109-053-1

Ambuja Cements: Weighted Average Cost of Capital

Ambuja Cements:
Weighted Average Cost of Capital

“Good evening all of you…” said Dr Martin, professor of Finance, to the first year MBA students
standing in the corridor leading towards the campus library of Alien Business School, Mumbai. For a
few seconds, the corridor echoed with the voices of the students wishing their professor. Dr. Martin
is one of the favourite faculty in the college and each and every student likes his friendly nature.
“Professor, would you like to join us in the discussion on the basic concepts of finance to prepare
ourselves for the upcoming finance class,” asked Atul. “Oh, really! That’s great,” replied Dr Martin.
“By the way, which concept are you trying to understand?” asked Dr. Martin. “Cost of capital,” said
Ashwani. “Ok, fine. We will discuss it in the conference room,” said Dr. Martin. Five minutes later,
around 10 students and the professor were sitting in the conference room next to the campus library
and were discussing the concept of cost of capital.
“Professor, are cost of capital and cost of equity the same?” asked Harsh. “It depends on the
structure of capital. If the capital is financed only through equity, then the cost of equity would be
equal to the cost of capital. Otherwise not,” said Dr. Martin. “It means a firm can finance capital
through other sources too?” asked Gopal. “Yes...would any one of you like to answer his question,”
asked Dr. Martin, giving a chance to the fellow students to answer. “Yes Professor, Shall I?” said
Ankita, taking the initiative. “Great. Go ahead,” said Dr Martin. “Other sources of financing capital
are debentures, term loans, and preference capital,” said Ankita. “Good. Apart from these, a few
others are rights issue, private placement, Global Depository Receipts issue, internal accruals and
last but not the least, bought out deals,” added Dr. Martin. All the students were delighted and their
curiosity increased to some extent. However, Puneet, who always thinks ahead, asked, “Professor,
when firms use different sources to finance the capital, how do they estimate cost of capital?”

This case study was written by Manish Agarwal (Faculty Associate) and D. Satish (Professor of Finance), IBS, Hyderabad. It is
intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management
situation. The case was compiled from published sources.

© 2009, IBSCDC
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 109-053-1
Ambuja Cements: Weighted Average Cost of Capital

Understanding Weighted Average Cost of Capital

“In such case, firms use ‘Weighted Average Cost of Capital’ (WACC),” replied Dr. Martin. “Sir,
what is WACC? Please explain to us,” asked all the students simultaneously. “Sure, why not? WACC
is the expected average cost of serving the existing capital,” You can get it by multiplying the cost of
each source with its weight in capital and adding up the former results,” replied Dr. Martin to all. He
further added, “WACC uses market value of each source to find out the weight of a particular
source in capital.” “Sir, where can we use this?” asked Harsh. “Good question,” said Dr. Martin. “It
is an appropriate discount rate to find out present value of future cash flows. It is also used in capital
budgeting analysis and firm valuation.”

Choosing a Company
“We will do an exercise to get a better understanding of WACC,” said Dr. Martin. “We will
take up real time data of some company and find out its WACC.” “Which company, Sir?” asked
Ankita. “Any suggestions,” said Dr. Martin throwing it open for the students to select a company.
“Sir, shall we take Reliance?” asked Puneet. “No Sir, that is too complex as it is a conglomerate
company. We have to take some company which is into one industry only,” said Harsh. “Yes, to
start with, take a company which has exposure in one or two industries only,” Dr. Martin replied.
“Then we will take Ambuja Cements. It is an Index company and has exposure to cement
industry only,” said Alok, who was quiet until now. “OK, then Ambuja Cements Limited (ACL)
(Annexure I) is final,” said Dr. Martin.

Setting Parameters
“Before you start, I would like to set some parameters. Use Capital Assets Pricing Model (CAPM)
to estimate the cost of capital, for market return take 10 years’ monthly returns of index (Annexure
II), use 10 years’ Indian government bond yield which was around 6.83% as on December 31st 2008
as risk free rate and use 3 years’ monthly return of ACL for beta calculation (Annexure III),” said
Dr. Martin. “Sir, for cost of debt, which cost should we take pre-tax or post-tax?” asked Atul.
“Ofcourse, post-tax” replied Dr. Martin. He further added, “Now, are you all ready to calculate
WACC for ACL?” “Yes Professor, we are. Thanks a lot,” replied all the students together.

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Ambuja Cements: Weighted Average Cost of Capital

Annexure I
Company Details: Ambuja Cements Limited
ACL is one of the most cost efficient cement companies in India. It is a part of Switzerland-based
Holcim Group, one of the leading cement suppliers in the world with a total capacity of 194.4 million
tonnes at the end of Calendar Year (CY) 2008.
The company was established by Narotam Satyanarayan Sekhsaria (Sekhsaria), a businessman from
Gujarat (Western India). Sekhsaria started Ambuja Cements Private Limited (ACPL) in 1981. The
company went for public issue in 1983. The company grew rapidly from just 0.7 million tonnes per
annum (mtpa) capacity in 1982 to 22 mtpa capacity by the end of CY08.
Financial Performance
The company reported 9.5% growth in sales (net to excise duty) in CY08, which increased to INR
62,617.9 million in CY08 from 57,186.0 million in CY07. However, the company’s Profit Before Tax
(PBT) decreased by 29.8% from INR 27,893.6 million in CY07 to INR 19,576.4 million in CY08,
mainly due to substantial increase in manufacturing and other expenses (22.2%). Even downward
movement in interest expenses (57.7% from INR 770.9 million in CY07 to INR 326.0 million in
CY08) was not able to was not able to stop PBT to shrink into red zone. Persuaded by the decline in
profit, the company provided only INR 5,679.3 million as taxes in CY08, which is 39.8% lower than
the provisions made in CY07. Ultimately, the net profit plunged by 24.7%, from INR 18,461.1 million
in CY07 to 13,897.1 million in CY08.
At the end of CY08, the company had INR 3,045.2 million of shareholders’ capital (divided into
1,522.6 million shares of INR 2 each) and INR 2,886.7 million of loan funds.

Compiled by the author from “Ambuja Cements Limited: Annual Report, 2008”, http://www.gujaratambuja.com/Guj-
Ambu-ar08-full.pdf

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Ambuja Cements: Weighted Average Cost of Capital

Annexure II
10-year Sensex Closing Price

Year BSE Sensex Closing Year BSE Sensex Closing

January-1998 3,224.36 March-2000 5,001.28

February-1998 3,622.22 April-2000 4,657.55

March-1998 3,892.75 May-2000 4,433.61

April-1998 4,006.81 June-2000 4,748.77

May-1998 3,686.39 July-2000 4,279.86

June-1998 3,250.69 August-2000 4,477.31

July-1998 3,211.31 September-2000 4,090.38

August-1998 2,933.85 October-2000 3,711.02

September-1998 3,102.29 November-2000 3,997.99

October-1998 2,812.49 December-2000 3,972.12

November-1998 2,810.66 January-2001 4,326.72

December-1998 3,055.41 February-2001 4,247.04

January-1999 3,315.57 March-2001 3,604.38

February-1999 3,399.63 April-2001 3,519.16

March-1999 3,739.96 May-2001 3,631.91

April-1999 3,325.69 June-2001 3,456.78

May-1999 3,963.56 July-2001 3,329.28

June-1999 4,140.73 August-2001 3,244.95

July-1999 4,542.34 September-2001 2,811.6

August-1999 4,898.21 October-2001 2,989.35

September-1999 4,764.42 November-2001 3,287.56

October-1999 4,444.56 December-2001 3,262.33

November-1999 4,622.21 January-2002 3,311.03

December-1999 5,005.82 February-2002 3,562.31

January-2000 5,205.29 March-2002 3,469.35

February-2000 5,446.98 April-2002 3,338.16

Contd...

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Ambuja Cements: Weighted Average Cost of Capital

Year BSE Sensex Closing Year BSE Sensex Closing

May-2002 3,125.73 September-2004 5,583.61
June-2002 3,244.7 October-2004 5,672.27
July-2002 2,987.65 November-2004 6,234.29
August-2002 3,181.23 December-2004 6,602.69
September-2002 2,991.36 January-2005 6,555.94
October-2002 2,949.32 February-2005 6,713.86
November-2002 3,228.82 March-2005 6,492.82
December-2002 3,377.28 April-2005 6,154.44
January-2003 3,250.38 May-2005 6,715.11
February-2003 3,283.66 June-2005 7,193.85
March-2003 3,048.72 July-2005 7,635.42
April-2003 2,959.79 August-2005 7,805.43
May-2003 3,180.75 September-2005 8,634.48
June-2003 3,607.13 October-2005 7,892.32
July-2003 3,792.61 November-2005 8,788.81
August-2003 4,244.73 December-2005 9,397.93
September-2003 4,453.24 January-2006 9,919.89
October-2003 4,906.87 February-2006 10,370.24
November-2003 5,044.82 March-2006 11,279.96
December-2003 5,838.96 April-2006 12,042.56
January-2004 5,695.67 May-2006 10,398.61
February-2004 5,667.51 June-2006 10,609.25
March-2004 5,590.6 July-2006 10,743.88
April-2004 5,655.09 August-2006 11,699.05
May-2004 4,759.62 September-2006 12,454.42
June-2004 4,795.46 October-2006 12,961.9
July-2004 5,170.32 November-2006 13,696.31
August-2004 5,192.08 December-2006 13,786.91

Contd...

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Ambuja Cements: Weighted Average Cost of Capital

Year BSE Sensex Closing Year BSE Sensex Closing

January-2007 14,090.92 January-2008 17,648.71
February-2007 12,938.09 February-2008 17,578.72
March-2007 13,072.1 March-2008 15,644.44
April-2007 13,872.37 April-2008 17,287.31
May-2007 14,544.46 May-2008 16,415.57
June-2007 14,650.51 June-2008 13,461.6
July-2007 15,550.99 July-2008 14,355.75
August-2007 15,318.6 August-2008 14,564.53
September-2007 17,291.1 September-2008 12,860.43
October-2007 19,837.99 October-2008 9,788.06
November-2007 19,363.19 November-2008 9,092.72
December-2007 20,286.99 December-2008 9,647.31

Compiled by the author from Centre for Monitoring Indian Economy (CMIE) Prowess Database.

Annexure III
Three Years’ Share Price Data of Ambuja Cements

Month-Year Stock Price

January-2006 88.50
February-2006 88.20
March-2006 103.25
April-2006 124.05
May-2006 92.90
June-2006 99.50
July-2006 104.70
August-2006 112.35
September-2006 116.85

Contd...

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Ambuja Cements: Weighted Average Cost of Capital

October-2006 117.25
November-2006 144.15
December-2006 141.30
January-2007 137.15
February-2007 115.95
March-2007 106.70
April-2007 117.95
May-2007 113.15
June-2007 124.55
July-2007 131.50
August-2007 133.45
September-2007 143.80
October-2007 144.65
November-2007 150.00
December-2007 146.90
January-2008 119.60
February-2008 120.95
March-2008 121.05
April-2008 113.90
May-2008 95.20
June-2008 75.70
July-2008 81.20
August-2008 80.20
September-2008 78.40
October-2008 60.95
November-2008 52.30
December-2008 69.70

Compiled by the author from Centre for Monitoring Indian Economy (CMIE) Prowess Database.