Impact of Capital Structure on Firm Value

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Impact of Capital Structure on Firm Value
Financial Management Assignment

10/12/2010

Completed and Submitted by,
Aishwarya R. (06)
Anjana Pradeep (12)
Arijit Ghosh (18)
Gayathri M.A. (34)
Jyothi D. (44)
Lavanya P. (51)

CONTENTS
INTRODUCTION.......................................................3 COMPANIES CHOSEN..............................................3 LARSEN AND TOUBRO............................................3 Overview……………………………………………………………...3 Calculation of optimum D/E ratio............................5 Impact of capital structure on firm value................6

AMBUJA CEMENTS..................................................7 Overview..................................................................7 Calculation of optimum D/E ratio............................7 Impact of capital structure on firm value................8

WIPRO.....................................................................8 Overview.................................................................8 Calculation of optimum D/E ratio...........................9 Impact of capital structure on firm value...............10

CONCLUSION.........................................................10 REFERENCES...........................................................10

Introduction
This assignment deals with the impact of the capital structure, portrayed by the debt-to-equity ratio of the company, on the firm value as perceived by the market price of the share. The debt-to-equity ratio is a measure of the company’s financial leverage. The ratio varies from industry to industry and is also firm-specific. The graph of D/E ratio versus Weighted Average Cost of Capital is used to determine the optimal D/E ratio for each company. Companies chosen: Larsen & Toubro, Ambuja cements and wipro. larsen and toubro

oVERVIEW
Larsen & Toubro (L&T) is a technology-driven USD 9.8 billion company that infuses engineering with imagination. It offers a wide range of advanced solutions, services and products. Debt-Equity Ratio

Year| 2006-2007 (In cr)| 2007-2008 (In cr)| 2008-2009 (In cr)| 2009-2010 (In cr)| Equity| 56.65| 58.47| 117.14| 120.44|
Reserves| 5660.28| 9382.22| 12342.55| 17882.22|
Total Equity| 5716.93| 9440.99| 12459.69| 18002.66|
Secured Loans| 245.40| 308.53| 1102.38| 955.73|
Unsecured Loans| 1832.35| 3275.46| 5453.65| 5845.10|
Total debt| 2077.75| 3583.99| 6556.03| 6800.83|
Debt equity ratio| 0.36| 0.38| 0.53| 0.37|

REASONS FOR RISE AND FALL OF THE D/E RATIO
L&T’s consolidated debt has risen to Rs 18,400 crore from Rs 6,430 crore over the years 2006 to 2008. Global rating agency Moody’s said the rating of Larsen & Toubro (L&T) predicted that the rating of L&T would be downgraded due to a surge in the company’s debt in the financial year 2008-2009. Rise from 0.38 to 0.53

The debt was supposed to have risen because of the development of many infrastructure projects. L&T recently formed two subsidiaries - L&T Power Projects as the investment vehicle for power projects and L&T Power Development Ltd to set up power plants. L&T funded the projects in 70:30 per cent debt-equity ratio and plans to bank on its strong balance sheet and order book position to raise the remaining equity portion. L&T and Japan’s Mitsubishi Heavy Industries (MHI) and Mitsubishi Electric Corporation (MELCO) formed a joint venture to make steam turbines and generators in 2007. L&T had had a capital expenditure of Rs 2,500 crore (Rs 25 billion) for the FY2008-2009 out of which the company raised 500-700 crore through debt, equity or a debt-equity mix in the second half of the financial year. Due to the non-availability of data with regard to the date and terms of debt taken by the company, the date on which the news was published is taken into account. The share price on the day, July 4, 2008, when it...
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