year 2001 2002 2002 2003 Interest (Rs in million) 143 113 Debt (Rs. In million) 780.44 964.66 Cost of debt (%) 18.32 11.71

41 2003 2004 2004 2005 2005 2006 116 74 43 1012.10 650.69 395.78 11.46 11.37 10.86

SOURCE: SECONDARY DATA INTERPRETATION The above table it is clear that the cost of debt has shown a decreasing trend in the five years. The cost of debt was high in the year 2001-2002 with 18.32% and low in 2003-2004 with 10.86%. Due to the high interest rate in 2001-2002 the cost of debt was maximum.

COMPOSITE COST OF CAPITAL By using composite cost of capital to determine the optimal debt-equity mix for the company. TABLE NO. 5.6 Computation of Composite Cost of Capital Debt-Equity Year Mix % 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 23:77 25:75 28:72 25:75 19:81 % 18.32 11.71 11.46 11.37 10.86 % 5.66 7.78 9.74 9.52 7.27 of Capital % 8.57 8.76 10.22 9.98 7.95 Cost of Debt Cost of Equity Composite cost

SOURCE: SECONDARY DATA

42

INTERPRETATION From the above, it is clear that the composite cost of capital is the lowest at 19% debt and 81% equity. Hence optimal debt-equity mix is 19% debt and 81% equity

DEBT- EQUITY RATIO The relationship between borrowed funds and owners capital is a popular measure of the long-term financial solvency of a firm. This relationship is shown by debt-equity ratio. This ratio was calculated to measure the relative claims of outsiders and the owners against the firms assets. It indicates the relationship between the external equities (or) outsiders funds and the internal equities (or) the shareholders funds. Debt equity ratio = Long term debt -------------------------Share holders fund

TABLE NO. 5.7 DEBT-EQUITY RATIO Year 2001 2002 2002 2003 Long term debt (Rs. million) 471.43 471.82 Share holders fund Debt equity ratio (Rs. million) 1556.36 1397.34 0.30 0.34

43 2003 2004 2004 2005 2005 2006 522.00 499.06 395.78 AVERAGE SOURCE: SECONDARY DATA INTERPRETATION It refers that the debt-equity ratio was high in 2003-2004 with 0.38 and low in 20052006 with 0.23. The ratio shows a decreasing trend. The standard norm for debt equity ratio is 2:1. According to the above table the company maintains debt-equity ratio as 0.32 on an average. It implies that for every one rupee of outside liability the firm has two rupees of owners capital. Since debt is less than equity in all the years the ratio is satisfactory to the company. CAPITAL GEARING RATIO The term capital gearing is used to describe the relationship between equity share capital including reserves and surplus to preference share capital and other fixed interest bearing loans. If preference share capital and other fixed interest bearing loans exceed the equity share capital including reserves, the firm is said to be highly geared and vice versa. 1367.85 1530.39 1715.10 0.38 0.33 0.23 0.32

Capital gearing ratio =

Equity share capital (+) reserves and surplus --------------------------------------------------------Long term debt

TABLE NO. 5.8 CAPITAL GEARING RATIO Equity share Capital + Year reserves & surplus (Rs. In million) 2001 2002 1556.30 Long term debt (Rs. In million) 471.43 Ratio (%) 3.30

44 2002 2003 2003 2004 2004 2005 2005 2006 1397.20 1368.40 1530.40 1715.40 471.82 522.00 499.06 395.78 2.96 2.62 3.07 4.33

SOURCE: SECONDARY DATA

INTERPRETATION It indicates that the capital-gearing ratio shows an increasing trend in the five years except in 2001-2002. Since equity share capital (+) reserves and surplus exceed the long-term debt in the years the company is said to be in a low gear.

INTEREST COVERAGE RATIO It is also known as time-interest-earned ratio. This ratio measures the debt servicing capacity of a firm in so far as fixed interest on long-term loan is concerned. It is determined by dividing the operating profits or earnings before interest and taxes (EBIT) plus depreciation by the fixed interest charges on loans.

Interest coverage ratio =

EBIT+ depreciation ----------------------------------Fixed interest charges

TABLE NO. 5.9 INTEREST COVERAGE RATIO EBIT (+) Depreciation Year (Rs in million) 2001 2002 2002 2003 614.10 584.70 Fixed interest charges (Rs in million) 143 113 Ratio (Times) 4.29 5.17

45 2003 2004 2004 2005 2005 2006 541.50 648.50 560.90 116 74 43 4.67 8.76 13.04

SOURCE: SECONDARY DATA

INTERPRETATION It reveals that the ratio is high during 2005-2006 with 13.04 times and low during 2001-2002 with 4.29 times the ratio has shown an increasing trend in the five years. This indicates the better position of creditors and thus the companys risk is lesser.

RATIO OF FIXED ASSETS TO FUNDED DEBT This ratio measures the relationship between the fixed assets and the funded debt and is very useful to the long-term creditors.

Fixed assets Ratio of fixed assets to funded debt = -------------------------------Funded debt

TABLE NO. 5.10 RATIO OF FIXED ASSETS TO FUNDED DEBT Year 2001 2002 2002 2003 2003 2004 Fixed assets (Rs in million) 1013 972 989 Funded debt (Rs in million) 93.40 116.40 173.00 Ratio (Times) 10.85 8.35 5.72

46 2004 2005 2005 2006 911 865 Average SOURCE: SECONDARY DATA 231.06 205.78 3.94 4.20 6.60

INTERPRETATION It shows that on an average 6.6 times of debt is in fixed assets. The ratio is high in the year2001-2002 with 10.85 times and low in the year 2004-2005 with 3.94 times. The ratio shows a decreasing trend in the five years. This indicates that the company had used less debt in the earlier stage and more debts in the later stages.

RATIO OF CURRENT LIABILITY TO PROPRIETORS FUND The ratio of current liabilities to proprietors fund establishes the relationship between current liabilities and the proprietors fund and indicates the amount of long term fund raised by the proprietors as against short-term borrowings.

Ratio of current liabilities to proprietors fund =

Current liabilities ------------------------Shareholders fund

TABLE NO. 5.11

RATIO OF CURRENT LIABILITY TO PROPRIETORS FUND

Year Current liabilities (Rs in million) 2001 2002 2002 2003 314.70 317.22 Shareholders fund (Rs in million) 1556.36 1397.34 Ratio (Times) 0.20 0.23

47 2003 2004 2004 2005 2005 2006 285.60 275.43 315.69 1367.85 1530.39 1715.10 0.21 0.18 0.18

SOURCE: SECONDARY DATA

INTERPRETATION It reveals that the ratio was high in the year 2002-2003 with 0.23 and low in the year 2004-2005 with 0.18. The table shows that the company had very less liabilities in proprietors fund.

PROPRIETORY RATIO Proprietory ratio is a variant to the debt equity ratio. This ratio establishes the relationship between shareholders funds to total assets of the firm. it is an important ratio for long-term solvency of a firm. Share holders fund Proprietory ratio = ------------------------Total assets

TABLE NO. 5.12 PROPRIETORY RATIO

Year 2001 2002 2002 2003

Share holders fund (Rs in million) 1556.36 1397.34

Total assets (Rs in million) 2274 2237

Ratio (Times) 0.68 0.62

48 2003 2004 2004 2005 2005 2006 1367.85 1530.39 1715.10 Average SOURCE: SECONDARY DATA 2465 2314 2225 0.55 0.66 0.77 0.66

INTERPRETATION The above table reveals that the ratio was high in the year 2005-2006 with 0.77times and low in 2003-2004 with 0.55. The ratio indicates that nearly 66% of the total assets are financed through shareholders funds and remaining 44% were financed through outsiders fund.

FIXED ASSETS TURNOVER RATIO The fixed assets turnover ratio indicates the velocity with which assets are turned over in relation to sales. This ratio is supposed to measure the efficiency with which fixed assets are employed. Fixed assets turnover ratio = Net sales ---------------Fixed assets

TABLE NO. 5.13 FIXED ASSETS TURNOVER RATIO Year 2001 2002 2002 2003 2003 2004 2004 2005 Net sales (Rs in million) 2161.90 2488.90 2483.40 2475.68 Fixed assets (Rs in million) 1013 972 989 911 Ratio (Times) 2.13 2.56 2.51 2.71

49 2005 2006 2748.38 Average SOURCE: SECONDARY DATA 865 3.18 2.62

INTERPRETATION It shows that ratio is high in the year 2005-2006 with 3.18 times low in the year 20012002 with 2.13 times. The table shows that on an average 2.09 times of investment are in fixed assets.

RATIO OF RESERVES TO EQUITY CAPITAL This ratio establishes a relationship between reserves and equity capital. The ratio indicates that how much profit does the firm for the future growth generally retain.

Reserves Ratio of reserves to equity capital = ----------------------------Equity share capital

TABLE NO. 5.14 RATIO OF RESERVES TO EQUITY CAPITAL

Year 2001 2002 2002 2003 2003 2004

Reserves& surplus (Rs in million) 1435.30 1303.90 1275.00

Equity share capital (Rs in million) 121.00 93.30 93.40

Ratio (Times) 11.86 13.97 13.65

50 2004 2005 2005 2006 1437.00 1622.00 Average SOURCE: SECONDARY DATA 93.40 93.40 15.39 17.37 14.45

INTERPRETATION It reveals that an average ratio of 14.45 of equity share capital represented by reserves. The ratio was highest in the year 2005-2006 with 17.37 low in the year 2001-2002 with 11.86. The table also indicates that good amount o earnings were retained as reserve for future growth and expansion of business.

CAPITAL STRUCTURE OF HUL (detergent division) (PROPORTION OF EQUITY AND DEBT CAPITAL) The capital structure is the combination or the proportion of different sources of financing (debt and equity) to the total capitalization. It is the permanent financing of a firm represented by long-term debt plus preferred stock plus net worth. The main problem in framing the capital structure is choosing the best mix of debt and equity.

TABLE NO. 5.15 CAPITAL STRUCTURE OF HUL Equity capital Year 2001 2002 2002 2003 2003 2004 2004 2005 (Rs.in.million) 1556.30 1397.20 1368.40 1530.40 Debt capital (Rs.in.million) 471.43 471.82 522.00 499.06 Proportion of debt & Equity 77:23 75:25 72:28 75:25

51 2005 2006 1715.40 395.78 81:19

SOURCE: SECONDARY DATA

INTERPRETATION The above table shows the proportion of equity &debt in the capital structure of HUL. During five years the company uses more equity capital than debt capital. In the year 20052006 the equity capital is maximum. Since the company has repaid the loans the debt capital is showing a decreasing trend.

PRICE-EARNINGS RATIO/EARNING YIELD RATIO The price earnings ratio is closely related to the earnings yield/earnings price ratio. It is actually the reciprocal if the latter. This ratio is a summary measure, which primarily reflects the factors such as growth prospects, risk characteristics, shareholders orientation, corporate image and degree of liquidity.

Market price of share Price earnings ratio = ---------------------------Earnings per share TABLE NO. 5.16 PRICE EARNING RATIO Year 2001 2002 2002 2003 Market price per share (Rs) 106 90 Earning per share (Rs) 21.45 21.03 Ratio (Times) 4.94 4.28

52 2003 2004 2004 2005 2005 2006 77 105 172 23.05 39.15 33.98 3.34 2.68 5.06

SOURCE: SECONDARY DATA

INTERPRETATION It indicates that the ratio is highest in the year 2005-2006 with 5.06 times and lowest in the year 2004-2005 with 2.68 times. Hence it can be concluded that an increase in earnings per share decreases the price earnings ratio, which is preferred by the investors.

RETURN ON SHARE HOLDERS INVESTMENT OR NET WORTH This ratio is one of the most important ratios used for measuring the overall efficiency of a firm. It shows the relationship between net profits (after interest and tax) and the proprietors funds. This ratio is of great importance to the present and prospective shareholders as well as the management of the company.

Net profit (after interest and tax) Return on shareholders investments = -----------------------------------------*100 Shareholders funds

TABLE NO. 5.16 RETURN ON SHARE HOLDERS INVESTMENT OR NET WORTH Year Net profit after tax (Rs in million) Share holders Fund (Rs in million) Ratio (%)

53 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 259.50 232.00 215.20 365.50 317.17 1556.36 1397.34 1367.85 1530.39 1715.10 16.48 16.60 15.73 23.88 18.49

SOURCE: SECONDARY DATA

INTERPRETATION It reveals that the ratio i.e. return is high in 2004-2005 with 23.88 and low in the year 2003-2004 with 15.73. Since the company has repaid the in 2003-2004 the ratio is lower. In all the other years the ratio shows an increasing trend, which is satisfactory to shareholders as well as to the management of the company.

CAPITAL STRUCTURE CALCULATION UNDER NET INCOME APPROACH FOR THE YEAR (2003-2004) FORMULA Net Income available to share holders = Earning before Interest and Tax Interest Total market value of firm V Where S = = Equity capitalization rate Market value of equity shares. Net income = S+D

D And,

Market value of debt

Earning Before Interest and Tax Ko = Overall Cost of Capital = V Year 2001- 2002

54 Debt capital Cost of debt Cost of equity = = = 1012.1 11.46% 8.24% = 425 million = 115.99 million = 309 million = 309/.0824 = 3750 million Market value of debt (ADD) V Ko = 1012.1 = 4762.1 = = IF DEBT IS INCREASED BY 100 Earning before interest and tax Less interest 425/4762.1 8.92%

Earning before Interest and Tax Interest (less)

Net income available to shareholders Market value of equity

CRORES (1000 million ) = 425 million = 230.57 million = 194.42 million

Net income available to shareholders

Market value of equity

= 194.42/.0824 = 2359.47 million

Market value of debt V Ko

= 2012.1 = 4371.57 million = 425/4371.57 = 9.72%

ITERPRETATION The above is the net income approach calculation of the company for the year 20032004. It shows that EBIT is 425 millions. The debt capital is 1012.1 millions. The value of the firm is 4762.1 millions the cost of capital is 8.92%.

55 By this assumption, if the debt is increased by 100 crores i.e. 2012.1 millions. This value of the firm will be increased to 4371.57 million and also increase the overall cost of capital from 8.92% to 9.72%.

VALUE OF THE FIRM ON THE BASIS OF NET OPERATING INCOME APPROACH YEAR 2003-2004
EBIT Debt capital Cost of debt Cost of equity Value of the firm V = 425 million = 1012.1 million = 11.46% = 8.24 = EBIT/Ko = 425/8.92 = 4764.57 million Market value of equity (S) = V-D

= 4764.57-1012.1 = 3752.47 million EBIT-I Equity capitalization rate = V-D = 425-115.99/4764.57-1012.1 = 8.24%

56 IF DEBT CAPITALIS INCREASED BY100 CRORES (1000 million)

EBIT Less Interest

= 425 million = 230.57 million = 194.42 million

Value of firm V

= 425/8.92 = 4764.57 million

Market value of equity (S)

=V-D = 4764.57-2012.1 = 2752.47 million EBIT - I

Capitalization rate

= V-D = 425-230.57/4764.57-2012.1 = 194.42/2752.47 = 7.06%.

Ko

= Ke{S/V}+Kd{D/V} = 0.0706{2752.47/4764.57}+0.1146{2012.1/4764.57} =0.0408+0.0484 =8.92%

INTERPRETATION The above shows the capital structure calculation of HUL under the net operating Income approach in the year 2003-2004. The EBIT is 425 millions. The value of the debt capital is 1012.1 millions. The value of the firm is 4764.57millions. The weighted average cost of capital is 8.92%. The cost of equity is 8.24%. If the debt is increased by 100 crores (1000 million) that is 2012.1millions, the value of the firm remains the same as 4764.57

57 millions. But the equity capitalization rate is decreased to 7.06%. The weighted average cost of capital will remain constant as 8.92%. Thus it is clear that according to NOI approach, change in capital structure does not affect the value of firm and weighted average cost of capital.

CHAPTER VI
FINDINGS OF THE STUDY
In this chapter the researcher has made an attempt to present the findings and suggestion of the study. Financial leverage shows a decreasing trend except in 2003-2004. This indicates that

a low rate of financial leverage was due to low interest out flow and consequently lowers borrowings. The operating leverage has been increased from 2.79 to 3.74 in the five years. This

indicates that the company had effectively used its variable operating cost. The combined leverage shows a decreasing trend except in 2002-2003. This indicates

that the total risk is decreasing year by year. The cost of equity was lower in 2001-2002 and was higher in 2003-2004. The market

price was very low, so the cost of equity was very high in that particular year. The cost of debt has shown a decreasing trend in the five years. Due to high rate of

interest, cost of debt was higher in 2001-2002 with 18.33. Debt equity ratio was in the decreasing trend, due to the repayment of debt. Debt is

more than equity in all the years and so the ratio is satisfactory to the company

58 Capital gearing ratio shows an increasing trend in the 5 years except in 2003-2004 .

This ratio indicates that the company is said to be in a low gear. Interest coverage ratio has shown an increasing trend in the five years. This indicates

the better position of creditors and less risk of the company. Ratio of fixed assets to funded debt shows an decreasing trend in the five years. This

indicates that the company had used less debt in the earlier state and more debts in the later stage. Ratio of current liability to proprietors funds shows an increasing trend . This ratio

reveals that the company has used more long term funds. Proprietors ratio shows a fluctuating trend in the five years. The ratio indicates that

nearly 66% of assets are financed through shareholders funds and remaining through outsiders. Fixed assets turnover ratio shows a fluctuating trend in the five years .The higher

turnover ratio indicates the more efficient management and better utilization of available fixed assets. Ratio of reserves to equity capital shows a fluctuating trend in the five years. The ratio

indicates that a fair amount of earnings were retained for future expansion. The capital structure of HUL reveals that debt capital proportion is decreasing year by

year due to repayment of debt The price-earnings ratio was high in 2005-06 with 5.06 times and low in 2004-2005

with 2.68 times. The ratio reveals that an increase in Earnings per share decreases the price earnings ratio, which is preferred by investors. Return on shareholders investment shows that return is low in 2001-2002 as the

company had repaid the loans. In the other years the ratio shows an increasing trend, which is satisfactory to shareholders as well as management of the company. Capital structure calculation of HUL under net income approach shows that an

increase in debt capital increase the value of the firm and reduces the overall cost of capital. Capital structure calculation of HUL under NOI approach shows that an increase in

the proportion of debt capital in capital structure does not affect value of firm and overall cost of capital.

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CHAPTER-VII
7.1 SUGGESTIONS & RECOMMENDATIONS
The company has to maintain the same proportion of debt-equity ratio. Fixed assets turnover ratio shows a fluctuating trend in the five years. So the company should maintain a higher turnover ratio for more efficient management and better utilization of available fixed assets. The company has effectively used its variable operating cost. So it should maintain the same level of usage in future which in turn will help the company in increasing its operating efficiency and better growth. Ratio of reserves to equity capital shows a fluctuating trend. So the company could maintain the higher ratio which will help the company to maintain a fair amount of earnings for future expansion. In future the company can use equity capital for long-term obligations and debt capital for the short-term obligations as equity capital is best suited for long run and debt capital is best suited for day-today activities.

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7.2 CONCLUSION
Leverage analysis of the company states that both financial and operating risk associated with the company is less and they are very efficient in using the operating cost. Cost of capital analysis of the company states that the company had taken steps to minimize their cost of capital and they were able to minimize it. It shows how effectively they had used the capital. The financial performance of the company is also good and they are maintaining it. Capital structure decisions are dynamic for every year. Overall, the companys capital structure is optimum. The study suggests that the company can maintain the same level of capital structure decisions to maximize its earning for the forth coming years.

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CHAPTER VIII
8.1 LIMITATION OF THE STUDY
1. The study mainly depends on the secondary data taken from annual report and internal records of the company. 2. The figures taken from the financial statement for analysis were historical in nature. 3. The study is confined to a short period of two months. This would not picture the exact position of the company. 4. The results made using the statistical techniques are expected outcomes and not the fact. 5. Every company will be having their own factors and situations. The findings of the study could be taken only as guidelines and cannot be applied directly to other companies of the same industry.

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8.2 SCOPE FOR THE STUDY

1. The study throws light on the need for analyzing the capital structure of the company. It also reveals the efficiency and effectiveness of the assessment of the factors. 2. The study can be help for the management for the further studies in the related areas. 3. The study can be served as a base for applying the other theories of capital structure and other financial tools. 4. It can also be useful for other organizations to carry the analysis in the similar areas. 5. This study can serve as a base for expanding the study by other researcher.

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