CHAPTER - I

INTRODUCTION

1

INTRODUCTION

INTRODUCTION:

Project report is a very special report in curriculum. It is a practical training-cum-

study course of approximately six weeks duration during which studies any particular

aspect – marketing, personnel, financial or any other aspect of interest of any

organization and prepares a report of his study. In such a project the student is required

to give some suggestions that is ought to be their own opinion about the outstanding

problem, if any, so such reports, in general, may be very helpful to the organization

concerned in solving their problems and in improving their products and services.

This project is a part of the summer training at “PATNA DAIRY PROJECT”

during 1st July to 31st July 2010 undertaken as apart of the MBA Program .The

project title “CAPITAL STRUCTURE – A STUDY IN PATNA DAIRY PROJECT”

holds much importance for the organization for the purposes of analysing financial

statements of the firm.

OBJECTIVE OF THE STUDY:

The main objective of the study is to make one-self acquainted with the

knowledge of the problem one faces during of an organization. The objective of the

study is resolved around following topic.

This project is the course requirement as a part of MBA curriculum.

To learn & understand capital structure.

To learn how the information from financial statement is useful for making

estimates for the future.

METHODOLOGY OF THE STUDY:

Methodology adopted for the study had great importance in the final report.

During the course of conducting the study of “Capital Structure” of Patna Dairy

Project, Patna, I have considered the source of data, which is primary and secondary

in nature.

2

PRIMARY SOURCES

1. INTERVIEW: After visiting the Patna Dairy Project, PATNA DAIRY

PROJECT, discussion were made with key managerial official especially

accounts and marketing personnel of the union about its prospects, future,

planning and sources meeting the financial requirement of the project.

2. OBSERVATION: Observation is one of the methods of data collection. Expert

opinion was taken on some matter. The whole official documentation was

observed and questions were put to the concerned authorities and collection

of data is done. The different documentation like balance sheet, profit and

loss A/C, of different challans, and order likewise issued to the creditors and

debtors, was observed.

SECONDARY SOURCES

1. Magazines : Business India, Business World.

2. Prospectus, Terminal plan, Annual report and other papers prepared by

PATNA DAIRY PROJECT organization.

LIMITATIONS OF THE STUDY:

In completing the study of this project, I encountered with a number of

difficulties. First difficulty was the limited time allotted to cover a vast topic like

“Capital Structure”.

Secondly, though the personnel of PATNA DAIRY PROJECT are very much

co—operative in nature and they also keenly taken interest in the project but they

failed to help much on account of their heavy work load.

Lastly sufficient material relating to working capital management in not

available in published forms and this made study a difficult one was overcome by

help of authorities of PATNA DAIRY PROJECT.

3

CHAPTER - II

ORGANISATIONAL

PROFILE

4

INTRODUCTION TO PATNA DAIRY PROJECT

THE INDIAN DAIRY MARKET - A PYRAMID

India has emerged as the largest milk producing country in the world

manufacturing about 92 million tonnes of milk per annum. It could be said of the

Indian dairy market as being a pyramid with the base made up of a vast market for

low-cost milk. The bulk of the demand for milk is among the poor in urban areas

whose individual requirement is small, maybe a glassful for use as whitener for their

tea and coffee. Nevertheless, it adds up to have sizable volume - millions of litres per

day. In the major cities lies an immense growth potential for the modern sector.

Presently, barely 1000 out of 3,700 cities and towns are served by its milk

distribution network, dispensing hygienically packed wholesome and quality

pasteurized milk. According to one estimate, the packed milk segment would double

in the next five years, giving both strength and volume to the modern sector. The

narrow tip at the top is a small but affluent market for western type milk products.

The effective milk market is largely confined to urban areas, inhabited by over

25 per cent of the country's population. An estimated 50 per cent of the total milk

produced is consumed here. At the turn of the twentieth century, the urban

population consuming milk has estimated to have risen by more than 100 million to

cross 364 million, a growth of about 40 per cent. The expected rise in urban

population would be a boon to Indian dairying. Presently, the organised sector, both

cooperative and private, and the traditional sector cater to this market.

HISTORICAL BACKGROUND OF DAIRY DEVELOPMENT

Dairy development, though, is a state subject under Constitution of India, the

centre and the state exercise joint jurisdiction. The central govt, lays down general

guidelines, the individual states design their Dairy Development Policies within it. Initially

in most of the states, Dairy Development was in the hands of State Dairy Development

Corporation or under the State Govt. itself. Animal Husbandry was considered an

activity for rural areas, whereas dairy development was limited only in the cities.

5

Project such as key Village Scheme and Intensive Cattle Development

Programme were taken up for improving milk yield, but these projects by

themselves, never paid much attention either to the marketing of additional milk

supposed to be produced or to its processing. Urban milk traders, who, together with

middlemen, exploited the producers and consumers, such a structure, could not

transform the livelihood of the rural poor through dairy farming a subsidiary

occupation.

A SHIFT TO “ANAND PATTERN”:

The Anand Pattern is an integrated cooperative structure that procures,

processes and markets produce. Supported by professional management, producers

decide their own business policies, adopt modem production and marketing

techniques and receive services that they can individually neither afford nor manage.

The Anand Pattern succeeds because it involves people in their own

development through cooperatives where professionals are accountable to leaders

elected by producers- The institutional infrastructure — village cooperative, dairy and

cattle feed plants, state and national marketing — is owned and controlled by

farmers. .

Anand Pattern cooperatives have progressively, linked producers directly with

consumers.

It was in the year, 1964, when the Prime Minister of India, the Late Shri Lal

Bahadur Shastri visited the Kaira (Khc-da) District Co-operative Milk Producers'

Union Ltd, popularly known as AMUL (Anand Milk Union Ltd). The Prime minister

stayed overnight in village Ajarpura and spent several hours discussing with the

farmers the affairs of their village co-operative. From the discussion, the Prime

Minister could come to the conclusion that because the farmers formulate and

implement their own policies and programmes for dairy development in their areas,

because their elected representatives managed the village society and district union,

and because they had good sense to employ competent professionals to manage

the dairy factories, the Amul Dairy was sensitive to their needs and was responsive

to their demands. The Prime Minister was so convinced and impressed by AMUL

6

model of dairy development that he asked Dr. V Kurien, the then General Manager

of AMUL to prepare a programme for replicating the AMUL model throughout India.

He also decided that Govt of India would create a body, whose job would be to

replicate 'Anands'. The NDDB to be headed by Dr. V. Kurien, was thus created in

1965 and was officially registered on 27' September, 1965 as an Autonomous

Society under the administration control of Union Ministry of agriculture.

OPERATION FLOOD

One of the world's largest rural development programmes Launched in

1970`s. Operation Flood has helped dairy farmers direct their own development,

placing control of the resources they create in their own hands- A National Milk Grid

links milk producers throughout India with consumers in over 700 towns and cities,

reducing seasonal and regional price variations while ensuring that the producer gets

fair market prices in a transparent manner on a regular basis.

The bedrock of Operation Flood has been village milk producers'

cooperatives, which procure milk and provide inputs and services, making modem

management 'and technology available to members. Operation Flood's objectives

included:

Increase milk production ("a flood of milk")

enhance the rural incomes

Reasonable prices for consumers

PROGRAMME IMPLEMENTATION

Operation Flood was implemented in three phases:

Phase 1

Phase I (1970-1980) was financed by the sale of skimmed milk powder and

butter oil gifted by the European Union then EEC through the World Food

Programme. NDDB planned the programme and negotiated the details of EEC

assistance.

During its first phase, Operation Flood linked 18 of India's premier milk sheds

7

with consumers in India's four major metropolitan cities: Delhi, Mumbai, Kolkata and

Chennai.

Phase 2

Operation Flood's Phase II (198!-85) increased the milk sheds from 18 to 136;

290 urban markets expanded the outlets for milk by the end of 1985. A self-

sustaining system of 43,000 village cooperatives covering 4.25 million milk

producers had become a reality. Domestic milk powder production increased from

22,000 tons in the pre-project year to 140.000 tons by 1989, all of the increase

coming from dairies set up under Operation Flood. In this way EEC gifts and World

Bank loan helped to promote self-reliance. Direct marketing of milk by the producer's

cooperatives increased to a several million litres a day.

Phase 3

Phase III (1985-1996) enabled dairy cooperatives to expand and strengthen

the infrastructure required to procure and market increasing volumes of milk.

Veterinary first-aid health care services, feed and artificial insemination services for

cooperative members were extended, along with intensified member education.

Operation Flood's Phase III consolidated India's dairy cooperative movement,

adding 30,000 new dairy cooperatives to the 42,000 existing societies organised

during Phase II, Milk sheds peaked to 173 in 1988-89 with the numbers of women

members and Women's Dairy Cooperative Societies increasing significantly.

Phase III gave increased emphasis to research and development in animal

health and animal nutrition. Innovations like vaccine for Theileriosis , bypass protein

feed and urea-molasses mineral blocks, all contributed to the enhanced productivity

of mulch animals.

From the outset, Operation Flood was conceived and implemented as much

more than a dairy programme. Rather, dairying was seen as an instrument of

development, generating employment and regular incomes for millions of rural

people- "Operation Flood can be viewed as a twenty year experiment confirming the

Rural Development Vision" (World Bank Report 1997c.).

8

ORGANISATIONAL STRUCTURE OF PATNA DAIRY PROJECT

THREE TIER STRUCTURE

The Village Society

An Anand Pattern village dairy cooperative society (DCS) is formed by milk

producers. Any producer can become a DCS member by buying a share and

committing to sell milk only to the society. Each DCS has a milk collection centre

where members take milk every day. Each member's milk is tested for quality with

payments based on the percentage of fat and SNF. At the end of each year, a

portion of the DCS profits is used to pay each member a patronage bonus based on

the quantity of milk poured

The District Union

A District Cooperative Milk Producers’' Union is owned by dairy cooperative

societies. The Union buys all the societies' milk, then processes and markets fluid

milk and products. Most Unions also provide a range of inputs and services to DCSs

and their members: feed, veterinary care, artificial insemination to sustain the growth

of milk production and the cooperatives' business. Union staff train and provide

consulting services to support DCS leaders and staff.

The State Federation

The cooperative milk producers' unions in a state form a State Federation.

This is responsible for marketing the fluid milk and products to the member unions.

Some federations also manufacture feed and support other union activities.

PATNA DAIRY PROJECT

Vaishal Patliputra Dugdh Utpadak Sahkari Sangh Ltd (VPDUSS) is a

District Level Milk Union set up in Bihar on Anand Pattern under Operation Flood.

Registered on 02-07-1987 under Bihar & Orissa Co-operative Act. 1935, it is one of

the five Milk Unions set up under Operation Flood in Bihar. Headquartered at

9

Phulwarisharif, Patna, it has a dairy' plant and a cattle feed plant at Patna and 4

Chilling Centres at Hajipur, Biharsharif, Ekangarsarai and Asthawa. All milk unions

are affiliated to the Bihar State Co-operative Milk Producers Federation Ltd, which is

the apex body in the state of Bihar. Central and State Govt. have Jointly promoted

these Milk Unions with a view to organise, develop and strengthen dairy co-

operatives and to modernise the dairy industry for self-sufficiency and self-reliance in

milk and milk products, as envisaged under Operation Flood.

The National Dairy Development Board, managing the Feeder Balancing

Dairy of 1.0 lake litres and a Cattle Feed Plant with 100 Metric /day capacity at Patna

(set up under the Operation Flood-1) since August, 1981 in the name and style of

Patna Dairy Project (PDP) as per the Govt. decision, transferred the management of

NDDB, the project progressed very well on co-operative principles envisaged under

OF and commercial lines as well.

The NDDB was managing the Project on behalf of a milk shed level milk union

to be formed in Patna milk shed under OF on Anand Pattern. Accordingly after

formation of VPDUSS, the NDDB transferred .the management of PDP to the Sangh.

The PDP is so popular among public and those associated to it. The project

name under study, therefore, appears singly as VPDUSS, PDP or as VPDUSS-PDP

in the report.

PROGRESS OF PATNA DAIRY PROJECT

The NDDB immediately after taking over the project positioned an integrated

Spear Head Team to restructure the milk procurement activities and also for

streamlining the working of the FBD and CFP, Under the management of NDDB the

project had not only made excellent progress but had been able to establish the fact

that the co-operatives could function equally well in Bihar too what is essential is the

proper atmosphere and guidance.

Along with the organisation of milk procurement activities and management of

both the plants on commercial lines, NDDB took special care to develop the Vaishal

Patiipuira Dagdh Utpadak Sahkari Sangh Ltd. (VPDUSS), the milk shed level co-

operative for taking over the project once the DAIRYBOARD withdraws its

10

management. NDDB handed over the arrangements of Patna Dairy Project (PDP) to

Vaishai Patliputra Dugdh Utpadak Sahkari Sangh Ltd. (VPDUSS) with effect from

lst July. 1988.

PROGRESS UNDER VAISHAL PATLIPUTRA DUGDH UTPADAK SAHKARI SANGH LTD. (VPDUSS)

The major task before the Vaisha) Patliputra Dugdh Utpadak Sahkari Sangh

Ltd. (VPDUSS) that the excellent infrastructure developed by the National Dairy

Development Board (NDDB) is not only maintained but also to see that the pace of

development is not hampered. The Vaishal Patliputra Dugdh Utpadak Sahkari Sangh

Ltd. (VPDUSS) has been able to accomplish these tasks to a greater extent.

PRESENT STATUS

Milk Procurement:

There are at present 1257 no's of functional Dairy Cooperatives Societies

(DCS) in the areas of 'PDP covering 'the districts of Patna- Vaishaii, Nalanda and

fringe areas of Saran with a total membership of 94222. The daily average

procurement has reached up to 1106163 litres during the year 2007-2008. It is

hoped that the project shall collect above one & half Lakhs litres of milk per day in

commencing year. There are 173 no. of women Co-operative Societies exclusively

managed and run by rural women folk;- While the union has a fairly good number of

functional societies- emphasis is being given to consolidate the functioning of the

primary societies by increasing .-.the members" participation. The Co-operative

Development (CD) Programme'' was also initiated from March. 1991 with the

assistance of NDDB.

Technical Inputs:

The Union, in addition providing a ready and stable market for the rurally

produced milk at the door-slop has been providing the inputs required for milk

production enhancement viz. Artificial Insemination (AI) with Frozen Semen,

Veterinary First Aid (VFA), Vaccination, supply of balanced feed, supply of fodder

11

seeds, treatment of paddy straw/wheat bursa with Urea, supply of Urea Molasses

Block (UMB) etc on no profit no loss basis. The response from the milk producers for

all these inputs has been exceedingly encouraging and the Union is in the process of

extending these facilities to more and more societies and farmers.

Feeder Balancing Dairy:

The Feeder Balancing Dairy with a capacity to handle 1.5 lakes litres per day

(LLPD), has facilities for manufacture of milk powder. Butter, ghee, ice cream, peda,

paneer and Plain/Misti Dahl, Lassi, Matha,

The production and marketing of Table Butter under the brand name 'SUDHA'

was introduced from 1st October, 1993 and the response has been encouraging.

The marketing of Sudha brand of Ice Cream in Patna was started after test

marketing in August-September. 1994, was formally launched from April. 1995. The

initial response has been satisfactory. Efforts are on to increase the market share of

Sudha ice-cream

The marketing of Sudha brand Plain/Misti Dahl in Patna was started in Oct-

Nov.2001 and was formally launched from Nov.2001. The initial response for this

product too has been overwhelming.

The production of Sudha brand Lassie in Patna was started in April-May-2003

and the product of matha started in March-2007.

Cattle Feed Plant:

The role of balanced feed is not only increasing milk production but also

sustaining the same by ensuring regular conception need not be over emphasised.

Realising the same the Union has been making consistent efforts for popularising the

consumption of balanced feed by the milk producers.

In addition to catering to the needs of the Dairy Co-operative Societies cattle

feed is sold through dealers in rest of the state for better capacity utilisation of the

Plant. Further realising the importance of introduction of latest technologies in this

field, the production and sale of By Pass Protein feed was started from the year

1989-90. The response for this feed too is encouraging.

12

Milk Marketing:

The marketing of liquid milk in sachet was introduced from the year 1981

itself. However, initially the thrust was for organising the milk procurement activities

and to stabilise the same at reasonable level. Nevertheless there was some natural

growth in the milk marketing over the years. However, for various reasons there was

some stagnation for few years in the quantity of milk marketed. With certain

modifications in the policy decisions and because of concerted efforts,

the quantum of milk being marketed is steadily growing.

Quality & Productivity Activities:

The Dairy Plant Management Programme (DPM) was introduced in the year

1992 followed by Quality Assurance Programme (QAP) in the year 1993 with the

help of NDDB. This resulted in bringing about a positive change leading to \ liability

of the project coupled with lowering of operational costs on one hand and improved

quality of products on the other. Consequent to the liberalisation and globalisation of

Indian economy in early 90's it was felt that the organisation should strive to make its

total outlook, approach and systems of highest standards. Accordingly, it was

decided in the year 2001 that the organisation should go in for ISO certification both

in quality management system and food safety. This process was successfully

completed leading to ISO-9001: 2000 and HACCP (IS-15000) certification by Bureau

of Indian Standards in March, 2002.

The project has been honoured with "Best Productivity Performance" Award

for the three years 2000-2001, 2001-2002 & 2005-2006 by National Productivity

Council, New Delhi.

13

THRUST AREAS:

1. To make Sudha Brand a market leader by making Sudha Milk and milk.

Products a consumers' delight and ensuring-that the esteemed customers get

value for money.

2. Consolidation of the DCS's already organised leading to increase milk

procurement.

3. Further improvement in the involvement/participation of members in their Co-

operatives.

4. Bridging the flush-gap further,

5. Popularising ail the Input Programme.

6. Increasing the throughputs and sale of both milk and milk products as well as

cattle feed. By Pass Protein Feed & UMB.

7. Reducing further the handling losses and increasing the utilisation of plant

capacities.

8. Optimising the utilisation of all consumables.

9. Human Resource Development through training, orientation etc to the

employees at all levels for ensuring better motivation and involvement leading

to the employees at all levels for ensuring better motivation and involvement

leading to all round progress of the organisation.

VISION:

In line of values, by maintaining economic balance, the milk sangh shall

arrange to provide maximum return to producer's members and provide necessary

services for enhancing milk production. The milk union shall be well known as one of

the leading organizations in the country for its total quality.

MISSION

Socio economic up fulfilment of rural farmers through co-operative dairying.

Cater the needs of urban consumers by supplying hygienically packed milk

and milk products at reasonable prices.

Development and expansion of such other allied activities conducive for

dairying, improvement and protection of mulch animals for the betterment of

milk producers.

14

VALUES

Cooperation and Team spirit

Belief in cooperative organizations

Honesty

Total quality at every level

Discipline

Openness and Transparency

Trust and Motivation (from milk producer to consumers)

Education and Awareness at every level

AIMS AND OBJECTIVE OF PDP

The Patna dairy project aims mainly to concentrate on goods quality

procurement of milk maintain milk product for making them available to general

masses so that they can avail the opportunity of better nourishment.

As such aims of PDP are:-

To develop dairying on Anand Pattern in Bihar to cater the need of masses in

Patna and suburbs in terms of milk and milk product and at the same line

maintained high quality.

To eliminate middle-man between milkman and consumer there by stopping

undeserved share of profit to milkman which is the second most important

objective

To provide milk market to the milkman throughout the year thus helping them

to lead a better life.

To decrease the cost of production so that the ultimate consumer can get the

product at low and cheaper cost.

To help in the rural development by developing strong co-operative society to

guard the rural people and to help to overcome any set backs

To produce dairy product of high quality and built in food safety to meet a well

defined need use and purpose of judicious and efficient utilisation of

resources.

15

Promote innovation and development of new product.

To achieve continual improvement in customer satisfaction in term product

quality and service

To ensure continuous improvement in terms of physical financial performance

resulting in maximum production at optimum cost.

16

PATNA DAIRY PROJECT AT A GLANCE

Particulars 95-56 96-97 97-98 98-99*" 99-00 00-01 01-02 02-03 03-04 04-05 05-06 06-07 07-08 08-09No.of functional DCS 833 878 942 826 880 894 913 1007 1214 1233 1285 1277 1350 1257Total No.of Members 52619 56625 62762 51964 53084 55525 57695 61307 67649 71139 74663 77035 88617 94222Total No.of Families benifiled 56000 61701 67170 54654 57289 60685 62331 65829 72958 77191 81693 85723 95560 99893No.of functional milk Routes 28 28 30 22 22 22 22 22 22 22 25 25 25 25Total qty of milk Collected(in lakh Kg)

222.04 285 67 297.72 270.62 349.81 357.36 368.60 384.50 378.76 480.09 538.53 579.64 469.24 366.02

(a) Patna Milk Shed 215.23 279.23 297.72 193.67 301.30 355,40 323.37 353.26 375.73 480.09 537.97 579.64 469.71 335.17(b) From other Dairies 6.81 6.44 76.95 48.51 1.96 45.23 31.24 3.03 – 0.56 – 1.53 30.85Total Milk Sales(in lakhs Its) 197.53 249.22 272.45 316.75 315.80 299.45 334.52 331.91 381.17 385.91 441.09 578.04 533.72 555.09(a) Sales in Patna Milk Shed 197.11 227.58 25239 290.62 293.23 276.48 281.62 327.52 379.85 374.78 420.72 470.69 513.58 541.55(h) Sale in Comfed 0.42 21.67 20.06 26.13 22.57 22.97 15.95 0.19 1.00 5.20 10.73 68.8 19.74 13.54© Sale in Mother Dairy 36.95 4.20 0.32 5.93 9.64 38.55 0.4 0Max.Sale in Patna in a Day 142720 164400 166880 195284 252960 218894 219501 245257 301718 247813 351030 369793 383438 214376

No.of A.I.Centre orgnised(a) Single A.I. Centre 87 114 128 102 108 109 117 127 126 126 126 134 148 156(b) Cluster A-i. Centre 50 56 64 65 67 68 73 85 96 111 110 116 127 135No of A.I. Performed 60999 82520 97042 104125 104607 116426 123266 135299 139657 139332 148978 157764 139949 124545No of Calves Born out of A.I. 4791 4803 17055 27256 31046 32465 32713 42566 45522 49668 62821 72349 78656 56590No of DCS covered under VFA 339 371 643 632 640 661 747 770 788 868 868 640 599 599No.of Animals Treated 29113 33403 41796 32867 25183 38676 43032 46580 66680 64345 85861 101664 105812 78310(a) By First AID 22892 24165 32532 24125 15720 25241 38514 45935 66680 62128 84233 100395 104062 76295(b) For in Fertility 5041 9238 9264 8742 9463 13435 4518 645 2217 1628 1269 1750 2015(c) During routine visit 1180 - - - - - - - - - - -No.of Vaccinations done 85265 90318 111074 90501 73610 108610 143560 113550 186585 167825 105925 163325 167450 192712Total Cattle Feed SalefMTs.) 13923 18827 21485 22667 26031 18640 21033 23845 24190 20307 24732 27962 27313 23892Cattle Feed sold to DCS(MTs) 6563 9466 13165 11287 14681 13073 13894 15953 15663 17600 20952 23423 22137 18161Total Payment made to Producer's (Rs. Lakhs)

1570.83 2218.38 2353.15 1912.75 3425.28 3896.80 3283.83 3668.82 3973.34 5344.31 5871.40 6392.02* 5716.17 4810.7

Total Turn over (Rs. in Lakhs) 2841.77 4154.00 4736.04 5437.36 6543.09 6109.77 6442.01 6746.29 7440.89 8031.03 9798.00 11612.95* 142.02 150Surplus Cash generated (Rs. in Lakhs)

113.91 109.00 146.56 125.96 59.96 112.96 140.58 153.78 120.86 128.30 135.61 355.00* 12469.36 14183.05

* Tentative(The project was honoured with "BEST PRODUCTIVITY" award for dairy development and production consecutively for two years (2000-2001 & 2001-2002) by NPC Delhi.(The project received the" BEST PUBLIC UTILITY SERVICE AND SYSTEM AWARD" for the year 1982).A new milk union namely Shahabad was carved out from Patna Dairy Project area w.e.f. Nov.97. Hence the figures from 97-98 (from Nov.97) onwards does not include the new milk union area.

17

PATNA DAIRY PROJECT

NO. OF FUNCTIONAL DCS

18

PATNA DAIRY PROJECT

TOTAL NO.OF MEMBERS

19

PATNA DAIRY PROJECT

MILK PROCUREMENT ( IN LAKH KG )

20

PATNA DAIRY PROJECT

MAX. SALE IN PATNA IN A DAY

21

CHAPTER - III

CAPITAL STRUCTURE

THEORETICAL CONCEPTS

22

C APITAL S TRUCTURE

In order to run and manage a company, funds are needed. Right from the

promotional stage upto end, finance play an important role in a company’s life. If funds

are inadequate, the business suffers and if the funds are not properly managed, the

entire organisation suffers. It is, therefore, necessary that correct estimate of the current

and future need of capital be made to have an optimum structure which shall help the

organisation to run its work smoothly and without any stress.

Estimation of capital requirements is necessary, but the formation of a capital

structure is important. The capital structure is made up of debt and equity securities and

refers to permanent financing of a firm. It is composed of long-term debt, preference

share capital and shareholder’s funds.

The capital structure or financial leverage decision should be examined from the

point of its impact on the value of the firm. If capital structure decision can affect a firm’s

value, then it would like to have a capital structure, which maximises its market value.

However, there exist conflicting theories on the relationship between capital structure

and the value of a firm. But after going through all those theories we can say that the

trade-off between costs and benefits of debt can turn capital structure into a relevant

decision.

MEANING & DEFINITION

The term capital structure reflects the composition of the long-term sources of

funds. It includes equity capital including retained earnings and long-term debts. Thus,

short-term liabilities should be excluded from the formulation of capital structure. In a

simple way, capital structure is used to represent the proportionate relationship between

debt and equity.

In other words, capital structure represents as in what proportion the total amount

of capitalisation is divided in different securities.

23

Here, we know that capitalisation is a quantitative aspect of the financial planning

of an enterprise but capital structure is concerned with the qualitative aspect.

Capitalisation means total amount of securities issued by a company while

capital structure refers to the kinds of securities and the proportionate amounts that

make up capitalisation.

Capital structure is the mix of long-term sources and it includes owned capital,

preference share capital and long-term debt capital. Owned capital is known as variable

dividend security, preference share capital is considered as fixed-dividend security and

debentures / bonds / long-term debts are known as fixed interest bearing securities.

Some authors on Financial Management define capital structure in a broad

sense so as to include even the proportion of short-term debt. In fact, they refer to

capital structure as financial structure. Financial structure means the entire liabilities

side of the balance sheet. So, we can say that financial structure, generally, is

composed of a specified percentage of short-term debt, long-term debt and

shareholder’s funds.

OPTION DECIDING THE CAPITAL STRUCTURE FOR FINANCIAL MANAGER OR FORMS / PATTERNS OF CAPITAL STRUCTURE

The capital structure of a new company may consist of :-

a. Equity shares only.

b. Equity and Preferences shares.

c. Equity shares and Debentures.

d. Equity shares, Preferences shares and Debentures.

It may be : –

1. 100 % Equity / Share capital (Equity oriented / Share oriented).

2. 100 % Debt (Debt oriented capital).

24

3. 50 : 50 Share capital and Debt capital (Unit oriented).

4. 75 : 25 Share capital and Debt capital (Low gearing capital structure).

5. 25 : 75 Share capital and Debt capital (High gearing capital structure).

Here, we should clear the term ‘Capital gearing’ which refers to the relationship

between equity capital (equity shares plus reserves) and long-term debt. In simple

words, capital gearing means the ratio between the various types of securities in the

capital structure of the company.

A company is said to be in high gear, when it has a proportionately higher / large

issue of debentures and preference shares for raising the long-term resources, whereas

low-gear stands for a proportionately large issue of equity shares.

The capital gearing in the financial structure of a business has been rightly

compared with the gears of an automobile. The gears are used to maintain the desired

speed and control. Initially, an automobile starts with a low gear, but as soon as it gets

momentum, the low gear is changed to high gear to get better speed. Similarly, a

company may be started with high equity state i.e. low gear but after momentum, it may

be changed to high gear by mixing more of fixed interest bearing securities such as

preference shares and debentures. It may also be noted that capital gearing affects not

only the shareholders but the debenture holders, creditors, financial institutions, the

financial managers and others are also concerned with the capital gearing.

The technique of capital gearing can be successfully employed by a company

during various phases of trade cycles i.e. during the condition of inflation and deflation,

to increase the rate of return to its owners (equity shareholders) and thereby increasing

the value of their investments.

During Inflation or Boom period, a company should follow the policy of high gear

as the profits of the company are higher and it can easily pay fixed costs of debenture

and preferences shares. Further, during boom period, the rate of earnings of the

company is usually higher than the fixed rate of interest / dividend prevailing on

debentures and preferences shares. By adopting the policy of high gear, a company

25

can increase its earnings per share and thereby a higher rate of dividend.

During Deflation or Depression period the rate of earnings of a company is lower

than the rate of interest / dividend on fixed interest bearing securities and hence it

cannot meet the fixed cost without lowering the divisible profits and the rate of dividend.

It is, therefore, better for a company to remain in low gear and not to resort to fixed

interest bearing securities as source of finance during such period.

CAPITAL STRUCTURE IN A PERFECT MARKET :

Assume a perfect capital market (no transaction or bankruptcy costs; perfect

information); firms and individuals can borrow at the same interest rate; no taxes; and

investment decisions aren't affected by financing decisions. Modigliani and Miller made

two findings under these conditions. Their first 'proposition' was that the value of a

company is independent of its capital structure. Their second 'proposition' stated that

the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged

firm, plus an added premium for financial risk. That is, as leverage increases, while the

burden of individual risks is shifted between different investor classes, total risk is

conserved and hence no extra value created.

Their analysis was extended to include the effect of taxes and risky debt. Under a

classical tax system, the tax deductibility of interest makes debt financing valuable; that

is, the cost of capital decreases as the proportion of debt in the capital structure

increases. The optimal structure, then would be to have virtually no equity at all.

CAPITAL STRUCTURE IN THE REAL WORLD :

If capital structure is irrelevant in a perfect market, then imperfections which exist

in the real world must be the cause of its relevance. The theories below try to address

some of these imperfections, by relaxing assumptions made in the M&M model.

Trade-off theory :- Trade-off theory allows the bankruptcy cost to exist. It states that

there is an advantage to financing with debt (namely, the tax benefit of debts) and that

26

there is a cost of financing with debt (the bankruptcy costs of debt). The marginal

benefit of further increases in debt declines as debt increases, while the marginal cost

increases, so that a firm that is optimizing its overall value will focus on this trade-off

when choosing how much debt and equity to use for financing. Empirically, this theory

may explain differences in D/E ratios between industries, but it doesn't explain

differences within the same industry.

Pecking order theory :- Pecking Order theory tries to capture the costs of asymmetric

information. It states that companies prioritize their sources of financing (from internal

financing to equity) according to the law of least effort, or of least resistance, preferring

to raise equity as a financing means lender of last resort. Hence internal debt is used

first, and when that is depleted debt is issued, and when it is not sensible to issue any

more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy

of financing sources and prefer internal financing when available, and debt is preferred

over equity if external financing is required. Thus, the form of debt a firm chooses can

act as a signal of its need for external finance. The pecking order theory is popularized

by Myers (1984) when he argues that equity is a less preferred means to raise capital

because when managers (who are assumed to know better about true condition of the

firm than investors) issue new equity, investors believe that managers think that the firm

is overvalued and managers are taking advantage of this over-valuation. As a result,

investors will place a lower value to the new equity issuance.

Agency Costs :- There are three types of agency costs which can help explain the

relevance of capital structure.

Asset substitution effect: As D/E increases, management has an increased

incentive to undertake risky (even negative NPV) projects. This is because if the

project is successful, share holders get all the upside, whereas if it is

unsuccessful, debt holders get all the downside. If the projects are undertaken,

there is a chance of firm value decreasing and a wealth transfer from debt

holders to share holders.

Underinvestment problem: If debt is risky (eg in a growth company), the gain

from the project will accrue to debt holders rather than shareholders. Thus,

27

management have an incentive to reject positive NPV projects, even though they

have the potential to increase firm value.

Free cash flow: unless free cash flow is given back to investors, management

has an incentive to destroy firm value through empire building and perks etc.

Increasing leverage imposes financial discipline on management.

Other :-

The neutral mutation hypothesis firms fall into various habits of financing, which

do not impact on value.

Market timing hypothesis—capital structure is the outcome of the historical

cumulative timing of the market by managers.

Accelerated investment effect- even in absence of agency costs, levered firms

use to invest faster because of the existence of default risk.

SIGNIFICANCE OF CAPITAL STRUCTURE :

The Capital Structure decisions are very significant in financial management, as

they influence debt equity mix which ultimately affects shareholders return & risk.

The rate of dividend per share depends upon the capital structure of the

Company.

Capital structure is important from the view point of Company‘s financial liquidity

and for raising capital for future.

If capital structure is not framed properly, the situation of under or over

capitalization may be created.

The larger portion of debt in company‘s capital structure will increase financial

risk in company whereas larger portion of equity in Company‘s capital structure will

decrease EPS (Earning Per Share).

OPTIMAL CAPITAL STRUCTURE

As discussed above, the capital structure decision can influence the value of the

firm through the cost of capital and trading on equity or leverage. The optimum capital

28

structure may be defined as “that capital structure or combination of debt and equity that

leads to the maximum value of the firm” Optimal capital structure ‘maximises the value

of the company and hence the wealth of its owners and minimises the company’s cost

of capital’ (Solomon, Ezra, The Theory of Financial Management). Thus, every firm

should aim at achieving the optimal capital structure and then to maintain it.

The following considerations should be kept in mind while maximising the value

of the firm in achieving the goal of optimum capital structure :

(i) If the return on investment is higher than the fixed cost of funds, the company

should prefer to raise funds having a fixed cost, such as debentures, loans and

preference share capital. It will increase earnings per share and market value of

the firm. Thus, a company should, make maximum possible use of leverage.

(ii) When debt is used as a finance, the firm saves a considerable amount in

payment of tax as interest is allowed as a deductible expense in computation of

tax. Hence, the effective cost of debt is reduced, called tax leverage. A company

should, therefore, take advantage of tax leverage.

(iii) The firm should avoid undue financial risk attached with the use of increased

debt financing. If the shareholders perceive high risk in using further debt-capital,

it will reduce the market price of shares.

(iv) The capital structure should be flexible.

LEVERAGE :

The concept leverage is the most important concept of finance which shows the

relationship between risk and return which are existing in the different business

activities of a particular enterprises. This concept is based on assumption that one can

ensure maximum return at minimum risk. Which is only possible when the level of risks

and returns both are high. This denotes that our concentration is to maximise the return

of minimising risk. Minimisation of risk by avoiding risk or removing risk is very difficult to

achieve. The study of leverage helps the concern in identifying those risks and return

which are existing in operating as well as the financial activities of any business

29

enterprises. Risk is going to be identified when there is an increase in the amount of

loss and costs and decrease in the level of profit and sales. Returns are identified when

sales increases, costs decreases, and result of that the profit increases and loss

decreases. On the basis of these consideration the concept of leverage emerged in the

area of finance which clearly denotes that a certain change in the business activities

particularly operating activities and financial activities will bring change in the profitability

of the business enterprise which is identified in the form of risk and return. There are

two types of leverage. One is Operating Leverage and second is Financial Leverage

Operating leverage helps the concern in identifying leverage helps the concern in

identifying the amount of risk and return which are existing in the operating activities of

any business concern. Operating activities are basically concern with production,

purchase and the sales activities of a particular enterprise. It shows that reduction in the

level of fixed cost as well as the variable cost will affect the profitability immediately

which is known as the operating risk and return. In other words O.L. says about the

changes occurred in the level of sales brings changes in the level of profitability whether

such changes may be positive or negative. Positive changes are named as returns and

negative changes are named as risk. If the changes in the amount of sales increases

profits are reduces losses it is known as positive change but if it decreases profit and

increases losses it known as negative change. O.L. is mathematically calculated by

comparing the contribute with PBIT in absolute sales but when it is going to be

expressed in terms of degree it is calculated by comparing the percentage change in

PBIT with the percentage change in sales.

Leverage is one of the tool to evaluate the risk return relationship. It indicate level

of risk involved in a firm. There are mainly three types of leverages :

a. DOL (Degree of Operating Leverage),

b. DFL (Degree of Financial Leverage)

c. DCL (Degree of Combined Leverage).

30

a) DOL (Business Risk / Operating Risk) :- DOL refers to the ability of the firm to

make maximum utilization of operating fixed cost and to evaluate what will be the

effect of change in sales on EBIT (Earning Before Interest & Taxes).

b) DFL (Financial Risk) : - DFL refers to the ability of the firm to make maximum

utilization of financial fixed cost and to evaluate what will be the effect of change

in EBIT on EPS.

c) DCL : - DCL refers to the ability of the firm to make maximum utilization of total

fixed cost.

A Company having higher operating leverage should be accompanied by a low

financial leverage and vice versa otherwise it will face problems of insolvency &

inadequate liquidity.

Trading on Equity :

A Company may raise funds either by issue of share or by borrowings carry a

fixed rate of interest & this interest is payable irrespective of fact whether there is profit

or not. In case return on investment (ROI) is more than rate of interest on borrowed

funds, it is said that the Company is trading on equity.

Coverage Ratio :

The ability of the firm to use debt in the capital structure can also be judged in

terms of coverage ratio namely EBIT / Interest higher the ratio, greater is the certainty of

meeting interest payments.

31

FACTORS TO BE CONSIDERED WHILE EVALUATING THE OPTIONS :

Indifference point : -

Indifference point refers to the level of EBIT at which the EPS for both the given

options of raising the funds are equal.

Where, T = Corporate tax rate,

I1 = Interest charge for financial alternative one, I2 = Interest charge for financial

alternative two,

N1 = Number of equity share of the financial alternative one,

N2 = Number of equity share of the financial alternative one,

EBIT = Earnings before interest & taxes.

Financial Break Even Point (FBEP) :

FBEP refers to the level of EBIT at which EPS is Nil. Here the company earns an

amount equivalent to its financial commitments. If EBIT less than FBEP then, EPS will

be negative.

Corporate Taxes :

When taxes are applicable to corporate income, debt financing is advantageous.

This is because dividend & retained earnings are not deductible for tax purposes;

interest on debt is a tax deductible expense. As a results, the total income available for

both stockholders & debt holders is greater when debt capital is used.

32

FACTORS TO BE CONSIDERED :

Profitability : - The most profitable capital structure is one that tends to minimize

cost of finance and maximize EPS (Earning Per Share).

Flexibility : - The capital structure should be such that capital structure can raise

funds whenever needed.

Conservation : - The debt contained in capital structure should not exceed the

limit which the capital structure can bear.

Solvency : - The capital structure should be such that firm does not run risk of

becoming insolvent.

Control : - The capital structure should be so devised that it involves minimum

risk of loss of control of the Company.

THEORIES OF CAPITAL STRUCTURE

Different kinds of theories have been propounded by different authors to explain

the relationship between capital structure, cost of capital and value of the firm. The main

contributors to the theories are Durand, Ezra, Solomon, Modigliani and Miller.

The important theories are discussed below :

1. Net Income Approach.

2. Net Operating Income Approach.

3. The Traditional Approach.

4. Modigliani and Miller Approach.

1. Net Income Approach:- According to this approach, a firm can minimise the

weighted average cost of capital and increase the value of the firm as well as

market price of equity shares by using debt financing to the maximum possible

extent. The theory propounds that a company can increase its value and

decrease the overall cost of capital by increasing the proportion of debt in its

capital structure. The approach is based upon the following assumptions :

33

(i) The cost of debt is less than the cost of equity.

(ii) There are no taxes.

(iii) The risk perception of investors is not changed by the use of debt.

(iv)

(v)

(vi)

(vii)

(viii)

(ix)

(x)

(xi)

(xii)

The line of argument in favour of net income approach is that as the proportion of

debt financing in capital structure increase, the proportion of a less expensive source of

funds increases. This results in the decrease in overall (weighted average) cost of

capital lending to an increase rates are usually lower than dividend rates due to element

of risk and the benefit of tax as the interest is a deductible expense.

On the other hand, if the proportion of debt financing in the capital structure is

reduced or say when the financial leverage is reduced, the weighted average cost of

capital of the firm will increase and the total value of the firm will decrease. The Net

Income (NI) Approach showing the effort of leverage on overall cost of capital has been

presented in the following figure.

The total market value of a firm on the basis of Net Income Approach can be

34

KO (OVERALL COST OF CAPITAL)

KD (COST OF DEBT)

DEGREE OF LEVERAGE

CO

ST

OF

CA

PIT

AL

%

KE (COST OF EQUITY)

Net Income Approach : Effect of Leverage on Cost of Capital

ascertained as below :

V = S + D

Where, V = Total market value of a firm

S = Market value of equity shares

=

D = Market value of debt.

And, Overall cost of Capital or Weighted Average Cost of Capital can be

calculated as :

K0=

2. Net Operating Income Approach :- This theory as suggested by Durand is

another extreme of the effect of leverage on the value of the firm. It is

diametrically opposite to the net income approach. According to this approach,

change in the capital structure of a company does not affect the market value of

the firm and the overall cost of capital remains constant irrespective of the

method of financing. It implies that the overall cost of capital remains the same

whether the debt-equity mix is 50: 50 or 20:80 or 0:100. Thus, there is nothing as

an optimal capital structure and every capital structure is the optimum capital

structure. This theory presumes that :

(i) The market capitalises the value of the firm as whole;

(ii) The business risk remains constant at every level of debt equity mix;

(iii) There are no corporate taxes.

35

(iv)

(v)

(vi)

(vii)

(viii)

(ix)

The reasons propounded for such assumptions are that the increased use of

debt increases the financial risk of the equity shareholders and hence the cost of equity

increases. On the other hand, the cost of debt remains constant with the increasing

proportion of debt as the financial risk of the lenders is not affected. Thus, the

advantage of using the cheaper source of funds, i.e., debt is exactly offset by the

increased cost of equity.

According to the Net Operating Income (NOI) Approach, the financing mix is

irrelevant and it does not affect the value of the firm. The NOI approach showing the effect

of leverage on the overall cost of capital has been presented in the following figure.

The value of a firm on the basis of NET Operating Income Approach can be

determined as below :

V =

Where, V = Value of a firm

EBIT = Net operating Income or Earnings before interest & tax

K0 = Overall cost of capital

The market value of equity, According to this approach is the residual value

36

KO (OVERALL COST OF CAPITAL)

KD (COST OF DEBT)

DEGREE OF LEVERAGE

CO

ST

OF

CA

PIT

AL

%

KE (COST OF EQUITY)

The NOI Approach : Effect of Leverage on Cost of Capital

which is determined by deduction the market value of debentures form the total

value of the firm.

S = V-D

Where, S = Market value of equity shares

V = Total market value of a firm

D = Market value of debt

The cost of equity of equity capitalisation rate can be calculated as below :

Cost of Equity Capitalisation Rate (Ke)

=

=

3. The Traditional Approach :- The traditional approach, also known as

Intermediate approach, is a compromise between the two extremes of net

income approach and net operating income approach. According to this theory,

the value of the firm can be increased initially or the cost of capital can be

decreased by using more debt as the debt is a cheaper source of funds than

equity. Thus, optimum capital structure can be reached by a proper debt-equity

mix. Beyond a particular point, The cost of equity increases because increased

debt increases the financial risk of the equity shareholders. The advantage of

cheaper debt at this point of capital structure is offset by increased cost of equity.

After this there comes a stage, when the increased cost of equity cannot be

offset by the advantage of low-cost debt. Thus, overall cost of capital, according

to this theory, decreases u to a certain point, remains more or less unchanged for

moderate increase in debt thereafter; and increases or rises beyond a certain

point. Even the cost of debt may increase at this stage due to increased financial

risk. The theory has been explained in Illustration.

The traditional view point on the relationship between the leverage, cost of

37

capital and the value of firm has been shown in the figures below :

The figures above show that there can be a range of optimal capital structure or

a particular level of optimal capital structure.

Ke (COST OF EQUITY)

KO (OVERALL

COST OF CAPITAL)

Kd (COST OF DEBT)

RANGE OF OPTIMAL

CAPITAL STRUCTURE

CO

ST

OF

CA

PIT

AL

%

DEGREE OF LEVERAGE

Traditional Approach : Effect of Leverage on Cost of Capital

OO AA BB XX

CO

ST

OF

CA

PIT

AL

% KE (COST OF EQUITY)

KO (OVERALL COST OF CAPITAL)

Kd (COST OF DEBT)

DEGREE OF LEVERAGE

Traditional Approach : Effect of Leverage on Cost of Capital

OPTIMUMCAPITAL STRUCTURE

AAOO XX

38

4. Modigliani and Miller Approach :- M&M hypothesis is identical with the Net

Operating Income approach if taxes are ignored. However, when corporate taxes

are assumed to exist, their hypothesis is similar to the Net Income Approach.

(a) In the absence of taxes. (Theory of Irrelevance) The theory proves that the cost

of capital is not affected by changes in the capital structure or say that the debt-

equity mix is irrelevant in the determination of the total value of a firm. The

reason argued is that though debt is cheaper to equity, with increased use of

debt as a source of finance, the coat of equity increases. This increase in the

cost of equity offsets the advantage of the low cost of debt. Thus, although the

financial leverage affects the cost of equity, the overall cost of capital remains

constant. The theory emphases the fact that a firm’s operating income is

determinant of its total value. The theory further propounds that beyond a certain

limit of debt, The cost of debt increases (due to increased financial risk) but the

cost of equity falls thereby again balancing the two costs. In the opinion of

Modigliani& Miller, two identical firms in all respects except their capital structure

cannot have different market values or cost of capital because of arbitrage

process. In case two identical firms except for their capital structure have

different market values or cost of capital, arbitrage will take place and the

investors will engage in ‘Personal leverage’ (i.e. they will buy equity of the other

company in preference to the company having lesser value) as against the

‘corporate leverage’ ; and this will again render the two firms to have the same

total value.

The M&M approach is based upon the following assumptions:

(i) There are no corporate taxes.

(ii) There is a prefect market.

(iii) Investors act rationally.

(iv) The expected earnings of all the firms have identical risk characteristics.

(v) The cut-off point of investment in a firm is capitalisation rate.

(vi) Risk to invertors depends upon the random fluctuations of expected earnings and

39

the possibility that the actual value of the variables may turn out to be different

from their best estimates.

(vii) All earnings are distributed to the shareholders.

MM approach in the absence of corporate taxes, i.e. the theory of irrelevance of

financing mix has been presented in the following figure.

(b) When the corporate taxes assumed to exist. (Theory of Relevance) Modigliani

and Miller, in their article of 1963 have recognised that the value of the firm will

increase or the cost of capital will decrease with the use of debt on account of

deductibility of interest charges for tax purpose. Thus, the optimum capital

structure can be achieved by maximising the debt mix in the equity of a firm.

According to the M& M approach, the value of a firm unlevered can be calculated

as.

Value of Unlevered Firm (Vu) =

i.e. = ( (1-t)

and the Value of a Levered Firms is :

VL = Vu + tD

Where, Vu is value of unlevered firm

And, tD is the discounted present value of the tax savings resulting from the tax

deductibility of the interest charges, t is the rate of tax and D the quantum of debt used

in the mix.

Value of levered and unlevered firm under the MM model (assuming that

corporate taxes exist) has been shown in the following figure.

40

Earnings Before Interest & TaxOverall Cost of Capital

EBITK0

CAPITAL STRUCTURE PLANNING AND POLICY

Some companies do not plan their capital structures; it develops as result of the

financial decisions taken by the financial manager without any formal policy and

planning. Financing decisions arte reactive and they evolve is response to the operating

decisions. These companies may prosper in the short-run, but ultimately they may face

considerable difficulties in raising funds to finance their activities. With unplanned capital

structure, these companies may also fail to economise the use of their funds.

Consequently, it is increasingly realised that company should plan its capital structure to

maximise the use of the funds and to be able to adapt more easily to the changing

conditions.

Theoretically, the financial manager should plan an optimum capital structure for

his company. The optimum capital structure is one that maximises the market value of

the firm. So far our discussion of the optimum capital structure has been theoretical. In

practice, the determination of an optimum capital structure is a formidable task, and on

has to go beyond the theory. There are significant variations among industries and

among companies within an industry in terms of capital structure. Since a number of

factors influence the capital structure decision of a company, the judgment of the person

VA

LU

E

VL (VALUE OF LEVERED FIRM)

DEGREE OF LEVERAGE

VU (VALUE OF UNLEVERED FIRM)

OO XX

VALUE OF INTEREST TAX SHIELD

(MM Approach : Value of Levered and Unlevered) Firm

41

making the capital structure decision plays a crucial part. Two similar companies may

have different capital structure if the decision-makers differ in their judgment of the

significance of various factors. A totally theoretical model perhaps cannot adequately

handle all those factors, which affect the capital structure decision in practice. These

factors are highly psychological, complex and qualitative and do not always follow

accepted theory, since capital markets are not perfect and the decision has to be taken

under imperfect knowledge and risk.

The board of directors or the chief financial officer (CFO) of a company should

develop and appropriate or target capital structure, which is most advantageous to he

company. This can be done only when all those factors, which are relevant analysed

and balanced. The capital structure should be planned generally keeping in view the

interests of the equity shareholders and the financial requirements of a company. The

equity shareholders, being the owners of the company and providers of risk capital

(equity), would be concerned about the ways of financing a company’s operations.

However the interests of other groups, such as employees, customers, creditors,

society and government, should also be given reasonable consideration. As stated in

chapter 1, when the company lays down its objective in terms of the shareholder wealth

maximisation (SWM), it is generally compatible with the interests of other groups. Thus,

while developing and appropriate capital structure for its company, the financial

manager should inter alia aim at maximising the long-term market price per share.

Theoretically, there may be a precise point or range within which the market value per

shares maximum. In practice, for most companies within an industry there may be a

range of an appropriate capital structure within which there would not be great

differences in the market value per share one way to get an idea of this range is to

observe the capital structure patterns of companies vis-a-vis their market prices of

shares. It may be found empirically that there are not significant differences in the share

values within a given range. The management of a company may fix its capital structure

near the top of this range in order to make maximum use of favourable leverage,

subject to other requirements such as flexibility, solvency, control and norms set by the

financial institutions, the Security Exchange Board of India (SEBI) ad stock exchanges.

42

PRACTICAL CONSIDERATIONS IN DETERMINING CAPITAL STRUCTURE

The determination of capital structure in practice involves additional

considerations in addition to the concerns about EPS, value and cash flow. A firm may

have enough debt servicing ability but it may not have assets to offer as collateral.

Attitudes of firms with regard to financing decisions may also be quit often influenced by

their desire of not losing control, maintaining operating flexibility and have convenient

timing and cheaper means of raising funds. Some of the most important considerations

are discussed below.

Assets

The forms of assets held by a company are important determinants of its capital

structure. Tangible fixed assets serve as collateral to debt. In the event of financial

distress, the lenders can access these assets and liquidate them to realise funds lent by

them. Companies with higher tangible fixed assets will have less expected costs of

financial distress and hence, higher debt ratios. On the other hand, those companies,

whose primary assets are intangible assets, will not have much to offer by way of

collateral and will have higher costs of financial distress. Companies have intangible

assets in the form of human capital, relations with stakeholders, brands, reputation etc.,

and their values start eroding as the firm faces financial difficulties and its financial risk

increases.

Growth Opportunities

The nature of growth opportunities has an important influence on a firm’s

financial leverage. Firms with high market –to-book value ratios have high growth

opportunities. A substantial part of the value for these companies comes from

organisational or intangible assets. These firms have a lot of investment opportunities.

There is also higher threat of bankruptcy and high costs of financial distress associated

with high growth firms once they start facing financial problems. These firms employ

lower debt ratios to avoid the problems of under-investment and costs of financial

43

distress. But bankruptcy is not the only time when debt-financed high-growth firms let go

of the valuable investment opportunities. When faced with the possibility of interest

default, managers tend to be risk averse and either put off major capital projects or cut

down on R&D expenses or both. Therefore, firms with growth opportunities will probably

find debt financing quite expensive in terms of high interest to be paid due to lack of

good collateral and investment opportunities to be lost. High growth firms would prefer

to take debts with lower maturities to keep interest rates down and to retain the financial

flexibility since their performance can change unexpectedly any time. They would also

prefer unsecured debt to have operating flexibility.

Mature firms with low market-to-book value ratio and limit growth opportunities

face the risk of managers spending free cash flow either in unprofitable maturing

business or diversifying into risky business. Both these decisions are undesirable. This

behaviour of managers can be controlled by high leverage that makes them more

careful in utilising surplus cash. Mature firms have tangible assets and stable profits.

They have low costs of financial distress. Hence these firms would raise debt with

longer maturities as the interest rates will not be high for them and they have a lesser

need of financial flexibility wince their fortunes are not expected to shift suddenly. They

can avail high interest tax shields by having high leverage rations.

Debt- and Non-debt Tax Shields

We know that debt, due to interest deductibility, reduces the tax liability and

increases the firm’s after-tax free cash flows. In the absence of personal taxes, the

interest tax shields increase the value of the firm. Generally, investors pay taxes on

interest income but not on equity income. Hence, personal taxes reduce the tax

advantage of debt over equity. The tax advantage of debt implies that firms will employ

more debt to reduce tax liabilities and increase value. In practice, this is not always true

as is evidenced form many empirical studies. Firms also have non-debt tax shields

available to them. For example, firms can use depreciation, carry forward losses etc. To

shields taxes. This implies that those firms that have larger non-debt tax shields would

employ low debt, as they may not have sufficient taxable profit available to have the

benefit of interest deductibility. However, there is a link between the non-debt tax

44

shields and the debt tax shields since companies with higher depreciation would tend to

have higher fixed assets, which serve as collateral against debt.

Financial Flexibility and Operating Strategy

A cash flow analysis might indicate that a firm could carry high level of debt

without much threat of insolvency. But in practice, the firm may still make conservative

use of debt since the future is uncertain and it is difficult t be able to consider all

possible scenarios of adversity. It is, therefore, prudent to maintain financial flexibility

that enables the firm to adjust to any change in the future events or forecasting error.

As discussed earlier, financial flexibility is a serious consideration in setting up

the capital structure policy. Financial flexibility means a company’s ability to adapt its

capital structure to the needs of the changing conditions. The company should be able

to raise funds, without undue delay and cost, whenever needed, to finance the profitable

investments. It should also be in a position to redeem its debt whenever warranted by

the future conditions. The financial plan of the company should be flexible enough to

change the composition of the capital structure as warranted by the company’s

operating strategy and needs. It should also be able to substitute one form of financing

for another to economise the use of funds. Flexibility depends on load covenants, option

to early retirement of loans and the financial slack, viz., excess resources t the

command of the firm.

Loan Covenants

Restrictive covenants are commonly included in the long-term loan agreements

and debentures. These restrictions curtail the company’s freedom in dealing with the

financial matters and put it in an inflexible position. Covenants in loan agreements may

include restrictions to distribute cash dividends, to incur capital expenditure, to raise

additional external finances or to maintain working capital at a particular level. The types

of covenants restriction the firm’s investment, financing and dividend policies vary

depending on the source of debt. While private debt contains both affirmative and

negative covenants, public debt has a lot of negative covenants and commercial paper

does not entail much restrictions. Loan covenants may look quite reasonable from the

45

lenders point of view as they are meant to protect their interests, but they reduce the

flexibility of the borrowing company to operate freely and it may become burdensome if

conditions change. Growth firms prefer to take private rather than public debt since it is

much easier to renegotiate terms in time of crisis with few private lenders than several

debenture-holders. Generally, a company while issuing debentures or accepting other

forms of debt should ensure to have minimum of restrictive clauses that circumscribe its

financial actions in the future in debt agreements. This is a tough task for the financial

manager. A highly levered firm is subject to many constraints under debt covenants that

restrict its choice of decisions, policies and programmes. Violation of covenants can

have serious adverse consequences. The firm’s ability to respond quickly to changing

conditions also reduces. The operating inflexibility could prove to he very costly for the

firms that are operating in unstable environment. These companies are likely to have

low debt ratios and maintain high financial flexibility to remain competitive and not allow

compromising their competitive posture. Thus, financial flexibility is essential to maintain

the operating flexibility and face unanticipated contingencies.

Financial Slack

The financial flexibility of firm on the financial slack it maintains. The financial

slack includes unused debt capacity, excess liquid asset, unutilised lines of credit and

access to various untapped sources of funds. The financial flexibility depends a lot on

the company’s debt capacity and unused debt capacity. The higher is the debt capacity

of a firm and the higher is the unused debt capacity, the higher will be the degree of

flexibility enjoyed by the firm. If a company borrows to the limit of its debt capacity, it will

not be in a position to borrow additional funds to finance unforeseen and unpredictable

demands except at restrictive and unfavourable terms. Therefore, a company should

not borrow to the limit of its capacity, but keep available some unused capacity to raise

funds in the future to meet some sudden demand for finances.

Early repayment

A considerable degree of flexibility will be introduced if a company has the

discretion of early repaying its debt. This will enable management to retire or replace

46

cheaper source of finance for the expensive one whenever warranted by the

circumstances. When a company has excess cash and does not have profitable

investment opportunities, it becomes desirable to retire debt. Similarly, a company can

take advantage of declining rates of interest if it has a right to repay debt at its option.

Suppose that funds are available at 12 per cent rate of interest presently. The company

has outstanding debt at 16 per cent rate of interest. It an save in terms of interest cost if

it can retire the ‘old’ debt and replace it by the ‘new’ debt.

Limits of financial flexibility

Financial flexibility is useful, but the firm must understand its limit. It can help a

profitable firm to seize opportunities, and it can provide temporary help in adverse

situation, but it cannot save a firm, which is basically unhealthy. No doubt that financial

flexibility is desirable, but the firm should have basic financial strength. Also, it is

achieved at a cost. A company truing to obtain loans on easy terms will have to pay

interest at higher rate. Also, to obtain the right refunding, it may have to compensate

lenders by paying a higher interest or any have to allow them to participate in the equity.

Therefore, the company should compare the benefits and costs of attaining the desired

degree of flexibility and balance them properly.

Sustainability and Feasibility

The financing policy of a firm should be sustainable and feasible in the long run.

Most firms want to maintain the sustainability of their financing policy over a long period

of time. The sustainable growth model helps to analyse the sustainability and the

feasibility of the ling-term financial plans in achieving growth. This model is based on

the assumption that the firm used the internal financing and debt, consistent with the

target debt-equity ratio and payout ratio and does not issue shares during the planning

borazon. Given the firm’s financing and payout policies and operating efficiency, this

model implies that its assets and sales will grow in tandem with growth in equity

(internal). Thus, the sustainable growth depends on return on equity (ROE) and

retention ratio :

47

Sustainable growth = ROE x (1 - payout) (30)

ROE depends on assets turnover, net margin, and financial leverage :

ROE = asset turnover x net margin x leverage

ROE = assets/sales x net profit/sales x assets/equity (31)

Alternatively, ROE depends on the firm’s before-tax return on capital employed (ROCE),

the financial leverage premium and the tax rate:

ROE = [ROCE + (ROCE - kd) D/E](1 - T) (32)

The sustainable growth model indicates the growth rate that the firm should

target. Any other growth rate will not be consistent with the financial policies set by the

management. If the firm intends to achieve a different growth rate than that implied by

the sustainable growth model, it will have to change its financial policy, either the debt-

equity ratio, or the payout ratio or both. In face, the model also indicates the trade-offs

between the financial polices for achieving higher growth, the firm can examine its

operating policies vis-a-vis price, cost, assets utilisation etc. The firm must realise that

growth does not ensure value creation. It the firm does not account for the investment

duration and the cost of capital, growth may destroy value. The firm should also

examine the impact of alternative financial policy on the value of the firm.

Control

In designing the capital structure, sometimes the existing management is

governed by its desire to continue control over the company. This is particularly so in

the case of the firms promoted by entrepreneurs. The existing management teal not

only wants control and ownership but also to manage the company, without any outside

interference.

Widely held companies

The ordinary shareholders elect the directors of the company. It the company

issues new shares, there is risk of dilution of control. The company can issue rights

shares to avoid dilution of ownership. But the existing shareholders may not be willing to

fully subscribe to the issue. Dilution is not a very important consideration in the case of

48

widely held companies. Most shareholders are not interested in talking active part in a

company’s management. Nor do they have time and money to attend the meetings.

They are interested in dividends ad capita gains. IF they are not satisfied, they will sell

their shares. Thus, the best way to ensure control and to have the confidence of the

shareholders is to manage the company most efficiently and compensate shareholders

in the form of dividends and capital gains. The risk of loss of control can be reduced by

distribution of shares widely and in small lots.

Closely held companies

The consideration of maintaining control may be significant in case of closely held

and small companies. A shareholder or a group of shareholders can purchase all or most

of the new shares of a small or closely held company and control it. Even if the owner-

managers hold the majority shares, their freedom to manage the company will e curtailed

when they go for initial public offerings (IPOs). Fear of sharing control and being interfered

by others often delays the decision of the closely held small companies to go public. To

avoid the risk of loss of control, small companies may slow their rate of growth or issue

preference shares or raise debt capital. It the closely held companies can ensure a wide

distribution of shares, they need not worry about the loss of control so much.

The holders of debt do not have voting rights. Therefore, it is suggested that a

company should use debt to avoid the loss of control. However, when a company uses

large amount of debt, a lot of restrictions are put by the debt-holders, specifically the

financial institutions in India, since they are the major providers of loan capital to the

companies. These restrictions curtail the freedom of the management to run the

business. Avery excessive amount of debt can also cause serious liquidity problem and

ultimately render the company sick, which means a complete loss of control.

Marketability and Timing

Marketability means the readiness of investors to purchase a security in a given

period of time and to demand reasonable return. Marketability does not influence the

initial capital structure, but it is an important consideration to decide about the

appropriate timing of security issues. The capital markets are changing continuously. At

49

one time, the market favours debenture issues, and , at another time, it may readily

accept share issues. Due to the changing market sentiments, The company has to

decide whether to raise funds with an equity issue or a debt issue. The alternative

methods of financing should, therefore be evaluated in the light of general market

conditions and the internal conditions of the company.

Capital market conditions

If the capital market is depressed, a company will not issue equity shares, but it

may issue debt and wait to issue equity shares till the share market revives. During

boom period in the share market, it may he advantageous for the company to issue

shares at high premium. This will help to keep its debt capacity unutilised. The internal

conditions of a company may also dictate the marketability of securities. For example, a

highly levered company may find it difficult to raise additional debt. Similarly, when

restrictive covenants in existing in existing additional debt. Similarly, when restrictive

covenants in existing debt-agreements preclude payment of dividends on equity shares,

convertible debt may be the only sources of raise additional funds. A small company

may find difficulty in issuing any security in the market merely because of its small size.

The heavy indebtedness, low payout, small size, low profitability, high degree of

completion etc. Cause low rating of company, which would make it difficult for the

company to raise external finance at favourable terms.

Issue Costs

Issue or flotation costs are incurred when the funds are externally raised.

Generally, the cost of floating a debt is less than the cost f floating an equity issue. This

may encourage companies to use debt than issue equity shares. Retained earnings do

not involve flotation costs. The source of debt also influences the issue costs with fixed

costs being much higher for issue of commercial paper and public debt (debenture) than

the private debt. This also means that economies of scale are high for the debt

instruments having high fixed costs. Hence these instruments should be used when

large amounts of funds are needed. Issue costs as a percentage of funds raised will

decline with large amount of funds. Large firms require large amounts of funds, and they

50

may plan large issues of securities to economise on the issue costs. These firms are

more likely than others to resort to commercial paper or public debt for raising capital. A

large issue of securities can, however, curtail a company’s financial flexibility. The

company should raise only that much of funds, which it can employ profitably. Many

other more important factors have to be considered when deciding about the methods

of financing and the size of a security issue.

Capacity of Raising Funds

The size of a company may influence its capital and availability of funds from

different sources. A small company finds great difficulties in raising long-term loans. It is

able to obtain some long-term loan, it will be available at a higher rate of interest and

inconvenient terms. The highly restrictive covenants in loan agreements in case of small

companies make their capital structure very inflexible and management cannot run

business freely without interference. Small companies, therefore, depend on share

capital in the capital markets. Also, the capital base of most small companies is so small

that they can not be listed on the stock exchanges. For those small companies, which

are able to approach the capital markets, the cost of issuing shares is generally more

than the large ones. Further, resorting frequently to ordinary share issues to raise long-

term funds carries a greater risk of the possible loss of control for a small company. The

shares of small companies are not widely scattered and the dissident group of

shareholders can be easily organised to get control of the company. The small

companies, therefore, sometimes limit the growth of their business to what can easily

financed by retaining the earnings.

A large company has relative flexibility in designing its capital structure. It can

obtain loans on easy terms and sell ordinary shares, preference shares and debentures

to the public. Because of the large size of issues, its cost of distributing a security is less

than that for a small company. A large issue of ordinary shares can be widely distributed

and thus, making the loss of control difficult. The size of the firm has an influence on the

amount and the cost of funds, but it does not necessarily determine the pattern of

financing. In practice, the debt-equity ratios of the firms do not have a definite

relationship with their size.

51

CHAPTER - IV

CAPITAL STRUCTURE DECISION : DATA ANALYSIS & INTERPRETATION

52

VAISHAL PATILIPUTRA DUGDH UTPADAK SAHKARI SANGH LTD

BALANCE SHEET(As on 31st march 2008)

LIABLITIES SHARE CAPITALAUTHORISED SHARE CAPITAL

PAID UP SHARE CAPITALSHARE DEPOSIT

50000000.00

9043300.00 1191189.84 10234489.84

RESERVES & SURPLUS 241714627.52LONG TERM LOAN 31424000.00CURRENT LIABLITIESPROVISION SUNDRY CREDITORSDEMAND LOAN WITH BANKINTREST PAYABLLIABLITY FOREXPENSESLIABLITIES-OTHERLIABLITIY-VAT

5885723.08 151084261.15 70316474.10 2180206.18 11463770.80 18840419.06 966067.85 260736922.22

NET PROFIT FROM P/L ACCOUNT

5860196.05

549970235.63ASSETSFIXED ASSET 227219711.34INVESTMENTS 51689255.55CURRENT ASSETCLOSING STOCKDEPOSITLOAN & ADVANCESUNDRY DEBTORSCASH-IN –HANDBANK ACCOUNT INTREST RECEIVABLESINVESTMENT(short term)STOCK & STORES

7531374.00 1973366.83 180755910.23 27875007.44 207909.85 64766594.92 3908027.12 84407418.31 62315660.04 271061268.74

549970235.63

53

VAISHAL PATILIPUTRA DUGDH UTPADAK SAHKARI SANGH LTDBALANCE SHEET

(As on 31st march 2009)LIABLITIES SHARE CAPITALAUTHORISED SHARE CAPITAL

PAID UP SHARE CAPITALSHARE DEPOSIT

50000000.00

9254100.00 1164996.59 10419096.59

RESERVES & SURPLUS 259147749.05LONG TERM LOAN 48568000.00CURRENT LIABLITIESPROVISION SUNDRY CREDITORSDEMAND LOAN WITH BANKINTREST PAYABLELIABLITY FOR EXPENSESLIABLITIES-OTHERLIABLITIY-VAT

6897121.86189496174.24

70003516.0025679772.07

16487422.83 19425725.36 744591.19 305622523.55

NET PROFIT FROM P/L ACCOUNT

8153851.43

631911220.62ASSETSFIXED ASSET 239611774.43INVESTMENTS 83608423.84CURRENT ASSETCLOSING STOCKDEPOSITLOAN & ADVANCESUNDRY DEBTORSCASH-IN –HANDBANK ACCOUNT INTREST RECEIVABLESINVESTMENT(short term)STOCK & STORES

12151249.00 5061277.83 15552379.20 33782122.41 81202.45 58984222.62 7032101.16 83259638.00 92786829.68 308691022.35

631911220.62

54

VAISHAL PATILIPUTRA DUGDH UTPADAK SAHKARI SANGH LTDTRADING & PROFIT & LOSS ACCOUNT

(for the year ending 31st march 2008)

Particulars Amount in Rs. Particulars Amount in Rs.Opening Stock

Stock of Finished GoodsPurchase Accounts

Purchase for saleDirect Expenses

Carriage & HandlingConsumption of Packing Mat CFConsumption of Packing Mat FBDConsumption of Raw Mat CFConsumption of Raw Mat FBDConversion Exp.DepreciationPower & FuelRepair & MaintenanceStores & Spares ConsumptionWages

Gross Profit c/o

11075497.00

59710507.60

51630002.599459622.74

38149800.18158332124.89771958375.07

220016.258342641.00

41284779.437568257.681015504.463437398.41

11075497.00

59710507.60

1091398522.7092283032.38

SalesSale of Cattle FeedSale of MilkSale of Milk Product

Closing StockStock of Finished Goods

197666732.00890761077.83158508375.85

7531374.00

1246936185.68

7531374.00

1254467559.68 1254467559.68

Indirect ExpensesFringe Benefit axInterest PaidOther expensesSalary and WagesStatutory Audit FeeProfit Before TaxIncome Tax

Nett Profit

204041.002124498.15

36008680.0861055750.55

112360.00 99505329.78

2398746.005860196.05

Gross Profit b/fOther Receipts

Income from scrap & other receipts

Interest Received5825692.019655547.44

92283032.38

15481239.45

8258942.052398746.00

107764271.83 107764271.83

55

VAISHAL PATILIPUTRA DUGDH UTPADAK SAHKARI SANGH LTDTRADING & PROFIT & LOSS ACCOUNT

(for the year ending 31st march 2009)

Particulars Amount in Rs. Particulars Amount in Rs.Opening Stock

Stock of Finished GoodsPurchase Accounts

Purchase for saleDirect Expenses

Carriage & HandlingConsumption of Packing Mat CFConsumption of Packing Mat FBDConsumption of Raw Mat CFConsumption of Raw Mat FBDConversion Exp.DepreciationPower & FuelRepair & MaintenanceStores & Spares ConsumptionWages

Gross Profit c/o

7531374.00

92707476.63

54812685.678100523.80

42072961.80147840132.31882258493.10

0.0010245585.0051286601.46

9787794.491450497.593772111.35

7531374.00

92707476.63

121127386.57107143964.61

SalesSale of Cattle FeedSale of MilkSale of Milk Product

Closing StockStock of Finished Goods

195057603.901046161168.42

165640180.49

12151249.00

1406858952.81

12151249.00

1419010201.81 1419010201.81

Indirect ExpensesFringe Benefit axInterest PaidOther expensesSalary and WagesStatutory Audit FeeProfit Before TaxIncome Tax

Nett Profit

280449.005698857.19

41596884.0566487331.92

100000.00 114163522.16

2333553.008153851.43

Gross Profit b/fOther Receipts

Income from scrap & other receipts

Interest Received3482365.74

14024596.24

107143964.61

17506961.98

10487404.432333553.00

124650926.59 124650926.59

56

LIQUDITITY RATIO

PARTICULAR 2008-09 2009-10CURRENT RATIO=CURRENT ASSET/CURRENT LIABLITY

271061268.74/260736922.22=1.03:1

308691022.35/305622523.55=1.01:1

QUICK RATIO =(CURRENT ASSET-INVENTORY)/ CURRENT LIABLITY

201214234.70/260736922.22=0.77:1

203752943.67/305622523.55=0.66:1

LEVERAGE RATIO

PARTICULAR 2007-08 2008-09CAPITAL GEARING RATIO=FIXED INTREST BEARING FUND/EQUITY SHARE CAPITAL

31424000/9043300=3.48

48568000/9254100=5.25

INTREST COVERAGE RATIO=EBDT/FIXED INTREST CHARGE

8258942.05/2124498.15=3.89

10487404.43/5698857.19=1.84

DEBT EQUITY `RATIO=LONG TERM LOAN /SHAREHOLDER FUNDS

31424000.00/251949117.36=0.12

48568000.00/269566845.64=0.18

TOTAL DEBT=TOTAL ASSET / LONG TERM LOAN

549970235.63/31424000.00=17.50

631911220.62/48568000.00=13.01

57

GLANCE OF FINANCIAL ANALYSIS IN VDPUSSL

PARTICULAR 2007-08 2008-09

LIQUDITY RATIO

CURRENT RATIO 1.03:1 1.01:1QUICK RATIO 0.77:1 0.66:1PROFITABLITY RATIOGROSS PROFIT RATIO 8.07% 7.62%NET PROFIT RATIO 0.83% 0.58%RETURN ON NETWORTH FUND 5.14% 3.02%RETURN ON TOTAL ASSET 1.06% 3.91%RETURN OF CAPITAL EMPLOYED 4.032% 3.91%ACTIVITY RATIOSTOCK TURNOVER RATIO 166 Times 116TimesWORKING CAPITAL TURNOVER RATIO 121 Times 458 TimesFIXED ASSET TURNOVER RATIO 5.08 Times 5.4 2Times LEVERAGE RATIO CAPITAL GEARING RATIO 3.40 5.25INTREST COVERAGE RATIO 3.88 1.84DEBT EQUITY RATIO 1.25 0.18TOTAL DEBT /ASSET RATIO 18 13

58

PATNA DAIRY PROJECT.

Calculation of EBIT, EBT & EAT

(All in Rs.)

Years

Total Cap Employed

Long Term Debts

Equity Share Capital

Reserve and Surplus

Net Worth EBIT Interest EBT Dividend EAT

07-08 283373117.4 31424000 9043300 241714628 113904962 10383440 2124498.2 8258942.05 1053528 5860196.1

08-09 305622523.6 48568000 9254100 259147749 124671929 16186262 5698857.2 10487404.4 1085196 8153851.4

Sourses of Annual reports of Patna Dairy Project.

Computation of DFL,EPS,DPS, D/P Ratio, Cost of Debt,Equity & ROI

Years DFLEPS (Rs)

DPS (Rs)

D/P Ratio

ROICost of

debt (%)

Cost of Equity

(%)

Rate of Return

(%)

07-08 1.257 11.720 2.107 17.978 11.500 8.160 0.925 2.068

08-09 1.543 16.308 2.170 13.309 11.500 8.941 0.870 2.668

Sources :- Computed from Annual Reports of Patna Dairy Project.

Notes and Explanations:-

1) DFL = EBIT/EBT

2) EPS = EAT/No of Equity Shares.

3) DPS = Dividend/ No of Equity Shares

4) D/P Ratio = (DPS/EPS) *100

5) Rate of Intt.= (Intt./Long term debt)*100

6) Cost of debt (%) = Rate of Intt.(1- Tax Rate)

7) Cost of Equity (%) = (Dividend/Net Worth)*100

59

8) Rate of Return on Investment = (EAT/Total Cap.Employed)*100

60

GRAHICAL PRESENTATION

61

62

Analysis

Ratio 2008 2009

Debt Equity Ratio 1.25 0.18

Debt to Assets Ratio 18 13

Interest Coverage Ratio 3.88 1.84

Debt equity ratio

It is calculated by dividing long term debt by total equity. It implies the

proportion of long term debt employed in a firm for every Re 100 of equity. We can

see that over 2008 to 2009, this ratio has come down. However as we can see, this

is not because of additional equity raised by the firm or redemption of debt. This is

because of the increase in shareholder’s equity out of increase in reserves from

241714627.52 in 2008 to 259147749.05 in 2009. Thus the company is using

ploughing back of profits as a major source of funds. The decrease if D/E ratio also

implies that the company has become financially sound over that years and it can

face difficult situations more effectively as it will has lesser amount of interest

liabilities. Also the company is in a better position to avail debt as and when required.

But it also means that the company is reducing its financial leverage because of

which it won’t be able to trade on equity.

Debt to assets ratio

It is calculated by dividing long term debt by total assets of the firm. It shows

how much of the total assets of the firm is financed by debt. It is also an indicator of

the financial soundness of the firm and also the risk of the lenders. We can see that

over 2008 to 2009 this ratio has also come down from 13 to 18 as the value of its

assets have increased more than the increase in debt. Hence, it is in a better

position to repay debt over the long term.

Interest coverage Ratio

It is calculated by dividing profit before interest and tax by the interest paid to

lenders. It shows the ability of the company to paid interest charges out of its current

63

earnings. It has increase from 3.88 to 1.24 which is not good sign for the lenders as

the company.

Hence from the analysis of the financial statement of the firm, we can see

than the company is reducing the proportion of debt in its capital structure which is a

conservative approach. It is using reserves as a major means to finance its

operations. This has advantages as well as disadvantages which have already been

explained in the theory above.

INVESTMENT MADE BY THE DCS AS EQUITY SHARES

Vaishal Patliputra Dugdh Utpadak Sahkari Sangh Ltd. has an authorised

share capital of Rs. 5,00,00,000/- of face value Rs. 100 each. Total paid up share

capital in 2007-08 was Rs. 9043300 which rose to Rs. 9254100 in 2008-09. Total

share capital deposit decreased from Rs. 1191189.84 in 2007-08 to Rs. 1164996.59

in 2008-09.

ASSETS CREATED BY THE GOVT. DIRECTLY

Vaishal Patliputra Dugdh Utpadak Sahkari Sangh Ltd. has been sanctioned

with some assets by the government. Total assests received from Government of

Bihar worth Rs. 3,14,24,000 as on 31st March 2009.

FUNDING FROM THE GRANTS

Vaishal Patliputra Dugdh Utpadak Sahkari Sangh Ltd. has continuously been

receiving various grants under various schemes of govt. and institutions. Some of

the grants received by VPDUSS are NDDB Grant Under Operation Flood, State and

central Government grants under different schemes, such as IDDP, Nalanda; DRDA,

CMP etc.

LONG TERM LOANS

Vaishal Patliputra Dugdh Utpadak Sahkari Sangh Ltd. has acquired long term

loans from various sources, which includes NDDB, CDC and other banking and

financial institutions.

64

CHAPTER - V

CONCLUSION AND SUGGESTIONS

65

CONCLUSION

Capital structure may be defined as the mixture of debt and equity that

comprises the financing of its assets. Hence, the total balance of capital and

liabilities is financial structure, not a capital structure. The main objective of financial

manager behind capital structure management is to minimize the overall cost of

capital and risk, and take the advantage of favorable financial leverage and

corporate tax. So while maintaining the proportion between debt and equity, their

merits and demerits should be evaluated relatively. 

It is not possible to have an ideal capital structure, however, the management

should target capital structure and initial capital structure should be framed with

subsequent changes in initial capital structure to have it like target capital structure.

Some companies do not plan capital structure but they are still achieving a good

prosperity.

Patna Dairy Project is a cooperative organisation and profit is not the

objective. The objective of the firm is to render the services to its member, despite it

generate some surplus which is distributed among the member after retaining some

of the reserve. Decrease in gross profit ratio is the cause of enhancement of direct

cost such as material, labour and petroleum product.

The increase in the net profit and cash profit ratio demonstrate the efficiency

of the management as regard to the reduction of the direct cost.

Return on network and return on capital employed is reducing influence by the

capital grants received from the government agency and kept as a reserve enhance

the asset reduces the return. Though same may work as a future as better return on

network and return on capital employed.

Capital gearing is increased as there is moderate consideration of loan from

NCDFI has increased gearing. Interest coverage out of the profit is reduced as there

is an increase in the interest paid account due to increase in enhancement of loan

however the organisation is comfortably increase the net profit before the tax to the

tune of 78% as compare to the year 2007-08. Hence the coverage is reduce to

66

1.84% from 3.89% is excellent is a positive sign of performance.

There is increase in debt cause increase in debt equity ratio & debt is now 13

times. These all shows positive sign of organisation.

The company is currently run by cooperative movement. Equity shares are

increased to the tune with in the study period, where as secured loans under various

has also increased in the year 2008-2009.

The degree of financial leverage has showed an increasing trend. It has

grown by more than a half in 2008-09 when compared to 2007-08. Earning per share

(EPS) has increased by Rs. 4.587 from 2007-08 in 2008-09. The total EPS recorded

in 2008-09 was Rs. 16.308.

The cost of debt has remained constant due to just single factor, i.e., long

term liabilities include subsidised loans and fund raised through loan on which

interest is charged, the total cost of debt accumulates @11.5% p.a.

The cost of equity has lowered considerably due to increase in subsidised

grants from government in 2008-09 as compared to 2007-08.

The current year debt content includes loan from banks. If it is compared with

the share capital and Reserves (including Grants) then the ratio is not satisfactory.

Although company is employing debt in its capital structure, it is not able to take

advantage of borrowed capital, because as debt is cheaper source of finance only

when there are taxes.

The rate of return in 2007-08 was 2.068% which rose to 2.668% in 2008-09.

We can easily observe that the firm has been slowly and steadily outperforming in its

core operation areas.

Suggestions:-

1) The company should need to include more debt contents in its capital

structure in order to get the advantage of tax benefits as debt is a cheaper

source of financing.

2) The business environment of the company is reasonably good. The

67

company’s track record is always oriented towards profitable growth and with

strong fundamentals.

3) Smooth functioning will release locked up capital and improve the cash flow.

4) The capital should be used effectively with the improvement in manufacturing

activity and minimizing cost.

5) Acquisition of new assets of heavy costs should be done with proper capital

budgeting supported by payback period.

68

ANNEXURE

69

BIBLIOGRAPHY

ANNUAL REPORT OF VPDUSS

FINANCIAL MANAGEMENT BY KISHOR M.RAVI

FINANCIAL MANAGEMENT BY PANDEY I. M.

FINANCIAL MANAGEMENT BY KHAN AND JAIN

MANAGEMENT ACCOUNTING BY GUPTA S.P.

WEB SITES:

1. www.amul.com

2. www.comfed.com

3. www.google.com

4. www.ndri.com

5. www.nddb.com

70

CONTENTS

CHAPTER -I INTRODUCTION 1-3

i) INTRODUCTION TO THE TOPIC

ii) OBJECTIVES OF THE STUDY

iii) METHODOLOGY

iv) LIMITATIONS

CHAPTER-II ORGANISATIONAL PROFILE 4-21

i) THE INDIAN DAIRY MARKET - A PYRAMID

ii) HISTORICAL BACKGROUND OF DAIRY DEVELOPMENT

iii) ORGANISATIONAL STRUCTURE OF PATNA DAIRY PROJECT

iv) PROGRESS UNDER VAISHAL PATLIPUTRA DUGDH UTPADAK SAHKARI

SANGH LTD. (VPDUSS)

v) THRUST AREAS

vi) PDP : AT A GLANCE

CHAPTER-III CAPITAL STRUCTURE : THEORETICAL CONCEPTS 22-51

I) MEANING & DEFINITION

II) OPTION DECIDING THE CAPITAL STRUCTURE FOR FINANCIAL

MANAGER OR FORMS / PATTERNS OF CAPITAL STRUCTURE

III) CAPITAL STRUCTURE IN A PERFECT MARKET

IV) CAPITAL STRUCTURE IN THE REAL WORLD

V) SIGNIFICANCE OF CAPITAL STRUCTURE

VI) OPTIMAL CAPITAL STRUCTURE

VII) LEVERAGE

VIII) THEORIES OF CAPITAL STRUCTURE

IX) CAPITAL STRUCTURE PLANNING AND POLICY

X) PRACTICAL CONSIDERATIONS IN DETERMINING CAPITAL

STRUCTURE

CHAPTER-IV CAPITAL STRUCTURE DECISION : DATA

ANALYSIS & INTERPRETATION 52-63

CHAPTER-V CONCLUSION AND SUGGESTIONS 64-67

ANNEXURE BIBLIOGRAPHY 68-69

GLOSSARY 70-70

ACKNOWLEDGEMENT

71

Preparing the project is not a solely the work of single person. This project is

certainly not an exception to this adage. This is a collective effort of experience of

the consultant in corporate finance practice & mine.

Firstly, I would like to extend my highest regard to my respected H.O.D. Dr.

Brahmanand Pandey & Co-ordinator Dr. Md. Alamgir (Reader) of the

DEPARTMENT OF APPLIED ECONOMICS AND COMMERCE, PATNA

UNIVERSITY, PATNA for giving me fine opportunity to communicate my inner

feelings with facts.

I would like to thank to Managing Director of Patna Dairy Project Shree

Sudhir Kumar Singh for giving me an opportunity to do the summer project in Patna

Dairy Project.

I would like to express my gratitude to Shree Bhanu Pratap (Incharge

Accounts) for introducing me to Shree Ratneshwar Jha (Accounts Officer) as my

industrial guide.

I would further like to extend my gratitude to our respected and learned guide

Shree Ratneshwar Jha (Accounts officer) who has given me sufficient matter for

preparing my summer training report and a clear concept to communicate my

feelings regarding the same.

I would like to thank Shree S V Narsimhan , Shree Jawaid Akhtar , Shree

Madan Mohan Mishra, Shree Amit Sinha , Shree Vinay Kumar Mishra , Shree

Prasant Kumar Mishra ,Shree Ajay Kumar, Shree Naval Kumar Gupta for their

cooperation and support.

I am thankful to my parents and friends who has given me an excellent

support and perfect instructions to complete this project. I could not have

devoted the time and energy to this project without the support and encouragement

of my family members.

(Akhilesh Kumar)

72

PREFACE

A summer training report is a scientific and systematic study of real issues on

a problem with the application of management concepts and skills. The study can

deal with small or big issues in any area of organization. It can be a case study

where a problem has been dealt with through the process of management.

To attend maturity and perfection in any field, theoretical knowledge must be

blended with practice application. Management theory is no exception to it. Theory of

management needs to be tested and verified in various types of situation. Since a

manager works in a dynamic and complex environment, practical training is

indispensable for getting acquaintance with the environment.

Summer training is an essential part of Master of Business Administration

curriculum. It enables the student to share the real experience in industry. My

summer training was placed in Patna Dairy Project, Phulwari Sharif, Patna. The topic

of my project is "CAPITAL STRUCTURE - A STUDY IN PATNA DAIRY PROJECT".

I have tried my level best to present this summer training report in a simple

and lucid style so that it can be understood by anyone who goes through it. I hope

the summer training report will be much useful to the readers and users. I hope this

summer training report will help and guide to the potential students of Master of

Business Administration.

73