Beruflich Dokumente
Kultur Dokumente
**M.COM.(PART 1) Student
DNYANSADHNA COLLEGE, THANE
400604,
Maharashtra.India.
ABSTRACT
The use of flotation cost while making a financial management decision has
been the same around many years and numerous education literatures extensively
discuss the usage of it while making a capital budgeting decision. These literatures
allows the use of flotation cost to be included in the discount rate of the firm. This
traditional approach towards the use of flotation cost leads to a higher weighted average
cost of capital, thereby making significant errors while calculating the net present value
of a project. I am presenting an approach which can be an alternative to the existing
treatment of flotation cost and will be comparing with the traditional approach to find out
the cost of equity of BSE SENSEX 30 companies. The research paper will show if there
is difference in the cost of equity by using either approach and how significant is the
difference.
INTRODUCTION
The topic Corporate Finance of Financial Management quite often discusses the
various methods by which companies make their capital budgeting decisions. The Net
Present Value (NPV) approach is the most common approach used by managers all
around the world for the evaluation and selection of capital projects.
Graham and Harvey (2001) find that 75% of the firms that they surveyed use this
NPV approach as their investment criterion. The number of large firms using this
approach was even higher.
Where:
NPV = net present value of the project today (time 0),
-C0 = cash-flow in project today (the project investment),
Ci = cash-flow from project at future time i,
T = period in which last cash-flow occurs.
r = Weighted average cost of capital (WACC) is obtained as:
Cost of Equity =
+ Growth Rate
OR
Cost of Equity =
+ Growth Rate
Flotation cost: When a company raises new capital it generally seeks the help of
investment banks that charge the company with a fee according to the size and type of
offering. It is typically in percentage of the total issue of new capital.
The traditional approach of treatment of flotation cost:
Cost of Equity =
+ Growth Rate
LITERATURE REVIEW:
Various literature use traditional approach of incorporating the flotation cost while
calculating the cost of equity.
Brealey, Myers and Marcus (2007), Brigham and Ehrhardt (2005), Ross, Westerfield,
and Jaffe (2002) ,H. Kent Baker, J. Clay Singleton, E. Theodore Veit(2010 ) are the
types of literature where the author agrees to the fact that incorporating the flotation
cost which is a onetime cost for the firm raises the cost of equity which in turn affects
the WACC and NPV of a project.
ALTERNATE APPROACH:
Where:
NPV = net present value of the project today (time 0),
C0 = cash-flow in project today (the project investment),
Ci = cash-flow from project at future time i,
T = period in which last cash-flow occurs.
r = Weighted average cost of capital (WACC)
FC = Flotation Costs.
The problem with the traditional approach of treatment of flotation costs is that, the
costs are not an ongoing expense for the firm. Flotation costs are the expense occurring
at the initiation of a project and affect the project NPV by increasing the initial cash
outflow. Therefore, the correct way to account for flotation costs is to adjust the initial
project cost.
RESEARCH OBJECTIVES:
While making an informed decision of capital budgeting the CFO or the management
team of expertise evaluate various methods to arrive at cost of equity. The objectives of
this research are:
1) To measure the cost of equity of public companies by both the traditional as well
as the alternate method.
2) To identify if there is a difference in cost of equity arrived due to the use of two
different methods.
3) To identify if this difference is adequate enough to change the methods of
treating the flotation costs.
HYPOTHESIS:
Based on the literature reviewed and the conceptual model following hypotheses
were generated to be verified:
H01: The flotation costs should be incorporated in the Dividend Discount Model
(DDM) while calculating the cost of equity.
H02: The flotation cost should treated as negative cash outlay while calculating the
NPV.
(%g)
%COE(old
%COE(ne
method)
w method)
AXIS BANK
11.11
15.08
15.12
BAJAJ AUTO
11.11
13.42
13.44
BHEL
47.69
48.76
48.77
BHARTI AIRTEL
80
80.58
80.59
CIPLA
0.421
0.425
COAL INDIA
107.14
111.0158
111.055
20
20.64
20.64
GAIL(INDIA)
8.33
10.64
10.67
HDFC
24.55
25.42
25.43
HERO MOTOCORP
8.33
10.74
10.76
HINDALCO INDUSTRIES
28.57
29.32
29.33
HINDUSTAN UNILEVER
23.81
25.66
25.68
12
13.409
13.42
15
16.512
16.52
INFOSYS LTD.
50
51.89
51.91
ITC LTD.
14.29
16.32
16.34
15.45
16.42
16.43
9.18
9.19
50
50.56
50.57
NTPC LTD.
27.78
31.29
31.32
10
13.25
13.29
RELIANCE INDUSTRIES
5.56
6.73
6.74
18
19.42
19.44
27.71
28.89
28.90
SUN PHARMACEUTICAL
30.5
30.97
30.97
45.45
47.95
47.98
7.56
8.07
8.07
16.72
18.28
18.30
8.66
11.09
11.11
14.29
16.02
16.04
WIPRO LTD.
st
REFERENCES:
Graham, J. R., and C. R. Harvey (2001), The Theory and Practice of
Corporate Finance: Evidence from the Field, Journal of Financial Economics, 187243.
Eugene Brigham, Michael Ehrhardt, Financial Management: Theory & Practice.
Cengage Learning, 2005.
H. Kent Baker, J. Clay Singleton, E. Theodore Veit, Survey Research in Corporate
Finance: Bridging the Gap between Theory and Practice. Oxford University Press,
2010.
Ross, Stephen A., Randolph W. Westerfield, and Jeffrey F. Jaffe (2002),
Corporate Finance, New York, New York: Irwin/McGraw-Hill.
Brealey, Richard A., Stewart C. Myers, and Alan J. Marcus (2007), Fundamentals of
Corporate Finance, New York, New York: Irwin/McGraw-Hill.
Institute, CFA. 2015 CFA Level I Volume 4 Corporate Finance and Portfolio
Management. Wiley Global Finance, 2014-07-14.