FINANCIAL

CIA 1.2

MANAGEMENT
Research Article Review – Capital Structure Decisions

Submitted By
SALONI JAIN
1820343
 Index

S.No. Topic Page No.

1 Background 2
2 Article Review I 3-6
3 Article Review II 7-10
4 Article Review III 10-13

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 Background

Capital Structure or Capital Mix is an important decision to control the overall cost of capital and in order to
improve the earning per share of the shareholders. This combination or mix influences the overall cost of
capital. Normally capital structure will be the mix of equity and debt. Capital structure is the crucial decision to
be taken by every business, the positives and negatives of these decisions plays an important role in determining
the future of every business.

The modern theory of capital structure was established by Modigliani and Miller .According to Myers, ‘there is
no universal theory of the debt--equity choice, and no reason to expect one’. The theories can be separated into
two groups – either they predict the existence of the optimal debt-equity ratio for each firm known as static
trade-off theory or they declare that there is no well-defined target capital structure known as pecking-order
hypothesis.

A capital structure of a firm consist of long-term debt, short-term debt, equity and preferred equity. A company's
proportion of short- and long term debt and debt and equity is considered when analysing capital structure.
When analysts refer to capital structure, it means firm's debt-to-equity (D/E) ratio, which projects the risk of the
company.

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 Research Article Review- I

Topic – Capital Structure & Leverage Analysis:A Case Study Of Steel Authority Of India Ltd. (Sail)

Journal Name – ASBM Journal of Management

Volume – 5

Issue – 1

Summary

Dr. Ashok Kumar in this article studies the capital structure performances of Steel Authority Of India through
EBIT-EPS analysis. The capital structure of SAIL is analyzed for the duration of 1996-97 to 2003-04. The study
is made to analyze the factors that influence capital structure decisions of the company and to know the impact
of these factors on the capital structure decisions and planning of an organization. In this study , levels of debt
financing has been evaluated , that what is the effect of high and low debt financing, during the period of the
study.
The study reflected that SAIL has used high level of debt financing , which resulted in high cost of capital as its
cost of debt was higher than the cost of equity. The ICR was too low for all the years because of high interest
and low profits . The value of the company declined over years because of the investment decisions of the
company that are reflected from the EBIT as well as the high cost of capital due to unbalanced capital structure.

METHODOLOGY

Objective

The followings are the objectives of the study -

 To study the capital structure decisions made by the firm.

 To study the impact of various determinants of capital structure.
 To study the connection between capital structure and value of firm.
 To take measure of the performance of the firm with respect to capital structure.

Tools

To assess the significance of “Capital structure analysis” of Steel Authority of India Limited the following tools
of analysis have been used :-

 Ratio analysis.

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  Bar Chart.

 Pie Chart.

Data Collection

 In this study, the sample of eight financial years from 1996-97 to 2003-04 is taken from Annual accounts
of SAIL.
 Secondary data has been used in this research study, which are balance sheets and their related schedules
of the past financial years from 1997 to 2004 of Rourkela Steel Plant, Rourkela.

Data Analysis

The data analysis has been done by taking into account various determinants and the equity and debt capital of
the firm.

Equity Capital : The company has an issued and paid up equity capital of Rs.4130.40 crores. The net worth of
the company is decreasing over the years. This is because of the losses suffered by the company from the year
1998-99 to 2002-03 and the company has been able to write off all its previous losses in the year 2003-04.

Debt Capital :The debt capital of the company comprises of both secured as well as unsecured loans. The debt
capital of the company increased till the year 1998-99 because of the modernization program but the company
went for debt swapping and loans repayments in the year 1999-00. So the debt capital of the company has
decreased subsequently from 2000-01.

Cost of Capital: Cost of debt is increasing till the year 2000-01 but was decreased subsequently from the year
2001-02. This is because of the debt swapping and debt repayments in the year 2000-01.

The cost of equity of SAIL is very high in the year 1996-97 as the company was making profits and the net
worth was increasing but subsequently cost of equity reduced and is 0 in all the years from 1997-98 to 2003-04
because the company had suffered from losses.

WACC: The WACC of the company is very high in the years from 1999-2002 because of huge losses . The
introduction of more debt capital is increasing the WACC because of the high cost of debt. The company has an
interest tax shield in the year 1996-97, 1997-98 and 2003-04 because the company has made profits in these
years only.

Interest Coverage Ratio : The ratio should be 3 times for comfortable service of debt. But for the years from
1996-2003, it has been less than 1, because of issue of more debt capital. Only in the year 2003-04, it has
increased to 3.92 because of capital repayments and swapping.

Debt Equity Ratio : The debt equity ratio has been very high for all these years from 1996-2003 i.e. more than
the industrial ratio of 1.5.

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Strategies

The strategies or techniques adopted by SAIL in making their capital structure decisions are as follows :-
 SAIL has used only two sources of finance to finance its assets and working capital , which are equity
capital and debt capital.
 SAIL is authorized to issue equity shares of Rs.5000 crores but the company has an issued and paid up
equity capital of Rs.4130.40 crores till the year 2003-04.
 The debt capital of the company comprises of both secured as well as unsecured loans.
 The loans taken from secured sources are more than unsecured ones till the year 2001-02. This is because
the company went a huge modernization program in the year 1991-92 and required a huge capital
 The company went for a debt swapping from the year 1999-00 and has the rate of interest on secured loans
ranging from 10 to 14 percent which is between 10 to 14 percent on unsecured loans.
 The sources of debt for the company are working capital borrowings from banks, term loan from banks and
financial institutions, foreign loans, public deposits, Government of India, tell Development Fund.
 The debt capital of the company increased till the year 1998-99 because of the modernization program but
the company went for debt swapping and loans repayments in the year 1999-00. So the debt capital of the
company has decreased subsequently from 2000-01.
 The technique of trading on equity was followed by the company in making capital structure decisions.
Trading on equity also known as financial leverage means using debt financing to increase earnings per
share.
 Analyzing the debt ratio of SAIL, it is concluded that debt forms more than 65% of the total capital
employed by the firm. It has also reached to 86% in the year 2000-01 and 2002-03.
 Analysis of the debt equity ratio reveals the fact that the debt component is very high as compared to value
of equity. The ratio is always more than 2 and sometimes it is also more than 6. It is very high as compared
to the industry average debt equity ratio of 2:1.

Proposed Changes

The major proposed changes in the capital structure decision of SAIL are as follows :-

 The company should have issued equity shares instead of raising capital through debt.
 The company should have used more equity capital as all the factors for determination of capital structure is
against the issue of debt capital.
 The cost of capital is increasing with an increase in the debt component in the capital structure. The cost of
debt is high than the cost of equity. The cost of debt i.e. interest also contributes towards the losses made by
the company. The WACC is had also increased. All these costs lead to a conclusion that the company
would not have gone for raising debt capital.
 The company had saved corporate tax on interest only in 3 years out of 8 years of profits. Rest of the years,
company had suffered from loss and hence no taxes were paid and saved.
 The interest coverage ratio of SAIL is very less than a comfortable ratio of 3 times. Hence the company was
not in a position of comfortable service of debt and should have used alternative means of financing capital.

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 An analysis of the factors responsible for selection of capital structure indicate that almost all the factors
like cost of capital, trading on equity, taxes saved, leverage effect, debt capacity of the firm, and stability of
earnings are against raising debt capital by the company.

Conclusion

After the examination of the financial statements of Steel Authority of India Limited (SAIL), the initial
impression any one may frame is that the losses incurred by the company is the outcome of unbalanced capital
mix. The investment decisions made the value of the company decline ,which is reflected from the EBIT as well
as the high cost of capital due to unbalanced capital structure.

Reference :

Panigrahi,A.(2014).ASBM Journal of Management. Capital Structure & Leverage Analysis:A Case Study Of

Steel Authority Of India Ltd. (Sail). Vol.5(1),3-21.

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 Research Article Review- II

Topic – Capital Structure Of Internet Companies : Case Study

Journal Name – Journal Of Internet Commerce

Volume – 13

Issue – 3

Summary

Z.Lee & S.Liang through this article has analyzed the capital structure decisions of internet companies.Large
internet companies usually uses low debt financing as a means of financing their working capital and assets .The
reason behind using high equity capital is high profits, which allows them to pay the cost of equity and
secondly, large internet companies have more intangible assets which increases risk . Whereas small internet
companies uses high debt financing or private instruments because of the inability to pay the cost of capital .
For analyzing the capital decisions of internet industry , it has been broadly categorized as large internet
companies(Google & Yahoo),which have a market value of more than 1billion and small internet
companies(Look Smart & Rediff ) having market value of less than 1 billion.
The various form of debt-equity financing used by different companies has been analyzed by taking into
consideration various determinants of capital structure decisions.

METHODOLOGY

Correlation, Regression and Anova is used to investigate the significant relationships and causal effect of board
size, board meeting, board committee, board composition and disclosure practices as independent variables with
return on assets and return on capital employed as the dependent variable.

Objective

 To study the capital structure of the firm during the study period
 To study the value of the company
 To study the influence of capital structure on Return on equity

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Tools

 To assess the significance of ‘Capital Structure’ of Tata Motors Limited Ltd during the study period of
2003-2004 to 2012-2013, mainly the ratio analysis is used to analyze the data.
 The dependent variable is the MNCs’ financial performance, which is to be measured by ROA and ROCE .
 ROA and ROCE is an accounting- based performance measure and is included for robustness .

Data Collection

 Secondary data is used for the study.

 The financial statements of Tata Motors Limited for the 10 years are taken from CMIE prowess.

Data Analysis

 Most large companies in the Internet industry are underleveraged. Low debt ratio is hurting the companies’
profitability.
 Most small companies in the Internet industry are overleveraged.
 Ratio analysis suggests that Google’s optimal debt ratio is 10.01%, however, its current debt ratio is 4.02%,
because low debt implies low bankruptcy cost and high level of confidence for investors.
 The percentage of google shares owned by insiders are 4% so as to have fewer conflicts between company
and outsiders.
 Yahoo debt/equity ratio is low. Yahoo currently has a debt/equity ratio of 6.3% and their optimal ratio is
around 25% ,which shows that it is underleveraged and should use more debt financing for raising funds.
 Look Smart debt/equity is high. Look Smart currently has a debt/equity ratio of 22.02 % and their optimal
ratio is 0.0%,which shows they are overleveraged and should not use debt as a means of financing .The
reason could be because the tax advantage is not as important as for the large companies.
 Rediff debt/equity is high. Rediff currently has a debt/equity ratio of 1.42% and their optimal ratio is
0.0%.The reason is same for all small internet companies.

Strategies

In this study of internet industry companies are divided into two group of large firms of more than 1 billion
market value and small firms of market value of less than 1 billion.

Large Companies –

Large companies adopt low debt financing as an option to finance their assets and opts for equity due to high
profits.

Google

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 Google uses more equity financing rather than debt financing as it evolved from introductory to growing
stage over the years.
 Google changed its debt/assets ratio from 4.7% to 8.4% during 2010 and 2012 and now back to the 4.02%
in 2013 .

Yahoo

 Yahoo debt/equity ratio is low. Yahoo currently has a debt/equity ratio of 6.3% and their optimal ratio is
around 25% .
 Market Condition has also been an important factor in change in debt/equity ratio of Yahoo. As in the year
2003-04 yahoo had a high debt/equity ratio because it was a struggling period due to the dot-com bubble
burst, and there was shortage of funds so debt financing was used.
 The company does not use debt as a financing instrument as it has most of its assets as intangible assets like
intellectual property rights and developed technology, which has a higher risk and higher bankruptcy cost.
 The company has other deductions to reduce tax-bite such as depreciation of $481M .They believe that that
their tax-shield is sufficient enough to not to finance debt.

Small Companies –

Whereas in the case of small companies the debt financing ratio is more due the inability to pay the financing
cost due to lack adequate profits.

Look Smart

 These companies have little access to loans and have exhausted its equity opportunities and survives
through private placements which are low in cost .

Rediff

 Rediff has a high debt/equity ratio because of low profits.

 Rediff does not use equity as a means of financing due to the fact of low revenue to pay the financing cost.

Proposed Changes

 Low debt ratio is hurting the large companies’ profitability .The company should issue low debt to increase
the profits. Even after taking factors like cost of debt and low flexibility into account the companies are
underleveraged.
 Most small company are overleveraged , but should use less debt .They should take into account long term
problems of carrying too much debt. Such small companies can use preferred stocks.
 Internet companies can use international financing more efficiently. Corporations can raise international
debt in different currencies. The currency differential doesn’t just diversify risk, it helps to shop for lower
interest rates in a limitless international market.

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Conclusion
We analyze the financing decisions and capital structure of internet companies and relate observed findings to
the common capital structure theories. Large internet companies usually have low debt and small internet
companies have high debt.

We find that one particular strategy or determinant cannot individually determine a firm’s capital structure and
their use of sources of financing accurately but can complement each other to help explain observed behavior.

Reference :

Lee,Z.Liang,S.&Miglo,A.(2014).Capital Structure Of Internet Companies : Case Study. Journal Of Internet

Commerce.Vol.13(3),1-37.

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 Research Article Review- III

Topic – A Study on Capital Structure and Leverage of Tata Motors Limited: Its Role and future Prospects

Journal Name – Procedia Economics and Finance

Volume – 11

Issue – 14

Summary

M.Sekar, M.Gowri & G.Ramya studies the capital structure decisions and leverage of Tata Motors Limited. The
analysis is made through EBIT-EPS method and has been conducted for the years 2003-04 to 2012-2013 . The
analysis was made to know the effect of different factors or determinants on the capital structure of the firm and
its impact on the value of the firm.
In this study net worth of the company increased throughout the period due to an increase in the issue of equity
capital over the years. Tata Motors has not use debt as a major source of financing as the debt capital has been
increasing over the years and capital and interest repayments has also been made. An analysis of the factors
responsible for selection of capital structure indicate that almost all the factors like cost of capital, trading on
equity, taxes saved, leverage effect, debt capacity of the firm, and stability of earnings are against raising debt
capital by the company.

The value of the company is increased over years because of the investment decisions of the company that are
reflected from the EBIT as well as the low cost of capital due to balanced capital structure

METHODOLOGY

Objective

 To study the capital structure of the firm during the study period
 To study the value of the company
 To study the influence of capital structure on Return on equity

Tools

To assess the significance of ‘Capital Structure’ of Tata Motors Limited Ltd during the study

period of 2003-2004 to 2012-2013, mainly the ratio analysis is used to analyze the data.

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Data Collection

Secondary data is used for the study. The financial statements of Tata Motors Limited for the 10 years are taken
from CMIE prowess.

Data Analysis

The data analysis has been done by taking into account various determinants and the equity and debt capital of
the firm.

 Equity Capital : The equity capital of the company was 332 crores in the year 2002-2003. The company
continued issuing equity shares every year , except for the year 2006-07 and 2007-08. With the increase in
equity capital the net worth of the company has also increased over the years.
 Debt Capital : The debt capital of the company has increased over the years till 2009 because of investment.
But has decreased from 2010 because of capital repayment and debt interest swapping.
 Cost of Debt : The cost of debt has decreased over the years from as high as 17.93% in 2002-03 to 9.72 %
in 2012-2013.The reason behind this is company’s profits are increasing and has been able to reduce its
interest expense by debt repayments.
 Cost of Equity : The cost of equity has decreased over the years from as high as 22.54% in 2002-03 to 1.57
% in 2012-2013.This is because in the year 2012-2013 the company has suffered from losses due to decline
in the product sales. The dividend % decreased from 200% to 100 % in the last 3 years.
 WACC : The WACC of the company is fluctuating over the period. It is very high for the period of 2002-03
because of excessive losses .This also let to an increase in debt capital and cost of debt is more than the cost
of equity for that period.
 ROI : On comparing the ROI and cost of debt , ROE has always been lesser than cost of debt. It says that
debt as a financing tool should not be used for leveraging.
 ROE : It is inferred that ROE is increasing over the years. The highest return on equity is 86.38 % and the
lowest being 37.15 % .
 Debt/Equity Ratio : The debt/Equity ratio is always less than the industrial approved ratio of 2:1.This means
low debt financing has been used in the capital structure of Tata Motors.

Strategies

 Equity and debt are the only two sources of financing used by Tata Motors to finance its assets and working
capital .
 Tata Motors Limited is authorized to issue a paid up capital of 638.07crores . It has issued capital for all the
years reaching its authorized issue of 638.07 crores in the year 2012-13.The company has issued capital for
all the years except for the years 2006-07 and 2007-08.
 Tata Motors has benefitted from its financial mix and increasing share capital every year , as the net worth
of the company is also increasing over the years. Except for the year 2012-13 because of writing off the
debit balance of P&L.

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 The debt capital of the company comprises of both secured as well as unsecured loans. The loans taken
from secured sources are more than unsecured ones. This is because the company made a huge investment
for developments in the year 2009-2010. The company debt capital decreased in 2010-11 as it went for debt
repayment.
 The sources of debt financing for the company was from banks , foreign loans and public deposits.
 The debt equity ratio of the company is high . The debt-equity ratio of the company is always more than 0.1
and sometimes more than 1 ,but the industry expected ratio is 0.33.This shows that the company has used
more debt than its optimal debt ratio.
 Using proper debt component company is also benefited with tax-shield for the years, because debt is a tax-
deductible expense.
 Tata Motors is underleveraged as using equity as its major financing instrument.
 As the ROI is always less than cost of debt ,the company does not use the technique of trading on equity.
 The company has an optimal capital structure mix as all the factors such as cost of capital, trading on
equity, taxes saved, leverage effect, debt capacity of the firm, and stability of earnings does not favors debt
financing.

Proposed Changes

 The company needs to lower its fixed bearing expenses such as interest on debt , which means lowering its

cost of debt.

 The company needs to lower the degree of financial leverage i.e. use more of equity than debt. As seen

from the analysis the company’s debt-equity ratio was always higher than the industrial expected ratio of

0.33, which will make it more difficult for Tata Motors in the future to repay its debt.

Conclusion

The net worth of the company increased over the years. The debt capital has decreased along the years because
of repayments and debt swapping. The WACC of the company has fluctuated along the years. The WACC was
very high in the year 2002-03 because of losses and reduction in net worth of the company, which has led to an
increase in debt capital. The WACC of the company started decreasing from the 2004-05 because the company
adopted the way of cost effectiveness. The debt ratio and debt equity ratio of the company are low which
suggest that low amount of debt in the capital structure. Since Tata Motors has an optimal capital structure, it
will have positive impact in its future business.

Reference :Sekar, M. M. Gowri, Ms. &G. Ramya, Ms.(2014). A Study on Capital Structure and Leverage of
Tata Motors Limited: Its Role and Future Prospects. Procedia Economics and Finance. Vol.11(14),445-458.

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