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In Accounting, the cost of capital is the cost of a company's funds (both debt and equity), or,
from an investor's point of view "the required rate of return on a portfolio company's existing
securities". It is used to evaluate new projects of a company. It is the minimum return that
investors expect for providing capital to the company, thus setting a benchmark that a new
project has to meet.
For an investment to be worthwhile, the expected return on capital has to be higher than the cost
of capital. Given a number of competing investment opportunities, investors are expected to put
their capital to work in order to maximize the return. In other words, the cost of capital is the rate
of return that capital could be expected to earn in the best alternative investment of equivalent
risk. If a project is of similar risk to a company's average business activities it is reasonable to
use the company's average cost of capital as a basis for the evaluation. However, for projects
outside the core business of the company, the current cost of capital may not be the appropriate
yardstick to use, as the risks of the businesses are not the same.
A company's securities typically include both debt and equity, one must therefore calculate both
the cost of debt and the cost of equity to determine a company's cost of capital. Importantly, both
cost of debt and equity must be forward looking, and reflect the expectations of risk and return in
the future. This means, for instance, that the past cost of debt is not a good indicator of the actual
forward looking cost of debt.
Once cost of debt and cost of equity have been determined, their blend, the weighted average
cost of capital (WACC), can be calculated. This WACC can then be used as a discount rate for a
project's projected cash flows.
No Change in Capital Structure:
The capital mix or structure of the new project investment should be same as the companys
existing structure. It means that if the company has 70:30 ratio of debt to equity in their current
balance sheet, inclusion of the new project will maintain the same.

No change in Risk of New Projects: The risk associated with the new project will be like the
existing projects. For example, a textile manufacturer expands and increases the no. of looms
from 60 to 100. Since the industry and business is same, there will be almost no change in the
risk profile of current business and the new expansion.
Advantages of Weighted Average Cost of Capital (WACC)
Simple and Easy: The biggest advantage of using WACC as a hurdle rate to evaluate the new
projects is its simplicity. The calculation does not involve too much of complication. The
manager just needs to apply weights of each source finances with its cost and aggregate the
Single Hurdle Rate for All Projects: One single hurdle rate for all projects saves a lot of time of
the managers in evaluation of the new projects. If the projects are of same risk profile and there
is no change in the proposed capital structure, the current WACC can be applied and effectively
Prompt Decisions Making: It is said that the same opportunity never knocks twice. For taking
advantage, the right decisions have to be taken at the right time. Since, single rate is used for all
new projects, the decisions can be arrived at a faster pace and the new opportunity can be
grabbed and taken benefit of.
Disadvantages of Weighted Average Cost of Capital (WACC)
The disadvantages are stemmed mainly from the assumptions of the applicability of WACC. The
practicability and limitations of the assumptions are discussed below. The remedy to overcome
the problem is also specified.
Difficulty in Maintaining the Capital Structure:
The impractical assumptions of No Change in Capital Structure has rare possibilities of
prevailing all the time. It suggests same capital structure for new projects. There are two
possibilities for funding the project in this way.
First is to fund it with the retained earnings. In this case, it would be reasonably correct to
assume that the new project is funded with same capital structure. The limitation here is of
availability of free cash with the company. Even if the free cash is available, it will put a cap on

the size of the investment. Suppose, the new project requires, $100 million, the company has
only $70 million. What to do for the remaining $30 million?
Second possibility is raising fund in the same capital mix. It is not impossible to do that but at the
same time getting funds at our own terms is not easily possible in the market. On the top of
everything, the primary focus of management of a company would not be to maintain capital
structure ratio but to reduce the cost of capital as low as possible to achieve the shareholders
profit and wealth maximization.
Remedy to this problem is that the target capital structure should be taken into consideration and
not the existing. and therefore the calculation of WACC should be adjusted accordingly.
Accepting Bad Projects and Rejecting Good Projects:
The impractical assumptions of No Change in Risk Profile of New Projects again has its inbuilt
drawbacks. Risk is a very wide term and is affected by a big list of factors. Under that situation,
assuming no change in risk profile of new projects would be very unrealistic. Let us assume two
Company Expanding in its Own Industry:
The assumption can be reasonably true if the company is expanding in its very own industry and
the same business like the textile example given above. Still it is not completely true because the
risk associated with installing looms in past and today may be different. The technology may be
different and complicated. The quality and cost aspects may be dissimilar.
Company Expanding in Different Industry:
The assumption in this case would surely prove malicious. It is because FMCG and Heavy
Machineries cannot have same risk profile. Having different risk profile, the cost of equity would
also be different and therefore applying the same WACC pose a very high risk of rejecting good
projects that will create value and accepting projects that will diminish the value of the
shareholders wealth.
Remedy to this problem is that the WACC should be adjusted to take effect of the change in risk.

Difficulty in Acquiring Current Market Cost of Capital:

The WACC used for evaluation of new projects require consideration of present day cost of
capital and knowing such costs is difficult. The WACC considers mainly equity, debt and
preferred. The interest cost of debt keeps changing in the market depending on the economic
changes. The expected dividend of the preferred also keeps changing with the market sentiments
and the most fluctuating is the expected cost of equity.

Important Sources of Capital Avoided:

While making WACC calculations, only equity, debt and preference shares are considered for the
sake of simplicity assuming that they cover major portion of the capital. In support of absolutely
correct approach towards discounting rate, if we include convertible or callable preference
shares, debt, or stock market linked bonds, or puttable or extendable bonds, warrants, etc also
which are also a claimant to the profits of the company like equity, debt and preference shares, it
will make the calculations very complex. Too much complexity is a probable reason for
mistakes. On the similar grounds, the short term borrowings and the cost of trade credit is also
not taken into consideration. Factors like such if introduced, will definitely change the WACC.
We will not go into the magnitude of difference these things will have on the calculations of the
WACC but the impact is there.


Cement Industry Overview

The Indian Cement industry dates back to 1914, with first unit was set-up at Porbandar with a
capacity of 1000 tones. Currently The Indian cement industry with a total capacity of about 170
m tones (excluding mini plants) in FY07-08, has surpassed developed nations like USA and
Japan and has emerged as the second largest market after China. Although consolidation has
taken place in the Indian cement industry with the top five players controlling almost 50% of the
capacity, the remaining 50% of the capacity remains pretty fragmented. Per capita consumption
has increased from 28 kg in 1980-81 to 115 kg in 2005. In relative terms, Indias average
consumption is still low and the process of catching up with international averages will drive
future growth. Infrastructure spending (particularly on roads, ports and airports), a spurt in
housing construction and expansion in corporate production facilities is likely to spur growth in
this area. South-East Asia and the Middle East are potential export markets. Low cost technology
and extensive restructuring have made some of the Indian cement companies the most efficient
across global majors. Despite some consolidation, the industry remains somewhat fragmented
and merger and acquisition possibilities are strong. Investment norms including guidelines for
foreign direct investment (FDI) are investor-friendly. All these factors present a strong case for
investing in the Indian market.

Now, the Indian cement industry is on a roll. Riding on increased activity in real estate, cement
production has registered a growth of 9.28 per cent in April, 2008, at 14 million tones as against
11.41 million tones in the corresponding period a year ago.
The growth trend has been on for some time now. If these trends are anything to go by, it will not
be long before the sector will match the demand supply gap.
During the Tenth Plan, the industry, which is ranked second in the world in terms of production,
is expected to grow at 10 per cent per annum adding a capacity of 40-52 million tones, according
to the annual report of the Department of Industrial Policy and Promotion (DIPP). The report
reveals that this growth trend is being driven mainly by the expansion of existing plants and
using more fly ash in the production of cement.


Shree Cement Limited is a Beawar based company, located in Rajasthan. The Company is a part
of the Bangur Group and was incorporated on 25th October1979, at Jaipur with a Vision: To
register strong consumer surplus through a superior cement quality at affordable price.
Commercial production commenced from 1st May1985 with a installed capacity of 6 lacs tones
per annum in Beawar dist. Ajmer, the capacity of this plant was upgraded to 7.6 lacs tones per
annum during 1994-95 by a modernization and up gradation programme.

In 1995 - The

Company undertook the implementation of new unit of 1.24 MT capacity per annum named "Raj
Cement. In 1997 The Company commissioned its second cement plant - Raj Cement with a
capacity of 12.4 lacs tones per annum adjacent to its existing plant in order to take full advantage
of its existing infrastructure and already developed captive mining lease enough to sustain a new
cement plan. The cumulative capacity was enhanced by de-bottlenecking and balancing
equipment in December 2001 to 2.6 MTPA. A product called Tuff Cemento has also launched
by the company in April 2007. At present company is producing over 100% capacity utilization,
it is the largest single location cement producer in north India (sixth in country).
























34.84 CRORES




34.84 CRORES



Cement Limited is one of the fastest growing Cement Companies in India. Presently
Shree Cement has 9.1 MTPA capacity in three plants (Shree in Beawar 2.6 MTPA, Ras in Pali
District 3 MT and Khushkhera capacity is 3.5 MTPA) The organization has performed
exceptionally well in the year 2007-08 increasing the PBT by 95% the reasons for this
remarkable achievement and key strengths of the company are discussed in the report. For
the last 18 years, it has been consistently producing many notches above the nameplate capacity.
The company retains its position as north Indias largest single-location manufacturer. Shrees
principal cement consuming markets comprise Rajasthan, Delhi, Haryana, Punjab, Uttar Pradesh
and Uttranchal. Shree manufactures Ordinary Portland Cement (OPC) and Portland Pozzolana
Cement (PPC). It has three brands under its portfolio viz., Shree Ultra Jung Rodhak Cement,
Bangur Cement and Tuff Cemento.
The Shree Vision

To be one of the Indias most respected enterprise through best-in-class performance and
leading by low carbon philosophy making it a progressive organization that all stakeholders
proud to deal with.
The Shree Mission
The company continues to be one of the most operationally efficient and energy conserving
cements producers in the world. Its mission statement is

To harness sustainability through low-carbon philosophy

To sustain its reputation as one of the most efficient manufacture globally.

To continually have most engaged team.

To continually add value to its products and operation meeting expectations of all its


To continually build and upgrade skills and competencies of its human resource for


To be a responsible corporate citizen with total commitment to communities in which

it operates and society at large.

Origin of the Company

Promoted by the Bangur Group, Shree Cements is the largest cement producer in Rajasthan. The
company has a total installed capacity of 6.825 million tonne (opc basis)The plants are
strategically located in central Rajasthan, from where it can cater to the entire Rajasthan market
as well as Delhi and Haryana. The company has about 100 sales offices spread across the states
of Rajasthan, Uttar Pradesh, Uttaranchal, Delhi, Haryana, Punjab and Jammu & Kashmir. Its
cement is marketed under the brand name of Shree Ultra Cement with different grades like 33,
43 and 53 and sub-brand names like "red oxide cement", "Jung Rodhak Cement", etc.

Shree Cement Ltd (SCL) is located at Beawer, Rajasthan, Indias largest cement producing state.
It was incorporated in 1979. Commercial production at its 0.6 million tones per annum (mtpa)
cement plant in Rajasthan commenced in May 1985. Three companies of the Bangur group
promoted SCL. These companies are Shree Digvijay Company Ltd, Graphite India Ltd and Fort
Gloster Industries Ltd. Over the years, SCL's capacity rose and touched 2 mtpa by 1997-98. Its
current cumulative installed capacity stands at 2.6 mtpa& in 2003-04 the company produced 2.84
million tones of
cement making it the largest single location cement producer in north India. It is operating at
over 100% capacity utilization.
Shree caters to cement demand arising in Rajasthan, Delhi, Haryana, UP and Punjab. What is
strategic for SCL is that it is located in central Rajasthan so it can cater to the entire Rajasthan
market with the most economic logistics cost. Also, Shree Cement is the closest plant to Delhi
and Haryana among all cement manufacturers in its state and proximity to these profitable
cement markets renders the company an edge over other cement companies of the company in
terms of lower freight costs. Shrees total captive power plant capacity today stands at 101.5
MW. In 2000-01, the company has succeeded in substituting conventional coke with 100 per cent
pet coke, a waste from refineries, as primary fuel resulting in lower inventory and input costs. In
the past two years the price of coal has gone up. Earlier dependent on good quality imported
coal, the company's switch to pet coke could not have come at a better time. The company also
replaced indigenous refractory bricks with imported substitutes, reducing its consumption per
tonne of clinker. The company has one of the most energy efficient plants in the world. The
captive plant generates power at a cost of Rs 4.5 per unit (excluding interest and depreciation) as
compared to over Rs 5 per unit from the grid. In appreciation of its achievements in Energy
sector, the Company has been awarded the prestigious 'National Energy Conservation Award" for

the year 1997. Shree is rated best by Whitehopleman, an international agency specializing in the
rating of cement plants.


Incisive execution of Shrees multiple competitive brand strategy has been delivering results
along anticipated lines. Consistency in brand strategy is helping Shree to sustain its brands
having lasting impression among its consumers.
The steady growth in Shreee volume especially year-on year in the last two fiscals, testifies to
the effectiveness of its multi brand marketing strategy.

Launched in 2002, Shree Ultra was the companys first brand, the first manifestation of Shrees
strategic move from commodity to brand marketing.
Its generic OPC version has been joined by a variant, Shree Ultra Jung Rodhak, on the functional
differentiator of rust prevention. Together the two variance have made Shree Ultra the flagship
brand of the company, contributing half of the Shrees total sales.
The brand was launched with powerful media and promotional support, the imaginative
advertising and the momentum has clearly sustained its growth over time.
Today it is present all of Shree Cements market territories. In 07-08 it chalked up its highest
volumes in the home market of Rajasthan, and in the NCR, the main focus of the construction
boom in north India.
Overall, Shree Ultra volumes reflects its acceptance by professional influencers. Which in turn
facilities acceptance by domestic consumers. Their support, as well as sustained local
promotions, has helped to improve brand recall, and prepared the ground for fresh initiatives in
the market place.


Bangur Cement was launched in 2006 as a premium brand, competitive with best in the market
designed to full fill user aspiration for high quality construction, the brand tagline reflects its
promise of top-of-market value: Sasta Nahi, Sabse Achcha.
Given the premium profile design for it the brand is supported by a matching network of
business partners and business associates carefully selected for the track record in selling to high
end market segment.
Its early successes are founded on a two tier marketing and distribution programme. At one level
Shrees field forts takes the trades in to the confident with transparent terms and tested and
proven promotional offrings.
On a more exclusive level, it deploys special teams of highly professional technical sales experts
t conduct direct, one on one interaction with opinion builders and influencers if high standing
among the fraternity of respected construction space list.
Bangur Cement has achieved 95% of its total sales in the trade segment. It has made selective
penetration in both urban and rural markets. Bangur cement maintained its zero outstandings
status in this year as well.
This is the latest brand offering from Shree Cement, directed at a highly competitive niche
market, with aggressive and establish competitors.
It has been position as rock strong- on the promise of high performance, able to withstand
exceptionally harsh environmental conditions.
Launched in the first month of the year under review, Tuff Cemento was able to secure a network
of the 1000 dynamic and resourceful dealers in a record time of about four months.


The brand is consolidated its position in the market, and the making further headway in
Rajasthan, Delhi, Haryana, parts of south Punjab and Western U.P.
While its current status would otherwise be regarded as reasonable. Tuff Cemento has an
altogether more ambitious agenda: to be aggressively competitive and become a leading brand in
the coming months, and to enable Shree Cement to achieve the maximum possible combined
market share in its market.

The Cement Industry Structure

Presently the total installed capacity of Indian Cement Industry is more than 175 mn tones per
annum, with a production around 168 mn tones . The whole cement industry can be divided into
Major cement plants and Mini cement plants.
Major Cement Plants:
Plants : 140
Typical installed capacity
Per plant : Above 1.5 mntpa
Total installed capacity : 170 mntpa
Production 07-08: 161 mntpa
All India reach through multiple plants
Export to Bangladesh, Nepal, Sri Lanka, UAE and Mauritius
Strong marketing network, tie-ups with customers, contractors
Wide spread distribution network .
Sales primarily through the dealer channel
Mini Cement Plants:
Nearly 300 plants & Located in Gujarat, Rajasthan, MP mainly


Typical capacity < 200 tpd

Installed capacity around 9 mn. Tones
Production around : 6.2 mn tones
Mini plants were meant to tap scattered limestone reserves. However most set up in AP
Most use vertical kiln technology
Production cost / tonne - Rs. 1,000 to 1,400
Presence of these plants limited to the state
Infrastructural facilities not the best
Regional division
The Indian cement industry has to be viewed in terms of five regions:-

North (Punjab, Delhi, Haryana, Himachal Pradesh, Rajasthan, Chandigarh, J&K and
West (Maharashtra and Gujarat);
South (Tamil Nadu, Andhra Pradesh, Karnataka, Kerala, Pondicherry, Andaman & Nicobar and
East (Bihar, Orissa, West Bengal, Assam, Meghalaya, Jharkhand and Chhattisgarh); and
Central (Uttar Pradesh and Madhya Pradesh).

Quality Policy:
To provide products conforming to national standards and meeting customers requirements to
their total satisfaction.


To continually improve performance and effectiveness of quality management system by setting

and reviewing quality objectives for:
Customer Satisfaction
Cost EffectivenessSs

Energy Policy:
To reduce to the maximum extent possible the consumption of energy without imparting
productivity which should help in:
Increase in the profitability of the company
Conservation of Energy
Reduction in Environmental pollution at energy producing areas Since Energy is Blood of
Industry, It is the responsibility of all of us to utilize energy effectively and efficiently
Environment Policy:
To ensure :
Clean, green and healthy environment
Efficient use of natural resources, energy, plant and equipment
Reduction in emissions, noise, waste and greenhouse gases
Continual improvement in environment management
Compliance of relevant environmental legislation

Water Policy:
To provide sufficient and safe water to people & plant as well as to conserve water, we are
committed to efficient water management practices viz,
Develop means & methods for water harvesting

Treatment of waste discharge water for reuse

Educate people for effective utilization and conservation of water
Water audit & regular monitoring of water consumption

Health & Safety Policy:

To ensure good health and safe environment for all concerned by:
Promoting awareness on sound health and safe working practices
Continually improving health and safety performance by regularly setting and reviewing
objectives & Targets
Identifying and minimizing injury and health hazards by effective risk control measures
Complying with all applicable legislations and regulations

Human Resource Policy:

We at Shree Cement are committed to
Empower People
Honour individuality
Non discrimination in recruitment process
Develop Competency
Employees shall be given enough opportunity for betterment
None of the person below the age of 18 years shall be engaged to work
Incidence of Sexual Harassment shall be viewed seriously


Statute enacted shall be honoured in letter & spirit & standard Labour Practices shall be
followed. Every employee shall be accountable to the law of the land & is expected to follow the
same without any deviation
Management will appreciate observance of Business ethics & professional code of conduct
To follow safety & Health. Quality, Environment, Energy Policy

IT Policy:
To provide a robust IT platform suitable to the business processes and integrated management
practices of the company, resulting into better speed, efficiency, transparency, internal controls
and profitability of business




The main objective of a business firm is to maximize the wealth of its shareholders in the longrun, 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. The cost of equity and cost of debt are the rate of
return that need to be offered to those two groups of suppliers of the of capital in order to attract
funds from them.

The primary function of every financial manager is to arrange adequate capital for the firm. A
business firm can raise capital from various sources such as equity and or preference shares,
debentures, retain earning etc. This capital is invested in different projects of the firm for
generating revenue. On the other hand, it is necessary for the firm to pay a minimum return to
each source of capital. Therefore, each project must earn so much of the income that a minimum
return can be paid to these sources or supplier of capital. What should be this minimum return?
The concept used to determine this minimum return is called Cost of Capital. On the basis of it
the management evaluates alternative sources of finance and select the optimal one. In this
chapter, concepts and implications of firms cast of capital, determination of cast of difference
sources of capital and overall cost of capital are being discussed.



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 form the point of view of the firm using the capital, cast 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 itBORROWING AND
LANDING RATES. The borrowing rates means the rate of interest which must be paid to
obtained and use the capital. Similarly, landing rate is the rate at which the firn discounts its
profits.It may also the opportunity cost of the funds to the firm i.e. what the firm would earn by
investing these funds elsewhere. In practice the borrowing rates used indicate the cost of capital
in preference to landing rates.

Technically and Operationally, the cost of capital define as the minimum rate of return a firm
must earn on its investment in order to satisfy investors and to maintain its market value. I.e. it is
the investors required rate of return. Cost of capital also refers to the discount rate which is used
while determining the present value of estimated future cash flows. In the other word of John J.
Hampton, The cost of capital is the rate of return in the firm requires from investment in
order to increase the value of firm in the market place. For example if a firm borrows Rs. 5
crore at an interest of 11% P.A., then the cost of capital is 11%. Hear its 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. Solomon Ezra, has called It the minimum required rate of return or the cut
of rate for capital expenditure.


It is not a cost in reality the cost of capital is not a cost as such, but its rate of return which it
requires on the projects.



Cost of capital is the minimum rate of return a firm is required in order to maintain the market
value of its equity shares.


Cost of capital is the reward for the business and financial risk. Business risks is the
measurement of variability in profits due to changes un sales, while financial risks depends on
the capital structure i.e. that equity mix of the firm.


The cost of capital is very important concept in the financial decision making. The progressive
management always likes to consider the cost of capital while taking financial decisions as its
very relevant in the following spheres...
1.Designing the capital structure: the cost of capital is the significant factor in designing a
balanced an optimal capital structure of a firm. While designing it, the management has to
consider the objective of maximizing the value of the firm and minimising cost of capita. I
comparing the various specific costs of different sources of capital, the financial manager can
select the best and the most economical source of finance and can designed a sound and balanced
capital structure.
2.Capital budgeting decisions: the cost of capital sources as a very useful tool in the process of
making capital budgeting decisions. Acceptance or rejection of any investment proposal depends
upon the cost of capital. A proposal shall not be accepted till its rate of return is greater then the
cost of capital. In various methods of discounted cash flows of capital budgeting, cost of capital


measured the financial performance and determines acceptability of all investment proposals by
discounting the cash flows.

3.Comparative study of sources of financing: there are various sources of financing a project.
Out of these, which source should be used at a particular point of time is to be decided by
comparing cost of different sources of financing. The source which bears the minimum cost of
capital would be selected. Although cost of capital is an important factor in such decisions, but
equally important are the considerations of retaining control and of avoiding risks.

4.Evaluations of financial performance of top management: cost of capital can be used to

evaluate the financial performance of the top executives. Such as evaluations can be done by
comparing actual profitability of the project undertaken with the actual cost of capital of funds
raise o finance the project. If the actual profitability of the project is more then the actual cost of
capital, the performance can be evaluated as satisfactory.

5.Knowledge of firms expected income and inherent risks: investors can know the firms
expected income and risks inherent there in by cost of capital. If a firms cost of capital is high, it
means the firms present rate of earnings is less, risk is more and capital structure is imbalanced,
in such situations, investors expect higher rate of return.

6.Financing and Dividend Decisions: the concept of capital can be conveniently employed as a
tool in making other important financial decisions. On the basis, decisions can be taken regarding
dividend policy, capitalization of profits and selections of sources of working capital.


1.Historical Cost and future Cost
Historical Cost represents the cost which has already been incurred for financing a project. It is
calculated on the basis of the past data. Future cost refers to the expected cost of funds to be
raised for financing a project. Historical costs help in predicting the future costs and provide an

evaluation of the past performance when compared with standard costs. In financial decisions
future costs are more relevant than historical costs.

2.Specific Costs and Composite Cost

Specific costs refer to the cost of a specific source of capital such as equity share. Preference
share, debenture, retain earnings etc. Composite cost of capital refers to the combined cost of
various sources of finance. In other words, it is a weighted average cost of capita. It is also
termed as overall costs of capital. While evaluating a capital expenditure proposal, the
composite cost of capital should be as an acceptance/ rejection criterion. When capital from more
than one source is employed in the business, it is the composite cost which should be considered
for decision-making and not the specific cost. But where capital from only one source is
employed in the business, the specific cost of those sources of capital alone must be considered.
3.Average Cost and Marginal Cost
Average cost of capital refers to the weighted average cost of capital calculated on the basis of
cost of each source of capital and weights are assigned to the ratio of their share to total capital
funds. Marginal cost of capital may be defined as the Cost of obtaining another rupee of new
capital. When a firm raises additional capital from only one sources (not different sources), than
marginal cost is the specific or explicit cost. Marginal cost is considered more important in
capital budgeting and financing decisions. Marginal cost tends to increase proportionately as the
amount of debt increase.
4. Explicit Cost and Implicit Cost
Explicit cost refers to the discount rate which equates the present value of cash outflows or value
of investment. Thus, the explicit cost of capital is the internal rate of return which a firm pays for
procuring the finances. If a firm takes interest free loan, its explicit cost will be zero percent as
no cash outflow in the form of interest are involved. On the other hand, the implicit cost
represents the rate of return which can be earned by investing the funds in the alternative
investments. In other words, the opportunity cost of the funds is the implicit cost. Port field has
defined the implicit cost as the rate of return with the best investment opportunity for the firm
and its shareholders that will be forgone if the project presently under consideration by the firm

were accepted. Thus implicit cost arises only when funds are invested somewhere, otherwise
not. For example, the implicit cost of retained earnings is the rate of return which the shareholder
could have earn by investing these funds, if the company would have distributed these earning to
them as dividends. Therefore, explicit cost will arise only when funds are raised whereas implicit
cost arises when they are used.

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 firms 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.

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. The cost of capital of
these different sources is called specific cost 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. The computation procedure of specific costs is explained in the
pages that follow


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 after22

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. Traditionally, tax
savings that occur because interest is deductible while equity payout is not have been modeled as
a primary benefit of debt. Large firms with tangible assets and few growth options tend to use a
relatively large amount of debt. Firms with high corporate tax rates also tend to have higher debt
ratios and use more debt incrementally. A company will use various bonds, loans and other forms
of debt, so this measure is useful for giving an idea as to the overall rate being paid by the
company to use debt financing. The measure can also give investors an idea as to the riskiness of
the company compared to others, because riskier companies generally have a higher 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 earnws less than this interest
rate (12%) than the income available to the shareholders will be redused 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. But, to know the real cost of debt, the relation of the
interest rate is to be established with the actual amount realised or net proceeds from the issue of

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))
The before tax rate of interest can be calculated as below:

Interest Expense of the company



Total Debt

Net Proceeds:
1. At par

= Par value Floatation cost

2. At premium

= Par value + Premium Floatation cost

3. At Discount

= Par value Discount Floatation cost


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--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).


The computation of cost of euity share capital is relatively diffiult because nether the rate of
dividend is predetermind nor the payment of dividend is legally binding, therefore, some
financial experts hold the opinion the p.s capital does not carry any cost but this is not true.
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
excistingshare 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 atleast
so much income that the market price of its ecisting share remains unchanged. This expected
minimum rate of return is the cast o equity share capital. Thus, cost of equity sahre capital may
be define as the minimum rate of return that a firm must earn on the equity financed portion of a
investment- project in order to leave unchanged the market price of its shares. The cost of equity
can be computed by any of the following method:

1. Dividend yield method:

Ke = DPS\mP*100
Ke= cost of equity capital
Dps= current cash dividend per share
Mp=current market price per share

2. Earning yield method:

Ke= EPS\mp*100
Eps= earning per share

3. Divideng yield plus growth in dividend method:

While computing cost of capital under dividend yield(d\p ratio)method, it had been asumend that
present rate of dividend will remail the same in future also. But, if the management astimates that
companies prestnet dividend will increased continuisly for the year to come, then adjustment for
this increase is essential to compute the cost of capital.
The growth rate in dividend is assumed to be equal to the growth rate in earning per share. For
example if the EPS increase at the rate of 10% per year, the DPS and market price per share

would show an increase at the rate of 10%. Therefore, under this method, cost of equity capital is
computed by adjusting the present rate of dividend on the basis of expected future increase in
companys earning.

Ke= DPS\MP*100+G
G= Growth rate in dividend.
4. Realised yield methd:
In case where future dividend and market price are uncertain, it is very difficult to estimate the
rate of return on investment. In order to overcome this difficulty, the average rate of return
actually relise in the past few year by the investors is used to determine the cost of capital. Unddr
this method, the realised yield is discounted at the present value factor, and then compare with
value of investment this method is based on these assumptions. The companys risk doe not
change i.e. dividend and growth rate are stable.
The alternative investment opportuinities, elsewhere for the investor, yield the return wshich is
equal to realisedyiels in the company, and
The market of equity share of the company does not fluctuate widly.

Cost of newly issued equity shares

when new equityshare are issued by a company, it is not possible to realise the marlet price per
share, because the company has to incur some expenses on new issue, including underwriting
commission, brokerage etc. so, the amount of net proceeds is calculated by deducting the issue
expenses form the expected marlet value or issue price. To acertain the cost of capital, dividend
per share or EPS is divided by the amount of net proceeds. Any of the following formulae may
be used for this purpose:

Ke= DPS\NP*100
Ke= EPS\NP*100


Generally, compnays do not distribute the entire profits by way of dividend among their share
holders. A part of such profit is reatianed for future expantion and development. Thus year by
year, companies create sufficiat fund fior the fianancingthrugh internal sources. But , nether the
company pays any cost nor incur any expenditure for such funds. Therefore, it is assumed to cost
free capital that is not true. Though ratain earnings like retained earnings like equity funds have
no explicit cost but do have opportunity cost. The opportunity cost iof retained earnings is the
income forgone by the share holders. It is equal to the income what a share holdersculd have earn
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 busieness. Therefore ,
every share holders expects from the company that much of income on ratined earnings for
which he is deprived of the income arising o its alternative investment. Thus, income forgone or
sacrifised is the cost of retain earnings which the share holders expects from the company.


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 projets is evaluated by comparing the
exprcted rate of return with overall cost of apital 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 sources 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 firms capital structure. It is also termed as
Composite Cost of Capital or Overall Cost of Capital or Average Cost of Capital.

WEIGHTED AVERAGE, How to calculate?

Though, the concept of weighted average cost of capital is very simple. Yet there are many
problems in its calculation. Its computation requires :

1.Assignment of Weights : First of all, weights have to be assigned to each source of capital for
calculating the weighted average cost of capital. Weight can be either book value weight or
market value weight. Book value weights are the relative proportion of various sources of
capital to the total capital structure of a firm. The book value weight can be easily calculated by
taking the relevant information from the capital structure as given in the balance sheet of the
firm. Market value weights may be calculated on the basic on the market value of different
sources of capital i.e. the proportion of each source at its market value. In order to calculate the
market value weights, the firm has to find out the current market price of each security in each
category. Theoretically, the use of market value weights for calculating the weighted average cost
of capital is more appealing due to the following reasons:

The market value of securities is closely approximate to the actual amount to be

received from the proceeds of such securities.

The cost of each specific source of finance is calculated according to the

prevailing market price.


But, the assignment of the weight on the basic of market value is operationally inconvenient as
the market value of securities may frequently fluctuate. Moreover, sometimes, no market value is
available for the particular type of security, especially in case of retained earnings can indirectly
be estimated by Gitmansmethod. According to him, retained earnings are treated as equity
capital for calculating cost of specific sources of funds. The market value of equity share may be
considered as the combined market value of both equity shares and retained earnings or
individual market value (equity shares and retained earnings) may also be determined by
allocating each of percentage share of the total market value to their respective percentage share
of the total values.

For example:- the capital structure of a company consists of 40,000 equity shares of Rs. 10 each
ad retained earning of Rs. 1,00,000. if the market price of companys equity share is Rs. 18, than
total market value of equity shares and retained earnings would be Rs. 7,20,000 (40,000* 18)
which can be allocated between equity capital and retained earnings as follows-

Market Value of Equity Capital = 7,20,000*4,00,000/5,00,000

=Rs. 5,76,000.
Market Value of Retained Earnings= 7,20,000*1,00,000/5,00,000
=Rs. 1,44,000.

2.Computation of Specific Cost of Each Source :

After assigning the weight; specific costs of each source of capital, as explained earlier, are to be
calculated. In financial decisions, all costs are after tax costs. Therefore, if any source has
before tax cost, it has to be converted in to after tax cost.

3.Computation of Weighted Cost of Capital :


After ascertaining the weights and cost of each source of capital, the weighted average cost is
calculated by multiplying the cost of each source by its appropriate weights and weighted cost of
all the sources is added. This total of weighted costs is the weighted average cost of capital. The
following formula may be used for this purpose :
Kw = XW/W
Here; Kw = Weighted average cost of capital
X = After tax cost of different sources of capital
W = Weights assigned to a particular source of capital

Example: Following information is available with regard to the capital structure of ABC Limited
Sources of Funds

Amount(Rs.) After tax cost of Capital

E.S. Capital



Retained Earning



P.S. Capital






You are required to calculate the weighted average cost of capital.

Computation of Weighted Average Cost of Capital




E.S. Capital




tax Weighted




(5)= (3) * (4)



Retained Earning





P.S. Capital














Weighted Average Cost of Capital (WACC)

.10850 or 10.85%


Cost of Debt Capital:
For the year 2008-09:
Total Debt Capital = Term loan from Banks + Debts
= 112573.18 + 800 = 113373.18 lacs
Total Interest Paid = 9636.72 lacs
Tax Rate = 30%

Interest Expense of the company

Kd (before tax) =



Total Debt
Kd (before tax)




Kd (after tax)

Kd (after tax)

Interest Rate Before Tax Tax Rate ( 30%.)

8.50% - 30%

= 5.95%

For the year 2007-08

Total Debt Capital = Term loan from Banks + Debts

= 83427.02+1400 = 84827.02lacs
Total Interest Paid = 6573.02 lacs
Tax Rate

= 30%

Kd (before tax)



= 7.75%


Kd (after tax)

7.75% - 30%

= 5.42%

For the year 2006-07

Total Debt Capital = Term loan from Banks + Debts
= 28617.33+2000= 30617.33lacs
Total Interest Paid = 2143.21lacs
Tax Rate

= 30%

Kd (before tax)





Kd (after tax)

7% - 30%

= 4.90%






Total Debts (Term loan from 112573.18+










Total Interest paid




Interest Rate (Before Tax)




Interest Rate (After Tax)= Interest 5.95%



Rate Before Tax Tax Rate 30%.








No. of Shares (In lacs)




DPS Given





Not given




Market Price (at the end of 1079.40

Earning per equity share 74.74
of rs. 10(in Rs.)
Proposed final dividend 2786.98
on equity share (in lacs)
Market Capitalisation (in 376033.01

1. Dividend yield plus growth in dividend method:-

Ke = DPS\mP*100 + G

Dps = Current cash dividend per share = 8 Rs.

Mp = Current market price per share

= 1079.40 Rs.

= 10%

= Growth rate



2. Earning yield method:Ke= EPS\mp*100


100 + 10%

= 10.74%

Eps = earning per share = 74.74 Rs.

Mp = Market prise

= 1079.40 Rs.





3. Dividend per share method:-

Ke = Proposed final dividend on Equity Share / No. of Equity Share

Proposed final dividend on Equity Share = 2786.98 Lacs
No. of Equity Share = 348.37 Lacs



Dividend Per share method


Earning Yeild Method


Dividend yield plus growth method




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


We = Weight of equity
Wd = Weight of Debt.
Ke = Cost of Equity Share capital
Kd = Cost of Debt. capital

WACC = ( 0.768 * 10.74) +( 0.232 *5.95 ) = 9.628%









r tax

d Cost












(5)= (3) *










Weighted Average Cost of Capital (WACC)


Chapter 4 Recommendations & conclusions

Recommendations The study in foregoing chapters and conclusions in this chapter point out the
need of better working capital management in the cement industry for which following
recommendations are made. In our country, cement industry adequate concern is not shown for
proper management of working capital. In order to make industry conscious about the need of
better management. Cement Manufacturers Association should create awareness by arranging
seminars and workshops in which top management and senior officers from the finance and
marketing departments of the industry should be invited. 265 The Cement Manufacturers
Association should also publish literature about working capital management practices in other
countries and invite foreign experts for talk on specific subjects of working capital management.
If Association introduces awards for best working capital managed company, it may encourage
companies to be more concerned to manage their working capital better. Cash ratio to total

current assets should be brought down to 2-4 per cent. If some companies can manage within this
range there is no reason why others cannot do so. It is largely due to lack of awareness and
planning, unreliability of forecast for cash flow specially from sundry debtors. There is also lack
of planning with regard to sundry payments. There is an urgent need of cash budgeting by all
cement companies. This requires proper estimation of cash and credit sales, production planning,
purchase planning for inputs, financing plan and capital budget. This also requires estimation of
profits and cost of production properly, which is rarely done at present and if done it is far off
from the mark. Therefore, there is need of accurate forecasting by using modern statistical
techniques which need not be described in this study. The most important fact however is
awareness and monitoring. When there are deviations from the forecast the reasons must be
analysed for it and those responsible should be taken to task and for future better assessment be
made specially of sales and realisation from sundry debtors. Since there are a number of
uncertainties in the business forecast it 266 should not be based on single set of assumptions but
cash budgeting should be done on different assumptions. It is also desirable to estimate from the
estimates that one may remain prepared to meet the eventualities if they arise. The modern
models on computers should be worked out. There are various models available for the purpose
like Baunal Model, General Model, Millen and ORR Model.
The companies with past experience should draw the best model suited to them. The one of the
important factor in cash management is policy variable, which can be aggressive, moderate or
passive. This should not be dependent merely on whims of the top management or on the
recommendations and suggestions of sales department but cost benefit analysis should be done
taking into consideration the risk factor of credit sales and its cost versus the benefit of larger
sales on profitability.
The following variables should be estimated before the policy is decided:
1. Increase in sales by providing credit to buyers.
2. Cost of credit in terms of bad debts to receivables and interest cost.
3. Impact of larger sales on profits. It is regrettable that such calculations are not made and
policy is decided without detailed calculations.




M.R. Agarwal, Financial Management 1st Edition, 2008.


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