CORPORATE CAPITAL STRUCTURE

EXECUTIVE SUMMERY
INTRODUCTION
This thesis deals with questions concerning corporate capital structure. It examines show
Della tecnica company will decide his capital structure in a real life context. It also examines
if there is room for improvement when the company decide upon their capital structure.
Finally, it presents our conclusion based on the case studies Modern corporate finance theory
was born with the publication of Modigliani and Miller (M&M) theoretical model about
capital structure in 1958. They showed that, in a capital market free of taxes, transactions
costs, and other frictions, the choice of a firm capital structure could not affect its market
valuation The failure of management to insist on clear-cut objectives.
Modern corporate finance theory was born with the publication of Modigliani and Miller
(M&M) theoretical model about corporate capital structure in 1958. They showed that, in a
capital market free of taxes, transactions costs, and other frictions, the choice of a firm
capital structure could not affect its market valuation. Much of the capital structure theory
during the past forty years has involved examining how robust the model is to more realistic
assumptions regarding market frictions and the information sets available to managers and
shareholders. The development of agency theory in the 1980s, coupled with detailed
research into the extent and effects of bankruptcy costs during the 1980s, leads to a yet
more detailed view of the utility of the basic M&M capital structure theory. Finally, cross-
cultural examination of observed capital structure patterns in non-U.S. industrialized
countries has lead to our current mainstream view that corporations act as if there is a unique,
optimal capital structure for individual firms. This results from a trade-off between the tax
benefits of increasing leverage and increasing agency and bankruptcy costs that higher debt
entails. The fact that there seems to be an optimal capital structure for each individual firm is
very interesting, due to the fact that a companys result to a large extent depends on what
structure it has. This creates incentives for companies to revise their current capital structure.
Optimal Capital Structure Introduction

COMPANY INTRODUTION
At Della Tecnica, they posses a vibrant vision, a zest for innovation and a commitment to
sustainability. Started In 1996 Della Tecnica has been operating at an award winning level for
over a decade now. Today with over 1600 professionals networked across five offices in
India, they serve there clients as trusted advisors, combining localized expertise with global
perspective. At Della Tecnica there people are there key point of difference, and they have
always sought to attract the highest caliber of industry professionals. they boast a pool of
talented and experienced professionals offering an unparalleled breadth of services in
Architecture, Master Planning, Design and Build, Interiors, Development, Construction and
MEP Engineering Services with a combined portfolio of over a few million sq.ft. of award-
winning projects across industries throughout the country. there designers are known for their
innovation, leadership and exceptional client service.
A lot of repeat business reflects the trust and value our clients place in there experienced
Architects. Offering most of the essential services in-house also contributes to better
execution of projects by streamlining the team's communication and helps in delivering the
projects in the given time frame and manage the costs effectively. Our ability to integrate all
these services as individual profit centers, yet posing as a unified creative force, is in synch
with what today's world needs

Design & Build
Recognized as the market leader's providing comprehensive turnkey solutions and
consultancy in the field of Architecture, Design and Build. The organization has extended
both vertically and horizontally into a group of six companies - related yet independent
Verticals.

WHAT WILL DO COMPANY
In India's booming 'Design & Build' industry, Della Tecnica has been operating at an award-
winning level for over a decade now. This amounts to a significant experience in working
collaboratively to deliver superior Architecture and Design solutions for high profile &
diverse clientele such as the UB Group, Kingfisher Airlines, Bajaj Auto, Omega, Amsons,
Sahara Group, Crisil, Star TV, 9X, NDTV Imagine & Emerson Consultancy.
At Della Tecnica our people are our key point of difference, and Jimmy has always sought to
attract the highest caliber of industry professionals.
Today, we boast a pool of talented & experienced professionals offering an unparalleled
breadth of services in Architecture, Master Planning, Design & Build, Interiors,
Development, Construction & MEP Services with a combined portfolio of over a few million
sq.ft. of award-winning projects & many more on the boards. Our designers are known for
their innovation, leadership & exceptional client service.
A lot of repeat business reflects the trust & value our clients place in our experienced
Architects. Offering most of the essential services inhouse also contributes to better projects
by streamlining the team's communication and quality control. Our ability to integrate all
these services as individual profit centers, yet posing as a unified creative force, is in synch
with what today's world needs from design.
At Della Tecnica, we posses a vibrant vision, a zest for innovation and a commitment to
sustainability. Approaching challenges from different perspectives enhances our ability to
innovate. Recognized as market leaders in the field of Architecture, Design & Build, and as a
comprehensive Turnkey Solution Company, the organization has extended, both vertically
and horizontally into a group of six companies -related yet independent verticals.
Della Tecnica Group was started in 1996. Today with over 1500 professionals networked
across seven offices, we serve our clients as trusted advisors, combining localized expertise
with global perspective wherever new opportunities arise. Our infrastructure allows us to
simultaneously handle more than 50 projects across the country.

RESEARCH METHODOLOGY
The company that has been selected for this study is Della tecnica, One of the leading interior
desinging company company. The accounting year of Della tecnica is calendar year i.e. from
1st Jan to 31st Dec. The relevant data for the period of 2006, 2007, 2008, 2009 have been
collected from secondary source i.e. publish Annual accounts of the company for the
respective year. Data so collected have been classified, analyzed and interpreted
appropriately as per the help of different statistical tool and techniques.

MEANING OF RESEARCH:
Research can be understood as a combination of two words, re and search means search
again. The origin of research is the curiosity to know the truth of nature or knowledge. It is an
organized inquiry or a purposive investigation. This search may be made through in arbitrary
method or by a scientific method. Research can be defined as applying the methods of
science to the art of management.

DEFINATION OF RESEARCH:
According to WEBSTER DICTIONARY To research is to research or investigate
exhaustively. It is careful or diligent search inquiry or examination especially investigation or
experimentation. It is aimed at the discovery and interpretation of facts, revision of accepted
theories or laws in the light of net facts or practical application of such new or revised
theories or laws; it can also be the collection of information about a particular subject.
In the words of J. Francis Rummel Research is a careful inquiry or examination to discover
new information or relationships and to expand to verify existing knowledge.

FORMULATING RESEARCH PROBLEM:
The problem to be investigated must be defined unambiguously that will help in
discriminating the relevant data with irrelevant data. Once the problem is formulated a brief
summary may be written down which is called as research plan. Research plan helps the
research to organize his ideas in a form to look.
Here research problem is related to the intangible accounting practices of Della Tecnica
Pvt.Ltd Mumbai.

EVALUATE RESEARCH PROBLEM:

Research Problem is evaluated with the help of following ratios- EVA (Economic Value
Added), MVA (Market Value Added), BV (Brand Value) and whether company is following
the prescribed accounting standard related to intangible accounting practices is assessed with
the help of annual report of the company.Della Tecnicas client

SCIENTIFIC APPROACH
This thesis is a mixture of a theoretical and empirical study. A study can either be deductive
or inductive, but it can also be abductive when the researchers use a combination of the two
approaches. The definition of the problem issue often indicates whether it is an inductive or
deductive approach. The deductive approach is preferred when the problem issue can be
derived from theory and the theory forms the basis for the empirical study. On the other hand,
the inductive way is preferred when the problem
issue has no connection to any kind of theory and where the facts speak for themselves and
seek regularity in events (Halvorsen, 1992).

Choice of scientific approach
We intend to utilize an abductive approach in our thesis since our first research question is of
an inductive nature. This is because it does not rely on theory. However, our second research
question is of a deductive nature since this question could be derived from theory and this
theoretical framework will form the basis of our empirical case studies.

STRATEGIC APPROACH
According to Patel and Davidson (1994), every study has a research design. The strategy one
uses when conducting a study depends on how much knowledge the researcher has about the
problem area and how well the problem is structured and formulated. There are three
strategic approaches. Optimal Capital Structure Methodology 6 The explorative approach is
used when there only exists little or no knowledge of the problem area. Here the researcher
often uses several techniques for gathering information and thereby explains the problem
from many different angles. It often concerns the initial stage of the research process. It is
used to identify a problem, to specify and structure a problem, to generate ideas, and to
formulate hypotheses. This research design is characterized by flexibility in order to cope
with the unexpected, and to discover ideas that are not recognized at the beginning. The
descriptive approach is used when there already exists knowledge of the problem area and the
formulation of the problem is fairly well structured. The study gets a descriptive nature while
simultaneously investigating the issue in depth. The explanatory approach to a study assumes
that the researcher has a wide knowledge of the problem area and that there exist theories in
the area. An explanatory approach has the purpose to study a cause-and-effect connection.

Choice of strategic approach
We will use the explanatory approach since we have gained a wide knowledge within the
problem area and since there exist many theories that we intend to rely on. We further aim to
study how different variables affect the capital structure; hence this approach would be
suitable.

Research objectives
To study the optimal capital structure of the Della tecnica and if there is room for
improvement.
1. To study the theoretical aspect of the optimal capital structure.
2. To know the importance of the optimal capital structure on profitability of company.
3. To study the preferences of the client due to the optimal capital structure.
4. To a certain the relationship between EBIT and EPS .

Scope of the study
The capital structure decision can influence the value of the firm through the cost of capital
and trading on equity or leverage. The optimal capital structure may be defined as that capital
structure or combination of debt and equity thats lead to the maximum value of the firm
optimal capital structure maximize the value of the company and hence the wealth of its
owners and minimize the companys cost of capital (solomon Ezra, the theory of
financial management ). Thus, every firm should aim at achieving the optimal capital
structure and then maintain it.
The following consideration should be kept in mind while maximizing the value of the firm
in achieving the optimal capital structure
1) If the return on investment is higher than the fixed cost of funds, the company should
prefer to raised funds having a fixed cost, such as debenture, loans and preference share
capital. It will increase earning per share and market value of the firm. Thus, a company
should, make maximum possible use of leverage.
2) When debt is use of source of finance, the firm saves aconsidarable amount in payment of
tax as intarest is allowed as a deductable expencse in computaion of tax. Hence, the effective
cost of debt is redce, tax is leverage a company should therefore, take advantage of tax
leverage.
3) The firm should avoid undue financial risk attched with the useof intrested debt financing,
if the shre holders perceive high risk in using further debt-capital, it will reduce the market
price of shares.
4) The capital structure should be flexible.

PROBLEM DISCUSSION
Substantial parts of the literature concerning capital structure have dealt with issues regarding
the leverage ratios. These leverage ratios have been analyzed in many different ways. Our
research problem will also deal with these ratios but in an entirely new way. We have not
been able to find any material concerning how companies should decide these leverage ratios
in practice, except for some theoretical models. These models are unfortunately not
applicable in practice because of their inability to deal with important factors such as the
firms asset structure. It would therefore be interesting to investigate how companies
determine their capital structure since the lack of literature within the area is as great as it is.
Could it be the case that companies have developed their own models? Is the difference in the
decision process big between companies within the same industry? Does the highest levered
company have a totally
different procedure from the lowest levered company? It could be suspected that there exist
possibilities for companies to improve their capital structures because of the lack of
theoretical guidelines. To be able to examine this kind of questions we believe that we need
to investigate companies that are as comparable as possible within the same
industry. We will therefore investigate a refined industry, since this approach enables a fair
comparison. We have examined all industries in India and come to the conclusion that the
Building Construction industry suits our purpose best. This is because all companies within
the Building construction industry experience very similar businesses, i.e. buying, selling,
managing and acquiring Building Construction properties.

PROBLEM AND PURPOSE
Our purpose is to solve the research questions stated below, which are formulated on the
basis of the problem discussion. It concerns the practical Optimal Capital Structure
Introduction matter of deciding the appropriate capital structure and the possibility of
improvements.
I. How do the Della Tecnica Pvt. Ltd. decide their capital structure?
II. Are their current capital structures optimal or is there room for improvements?

CONTRIBUTION
My thesis will shed new light on a specific area of capital structure, namely how companies
decide their capital structures. Much work has been done in the statistical field, i.e.
comparing leverage ratios through cross sectional analysis or other comparisons. Except for
the inapplicable theoretical models we have not been able to find any material concerning
how companies should act when determining their capital structure,. Our study will
complement existing studies since we are investigating important factors that affect the
optimal capital structure for real estate companies. A further contribution is the investigation
regarding how the companies could improve their current capital structures by combining the
existing theory, models and empirical findings.

LIMITATION OF STUDY
Due to non availability of annual reports related to the financial year 2008-09.
This project report is restricted for the four year viz 2006, 2007, 2008, and 2009.


Forms / patterns of capital structre
The capital structure of new company may consist of any of the following forms:
A) Equity shares only
B) Equity and prefeerence shares
C) Equit and debentures
D) Equity shares, Preference shares and debentures.

IMPORTANCE OF CAPITAL STRUCTURE
The term capital refers to the relationship between the various long term form s of
financing such as debenture, preference shares capital and equity share capital. Financing the
firms assets is a very crucial problem in every business and as a general rule there should
be a proper mix of debt and equity capital in financing in the firms assets . The use of long
term fixed interest bearing debt and preference share capital along with equity shares is called
Financing leaverage or trading on equity . the long term fixed interest bearing debt is
employed by a firm to earn more from the use of these source than their cost so as to increse
the return on owners equity. It is true that capital struture can not affect the total earning of
the firm but it can affect of share of eaning available for equity share shareholders. Say for
exampale, A company has an equity capital of 1,000 shares of Rs. 100 each fully paid and
earns an average profits of Rs. 30,000. Now the company want to make an expansion and
needs another Rs. 10000 the option with the copmany are eithers to isseu new shares or raise
loans [at] 10% p.a. Assuming that the company would earn the same rate of profit. It is
advisable to raise loan as by doing so earning per share magnifying. The company shall pay
only Rs. 10,000 as interest and profit expected shall be Rs. 60,000 (before payment of
interest) After the payment of interest the profit left for equity shareholders shall be Rs.
50,000 (ignoring tax) it is 50% return on equity capital against 30%return otherwise however,
leaverege can operate adversaly also if the rate the interest on long-terms loans is more than
the expected rate of earning of the firm.

ESSENTIAL FEATURES OF SOUND/OPTIMAL CAPITAL MIX
A sound or an appropriate capital structure should have the following essential features :
I. Maximum possible use of leverage.
II. The capital structure should be fllexible so that it can be easily altered.
III. To avoid undue Financial business risk will increase of debt.
IV. The use of debt should be within the capacity of a firm. The firm should be in position to
meet its obligationsin paying the loan and interest charges as and when due.
V. It should involve minimum possible risk or loss of cantrol.
VI. It must avoid undue restrictions in arregement of debd.
VII. It should be easy to understand and simple to operate to the extent possible.
VIII. It should minimise the cost of financing and maximise earnings per shares.

FACTORS DETERMINING THE CAPITSL STRUCTURE

I. Financial leverage or trading on equity.
II. Growth and stability of sales.
III. Cost of capital
IV. Risk
V. Cash flow Ability to service debt.
VI. Nature and size ofa firm.
VII. Cantrol.
VIII. Flexibility.
IX. Requirement of Investors.
X. Capital market condition
XI. Asset structure
XII. Purpose of financing
XIII. Period of finance
XIV. Cost of flotation
XV. Personal consideration
XVI. Corporate tax rate
XVII. Legal requirements

SIGNIFICANCE OF CAPITAL GEARING
The problem of capital gearing is very important in acompany. It has a direct bearing on the
divisable on the divisible profits of a company and hence a proper capital gearing is a very
imporatant for the smooth running of an enterpriese, In in case of a low geared company, the
fixed capital by way of fixed divident on preference share and interest and interest on
debentures is low and the equity shareholders may get ahigher leaving lesser divisible profits
for the equity shareholders.
The capital gearing in the financial structure of a business has been rightly completed with
gears of an automobiles. The gears used to maintain the desired speed and cantrol. Initially,
an automobile starts with a low gears, but as soon as it gets momentum, the low gwars is
changed to high gear to get better speed.similarly, a company may be started with high equity
started with high eqity state. That is low gear but after momentum, it may be changed to high
gearby mixing more of fixed interest bearing securities such as preference shares and
debentures. It may also be noted that capital gearing affects not only the shareholders but the
debentureholders, creditors, financial institutions, the financial maneger and others also
concerned with the capital gearing.

CAPITAL GEARING AND TRADE CYCLES
The tecniques of capital gearing can be sucsessfuly employed by a company during various
phases of trade cycle, ie. During the conditions of inflation and deflation, to increase the rate
of return to its owners ( Equity shareholders ) and thereby increasing the value of thair
investments. The effect of capital gearing during various phases of trade cycle is discussed
below :
1) During inflation or boom period :- A company should follow the policy of high gear
during inflation or boom period as the profit of the company are higher and it can easily pay
fixed costs of debentures and preference shares. Furthers during boom period,the rate of
earing of the company is usualy higher than the fixed rate of interested/dividend prevailing on
debentures and preference shares. By adopting the policy of high gear, a company can
increases its earning per share and thereby a higher rate of dividend.
2) During deflation or Depression period :- During depression the rate of earinigs of the
company is lower than the rate of interest/dividend on fixed interest bearing securities and
hence it can not meet the fixed costs without lowring the divisible profits and rate of
dividents, it is therefore, better for a company to remain in low gear and not to fixed interest
bearing securities as source of finance during such period.
Theories of capital structure
Different kinds of theories have been propounded by different authers to explain the
relationship between capital structure, cost of capital and value of the firm. The main
contributors to the theories are Dorand, Ezra, Solomon, Modiglini and Milleer.
The important theories are discussed below :
1) Net Income Approch.
2) Net Operating Income Approch.
3) The Tradational Approch.
4) Modigliani and Miller Approch
1) Net Income Approch : Accoding to this approch, a firm can minimise the waighted
average cost of capital and increase the value of the firm as well as market price of equity
shares by using debt financing to the maximum possible extent. The theories propound that a
copany can increase its value and decrease the overall cost of capital by increasing the
proportion of debt in its capital structure. This approch is based upon The following
assumption :
I. The cost of debtis less than the cost of equity.
II. There are no taxes.
III. The risk pareception of investors is not changed by the use of debt
The line of argument in favour of net net income approch is that as the praportion of debt
financing in capital structure increase, praportion of a less expensive source of funds
increases. This results in the decreases in overall ( Waighted average cost of capital leading to
an increases in the value of the firm. The reason for assuming cost of debt to be less than the
cost of equity are that interast rate are usually lower than dividend rates due to element of risk
and the benefit of tax as the interest is a deductable exenses.
On the other hand, If the praportion of debt financing in the capital of the firm in the
increases and the totle value of the firm will decreses . the net income approch showing the
effect of leverage on overall cost of capital has been presented in the following figure
V = S+D
Where : V= Totale market valu of a firm
S = Market value of equity
= Earning Available to Equity Sharehlders (NI)
Equity capitalisation rate

D = Market value of debt.
And overall cost of capital or Weighted average cost of capital can be calculated as:
EBIT
Ko = --------------------
V
2) Net operating Income Approch : This theory as suggested by Durunt is another extreme of
the effect of the leverage on the value of the firm. It is dimetrically opposite to the net income
approch. According to this approch change in the capital structure of the company does not
affect of the market value of the firm and the overall cost of capital remain constant
irrespective of the methode of financinng it implies that the overall cost of capital remains the
same wether the debt.-equity mix is 50:50 or 20:80 or 0:100, thus, there is nothing as an
optimal capital structure and every capital structure is the optimal capital structure. This
theory presumes that:
I. The market capitalises the value of the firm is whole ;
II. The business risk remains constant at every level of debt. equity mix;
III. There are no corporate taxe.
The reasons propounded for such assumption are that increased us of debt increses the
financial risk of the equity shareholders and hence the cost of equity is raised on the other
hand, the cost of debt remain constant with the increasing praportion of debt as the financial
risk of the lenders is not affectthus, the advantage using the cheapper sources of funds that
debt is exactaly offset by increased cost of equity.
According to the net operating income ( NOI) Approch the following mix is relevent and it
does not affect the value of the firm the NOI approchshowing the effect of leverage on the
overall cost of capital has been presented in the following figure.
EBIT
V= ------
Ko
Where, V= value of the firm
EBIT= net operating income and earining before interest and tax
Ko= overall cost of capital

THE MARKET VALUE OF EQUIT,
According to this approch is the ressidual valued which is determined by deducting the
market value of debenture from the totle market value of the firm.
Where, S = V-D
S = market valueof equity shares
V= totle market value of a firm
D = market value of debt
The cost of equity or equity capitalisation rate can be calculated as below
Cost of equityor equity capitalisation rate (Ke) =
Earning after interest and before tax
= ---------------------------------------------------
V-D

3) THE TRADITIONAL APPROACH.
The tradational approch are also known as intermediate approch is a comprise between two
the two extremes of net income approch and net operating income approch according to this
theory, the value of the firm can be increased intionaly or the cost of capital can be decreased
by using more debt as the debt is a cheaper source of the funds than equity. Thus optimum
capital structure can be reached by a proper debt equity mix. Beyond a particullar point, the
cost of capital increased because increased debt increase the financial risk of the equity
shareholders the advantage of the cheaper debt at this point of the capital can not be afset by
the advantage of low cost debt thus overall cost of capital, according to this theory decrease
upto certain point, remains more or less unchanged for modarate increased in debt thereafter ;
and increase or raised beyond a certain point. Even the cost of debt may increased in this
stage due to increased financial risk. Theory has been explained

4) MODIGLIANI AND MILLER APPROACH .
M & M Hypothesis is identical with the net operating income approch if taxes is ignored.
However, when corporate taxesare assumed to exist, their hypothesis is similar to the net
income approch.
a) In the absence of taxes. (Theory of Irrelevance) : the theory proves that the cost of capital
is not affected by changes in the capital structure or say that the debt-equity mix is irrelevant
in the determination of the totle value of the firm. The reason argued is that through debt is
cheaper to equity, with increased use of debt as a source of finance the cost of equity increse.
This increses in cost of equity offsets that advantage of the low cost of debt. thus, although
the financial leverageaffects the cost of equity,the overall cost of capital remain constant.
Theory emphasis the fact that a firms operating income is a determinant of its total value.
The theory further propounds that beyond acertain limit of debt, the cost of debt increases due
to increases financial risk but the cost of equity falls thereby again balancing the to cost of
debt increase ( due to increases financial risk ) but the cost of equity falls thereby again
balancing the to cost. In the opinion of Modiglini & Miller, to identical firms firms in all
respects except their capital structure can not have different market values or cost of capital
because of arbitrage process . In case to identical firms except for thair capital structure have
differunt market values or cost of capital, arbitrage will take place and the investor s will
engage in in parcenal leverage as against the corporate leverage ; and this will
again render the two firms to havrthe same total value.
The M&M approch is based upon the following assumption :
I. There are no corporate taxes.
II. There is a perfect market.
III. Investor act rationally.
IV. The expected earnings of all the firms have identical risk characteristics.
V. The cut-of point of investment in a firm is capitalisaton rate.
VI. Risk to investor depends upon the random fluctuations of expected earnings and the
possiblity that the actual value of the variable may turn out to be different from their best
estimets .
VII. All earings are distributed amongs the shareholders.
b) When corporate taxxes are assumed to exist. Theory of Relevance) Modiglini and Miller,
in their article of 1963 have recognised that the value of the firm will increased or the best of
capital will decreased with structure can be achived by maximising the debt mix in the equity
of a firm.

RISK RETURN TRADE OFF
Thus a firm has a reach a balance (trade-of) between the financial riskof non employement of
debt to capital increase its market value.

Capital structure decisions
Debt- equity mix


Financial risk
Non employement of debt capital risk ( NEDC)

Risk- return trade off
Market- value of the firm
(Risk return trde off )

Financial distress
Debt provides tax benefits to the firm, but it also puts pressure on the firm, since interest and
principal payments are obligations, according to the trade-off model. The closer the firm is to
bankruptcy, the larger is the cost of financial distress. The ultimate financial distress is
bankruptcy, where ownership of the firms assets is legally transferred from the
stockholders to the bondholders (Haugen & Senbet, 1978). Bankruptcy costs are made up of
two parts, direct and indirect costs. Direct costs can be seen as out-of-pocket cash expenses,
which are directly related to the filing of bankruptcy and the action of bankruptcy. Examples
of direct costs are fees for lawyers, investment bankers, administrative fees and value of
managerial time spent in administering the bankruptcy
(Haugen & Senbet, 1978). In 1990, Weiss estimated the direct cost of bankruptcy for 37 New
York and American Stock Exchange firms to be 3.1% of the firm value. Warner (1977) found
that direct costs of bankruptcy decrease when the size of the firm increases which implies that
for large companies bankruptcy costs are less important when determiningcapital structure
than it is for smaller firms. Indirect bankruptcy costs are expenses or economic losses that
result from bankruptcy but are not cash expenses on the process itself. Examples of such
costs caused by bankruptcy are sales that are lost during and after bankruptcy, diversion of
management time while bankruptcy is underway, and loss of key employees after the firm
becomes bankrupt. Sales can frequently be lost because of fear of impaired service and loss
of trust (Titman, 1984).
Altman provided a study in 1984 with a sample of 19 firms, 12 retailers, and 7 industrials that
all went bankrupt between 1970 and 1978. By Optimal Capital Structure Theoretical
Framework 24 comparing expected profits with actual profits, he found the arithmetic
indirect bankruptcy costs to be 10.5% of firm value. Altman (1984) also estimated that both
indirect and direct costs together are frequently greater than 20% of firm value. These
findings give us reason to believe that bankruptcy costs are sufficiently large to support a
theory of optimal capital structure that is based on the trade-off between gains from the tax
shield and losses that come with costs of bankruptcy.

Agency costs
Another factor that can be added to the trade-off model is the agency cost, which arises due to
conflicts of interests. There are two types of agency costs: agency costs of equity and agency
costs of debt. Agency cost of equity has its roots in the simple argument that you will work
harder if you are the owner of the company than if you were an employee. Also, if you own a
larger percentage of the company, you will work harder than if you owned a smaller
percentage of the company (Copeland & Weston, 1992). A more detailed discussion of the
agency cost of equity can be found in Appendix III. Agency costs of debt occur because there
is a conflict of interest between stockholders and bondholders. As a firm increases the
amount of debt in the capital structure, bondholders begin taking on an increasing fraction of
the firms business and operating risk, but shareholders and managers still control the
firms investment and operating decisions. This gives managers a variety of different ways
for selfish strategies, which will increase their own wealth, on behalf of the cost of the
bondholders. A more detailed
explanation can be found in Appendix I

ECONOMIC VALUE ADDED:
Stern and Stewart, a consultancy firm introduced a performance Measure called Economic
Value Added (EVA) to indicate the minimum return required by the shareholders to invest in
the companys shares. Economic Value Added (EVA) is the excess of actual return earned
by a firm over such minimum return required by the shareholders or investors. Here, actual
return implies the Net Operating Profit After Tax (NOPAT) and minimum return denotes cost
of capital employed (WACC * CE) to earn that profit. To put it in an equation form.
EV = NOPAT - (WACC x CE)
Where,
NOPAT = Net Operating Profit After Tax
WACC = Weighted Average Cost of Capital
CE = Capital Employed
NOPAT is calculated from net profit tax as appeared in the Profit and Loss Account by
adding back interest payments and subtracting and adding non-operating income and non-
operating expenses respectively. But in actual practice some other adjustments are made with
the net profit to calculate NOPAT to convert accounting profit to economic profit. Stern-
Stewart have mentioned 164 types of such adjustment that are kept out of purview of this
article for time and constraints.
WACC is the weighted average of the cost of all types of own capital and borrowed capital
such as equity share capital preference share capital, debentures, secured and unsecured loans
etc. with weights equivalent to the proportion of each element in the total capital of the
company. Capital employed denotes all finds belonging to the equity shareholders and all
interest bearing loan capital.

MARKET VALUE ADDED:

Market Value Added is used as a supplementary to Economic Value Added to evaluate the
performance of a company in the stakeholders value creation. It measures the market
value of the company over the value of the investors capital. In case of EVA economic
profit is taken into consideration, which is the value added by the company over given period,
the MVA is a measure of the investors perception of value added. It may be considered as
cumulative measure of corporate performance.
MVA = Current market value of debt and equity - Economic book value, where Economic
book value = Share capital + Reserve + debt.

TOTAL SHAREHOLDERS RETURN:

Total Shareholders Return (TSR) is a composite indicator which takes into account total
shareholders fund and the dividend declared / proposed by the company. It represents the
change in the capital value of a company over a period of one year, plus dividends, expressed
as a percentage of gain or loss on the beginning capital value. Capital value implies capital
employed excluding debt capital. The exclusive, of debt capital provides more accuracy in
measuring the Total Shareholders Return (TSR).
TSR = (Closing capital value Beginning capital value + Dividend) / (Beginning Capital
Value x 100).

Weighted Average Cost Of Capital - WACC

What Does Weighted Average Cost Of Capital - WACC Mean?
A calculation of a firm's cost of capital in which each category of capital is proportionately
weighted. All capital sources - common stock, preferred stock, bonds and any other long-term
debt - are included in a WACC calculation. All else help equal, the WACC of a firm
increases as the beta and rate of return on equity increases, as an increase in WACC notes a
decrease in valuation and a higher risk.
The WACC equation is the cost of each capital component multiplied by its proportional
weight and then summing:

Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of
a project, using the formula:
NPV = Present Value (PV) of the Cash Flows discounted at WACC.

APPLICATION OF ACCOUNTING
PRACTICES TECHINIQUES:
Table 8.1
ECONOMIC VALUE OF DELLA TECNICA (EVA)
(Rs. In Caror)
YEAR 2006 2007 2008-09
Cost of Capital Employed
1.Average Debt 163 382 342
2.Average Equity 2515 2402 1928
3.Average Capital Employed : (1+2) 2678 2784 2270
4.Cost of Debt, post-tax % 5.90 6.24 3.91
5.Cost of Equity % 16.38 17.59 14.47
6.Weighted Average Cost of Capital % (WACC) 15.74 16.03 12.88
7.COCE : (3) x (6) 421 446 *365
Economic Value Added (EVA)
8.Profit after tax, before exceptional items 1540 1,743 2444
9.Add : Interest, after taxes 7 17 17
10.Net Operating Profits After Taxes (NOPAT) 1547 1760 2461
11.COCE, as per (7) above 421 446 365
12.EVA : (10) - (11) 1126 1314 2097
*COCE is computed for 15 months

MVA OF HUL (MARKET VALUE ADDED):
(Rs. In crores)
YEAR 2006 2007 2008-09
1. Market Value of Debt 72 88 421
2. Market Value of Equity 47788 46575 51770
3. Total (1+2)
Economic Book Value 47860 46663 52191
4. Share capital 220 217 217
5. Reserves 2502 1221 1843
6. Debt 72 88 421
7. Total (4+5+6) 2794 1526 2481
8. MVA: (3-7) 45066 45137 49710

TSR OF HUL (TOTAL SHAREHOLDERS RETURN)
(Rs. In Crores)
YEAR 2006 2007 2008-09
1. Share Value at the closing of the year (P1) 216.55 213.90 237.50
2. Share Value at the beginning of the year (P0) 197.25 216.55 213.90
3. (P1-P0) 19.3 (2.65) 23.6
4. Add Dividend for the year 6 9 7.50
5. Total (3)+(4) 25.3 (6.35) 31.1
6. TSR: (5)/(6) in % 12.82 2.93 14.53
FINDINGS:
EVA:
Economic Value Added of Della tecnica has shown a constant growth in 3 years during the
study period. From a value of 1126 crore rupees during 2006 it rose up to 1314 crore in 2007
but showed sudden rise in 2008-09. The continue increasing EVA from 2006 to 2009 was
mainly due to increase in NOPAT, however that increase is proportionate to the increase
made in Capital Employed. In the 2006 Average Capital Employed was 2678 crores and in
the year 2007 Average Capital Employed was 2784 crores, but it suddenly fall down in 2008-
09 Average Capital Employed was 2270 crores.
The NOPAT in the year 2006 was 1547 and NOPAT in the year 2007 was 1760, but NOPAT
in the year 2008-09 showed a sudden rise was 2461 crores. The company should pay its due
attention by regulating capital employed to generate adequate (NOPAT) and snsure a stedy
growth of this indicator.
MVA:
Net Market Value Added (MVA) year wise has projected a mixed trend during the period
under study. from 45066 crore Rs. In the year 2006, it went up to 45139 crore in the next year
2007 but in the 2008-09 is increases in 49710 crore. The highest MVA during the year 2008-
09 was mainly attributable to the rise in the average market value per share by Rs.213.90 over
the price of 2007. Net MVA during 2006 was the lowest a value of 45066 crores but net
MVA during 2008-09 was the highest a value of 49710 crores. If we analyse the main reason
we can see that the increase in average share price during 2008-09 was highest which leads to
highest MVA and the during the period of 2006 when the prices of share was declined MVA
was the lowest.

TSR:
In terms of percentage the total shares return for the year 2006 is 12.82%, but shows a
decline of 2.93% in the next year i.e, 2007 while in the 2008-09 it again increases 14.59%. It
shows the decline in the year 2007 and growth in the 2008-09 year.

COMPANIES SWOT ANALYSIS:
Companys strength:
Strong and well brands with leading share positions.
Clients understanding and system for building clients insight.
Strong R&D capability well linked with business.
Integrated supply chain and well manufacturing units.
Intarnal structure with wide reach, high quality coverage and ability to leverage scale.
Ability to deliver cost savings.
High quality manpower resources.

WEAKNESSES:
Very large number of skills with dispersed manufacturing location.
High social costs in the plantation business.
Earning per share of Re. 1 is 8.41 in 2006, 8.73 in 2007 and 11.46 in 2008-09. It shows
better result of the company in 2008-09.
Return on capital employed is 67.0 % in the year 2006, 78.0 % in 2007, and 107.5 % in
2008-09 all the figures are showing better result of the company.