Research Proposal
Study Impact of Capital Structure on
performance of Hindalco Industries Ltd.
Submitted To:Prof. Manaswini Acharya
Submitted By:-
Anshul Agarwal (14PGDM072)
Ateek Agarwal (14PGDM075)
Kunwarpreet Singh (14PGDM088)
Mohit Sachdeva (14PGDM094)
Abstract:The present study is an attempt to understand the importance of capital structure employed by a
company, the impact on its performance and to a certain extent the correct mix of debt and equity
that should be employed under certain conditions. This study focuses on the capital structure
employed by Hindalco, an Indian aluminium manufacturing company under the Aditya Birla Group
by analyzing the past ten year financial data (2003-04 to 2012-13). Multiple Regression statistical
technique was employed to find relation between the enterprise value, cost of capital and debtequity. The entire analysis is done under on the confidence interval of 95%.The relation between
cost of capital and debt to equity on enterprise value was found to be statistically significant. It
also established that interaction factor of debt to equity and cost of capital on enterprise value is
statistically significant and hence the model could be used to predict the future value of the
enterprise.
KEYWORDS: Capital structure, Debt to equity, Beta, Cost of capital, Enterprise value, Economic
value added (EVA), Risk free rate, Risk premium
Introduction
Whenever a firm wants to finance its projects, assets and to acquire projects, it seeks for funds from the market. Markets as a
supplier of funds provide two basic ways for the corporation to have funds from it:
Equity
Debt
Equity in simple words is the part of ownership in the corporation so when a firm finances through the way of equity it
passes on a part of ownership associated with the funds employed by the investor. In case of debt, it is a typical loan which
company acquires, and pays back the loan amount with certain interest on that amount.
The two different options to finance have their own merits and demerits, so a balance between both has to be maintained
depending on the nature of industry, firms history, market conditions etc, combination of both refers to the capital structure
of the company.
Hindalco industries ltd. is aluminium manufacturing company under the Aditya Birla Group. The company enjoys annual
sales of US $ 15 billion and with employee strength of around 20000 listing it at 895th rank in Forbes global 2000. It is the
world's largest aluminium rolling company.
It is important to study the capital structure of a firm and impact of capital structure of a firm on its performance in the
market to understand that what is the correct mix for the two components of financing in a firm, whether a firm should go for
only one type of financing or a mix of both and how the investors react to the changing capital structure of the firm depicted
by the firm's performance.
Considering the market existence and scale of operations of Hindalco, it was considered a better option to carry study on as
it has been in market for more than 50 years with history of various capital structure and it would help give us a fair image
off the impact of capital structure on firm's performance.
The study will help us understand the importance of capital structure, its impact on performance and to a certain extent the
correct mix of debt and equity with respect to various conditions. The study on Hindalco could be extended to various other
similar firms to evaluate the capital structure and its bearing on the firm.
Literature Review
Capital structure is the combination of debt and equity capital employed by the firm in order to
generate money to finance its operations for uses ranging from expansion , acquisition to starting
of a new project .When an investor invests in a company , be it in the form of debt or equity , he
does it basically for returns. If he purchases a debt instrument then the company reimburse him by
interest and in case of equity company provide return to its equity holders. This combined payment
is called cost of capital which in simple terms is the cost that firm pays to get the capital. The key
challenge for a firm limits down to the optimal mix of debt and equity in the firm's capital structure
which will ultimately affect the firm's performance and profitability.
The field of capital structure was introduced by the Modigliani and Millers (1958) irrelevance
theory of capital structure which stated that in a perfect market condition the value of the firm is
irrelevant of how the firm has arranged for the capital or how it is financed. In 1977 Miller tried to
improve the theory by introducing the concept of corporate taxes in the model. He added that an
optimal capital structure exists for a firm which is determined by settlement between the
advantages and disadvantages of corporate taxes and exemptions of interest payments.
Since the assumptions of perfect market are far from real, new capital structure theories emerged
which worked on to predict the optimal capital structure. M. Sekar et al. (2014, P. 446) asserted
that the theories are majorly of two types - for predicting an optimal capital structure as a mix of
debt and equity (static trade off model) or theories that concluded that a target or optimal capital
structure cannot be defined (pecking order hypothesis).
Static trade off model points that a firm would reach at an optimal debt equity mix by trading off
between the costs and benefits of both the possible routes of financing after taking into account
various imperfections in the market including taxes and bankruptcy. Pecking order theory (Myers,
1984, Myers and Majluf, 1984) says that firm should prefer financing projects by internal ways that
is through retained earnings to minimize information asymmetry between outsiders and insiders of
the firm.
After that Baker and Wurgler (2002) came up with market timing theory of capital structure which
argues that cumulative effects of the previous attempts to time the market of equity shapes the
present capital structure of the firm.
Ghanbari, Ali Mohammad (2012) tried to measure the effect of capital structure (mix of debt and
equity) on the economic value added by the firm conducting extensive study of Indian automobile
industry comprising 17 companies. The study found a negative relation between EVA and debt to
equity ratio. So, it pointed that EVA decreases with additional debt added to capital structure of the
firm.
Garima Dalal (2013) in her study of Sensex 30 companies argued that variation in capital structure
of different companies depended on whether they belong to same industry citing the reason that
there are many qualitative and quantitative factors which exists because of its presence in a
certain industry which influences capital structure and financing decision, which vary from
company to company.
M. Sekar et al. (2014) analyzed the equity capital and debt capital of Tata Motors from 2003 to
2013 and analyzed the impact of capital structure mix that is debt equity ratio on the performance
of the firm, and concluded that there existed a positive correlation between the performance off
the firm and the capital structure of the firm.
Sukhdev Singh (2013) studied analyzed the trends of capital structure of 11 metal and 13 refinery
companies from 2002 to 2012 to find the relation between the capital structure and the industry in
which the firm operates. It found that companies used both equity capital and debt capital to
finance for maintaining a correct balance between low cost of capital and high risk profile. Further,
it founded that Metal companies used high debt to equity ratio as compared to refinery companies
which pointed to the effects that industry had on capital structure.
According to India Ratings and Research report (May 22, 2014), several BSE 500 corporate adopted
aggressive dividend payment strategy in 2013, despite reduction in their net profit. These firms
borrowed heavily from banks to pay dividends. It lead to change in capital structure with higher
debt to equity ratio. Hindalco Industries ltd. 2 returned 18.5% of profits to shareholders in 2013, up
from 15.4% in 2012. It has led to increased debt to equity ratio. The ratio increased to 0.72 in 2013
from 0.23 in 2012. This decision of high borrowing may impact the performance of company. As
there is no particular model available for capital structure decisions, an empirical study needs to be
done, in line with above studies using statistical tools like linear regression and correlations, to
study impact of such high borrowing on valuation of company.
Research Methodology
Objective of our Study
The objectives of our study were:
To understand the capital structure of the company
To find the relation between capital structure and value of firm
relation between cost of capital and enterprise value
Hypothesis I
Ho: There is no significant relation between debt to equity and enterprise value
H1: There is a significant relation between debt to equity and enterprise value
Hypothesis II
Ho: There is no significant relation between cost of capital and enterprise value
H1: There is a significant relation between cost of capital and enterprise value
Hypothesis III
Ho: There is no significant interaction effect between cost of capital and debt to equity on
enterprise value.
H1: There is a significant interaction effect between cost of capital and debt to equity on enterprise
value.
Hypothesis IV
Ho: The model is not useful in the prediction of the enterprise value.
H1: The model is useful in the prediction of the enterprise value.
Research Design
Secondary data of 10 years of past financial performance of Hindalco is taken. The financial
statement of Hindalco Ltd. Is taken performed hypothesis and ratio analysis to analyze the data.
Measure of Variables
Enterprise Value: Enterprise value is a parameter which takes in into account both debt
and equity for valuation of a company. This is our dependent variable and measures the
performance of the company. It is given by:
EV =Market Value+ Debt + Preferred equityCashCash equivalent
Cost of Capital (Ka): It is the sum of cost of equity and cost of debt. It is an independent
variable.
Ka=Ke+ Kd
Cost of equity (Ke): This is the required rate of return expected by an equity investor.
Ke=Rf + ERPbeta
Rf is risk free rate. It has been calculated based on 10 year G-sec yield. ERP is equity risk
premium for Sensex index4. Beta is the measure of volatility, or systematic, of the equity
shares in comparison to Sensex index5.
Cost of debt (Kd): This is the required rate of return by debt provider.
Kd=
Interst paid
Total debt
Capital structure ratio: Capital structure ratio defines the proportion of total debt and
equity taken for raising capital. It is also an independent variable.
Capital Ratio=
debt
equity
Shortcoming of the research
The research is based on a small period of 10 years and thus generalization on the basis of
this period may not be very accurate
The findings are limited only to Hindalco Ltd. so it cannot represent the entire
manufacturing Industry.
Statistical Analysis
The value of firm depends on various qualitative as well as quantitative variables but we cant
measure the effect of qualitative variables like reputation of promotions, political and economic
conditions and quality of top management. Thus, a development of well - defined model for this
analysis will not cover all the factors.
The other way of study is to develop a model using multiple regression method in which the
dependent variable is enterprise value and the independent variables are cost of capital and
capital structure. A model which will establish the equation between enterprise value, cost of
capital, debt to equity and the interaction between cost of capital and enterprise value and this will
check the significance of relationship between each factor with the enterprise value of the firm.
This is the method that is adopted in the research. Entire analysis is conducted at significance level
of 0.05.
Data representing the enterprise value cost of capital and debt to equity of Hindalco Ltd. from past
10 years is:
Year
Risk free
Rate(10
year Gsec yield)
Equity
Risk
Premium
Cost
of
debt
(kp)
Cost of
equity
(ke)
Cost of
Capital(k
a)
Debt to
Equity
Ratio
Enterprise
value (in
cr. Rs.)
2005
Beta
0.47420
4
0.51150
2
6.11%
7.20%
9.79%
4.47%
14.27%
0.5
15,698.38
2006
-0.6429
7.34%
7.20%
2.71%
4.59%
7.30%
0.51
23,851.29
2007
-0.73061
7.89%
7.20%
2.63%
3.29%
5.92%
0.59
20,144.15
2008
8.12%
7.20%
2.79%
3.37%
6.16%
0.48
28,457.53
2009
-0.74051
0.42865
9
7.69%
7.20%
10.78%
4.05%
14.82%
0.35
16,960.81
2010
-0.65772
7.23%
7.20%
2.49%
9.66%
12.15%
0.23
40,898.94
2011
-0.85701
7.92%
7.20%
1.75%
8.39%
10.14%
0.3
47,200.38
2012
-0.00457
0.92568
3
8.52%
7.20%
8.49%
2.02%
10.50%
0.45
38,780.72
8.36%
7.20%
15.02%
1.81%
16.83%
0.71
40,184.95
2004
2013
5.71%
7.20%
9.12%
6.30%
15.43%
0.37
13,743.58
Table 1 Represents variables of Hindalco Industries Ltd. for the period FY 2003 to FY 2014 .
Multiple linear correlation on these three variables is found and significance of relation among
them and significance of the model are tested. The STATCRUNCH output of the model is:
Multiple linear regression results:
Dependent Variable: Enterprise value
Independent Variable(s): Cost of Capital, Debt to Equity Ratio, Cost of Capital * Debt to Equity Ratio
Parameter estimates:
Parameter
Intercept
Estimate
-31814.808
Std. Err.
Alternat D
58466.197
T-Stat
ive
F
0 6
Pvalue
- 0.605
0.544157
Cost of Capital
Debt to Equity Ratio
3865.4314
2974.1098
31
0 6 1.299693 0.241
-31073.773
130662.99
0 6
6
4
- 0.819
0.237816
Cost of Capital * Debt to
516.68561
6591.2586
18
0 6 0.078389 0.940
Equity Ratio
52
Analysis of variance table for Multiple Regression Model:
Source
Model
DF
3
SS
1.1605705e9
MS
3.8685684e8
F-stat
12.13778
P-value
0.0059
Source
Error
Total
DF
6
9
SS
1.9123274e8
1.3518033e9
MS
F-stat
P-value
31872124
Summary of fit
Root MSE: 5645.5402
R-squared: 0.8585
R-squared (adjusted): 0.7878
The above analysis consists of two tables. The table 1 summarizes the parameter estimates and
can be used to find the equation of the multiple regression line.
Denoting cost of capital as x, debt to equity as y and enterprise value as z, the equation will
be:
z=3865.431 x 31073.773 y +516.686 xy31814.808
The x coefficient is indicating that for every 1% increase in the cost of capital, the enterprise
value is increasing by a factor of 3865.431. Similarly, for each increase in the debt to equity ratio,
the enterprise value is decreasing by a factor of 31073.773. Also, there is a joint effect of cost of
capital and debt to equity on the enterprise value and as the join effect increases by 1 unit, the
enterprise value increases by 516.686 units.
Also from the table of parameter estimates, the significance of the cost of capital, debt to equity
and interaction of cost of capital and debt to equity on enterprise value is checked and then will
use the ANOVA table to determine whether the model will be good to predict the enterprise value
or not.
Graph representing the value of the firm and debt to equity:
Graph representing the cost of capital and debt to equity:
Interpretations:
From Parameter Estimates table
The table contains the p value corresponding to each and every factor and an estimate whether a
particular variable is significantly affecting the value of the firm or not is established.
Parameters
Cost of Capital
Debt to Equity
Level of
Significance
pvalue
0.05
Interaction
Decision
0.2414
0.8199
Do not Reject Ho
Do not Reject Ho
0.9401
Do not Reject Ho
The above table shows that p value for all the three factors are coming greater than level of
significance. Therefore, the null hypothesis for all the three cases cant be rejected and hence,
there is no significant direct relationship between cost of capital and value of firm or debt to equity
and value of firm.
From Analysis of Variance Table
ANOVA table is useful here to determine the effectiveness of the model. The p value for the
model is 0.0059 which is less than level of significance. So, null hypothesis will be rejected and
decision is that there is sufficient evidence to conclude that the model is effective in determining
the value of the firm.
From Coefficient of Determination
Coefficient of Determination (R 2) for this test is 0.8585. The interpretation is that 85.85% of the
variation in the value of firm can be explained by the model and rest 14.15% variation is due to
other factors which cant be explained by the model.
Conclusion:
There are many factors which affect the enterprise value of the firm. Two chosen factors i.e. cost of
capital and debt to equity ratio finds the effect of these on enterprise value. After performing the
multiple regression analysis and appropriate tests, it can be concluded that cost of capital and debt
to equity dont have a direct impact on the enterprise value. On the other hand, the regression
model developed using the cost of capital and debt to equity of Hindalco is significantly useful to
determine the enterprise value. Hence, the use of any one factor either cost of capital or debt to
equity to estimate the value of the firm uses the multiple regression model consisting of these
factors to determine the value of the firm.
References
Journals
Baker, M., and J. Wurgler, 2002, Market timing and capital structure, Journal of Finance 57
Modigliani, F., and M.H. Miller, 1958, The cost of capital, corporate finance and the theory of
investment, American Economic Review 48, 261-297.
Modigliani, F., and M.H. Miller, 1963, Corporate income taxes and the cost of capital: A
correction, American Economic Review 53, 433-443
M. Sekar, Dr., 2014, " A Study on Capital Structure and Leverage of Tata Motors Limited: Its
Role and Future Prospects", 445-446
Ghanbari, Ali Mohammad,2014," Study of the effect of capital structure on economic value
added of Indian automobile industry"
John L. Campbell, Dan.S.Dhaliwal and William C. Schwartz Jr, 2011, Financing Constraints
and the Cost of Capital: Evidence from the Funding of Corporate Pension Plans
Md. Bokhtiar Hasan, A. F. M. Mainul Ahsan, Md. Afzalur Rahaman, Md. Nurul Alam, 2014,
Influence of Capital Structure on Firm Performance: Evidence from Bangladesh
Pamela Peterson Drake and Frank J. Fabozzi,2011, The Basics of Finance: An Introduction to
Financial Markets, Business Finance, and Portfolio Management
Links:
http://indianexpress.com/article/business/companies/indian-blue-chips-turn-todebt-to-pay-dividends/
http://dbie.rbi.org.in/DBIE/dbie.rbi?site=statistics
.http://www.pwc.in/publications/publications-2013/dissecting-indias-equity-riskpremium-how-much-to-expect-on-your-equity-investments.jhtml
http://statcrunch.pearsoncmg.com.ipaddress.com/
http://statcrunch.pearsoncmg.com.ipaddress.com/
http://www.real-statistics.com/correlation/one-sample-hypothesis-testingcorrelation/
Others:
Financial Management Book by I.M. Pandey
http://vassarstats.net/textbook/ch4apx.html
http://www.statsdirect.com/help/basics/pval.htm
ACE analyzer database [IMI INTRANET]
Appendix:
Graphs of regression Analysis:
A. Actual y values and estimated y values
B. Cost of capital residuals and value of the firm residuals
C. Debt to equity ratio residuals and value of the firm residuals
D. Interaction residuals and value of firm residuals
Cost of Debt Calculation
Cost of debt=
Month
3-Mar
Interst paid
Total debt
Interes
t
paid
Total
debt
Cost of
debt
138.6
2395.02
5.79%
4-Mar
161.59
2564.6
6.30%
5-Mar
169.96
3800
4.47%
6-Mar
225.17
4903.44
4.59%
7-Mar
242.39
7368.6
3.29%
8-Mar
280.63
8328.58
3.37%
9-Mar
336.93
8324.29
4.05%
10-Mar
613.78
6356.9
9.66%
11-Mar
610.26
8.39%
12-Mar
293.63
13-Mar
435.98
14-Mar
711.65
7271.5
14571.
91
24144.
77
26366.
95
Beta Calculation
2.02%
1.81%
2.70%
Beta=
Covar ( c 5, c 4 )
var ( c 4 )
C5: Percentage change in price of Hindalco equity share for given financial year (April to march)
C4: Percentage change in price of Sensex index for given financial year (April to march)
Covar : Covariance between given variables
Var: Variance of Given Variable
Month( Sensex(c
c1)
2)
Share
price
(c3)
Percentage change in
Sensex(c4)
3-Apr
2959.79
46.75
0.074654
3-May
3180.75
52.69
0.13405
3-Jun
3607.13
58.39
0.05142
3-Jul
3792.61
62.48
0.119211
3-Aug
4244.73
69.23
0.049122
3-Sep
4453.24
80.44
0.101865
3-Oct
4906.87
80.74
0.028114
3-Nov
5044.82
93.75
0.157417
3-Dec
5838.96
107.96
-0.02454
4-Jan
5695.67
119.55
-0.00494
4-Feb
5667.51
99.26
-0.01357
4-Mar
5590.6
108.58
0.011535
4-Apr
5655.09
109.61
-0.15835
4-May
4759.62
95.13
0.00753
4-Jun
4795.46
77.25
0.07817
4-Jul
5170.32
85.24
0.004209
4-Aug
5192.08
91.12
0.075409
4-Sep
5583.61
100.67
0.015879
4-Oct
5672.27
115.11
0.099082
4-Nov
6234.29
101.39
0.059093
4-Dec
6602.69
111.66
-0.00708
5-Jan
6555.94
121.77
0.024088
Percentage change in share price(c5
5-Feb
6713.86
111.07
-0.03292
5-Mar
6492.82
119.1
-0.05212
5-Apr
6154.44
110.49
0.0911
5-May
6715.11
101.33
0.071293
5-Jun
7193.85
96.54
0.061382
5-Jul
7635.42
102.56
0.022266
5-Aug
7805.43
108.5
0.106215
5-Sep
8634.48
122.52
-0.08595
5-Oct
7892.32
129.43
0.11359
5-Nov
8788.81
100.01
0.069306
5-Dec
9397.93
114.26
0.05554
6-Jan
9919.89
130.19
0.045399
6-Feb
10370.24
149.63
0.087724
6-Mar
11279.96
139.19
0.067607
6-Apr
12042.56
165.65
-0.13651
6-May
10398.61
203.74
0.020257
6-Jun
10609.25
161.52
0.01269
6-Jul
10743.88
158.54
0.088904
6-Aug
11699.05
146.31
0.064567
6-Sep
12454.42
156.62
0.040747
6-Oct
12961.9
155.58
0.056659
6-Nov
13696.31
173.19
0.006615
6-Dec
13786.91
157.39
0.022051
7-Jan
14090.92
158.07
-0.08181
7-Feb
12938.09
159.08
0.010358
7-Mar
13072.1
126.79
0.06122
7-Apr
13872.37
118.3
0.048448
7-May
14544.46
132.56
0.007291
7-Jun
14650.51
127.88
0.061464
7-Jul
15550.99
145.41
-0.01494
7-Aug
15318.6
154.44
0.128765
7-Sep
17291.1
145.63
0.147295
7-Oct
19837.99
156.53
-0.02393
7-Nov
19363.19
178.23
0.047709
7-Dec
20286.99
164.25
-0.13005
8-Jan
17648.71
195.06
-0.00397
8-Feb
17578.72
150.49
-0.11004
8-Mar
15644.44
184.27
0.105013
8-Apr
17287.31
149.58
-0.05043
8-May
16415.57
175.78
-0.17995
8-Jun
13461.6
174.28
0.066422
8-Jul
14355.75
129.02
0.014543
8-Aug
14564.53
128.11
-0.117
8-Sep
12860.43
122.5
-0.2389
8-Oct
9788.06
98.55
-0.07104
8-Nov
9092.72
60.2
0.060993
8-Dec
9647.31
53.05
-0.02312
9-Jan
9424.24
54.2
-0.05652
9-Feb
8891.61
49.05
0.091872
9-Mar
9708.5
38.6
0.174564
9-Apr
11403.25
51.9
0.282551
9-May
14625.25
53.85
-0.00899
9-Jun
14493.84
84.7
0.08117
9-Jul
15670.31
83.4
-0.00023
9-Aug
15666.64
100.2
0.093204
9-Sep
17126.84
105.85
-0.07185
9-Oct
15896.28
128.85
0.064791
9-Nov
16926.22
121.95
0.03182
9-Dec
17464.81
138.05
-0.06338
10-Jan
16357.96
160.75
0.004376
10-Feb
16429.55
147.25
0.066844
10-Mar
17527.77
161.25
0.001765
10-Apr
17558.71
181.7
-0.03497
10-May
16944.63
177.9
0.044632
10-Jun
17700.9
150.1
0.009457
10-Jul
17868.29
144.5
0.005755
10-Aug
17971.12
160.3
0.116743
10-Sep
20069.12
166.4
-0.00183
10-Oct
20032.34
196.75
-0.02551
10-Nov
19521.25
210.5
0.050603
10-Dec
20509.09
206.05
-0.10636
11-Jan
18327.76
246
-0.02752
11-Feb
17823.4
229.4
0.090994
11-Mar
19445.22
200.8
-0.0159
11-Apr
19135.96
208.65
-0.03306
11-May
18503.28
215.55
0.018515
11-Jun
18845.87
197.1
-0.03442
11-Jul
18197.2
186.4
-0.08355
11-Aug
16676.75
168.4
-0.01337
11-Sep
16453.76
150.35
0.076046
11-Oct
17705.01
131.3
-0.08933
11-Nov
16123.46
136.35
-0.04146
11-Dec
15454.92
122.65
0.112497
12-Jan
17193.55
115.75
0.03252
12-Feb
17752.68
146.65
-0.01963
12-Mar
17404.2
148.65
-0.00491
12-Apr
17318.81
129.45
-0.06353
12-May
16218.53
120.6
0.074695
12-Jun
17429.98
116.7
-0.01112
12-Jul
17236.18
119.9
0.011219
12-Aug
17429.56
103.75
0.07649
12-Sep
18762.74
120.5
-0.01372
12-Oct
18505.38
116.45
0.045096
12-Nov
19339.9
113.35
0.004489
12-Dec
19426.71
134.15
0.024104
13-Jan
19894.98
115.75
-0.05194
13-Feb
18861.54
99.35
-0.00137
13-Mar
18835.77
91.5
0.035486
13-Apr
19504.18
97.25
0.013132
13-May
19760.3
101.5
-0.01845
13-Jun
19395.81
99.75
-0.00258
13-Jul
19345.7
84.75
-0.03753
13-Aug
18619.72
104.9
0.04082
13-Sep
19379.77
110.65
0.092093
13-Oct
21164.52
115.15
-0.0176
13-Nov
20791.93
121.45
0.018216
13-Dec
21170.68
122
-0.03103
14-Jan
20513.85
109.55
0.029554
14-Feb
21120.12
105.1
0.05995
14-Mar
22386.27
138.1
0.001408
