Project

Topic:-Study of Capital Structure of SMEs Area of research:-Automobile Ancillaries units in NCR

SUBMITTED TO: PROF. PRASHANT GUPTA FINANCIAL MANAGEMENT KUMAR

SUBMITTED BY: ANKUSH SAXENA MANOJ 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 company

%of equity

% debt

Cost of equity(Ke)

Cost of debt(Kd)

W ACC

Remark (As per industry

average)

Denso auto parts Motherson sumi Harigh crankshaft ltd. ANG auto ltd. Roto pumps ltd. Subros ltd. Amtek auto ltd. Amtek India ltd. Bharat seets ltd. Clutch auto TOTAL AVERAGE

11.91 76.08 73.21

88.0 8 23.9 1 26.8 9 64.4 4 32.3 8 67.0 2 63.4 0 46.8 9 43.2 8 92.1 4 548. 43 54.8

45.03 12.75 0

0.3438 1.71 17.26

5.66 10.1 0 4.64

Below Below Below

36.55 67.61 32.97 36.59 53.1 56.17 7.86 452.05 45.2

72.15 0.33 41.37 .0347 0.4307 0.0143 3.35 175.45 17.5

6.92 5.78 30.18 0.6011 0.3803 14.08 39.22 116.47 11.6

30.8 2 2.09 33.8 6 0.39 4 40.7 0 6.1 62.4 6 196. 82 19.6

Above Below Above Below Above Below Above

Summary chart of capital structure

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

DENSO AUTOPART S

1.004

-0.188

HARIGH 3.45 CRANKSHA FT LTD. Motherson sumi ANG AUTO LTD. ROTO PUMPS LTD. SUBROS LTD. 1.06

0.761

2.62

ABOVE

0.506

0.5363

BELOW

1.605

0.34

0.545

BELOW

1.15

2.03

2.34

ABOVE

1.28

4.52

5.78

ABOVE

AMTEK 1.08 AUTO AMTEK 1.08 INDIA BHARAT 1.14 SHEETS CLUTCH 1.71 AUTO TOTAL 14.55 AVERAGE 1.455 *- DFL=EBIT/EBIT-I

0.614 2.39 1.39 3.2 15.563 1.5563

0.668 2.55 1.58 5.49 21.92 2.192

BELOW ABOVE BELOW ABOVE

*-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 StructureEquity- 11.91% Debt- 88.08% COST OF CAPITALCost of equity-

ke =

D1 P o

= 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 capitalSource Equity Debt .3438 cost 45.03 .8808 capital .1191

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. ADDRESSC-49, Phase II Gautam Budh Nagar Noida Uttar Pradesh-201 305 Capital StructureEquity- 73.21%

Debt- 26.89%

COST OF CAPITAL-

Cost of equity-

ke =

D1 P o

= 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 capitalSource Equity Debt 17.26 cost 0000 capital 73.21% 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 StructureEquity- 76.08% Debt- 23.91%

COST OF CAPITAL-

Cost of equity-

ke =

D1 P o

= 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 capitalSource Equity Debt 1.71 cost 12.75 .2391 capital .7608

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 StructureEquity- 36.55% Debt- 64.44%

COST OF CAPITALCost of equity-

ke =

D1 P o

= 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 capitalSource Equity Debt 6.92 cost 72.15 capital 36.55% 64.44%

Weighted cost of capital =72.15(.3655) +06.92(.6444) =26.37+4.45 =30.82% ROTO PUMPS LTD Capital StructureEquity- 67.61% Debt- 32.38% COST OF CAPITALCost of equity-

ke =

D1 P o

= 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 capitalSource Equity Debt 5.78 cost .33 .3238 capital .6761

Weighted cost of capital =.33(.6761)+5.78(.3238) =.22+1.87 =2.09%

SUBROS LTD.

ADDRESSLGF, World Trade Centre Barakhamba Lane New Delhi Delhi -110 001 Capital StructureEquity- 32.97% Debt- 67.02%

COST OF CAPITALCost of equity-

ke =

D1 P o

= .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 capitalSource Equity Debt 30.18 cost 41.37 .6702 capital .3297

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 Equity Debt .6011

cost .0347 63.40

capital(%) 36.59%

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 Equity Debt .3803

cost .4307 46.89

capital(%) 53.10

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 Equity Debt 14.08

cost .0143 43.28

capital(%) 56.17

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 Equity Debt 39.22

cost 3.35 92.14

capital(%) 7.86

WACC =3.35(7.86)+39.22(.9214) =62.46