Cost of Capital

A Case study of
telecommunication industry)

Someone

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 Introduction
The Indian economy has witnessed robust growth in the last few years and is expected
to be one of the fastest growing economies in the coming years. Demand for
commercial property is being driven by India’s economic growth. Real estate in India
contributes about 5 per cent to India’s gross domestic product (GDP). The total revenue
generated in 2010-11 stood at US$ 66.8 billion. India’s Information Technology (IT) and
Information Technology enabled Services (ITeS) segments are aligned in a way that the
growth in one avenue has ripple effects on another. The IT & ITeS industry, as a whole,
is the mainstay of Indian Technology sector as it has driven growth of the economy in
terms of employment, revenue generation, standards of living etc and has played a
major part in placing the country on the global canvas.
The project’s cost of capital is the minimum required rate of return on funds committed
to the project, which depends on the risk of its cash flows. The firm’s cost of capital will
be the overall, or average, required rate of return on the aggregate of investment
projects. It is a concept of vital importance in the financial decision-making. It is useful
as a standard for:
Evaluating investment decisions
Designing a firm’s debt policy 3. Appraising the financial performance of top
management
The firm’s cost of capital is the rate of return required by them for supplying capital for
financing the firm’s investment projects by purchasing various securities. It may be
emphasized that the rate of return required by all investors will be an overall rate of
return – a weighted rate of return. Thus, the firm’s cost of capital is the ‘average’ of the
opportunity costs (or required rates of return) of various securities, which have claims on
the firm’s assets. This rate reflects both the business (operating) risk and the financial
risk resulting from debt capital
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 Company profile

“
• Bharti Airtel Limited is a leading integrated telecommunications
company with operations in 20 countries across Asia and Africa.
Headquartered in New Delhi, India, the company ranks amongst
the top 5 mobile service providers globally in terms of subscribers.
In India, the company’s product offerings include 2G, 3G and 4G
services, fixed line, high speed broadband through DSL, IPTV,
DTH, enterprise services including national & international long
distance services to carriers. In the rest of the geographies, it
offers 2G, 3G mobile services. Bharti Airtel had over 246 million
customers across its operations at the end of February 2012.

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 Process
Methodology
The purpose of the research is to study the
relationship between various ratios to know the
impact of cost of capital on profit, growth,
investment decision and dividend decision in
Indian industries. Further, this paper is an effort to
know about how to frame an optimum capital
structure.
Objectives of the study
The objective of the study is to examine the
relationship between the working capital
management efficiency and profitability of the
Telecommunication industry in India.
• The following are the specific objectives:
• To analyze interrelationship and impact of Cost
of capital on various variables determining
companies performance
• To analyze the relationship between cost of
capital efficiency and profitability of selected
industries in India.
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 Hypothesis testing
Since the objective of this study is to examine co-relevancy between gross working capital to other variables
like fixed assets, total assets and sales. For this a set of testable hypotheses (the null hypothesis H0 versus
the Alternatives ones H1) is decided and proved by correlation analysis

Research hypotheses

 Hypothesis 1  Hypothesis 2  Hypothesis 3

H01: There is significant
relationship between the cost of
capital and profitability
H11: There is negative relationship
between the cost of capital and
profitability
H01: There is significant
relationship between the cost of
capital and liquidity
H11: There is negative relationship
between the cost of capital and
liquidity
H01: There is significant
relationship between the cost of
capital and dividend
H11: There is negative relationship
between the cost of capital and
dividend

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 Bharti Airtel
Calculation of Growth Rate
Year EPS Growt DPS Growth
h
Mar-05 10.62 2 1 0.50
Mar-06 21.27 10.65 1.00 3 -1 -0.33
Mar-07 32.9 11.63 0.55 2 0 0.00
Mar-08 40.7 0.52 0.02 2 2 1.00
Mar-09 24.82 -15.88 -0.39 4 -0.5 -0.13
Mar-10 32.56 7.74 0.31 3.5 7.5 2.14
Average 27.14 2.44 0.25 2.75 1.5 0.53
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Cost of Equity
ROE x Retaintion ratio Cost DPS/MP*100+G
of
equity
Based on retaintion ratio
23.98 26.67 1.025 25.00
*0.89 +23.9
9 8
Based on EPS 25.00 1.025 26.03
+3
Based on DPS 27.00 1.025 28.03
+15
Cost of Debt
12% Debanture 7.92 12*(1-
0.34)
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 Weighted Average Cost of
Capital
Weight WACC
Sources of Cost of
capital capital Book Value Market Value Book Value Market
Value
Debt 7.92 0.62 0.36 4.91 2.85

Equity 28.03 0.38 0.64 10.65 17.94

Total 35.95 1.00 1.00 15.56 20.79

Bharti Airtel Capital Structure, 2009-10

Sources of capital book value weight market value weight

Debt 33458 0.62 33458 0.36

Equity 20276 0.38 59678 0.64

Total Capital 53734 1.00 93136 1

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 CONCEPTUAL FRAMEWORK
(VARIABLES OF MEASURING COMPANIES’ PERFORMANCE)

• Profitability: Profitability implies profit-earning capability of

business unit. Return on Equity ( ROE ) is considered to
measure profitability of the concern.
• Liquidity: Liquidity refers to the ability of a concern to meet
its current obligation.
• Current ratio has been included in the models. It is calculated
by dividing current assets by current liabilities.
• Dividend pay out ratio: - It measures the relationship
between the earnings belonging to the ordinary shareholders
and the dividend paid to them. Dividend pay out ratio is
calculated by DPS/MPS*100
• Growth (G) – Growth of companies measures the rate at
which a firm is growing. It is one of the determinants of
financial performance of the company. It is calculated by
multiplying retention ratio and ROE

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 9

Pearson’s Correlation Coefficient Analysis

Pearson’s Correlation analysis is used to find the relation among various variables i.e.
cost of capital and profitability cost of capital and liquidity, cost of capital and dividend,
cost of capital and growth,. One variable cause, is an independent and another variable
result, will be a dependent variable. By using these ratios relationship between these
data can be measured. There is a negative relationship between first, second and third
but positive with forth variable.
Table 3- It is showing positive negative relation between cost of capital and liquidity,
profitability and dividend in Bharti Airtel Ltd. Highly negative correlation is showing that
both companies are enjoying its effectiveness. To maintain effectiveness and liquidity,
dividend policy and profit earning capacity, they required to manage minimum cost of
capital in a appropriate manner. It is indicating negative relationship between all three
variable.
 Types of Capital
Cost of Capital and Profitability
The aggregate result suggests that there is
relationship between cost of capital and
profitability of the company. The
relationship between the cost of capital
and profitability has been found in the
company. A negative relationship is
observed in the company. It is because
the profitable companies are expected to
procure the funds with cheaper cost.
Cost of Capital and Liquidity
In the sector of telecommunication group of
industries, the overall cost of capital and liquidity
is negatively related with each other. This implies
that highly liquid companies are procuring the
funds by incurring less amount of cost. On the
other hand less risky companies in terms of
liquidity are spending less amount of money for
mobilizing the capital for their survival and
growth. It is theoretically true that the investors
generally prefer to invest their funds in less risky
companies.
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 Pearson’s Correlation Coefficient Analysis
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 Conclusion

“ The study has analyzed there is significant relationship

between cost of capital and the efficiency, profitability,
dividend policy, growing capacity relationship of
Telecommunication industry in India; some of the important
ratios were used to measure the financial performance of
these companies. Based on the above analysis the significant
negative relationship is found between two variables other
than growth and cost of capital.
The overall cost of capital is affected by the designing of
capital structure of Indian industries. Therefore, maintenance
of optimum level of capital structure irrespective of nature of
industries is mandatory for a firm. Hence, the corporate
executive should give due attention for attaining optimum
level of capital structure for sustainable growth of the firm. The
optimum level of capital structure depends on nature of each
industry. The change of cost of capital affects the
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