Summer Training

Presentation
On
Cost Of Capital
Of
Shree Cememt Limited
From:- ANIKET SETHI
109115
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Shree Cement Ltd is a Rajasthan based company of
Bangur Group, located at Beawar.
It started operations in the year 1985 and has been
growing ever since.
It has been participating in the infrastructure
transformation of India for over two decades now.
It has installed capacity of 13 mn tonnes per annum .
It will invest Rs 3,500 crore to expand its cement
production capacity by seven million tonnes in the next
five years.
It is a leading cement manufacture company in North
India.
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 The turnover of the company in 2009-10 was Rs 3,632
crore and it posted a net profit of Rs 676 crore
 Its manufacturing units are located at Beawar, district
Ajmer, and Ras, district Pali, in Rajasthan.
 It also has grinding units at Khushkhera, district Alwar
in Rajasthan, near Gurgaon.
 The company has also established two grinding units
one at Suratgarh (Rajasthan) and another at Roorke
(Uttaranchal).
 It has three brands under its portfolio viz. Shree Ultra
Jung Rodhak Cement, Bangur Cement and Rockstrong
Cement.

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 SHREE – MULTIPLE BRANDING

Shree Ultra Jung Rodhak – Bangur Cement – Premium brand Tuff Cemento 3556– For
Unique Rust Resistant for extremely quality conscious beautiful rock strong structures
property. customers. that last.

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Cost Of Capital
• The main objective of a business firm is to maximize the wealth of
its shareholders in the long-run, the Management Should only invest
in those projects which give a return in excess of cost of fund
invested in the project of the business.

• The difficulty will arise in determination of cost of funds, if is raised

from different sources and different quantum.

• The various sources of funds to the company are in the form of

equity and debt.

• The cost of capital is the rate of return the company has to pay to
various suppliers of fund in the company.

• There are main two sources of capital for a company – shareholder

and lender.

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CONCEPT OF COST OF CAPITAL

• Cost of capital is the measurement of the sacrifice made

by investors in order to invest with a view to get a fair
return in future on his investments as a reward for the
postponement of his present needs.

• On the other hand from the point of view of the firm using
the capital, cost of capital is the price paid to the investor
for the use of capital provided by him.

• Thus, cost of capital is reward for the use of capital. Author

Lutz has called it” BORROWING AND LANDING RATES”.

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An Example of Cost of Capital

• For example if a firm borrows Rs. 5 crore at an interest of

11% P.A., then the cost of capital is 11%.

• Hear it’s the essential for the firm to invest these Rs. 5
Crore in such a way that it earn at least Rs. 55 lacks i.e. rate
of return at 11%.

• If the return less then this, then the rate of dividend which
the share holder are receiving till now will go down
resulting in a decline in its market value thus the cost of
capital is the reward for the use capital.

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SIGNIFICANCE OF CONCEPT OF COST OF CAPITAL

1. Designing the capital structure.

2. Capital budgeting decisions.

3. Comparative study of sources of financing.

4. Evaluations of financial performance of top management.

5. Knowledge of firms expected income and inherent risks.

6. Financing and Dividend Decisions.

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Assumption of Cost of Capital

While computing the cost of capital, the following assumptions

are made:

• The cost can be either explicit or implicit.

• The financial and business risks are not affected by investing in

new investment proposals.

• The firm’s capital structure remains unchanged.

• Cost of each source of capital is determined on an after tax

basis.

• Costs of previously obtained capital are not relevant for

computing the cost of capital to be raised from specific source.

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Computation of specific costs

• A firm can raise funds from different sources such as loan,

equity shares, preference shares, retained earnings etc. All
these sources are called components of capital.

• Computation of specific cost of capital helps in

determining the overall cost of capital for the firm and in
evaluating the decision to raise funds from a particular
source.

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COST OF DEBT CAPITAL

• Cost of Debt is the effective rate that a company pays on its

current debt. This can be measured in either before- or
after-tax returns; however, because interest expense is
deductible, the after-tax cost is seen most often. This is
one part of the company's capital structure, which also
includes the cost of equity.  

• Much theoretical work characterizes the choice between

debt and equity, in a trade-off context: Firms choose their
optimal debt ratio by balancing the benefits and costs.

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An Example of Cost of Debt

• Example-: If a company issues 12% debentures worth Rs. 5

lacs of Rs. 100 each at par, then it must be earn at least
Rs.60000(12% of Rs. 5 lacs) per year on this investment to
maintain the income available to the shareholders
unchanged.

• If the company earns less than this interest rate (12%) than
the income available to the shareholders will be reduced
and the market value of the share will go down.

• Therefore, the cost of debt capital is the contractual

interest rate adjusted further for the tax liability of the firm.

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Computation of Cost of Debt

The Cost of Debt (before tax) can be calculated as below:

Interest Expense of the company

= ---------------------------------------- X 100

Total Debt

• To get the after-tax rate, you simply multiply the before-tax

rate by one minus the marginal tax rate.

Cost of Debt = (before-tax rate x (1-marginal tax))

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COMPARATIVE CALCULATION OF Kd FOR FOUR YEAR

2009-10
Particular 2008-09 2007-08 2006-07

Total Debts (Term loan from Bank+ Debts) 131570.37+ 105716.94+ 112573.18+ 83427.02+
30000 000 800 1400
=161570.37 =105716.94 =113373.18 =84824.02

Total Interest paid 13065.36 9355.94 9636.72 6573.86

Interest Rate (Before Tax) 8.08% 8.85% 8.50% 7.75%

Interest Rate (After Tax)= Interest Rate Before 5.65% 6.20% 5.95% 5.42%
Tax – Tax Rate 30%.

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COST OF PREFERENCE SHARE CAPITAL

• Preference share is another source of Capital for a company.

Preference Shares are the shares that have a preferential right
over the dividends of the company over the common shares. A
preference shareholder enjoys priority in terms of repayment vis-
à-vis equity shares in case a company goes into liquidation.
Preference shareholders, however, do not have ownership rights
in the company. In the companies under observation only India
Cement has preference shares issued.

• Cost of Preference Capital = Preference Dividend/Market Value of

Preference

• Shree Cement has not paid any dividend to the Preference

Shareholders. Thus the Cost of Preference Capital is 0 (Zero).

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COST OF EQUITY SHARE CAPITAL

• The computation of cost of equity share capital is relatively

difficult because nether the rate of dividend is predetermined nor
the payment of dividend is legally binding.
• When additional equity shares are issued, the new equity share
holders get propranate share in future dividend and
undistributed profits of the company.
• If reduces the earning per shares of existing share holders
resulting in a fall in marker price of shares.
• Therefore, at the time of issue of new equity shares, it is the duty
of the management to see that the company must earn at least so
much income that the market price of its existing share remains
unchanged.
• This expected minimum rate of return is the cast of equity share
capital.

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Methods to calculate Cost of Equity

(1)Dividend yield method:

Ke = DPS\mP*100

(2) Earning yield method:

Ke= EPS\mp*100

(3) Dividing yield plus growth in dividend method :

Ke= DPS\MP*100+G

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COST OF EQUITY SHARE CAPITAL (KE)

Particular 2009-10

Dividend Per share method 13

Earning Yeild Method 8.43

Dividend yield plus growth method 10.56

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COST OF RETAIN EARNINGS OR INTERNAL EQUITY

• Generally, company’s do not distribute the entire profits by way

of dividend among their share holders.

• A part of such profit is retained for future expansion and

development.

• Therefore, it is assumed to cost free capital that is not true.

• Though retain earnings have no explicit cost like equity fund but
do have opportunity cost.

• The opportunity cost of retained earnings is the income forgone

by the share holders. It is equal to the income what a share
holders could have earns otherwise by investing the same in an
alternative investment, if the company would have distributed the
earnings by way of dividend instead of retaining in the business.

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WEIGHTED AVERAGE COST OF CAPITAL

• Once the specific cost of capital of the long-term sources i.e. the debt,
the preference share capital, the equity share capital and the retained
earnings have been ascertained, the next step is to calculate the overall
cost of capital of the firm.

• The capital raised from various sources is invested in different projects.

• The profitability of these projects is evaluated by comparing the

expected rate of return with overall cost of capital of the firm.

• The overall cost of capital is the weighted average of the costs of the
various sources of the funds, weights being the proportion of each
source of funds in the total capital structure.

• Thus, weighted average as the name implies, is an average of the cost of

specific sources of capital employed in the business properly weighted
by the proportion they held in firm’s capital structure.

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WACC OF SHREE CEMENT LIMITED (2009-2010)

Source Amount Weights After tax Weighted

Rs. Cost Cost

(2) (4) (5)= (3) * (4)

(1) (3)

E.S. Capital 801268.41 .8322 10.56 8.79

Debentures 161570.37 .1678 05.65 0.95

Total 962838.78 1.00 9.74

Weighted Average Cost of Capital (WACC) 9.74%

WACC = (We * Ke) + (Wd * Kd)

Where……We = Weight of equity
Wd = Weight of Debt.
Ke = Cost of Equity Share capital
Kd = Cost of Debt. capital
WACC = ( 0.8322 * 10.56) +( 0.1678 *05.65 ) = 9.74%

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Conclusion

• Cost of Debt is decreased in 2009-10 as compared to 2008-

09.

• Cost of Equity is also decreased in 2009-10 as compared to

2008-09.

• And that is why the Overall Cost of Capital or Weighted

Average Cost of Capital is also decreased.

• Because, company’s debentures is decreased and earning

per share and dividend per share is increased from the
previous financial year.

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Thank You 23