Cost of Capital and Profitability Analysis (A Case Study of Telecommunication Industry)
Cost of Capital and Profitability Analysis (A Case Study of Telecommunication Industry)
Cost of Capital and Profitability Analysis (A Case Study of Telecommunication Industry)
Case study of
teleCommuniCation industry)
asha sharma*
Abstract Finance is the supply of funds, which regulates the activities and operations of the industry.
Adequate finance is required besides the requirement of fixed and working capital for undertaking the program of
extension, reorganization or expansion. Finance regulates the activities and operations of the industry. Adequate
finance is required besides the requirement of fixed and working capital for undertaking the program of extension,
reorganization or expansion. There are various source of raising funds. Since, now-a-days market is open, so both
domestic and international market are available for procuring the funds. Finance is being raised through issue of
shares, debenture, bond and retained earnings (internal source) from domestic as well as international capital
market in the form of Global Deposit Receipts, American Deposit Receipts and Foreign Currency Convertible Bonds
and from the wide range of financial institutions. However, the finance is not free of cost. The charge on each
source capital is known as cost of capital. The cost of capital of any investment is the rate of return the
suppliers of capital would expect to receive if the capital were invested elsewhere in an investment of comparable
risk.
The present study focuses on whether cost of capital has any relationship with financial performance of companies
like capital structure. To know about the relationship between cost of capital and income generation capacity of a
company, gross profit ratio is not sufficient. If cost of capital is not taken care properly, if it is more than
returns, company can reach to crucial financial situation. So an effort has been made to measure impact of cost
of capital on various financial factors i. e., profitability, growth rate, liquidity and dividend policy. The statistical
like correlation and regression method have been applied. The study found that change of cost of capital affects
the company’s profitability position. The higher cost of capital adversely affects the profitability position of the
companies.
The Indian economy has witnessed robust growth in the last importance in the financial decision-making. It is useful as a
few years and is expected to be one of the fastest growing standard for:
economies in the coming years. Demand for commercial 1. Evaluating investment decisions
property is being driven by India’s economic growth. Real 2. Designing a firm’s debt policy 3. Appraising the
estate in India contributes about 5 per cent to India’s gross financial performance of top management
domestic product (GDP). The total revenue generated in
2010-11 stood at US$ 66.8 billion. India’s Information The firm’s cost of capital is the rate of return required by
Technology (IT) and Information Technology enabled them for supplying capital for financing the firm’s
Services (ITeS) segments are aligned in a way that the investment projects by purchasing various securities. It may
growth in one avenue has ripple effects on another. The IT & be emphasized that the rate of return required by all investors
ITeS industry, as a whole, is the mainstay of Indian will be an overall rate of return – a weighted rate of return.
Technology sector as it has driven growth of the economy in Thus, the firm’s cost of capital is the ‘average’ of the
terms of employment, revenue generation, standards of opportunity costs (or required rates of return) of various
living etc and has played a major part in placing the country securities, which have claims on the firm’s assets. This rate
on the global canvas. reflects both the business (operating) risk and the financial
risk resulting from debt capital.
The project’s cost of capital is the minimum required rate of
return on funds committed to the project, which depends on
the risk of its cash flows. The firm’s cost of capital will be reVieW of literature
the overall, or average, required rate of return on the
A comprehensive review of literature in respect of the
aggregate of investment projects. It is a concept of vital
parameters pertaining to financial performance, determinants
Bharti Airtel
Calculation of Growth Rate
Weight WACC
Sources of capital Cost of capital
Book Value Market Value Book Value Market Value
Debt 7.92 0.62 0.36 4.91 2.85
Equity 28.03 0.38 0.64 10.65 17.94
Total 35.95 1.00 1.00 15.56 20.79
Bharti Airtel Capital Structure, 2009-10
retained earnings, E= equity capital, D= debt capital R= Airtel Ltd. Highly negative correlation is showing that both
retained earnings. companies are enjoying its effectiveness. To maintain
effectiveness and liquidity, dividend policy and profit
earning capacity, they required to manage minimum cost of
CONCEPTUAL FRAMEWORK capital in a appropriate manner. It is indicating negative
(VARIABLES OF MEASURING relationship between all three variable.
COMPANIES’ PERFORMANCE)
Profitability: Profitability implies profit-earning capability Cost of Capital and Profitability
of business unit. Return on Equity ( ROE ) is considered to
measure profitability of the concern. The aggregate result suggests that there is relationship
between cost of capital and profitability of the company. The
Liquidity: Liquidity refers to the ability of a concern to meet relationship between the cost of capital and profitability has
its current obligation. been found in the company. A negative relationship is
Current ratio has been included in the models. It is calculated observed in the company. It is because the profitable
by dividing current assets by current liabilities. companies are expected to procure the funds with cheaper
cost.
Dividend pay out ratio: - It measures the relationship
between the earnings belonging to the ordinary shareholders
and the dividend paid to them. Dividend pay out ratio is Cost of Capital and Liquidity
calculated by DPS/MPS*100
In the sector of telecommunication group of industries, the
Growth (G) – Growth of companies measures the rate at overall cost of capital and liquidity is negatively related with
which a firm is growing. It is one of the determinants of each other. This implies that highly liquid companies are
financial performance of the company. It is calculated by procuring the funds by incurring less amount of cost. On the
multiplying retention ratio and ROE. other hand less risky companies in terms of liquidity are
spending less amount of money for mobilizing the capital for
ANALYSIS & FINDINGS their survival and growth. It is theoretically true that the
investors generally prefer to invest their funds in less risky
CORRELATION ANALYSIS companies.
industry. The study observed among the variables of capital positively affects the profitability position of the
financial performance; growth and profitability become companies.
significant factor of affecting cost of capital. The existence
of negative relationship between cost of capital and
referenCes
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the growth of company implying cost of capital are M. J. & Schwartz, E. S. (1978). Corporate Income Taxes,
increasing because of constant growth of company in its Valuation and the Problem of Capital Structure.
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Brigham, E. F. & Gopanski, L. C. (1985). Intermediate
The cost of capital is negatively related with the dividend
Financial Management, 21(3), pp. 204. New York :
whereas dividend is positively related with the cost of capital
Dryden Press.
for Telecommunication sector. The positive relationship
signifies that the investors have no preference for current Davenport, M. (1971). Leverage and the Cost of Capital:
dividend in general. Some Tests Using British Data/’ Economica, pp. 136 - 62.
DeAngelo, H. & Masulis, M. S. (1980). Optimal Capital
In this study, liquidity is taken for measuring the risk of the Structure under Corporate and Personal Taxation. Journal
companies from the point of view of shareholders investment of Financial Economics, 8, pp. 3 - 29.
concerned. It has been observed the cost of capital is
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Market: A Reply to M-M. American Economic Review,
less risky companies that is keeping larger amount of funds
53.
in form of liquidity is and able to procure the funds at cheaper
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Managerial Behavior, Agency Costs and Ownership
Structure. Journal of Financial Economics, 3, pp. 305 - 60.
ConClusion Kraus, A. & Litzenberger, R. H. (1973). A State Preference
The study has analyzed there is significant relationship Model of Optimal Financial Leverage. Journal of Finance,
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Telecommunication industry in India; some of the important Changes on Security Prices: A Study of Exchange Offers.
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these companies. Based on the above analysis the significant Masulis, M. S. (1983). The Impact of Capital Structure on
negative relationship is found between two variables other Firm Value. Journal of Finance, 38, pp. 107 - 25.
than growth and cost of capital. Miller, M. H. (1977). Debt and Taxes. Journal of Finance, 32,
The overall cost of capital is affected by the designing of pp. 261 - 73.
capital structure of Indian industries. Therefore, maintenance Modigliani, F. & Miller, M. H. (1958). The Cost of Capital,
of optimum level of capital structure irrespective of nature of Corporation Finance and the Theory of 36 Investment.
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executive should give due attention for attaining optimum Pandey, I. M. (1992). Capital Structure and Cost of Capital.
level of capital structure for sustainable growth of the firm. American Economic Review, 56, pp. 333 - 91. Vikas
The optimum level of capital structure depends on nature of Publishing House. Solomon, E. (1963). Leverage and the
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appendiX
Balance Sheet of Bharti Airtel
Mar ‘10 Mar ‘09 Mar ‘08 Mar ‘07 Mar ‘06 Mar ‘05
12 mths 12 mths 12 mths 12 mths 12 mths 12 mths
48 Journal of Commerce & Accounting Research Volume 1 Issue 4 October 2012
Sources Of Funds
Total Share Capital 1,898.77 1,898.24 1,897.91 1,895.93 1,893.88 1,853.37
Equity Share Capital 1,898.77 1,898.24 1,897.91 1,895.93 1,893.88 1,853.37
Share Application Money 186.09 116.22 57.63 30 12.13 2.72
Preference Share Capital 0 0 0 0 0 0
Reserves 34,650.19 25,627.38 18,283.82 9,515.21 5,437.42 2,675.38
Revaluation Reserves 2.13 2.13 2.13 2.13 2.13 2.13
Networth 36,737.18 27,643.97 20,241.49 11,443.27 7,345.56 4,533.60
Secured Loans 39.43 51.73 52.42 266.45 2,863.37 3,959.88
Unsecured Loans 4,999.49 7,661.92 6,517.92 5,044.36 1,932.92 1,034.41
Total Debt 5,038.92 7,713.65 6,570.34 5,310.81 4,796.29 4,994.29
Total Liabilities 41,776.10 35,357.62 26,811.83 16,754.08 12,141.85 9,527.89
Mar ‘10 Mar ‘09 Mar ‘08 Mar ‘07 Mar ‘06 Mar ‘05
12 mths 12 mths 12 mths 12 mths 12 mths 12 mths
Application Of Funds
Gross Block 44,212.53 37,266.70 28,115.65 26,509.93 17,951.74 13,240.63
Less: Accum. Depreciation 16,187.56 12,253.34 9,085.00 7,204.30 4,944.86 3,475.64
Net Block 28,024.97 25,013.36 19,030.65 19,305.63 13,006.88 9,764.99
Capital Work in Progress 1,594.74 2,566.67 2,751.08 2,375.82 2,341.25 994.46
Investments 15,773.32 11,777.76 10,952.85 705.82 719.7 931.9
Inventories 27.24 62.15 56.86 47.81 17.74 31.58
Sundry Debtors 2,104.98 2,550.05 2,776.46 1,418.52 1,076.17 715.74
Cash and Bank Balance 54.89 153.44 200.86 239.11 201.81 174.96
Total Current Assets 2,187.11 2,765.64 3,034.18 1,705.44 1,295.72 922.28
Loans and Advances 7,072.42 5,602.83 5,103.13 3,160.02 1,937.54 1,354.85
Fixed Deposits 761.86 2,098.16 302.08 541.35 105.61 209.17
Total CA, Loans & Advances 10,021.39 10,466.63 8,439.39 5,406.81 3,338.87 2,486.30
Deffered Credit 0 0 0 0 0 0
Current Liabilities 12,979.55 13,832.49 12,400.38 9,809.83 6,735.36 4,458.80
Provisions 658.75 634.4 1,961.95 1,232.84 537.44 249.32
Total CL & Provisions 13,638.30 14,466.89 14,362.33 11,042.67 7,272.80 4,708.12
Net Current Assets -3,616.91 -4,000.26 -5,922.94 -5,635.86 -3,933.93 -2,221.82
Miscellaneous Expenses 0 0.09 0.2 2.66 7.94 58.35
Total Assets 41,776.12 35,357.62 26,811.84 16,754.07 12,141.84 9,527.88
Contingent Liabilities 3,921.50 4,104.25 7,140.59 7,615.04 4,740.34 3,017.26
Book Value (Rs) 96.24 145.01 106.34 60.19 38.71 24.44
Ratios of Bharti Airtel company
Ratios
Operating profit per share (Rs) 21.32 38.28 56.16 69.5 36.65
Book value (excl rev res) per share (Rs) 38.71 60.19 106.34 145.01 96.24
Net operating income per share (Rs) 59.45 94.16 135.73 179.37 93.77
Free reserves per share (Rs) 28.11 49.88 83.18 121.78 84.64
Profitability ratios
Adjusted return on net worth (%) 27.42 35.23 32.04 33.74 23.27
Reported return on net worth (%) 27.47 35.35 30.94 28.13 25.79
Return on long term funds (%) 21.28 29.83 28.52 29.01 24.36
Leverage ratios
Liquidity ratios
Current ratio 0.44 0.47 0.57 0.69 0.68
Payout ratios
Coverage ratios
Adjusted cash flow time total debt 1.34 0.82 0.66 0.61 0.4
50 Journal of Commerce & Accounting Research Volume 1 Issue 4 October 2012
Fin. charges cov.ratio (post tax) 16.08 24.13 25.6 26.63 48.73
Component ratios