 Calculation of Cost of Debt and Cost of Equity

of ‘ULTRATECH’ Ltd –

Cost of equity is the rate of return which equates the present value of
expected dividends with the market share price.
It can be ascertained by various approaches that’s either through
Gordon’s Growth Model or by Capital Asset Pricing Model [CAPM].
By using CAPM method, cost of equity is calculated through Risk free
rate of return + beta of asset*(expected rate of return – risk free rate
of returns).
By focusing on 10 - year treasury constant maturity rate as the risk -
free rate, since it is updated daily, the current free risk rate is 6.36%.
Beta is the sensitivity of the unexpected excess asset returns to the
expected excess market returns. Ultratech cement’s Beta is -0.22.
Market premium is to be 6% which is being calculated through
subtracting expected rate of return with risk free rate of return.
Hence, cost of equity {Ke = 6.36 + (-0.22) * 6% = 5.04%}.

Moving forward to cost of debt, by using last fiscal year end interest
expense divided by the latest two – year average debt to get the
simplified cost of debt. As of march, 2021, Ultratech Cement’s
Interest expense was 205.005 Rs. Its total book value of debt [D] is Rs
3113.08. Therefore, Cost of Debt = 205.005/3113.08 = 6.58%.
{assuming – no tax impact}.
 CALCULATION OF COST OF DEBT AND COST
OF EQUITY of ‘ACC’ LTD. –

Cost of equity is the rate of return which equates the present value of
expected dividends with the market share price. It can be ascertained
by various approaches that’s either through Gordon’s Growth Model
or by Capital Asset Pricing Model [CAPM].
By using CAPM method, cost of equity is calculated through Risk free
rate of return + beta of asset*(expected rate of return – risk free rate
of returns). So, focusing on 10 - year treasury constant maturity rate
as the risk -free rate, since it is updated daily, the current free risk
rate is 6.36%. Beta is the sensitivity of the unexpected excess asset
returns to the expected excess market returns. Ultratech cement’s
Beta is 0.91. Market premium is to be 6% which is being calculated
through subtracting expected rate of return with risk free rate of
return.
Hence cost of equity = 6.36% + 0.91 * 6% = 11.82% .Moving forward
to cost of debt, by using last fiscal year end interest expense divided
by the latest two – year average debt to get the simplified cost of
debt. As of December 2020, ACC’s Interest expense was Rs. 570.8 mil
and total book value of debt [D] is Rs.512.4 mil. Therefore, Cost of
Debt = 570.8/512.4 = 1.11%. {assuming no tax impact}. Hence, it can
conclude by comparing cost of equity and debt of both the
companies, that cost of equity is higher in ACC ltd that’s 11.82% >
5.04%, which depicts higher relative risk, as equity shareholders
expects high returns which ultimately leads to increase in cost of
capital as well. On the other hand, cost of debt of Ultratech Ltd is
higher than ACC Ltd that’s 6.58 % > 1.11 %, which depicts increase of
risk in context to interest payment obligations by the company.
Hence, Ultratech Cement Ltd should focus on decreasing cost
component in relation to debt undertaken.
WORKING CAPITAL RATIOS / PERFORMANCE RATIOS of Ultratech
AMT IN CRORES/-
1] Raw material turnover ratio – Cost of raw material consumed /
Average stock of raw material. (Opening RM stock + Closing RM
stock)/2
- 5174.94/372.21 = 14 times

2] Debtor turnover ratio – Credit sales / Average account receivable

- 42677/ 2066.5 = 20 times

3] Creditors turnover ratio – Credit purchases / Average account

payable
- 1936/3650 = 53 times

4] Fixed asset turnover ratio – Turnover / Net Fixed assets (average

of opening and closing balances is taken).
- 43188/18848 = 2.29

5] Working capital Turnover ratio - Turnover / Net working capital

Where, net working capital is Current assets minus current liabilities.
(Average of opening and closing balances is taken)
- 43188/18848– 16925 = 22.45

6] Current ratio – Current assets / Current Liabilities

- 22983/19588 = 1.17
 Working capital / performance ratios of ACC LTD.
AMT IN CRORES/-
1] Raw material Turnover ratio – Cost of raw material consumed /
average stock of raw material. (Opening RM stock + Closing RM
stock)/2
- 1673/117 = 14.3 times

2] Debtor turnover ratio – Credit sales / Average account receivable

- 13486/540 = 24 times

3] Creditors turnover ratio – Credit purchases / Average account

payable
- 697/1443 = 48 times

4] Fixed asset turnover ratio – Turnover / Net Fixed assets (average

of opening and closing balances is taken).
- 13784/9726 = 1.41

5] Working capital Turnover ratio - Turnover / Net working capital

Where, net working capital is Current assets minus current liabilities.
(Average of opening and closing balances is taken)
- 13784/7876.9 – 4737.61 = 4.39

6] Current ratio – Current assets / Current liabilities

- 8330/4791 = 1.73
CONCLUSION FOR ULTATECH AND ACC LTD DRAWN FROM WORKING
CAPITAL RATIOS / PERFORMANCE RATIOS :–
Starting with raw material turnover ratio, ACC Ltd has higher raw
material turnover ratio as compared to Ultratech ltd, depicting fast
or rapid use of regular materials in the production. This is a positive
sign for ACC ltd, since size and operations are somewhat lower of
ACC, however the ratio of raw material usage is high, depicting a
positive signal, also Ultratech should focus on increasing this ratio, as
they resemble similar industry.
Moving towards debtor turnover ratio, ACC Ltd has higher ratio in
context to Ultratech Ltd, indicating a higher speed of collection of
credit sales. Therefore, Ultratech should emphasis on to increase this
ratio. On the other hand, Ultratech Ltd has higher Creditors turnover
ratio in respect to ACC Ltd, which indicates speed / velocity of
payment to creditors.
Fixed assets turnover ratio of Ultratech Ltd is higher than ACC Ltd
shows a positive sign, as it depicts ability to generate sales per rupee
of working capital. Company should focus to increase this ratio.
Also, the Working capital turnover ratio of Ultratech Ltd is very
higher in context to ACC Ltd, which shows a tremendous result, as it
assimilates company’s ability to generate sales per rupee of working
capital. ACC Ltd needs immense developments under this ratio in
order to compete against Ultratech Ltd.
Owing to the last ratio for comparison among two companies is
Current Ratio, where ACC Ltd shows a good signal in respect to
Ultratech Ltd as it has current ratio of 1.73 which is greater than
1.17. It describes ability to repay short term liabilities promptly.
However, ideal current ratio is 2:1, very high ration indicates
existence of idle current assets.