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 OFAUTOMOBILES
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 REVIEW
Various 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 BASE
This 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 capital
A. Capital structure
B. Cost of equity
C. Cost of debt
D. Weighted average cost of capital
2. Financial leverages
A. Degree of financial leverage
B. Degree of operating leverage
C. Degree of combined leverage

Name of %of % Cost of Cost of W Remark

company equity debt equity(Ke) debt(Kd) ACC (As per
industry
 average)

Denso auto 11.91 88.0 45.03 0.3438 5.66 Below

parts 8

Motherson 76.08 23.9 12.75 1.71 10.1 Below

sumi 1 0
Harigh 73.21 26.8 0 17.26 4.64 Below
crankshaft 9
ltd.
ANG auto ltd. 36.55 64.4 72.15 6.92 30.8 Above
4 2
Roto pumps 67.61 32.3 0.33 5.78 2.09 Below
ltd. 8
Subros ltd. 32.97 67.0 41.37 30.18 33.8 Above
2 6
Amtek auto 36.59 63.4 .0347 0.6011 0.39 Below
ltd. 0 4
Amtek India 53.1 46.8 0.4307 0.3803 40.7 Above
ltd. 9 0
Bharat seets 56.17 43.2 0.0143 14.08 6.1 Below
ltd. 8
Clutch auto 7.86 92.1 3.35 39.22 62.4 Above
4 6
TOTAL 452.05 548. 175.45 116.47 196.
43 82
AVERAGE 45.2 54.8 17.5 11.6 19.6

Summary chart of capital structure

Summary chart of leverages
NAME OF DEGREE OF DEGREE OF DEGREE OF REMARK
COMPANY FINANCIAL OPERATING COMBINED
(AS
LEVERAGE(D LEVERAGE(D LEVERAGE(DO
COMPARISIO
FL)* OL)* L X DCL)*
N TO
INDUSTRY
AVERAGE)
DENSO 1.004 -0.188 -0.189 BELOW
AUTOPART
S

HARIGH 3.45 0.761 2.62 ABOVE

CRANKSHA
FT LTD.

Motherson 1.06 0.506 0.5363 BELOW

sumi

ANG AUTO 1.605 0.34 0.545 BELOW

LTD.

ROTO 1.15 2.03 2.34 ABOVE

PUMPS LTD.

SUBROS 1.28 4.52 5.78 ABOVE

LTD.

AMTEK 1.08 0.614 0.668 BELOW

AUTO
AMTEK 1.08 2.39 2.55 ABOVE
INDIA
BHARAT 1.14 1.39 1.58 BELOW
SHEETS
CLUTCH 1.71 3.2 5.49 ABOVE
AUTO
TOTAL 14.55 15.563 21.92
AVERAGE 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 Wing
The Capital Court
Olof Palme Marg, Munirka
New Delhi
Delhi-110 067

Capital Structure-

Equity- 11.91%

Debt- 88.08%

COST OF CAPITAL-

Cost of equity-
D1
ke =
Po
= 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

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 II
Gautam Budh Nagar
Noida
Uttar Pradesh-201 305

Capital Structure-

Equity- 73.21%
Debt- 26.89%

COST OF CAPITAL-

Cost of equity-

D1
ke =
Po
= 0/.84+0 (since no dividend paid to shareholders from 1993)

= 00

Cost of Debt-
= intrest/Total borrow*100

= 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%

Weighted cost of capital

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

=0000+4.64

=4.64%

Motherson sumi
2nd Floor, F-7, Block B-1
Mohan Cooperative Industrial Estate
Mathura Road
New Delhi
Delhi-110 044
Capital Structure-

Equity- 76.08%

Debt- 23.91%

COST OF CAPITAL-

Cost of equity-
D1
ke =
Po
= 1.35/77.15+.11
= 12.75

Cost of Debt-

= intrest/Total borrow*100

= 9.99/457.9*100

= .0053*100(1-.21)

= 1.71

Weighte average caot of capital-

Source cost capital

Equity 12.75 .7608

Debt 1.71 .2391

Weighted cost of capital

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

=9.70+.4064

=10.10
ANG AUTO LTD.
1C/13, New Rohtak Road
Karol Bagh
New Delhi
Delhi-110 005

Capital Structure-

Equity- 36.55%

Debt- 64.44%

COST OF CAPITAL-

Cost of equity-
D1
ke =
Po
= 20/32.5+66.6

= 72.15

Cost of Debt-

= intrest/Total borrow*100

= 12.18/148.87*100

= .081*100(1-.15)

= 6.92

Weighte average caot of capital-

Source cost capital

Equity 72.15 36.55%

Debt 6.92 64.44%

Weighted cost of capital

=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-
D1
ke =
Po
= 2/34.1+.28

= .33

Cost of Debt-

= intrest/Total borrow*100

= .72/7.96*100

= 9.04*100(1-.36)

= 5.78

Weighte average caot of capital-

Source cost capital

Equity .33 .6761

Debt 5.78 .3238

Weighted cost of capital

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

=.22+1.87

=2.09%

SUBROS LTD.
ADDRESS-

LGF, World Trade Centre

Barakhamba Lane
New Delhi
Delhi -110 001

Capital Structure-

Equity- 32.97%

Debt- 67.02%

COST OF CAPITAL-

Cost of equity-
D1
ke =
Po
= .80/21.5+.3766

= 41.37

Cost of Debt-

= intrest/Total borrow*100

= 11.56/24.39*100
=.4339*100(1-.30)

= 30.18

Weighte average caot of capital-

Source cost capital

Equity 41.37 .3297

Debt 30.18 .6702

Weighted cost of capital

=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

Weighted avg. cost of capital-

Source cost capital(%)

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

Weighted avg. cost of capital-

Source cost capital(%)

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

Source cost capital(%)

Equity 3.35 7.86

Debt 39.22 92.14

WACC

=3.35(7.86)+39.22(.9214)

=62.46