Project Financial Management Capital Structures of Smes

Project

Topic:-Study of Capital Structure of SMEs

Area of research:-Automobile Ancillaries units in NCR

SUBMITTED TO: SUBMITTED BY:

PROF. PRASHANT GUPTA ANKUSH SAXENA

FINANCIAL MANAGEMENT MANOJ KUMAR

PARUL SIROHI

PRABHAT KUMAR

PRASHANT SHARMA

VIKAS CHAUDHARY

MBA 1ST YEAR , SEC.-B

SCHOOL OF MANAGEMENT (2008-10)

GAUTAM BUDDHA UNIVERSITY

GREATER NOIDA

STUDY ON CAPITAL STRUCTURE OF AUTOMOBILES ANCILLERIES SME’s IN (NCR) INDIA

Small and medium enterprises (SME) sector is a vital sector in the Indian context as it contributes a big chunk to national income. This paper examines the sources of funds of SME sector operating in the Gautama Buddha Nagar and Ghaziabad .For this purpose a survey of 20 SME’s was conducted.

INTRODUCTION

Capital structure is a mix of long term debt, specific short term debt, and common equity and prefers equity. The capital structure shows how a firm finances its overall operations and growth by using different sources of funds. This decision has been recognised as the most important decision a firm has to take because the capital structure affects the cost of capital, net profit, earning per share, and dividend power and liquidity position of the firm. These factors along with a number of other factors, determine the value of a firm. If a firm entirely relies on internal funds or equity, than the growth may be restricted due to unavailability of large amount of finance and if firm goes for external finance than chances of risk increases as the liability of firm enhances. Thus a fir has to manage lots of objectives so that liquidity of the firm remains maximum .So, capital structure is considered to be a very vital determinant of the value of the firm.

There are various approaches which have defined various assumptions and thus according to them various ways of forming a capital structure is better .one of them is Modigliani and miller approach which highlights the issues involved in financial structure decisions, viz, the cheaper cost of debt as compared to equity, the increase in risk and the cost of equity as debt increases and the benefit of tax deductibility of debt. They argued that in absence of taxes, cost of capital remained constant as the benefits of using cheaper debt were exactly offset by the increase in cost of equity due to increased risk. They concluded that with taxes and deductibility of interest charges, firms should use as much debt as possible. Myers (1984) stressed that capital structure has proved to be a recurrent puzzle in the field of finance.

Small and medium sized enterprises (SMEs) play an important role in the growth and development

of an economy. Given their potential to generate employment, foster technical innovation and entrepreneurship and raise exports, SMEs need to assume centre-stage in India’s trade policy. Their importance in the Indian economy is underscored by the fact that SMEs account for about 90% of the total industrial units in India and provide employment to more than three crore individuals.

The availability of finance for SME’s is a matter of significant importance to the policy maker all over the world. So to support SME’s various policies like time of credit approval is reduced and tariffs have been lowered for them

LITERATURE REVIEWVarious studies on capital structure related to SME’s were conducted in foreign countries. However, in the Indian context, the number is quite few. Depending on the various issues of capital structure, the review has been discussed in brief as follows.

CAPITAL STRUCTURE AND FIRM’S CHARACTERISTICS

Capital structure of a firm varies with its size, type and some other characteristics such as sales, growth and liquidity. It has been supported by the results of the studies conducted by various researchers from time to time.Sogorb-mira (2005) conducted a study of 6482 non financial Spanish SME’s during the five year period 1994-1998, modelling the leverage ratio as a function of firm-specific attributes hypothesised by capital structure theory. The result suggested that the capital structure of a firm depends to a great extent on the firm’s characteristics. It was found that non-debt tax shields and profitability are both negatively related to SME’s leverage, while size, growth options and asset structure has positive relation.

CAPITAL STRUCTURE AND INDUSTRYWISE DIFFERENCES

Joshua and Nicholas (2007) examined the effect of industry classification on the capital structure of SME’s in Ghana. The result of this study indicated that SME’s in the agriculture sector exhibited the highest capital structure and asset structure or collateral value while the wholesale and retail trade industry have the lowest debt ratio and asset structure. The result clearly indicates that industry effect is important in explaining the capital structure of SME’s and that there are variations in capital structure across the various industries.

NEED AND OBJECTIVES OF THE STUDY

The perusal of the literature reveals that a number of studies have been carried out in the area of capital structure of SME’s in the Indian context; still a wide gap exists in the research field with particular stress on the same aspect. Considering the importance of SME’s in India, the need for current study was felt to analyze the effect of cost of capital affecting the capital structure decision of SME’s. Therefore, the primary objective of this study is to get an idea regarding the capital structure of SME’s. The explicit objective of the study is to:

Study the sources of capital in SME’s. Study the factors that influence the choice of borrowed funds in the capital structure and

To analyze the impact of SME’s on the economy growth.MANAGEMENT DILEMMA

Decrease in profits while companies are performing well and generating good revenue.

MANAGEMENT QUESTION

What should be done to reduce cost and increase profit to maximize the shareholders wealth?

HYPOTHESIS

In order to empirically verify the above objectives the following hypothesis were framed and tested. H1 –small firms tend to rely on the internal sources of finance as compared to the large firms. H2 –there is no significant association between types of fund and degree of competition

faced by SME’s. H3 -there is no significant association between type of funds and level of investments in

SME’s.

DATA BASE AND METHODOLOGY

DATA BASEThis study focuses on identifying the influence of capital structure and their impact on the decision making ability of the SME’s. For accomplishing the objective, a survey was carried out through a non disguised structured questionnaire having open ended questions and the secondary data was also used because we were not able to collect the required information of the firm’s through questionnaire and the database was PROWESS DATABASE.

AREA OF STUDY; AUTOMOBILE ANCILLARY UNITS

We have studied the capital structure of the automobile ancillary smes in NCR region . The focus area is long term financial structure of the smes.We have covered two areas –

1. Cost of capitalA. Capital structureB. Cost of equityC. Cost of debtD. Weighted average cost of capital

2. Financial leveragesA. Degree of financial leverageB. Degree of operating leverageC. Degree of combined leverage

Name of company

%of equity

%debt Cost of equity(Ke)

Cost of debt(Kd)

WACC Remark(As per industry average)

Denso auto parts 11.91 88.08 45.03 0.3438 5.66 Below

Motherson sumi 76.08 23.91 12.75 1.71 10.10 Below

Harigh crankshaft ltd.

73.21 26.89 0 17.26 4.64 Below

ANG auto ltd. 36.55 64.44 72.15 6.92 30.82 Above

Roto pumps ltd. 67.61 32.38 0.33 5.78 2.09 Below

Subros ltd. 32.97 67.02 41.37 30.18 33.86 Above

Amtek auto ltd. 36.59 63.40 .0347 0.6011 0.394 Below

Amtek India ltd. 53.1 46.89 0.4307 0.3803 40.70 Above

Bharat seets ltd. 56.17 43.28 0.0143 14.08 6.1 Below

Clutch auto 7.86 92.14 3.35 39.22 62.46 Above

TOTAL 452.05 548.43 175.45 116.47 196.82

AVERAGE 45.2 54.8 17.5 11.6 19.6

Summary chart of capital structure

Summary chart of leverages

NAME OF COMPANY

DEGREE OF FINANCIAL LEVERAGE(DFL)*

DEGREE OF OPERATING LEVERAGE(DOL)*

DEGREE OF COMBINED LEVERAGE(DOL X DCL)*

REMARK(AS COMPARISION TO INDUSTRY AVERAGE)

DENSO AUTOPARTS

1.004 -0.188 -0.189 BELOW

HARIGH CRANKSHAFT LTD.

3.45 0.761 2.62 ABOVE

Motherson sumi

1.06 0.506 0.5363 BELOW

ANG AUTO LTD.

1.605 0.34 0.545 BELOW

ROTO PUMPS LTD.

1.15 2.03 2.34 ABOVE

SUBROS LTD. 1.28 4.52 5.78 ABOVE

AMTEK AUTO 1.08 0.614 0.668 BELOWAMTEK INDIA 1.08 2.39 2.55 ABOVEBHARAT SHEETS

1.14 1.39 1.58 BELOW

CLUTCH AUTO 1.71 3.2 5.49 ABOVETOTAL 14.55 15.563 21.92AVERAGE 1.455 1.5563 2.192

*- DFL=EBIT/EBIT-I

*-DOL=% CHANGE EBIT/% CHANGE Q

Q-SALES EBIT-EARNING BEFORE INTEREST AND TAX

Note :-details of calculations are given below

Conclusion :-

The greater the DOL, the higher is the operating leverage.

The average DOL of our industry is 1.55 which is greater than 1, this implies that operating leverage exists. Operating leverage exists when there are fixed operating costs. High operating leverage is good when revenues are high. Our industry’s DOL is 1.55 which is moderate and to cover risk they has to increase their sales.

DOL is 1.55 means 1% change in sales results in 1.55 % change in EBIT level.

Average DFL of industry is 1.455 which is moderate that means the EPS is not that much volatile.

DCL is 21.92 which means 1% change in sales will bring about 21.92 % changes in EPS.Therefore industry is good in terms of investment.

The cost of equity is 17.5 that means industry is paying higher interest to their share equity holders.That indicates the industry is attractive in terms of investment.

The cost of debt is 11.6 which implies that industry is getting loan on a moderate rate.

Calculations

DENSO AUTOPARTS

3rd Floor, Left WingThe Capital CourtOlof Palme Marg, MunirkaNew DelhiDelhi-110 067

Capital Structure-

Equity- 11.91%

Debt- 88.08%

COST OF CAPITAL-

Cost of equity-

= 6.53/43+.2985

= 45.03

Cost of Debt-

= intrest/Total borrow*100

= .02/3.77*100

= .0053*100(1-.35)

= .3438

Weighted average cost of capital-

Source cost capital

Equity 45.03 .1191

Debt .3438 .8808

k e=D1

Po

Weighted cost of capital

=.1191(45.03)+.8808(.3438)

=5.36+.3028

=5.66%

LEVERAGE

DFL=EBIT/EBIT-I

=42.87/42.87-.2

=1.004

DOL=%EBIT/%Q

=-0.02/.106

=-0.188

DCL=DOL X DFL

=1.004 X -0.188

=-0.189

HARIGH CRANKSHAFT LTD.

ADDRESS-

C-49, Phase IIGautam Budh NagarNoidaUttar Pradesh-201 305

Capital Structure-

Equity- 73.21%

Debt- 26.89%

COST OF CAPITAL-

Cost of equity-

= 0/.84+0 (since no dividend paid to shareholders from 1993)

= 00

Cost of Debt-


= 2.48/12.37*100

= .2004*100(1-.138)

= 17.26

Weighte average caot of capital-

Source cost capital

Equity 0000 73.21%

Debt 17.26 26.89%


=.7321(0000)+.2689(17.26)

=0000+4.64

=4.64%

Motherson sumi2nd Floor, F-7, Block B-1Mohan Cooperative Industrial EstateMathura RoadNew DelhiDelhi-110 044

k e=D1

Po

Capital Structure-

Equity- 76.08%

Debt- 23.91%

COST OF CAPITAL-

Cost of equity-

= 1.35/77.15+.11

= 12.75

Cost of Debt-


= 9.99/457.9*100

= .0053*100(1-.21)

= 1.71


Source cost capital

Equity 12.75 .7608

Debt 1.71 .2391


=12.75(.7608)+1.71(.2391)

k e=D1

Po

=9.70+.4064

=10.10

ANG AUTO LTD.

1C/13, New Rohtak RoadKarol BaghNew DelhiDelhi-110 005

Capital Structure-

Equity- 36.55%

Debt- 64.44%

COST OF CAPITAL-

Cost of equity-

= 20/32.5+66.6

= 72.15

Cost of Debt-


= 12.18/148.87*100

= .081*100(1-.15)

= 6.92

k e=D1

Po


Source cost capital

Equity 72.15 36.55%

Debt 6.92 64.44%


=72.15(.3655) +06.92(.6444)

=26.37+4.45

=30.82%

ROTO PUMPS LTD

Capital Structure-

Equity- 67.61%

Debt- 32.38%

COST OF CAPITAL-

Cost of equity-

= 2/34.1+.28

= .33

Cost of Debt-


= .72/7.96*100

= 9.04*100(1-.36)

= 5.78


Source cost capital

Equity .33 .6761

k e=D1

Po

Debt 5.78 .3238


=.33(.6761)+5.78(.3238)

=.22+1.87

=2.09%

SUBROS LTD.

ADDRESS-

LGF, World Trade CentreBarakhamba LaneNew DelhiDelhi -110 001

Capital Structure-

Equity- 32.97%

Debt- 67.02%

COST OF CAPITAL-

Cost of equity-

= .80/21.5+.3766

= 41.37

Cost of Debt-


= 11.56/24.39*100

=.4339*100(1-.30)

k e=D1

Po

= 30.18


Source cost capital

Equity 41.37 .3297

Debt 30.18 .6702


=41.37(.3297)+30.18(.6702)

=13.64+20.22

=33.86%

AMTEK AUTO LTD.

Plot No 16, Industrial Estate

Rozka-Meo (Sohna)

Gurgaon

Haryana-122 103

Cost of equity

Ke=D/P+G

= .5/106.25+.03

= .0347

Cost of debt-

Kd=i/avg.borrow*100

= 1939/2394.47*100

= .8097(1-.2576)

= .6011

Weighted avg. cost of capital-

Source cost capital(%)

Equity .0347 36.59%

Debt .6011 63.40

WACC-

=0.0347(.3659)+.6011(.6347)

=0.394

AMTEK INDIA LTD.

Village Narsinghpur

Old Manesar Road

Gurgaon

Haryana-122 001

Cost of equity

Ke=D/P+G

= .2/35+.42

= .4307

Cost of debt-

Kd=i/avg.borrow*100

= 2.61/569.51*100

= .4582(1-.17)

= .3803



Equity .4307 53.10

Debt .3803 46.89

WACC-

=43.07(.5310)+38.03(.4689)

=40.70

BHARAT SEATS LTD.

D-188

Okhla Industrial Area

Phase-I

New Delhi

Delhi-110 020

Cost of equity

Ke=D/P+G

= .5/9.2+(-.04)

= .0143

Cost of debt-

Kd=i/avg.borrow*100

= .67/3.28*100

= 20.42(1-.31)

= 14.08



Equity .0143 56.17

Debt 14.08 43.28

WACC

=0.0143(0.5617)+14.08(.4328)

=6.1

CLUTCH AUTO LTD

2E/14, 1st Floor

Jhandewalan Extension

New Delhi

Delhi-110 055

Cost of equity

Ke=D/P+G

= 1/19.25+3.3

= 3.35

Cost of debt

Kd=i/avg.borrow*100

= 11.49/24.6*100

= 46.7(1-.16)

= 39.22

Weighted avg. cost of capital


Equity 3.35 7.86

Debt 39.22 92.14

WACC

=3.35(7.86)+39.22(.9214)

=62.46

Documents

Project Financial Management Capital Structures of Smes