Analysis of Capital Structure of a Company

Analysis of Capital Structure of a Company

Name of the Company – Patni Computer Systems Ltd. Name of the Chairman – Narendra K. Patni Background of the Company The Patni Computer Systems Ltd. (Patni) was incorporated on 10th February 1978 under the Companies Act 1956. The company converted itself from a private limited company to a public limited company on 18th September 2003. It is now a leading IT consulting services and business solutions provider in India. The majority of the services offered are in the fields of insurance, manufacturing, retail, telecom etc.

It has over 12,500 professionals building up a strong team, with 23 sales and marketing offices internationally and many offshore development centres across eight cities in India. The company’s clientele has increased from 199 as of December,31st 2005 to 272 as of December,31st 2009. The company has been certified with ISO 9001:2000 certification and is assessed at SEI-CMMI level 5 and P-CMM level 3. The business processes at Patni are in accordance with Six Sigma and BS 7799. It has alliances with major IT companies such as Microsoft, SAP, Siebel and Oracle.

The major revenue generation of about 60% is from manufacturing and BSFI, but now the telecom domain is also gaining momentum and is contributing to the revenue generation. Whereas, geographically US is the major revenue generator contributing about 84. 8% to the total revenue. Europe generating revenue of 9. 1% and Japan that of 4. 3%. And receiving a percentage of 0. 7 from Asian countries and 1. 1% from the rest of the world. Though the percentage of revenue contribution by US has declined from 88. 8% in 2003 to 84. 8% in 2005, and the European region’s contribution has been steadily increased to 9. % in 2005 from 7. 2% in 2003. CAPITAL STRUCTURE Capital structure refers to the sources and division of capital for any organization. The combination of debt and equity forms a capital structure. •Share Capital (owned capital) i. Equity Share Capital ii. Preference Share Capital •Borrowed Capital (owed capital) i. Debentures ii. Long Term loan iii. Short Term Loan For example, a firm comprising of $20 million dollars in equity and $80 million dollars in debt, is said to be 20% equity-financed and 80% debt-financed. Therefore, in this example, 80% is referred to as firm’s leverage.

But in reality the capital structure of a firm may be highly complex and include many sources of funds Debt-Equity Ratio is the portion of equity and debt that a company is using to finance its assets. It is calculated by total of debts upon total equity. Factors affecting Capital Structure:- 1. Business Risk Business risk is the basic risk of the company’s operations. It excludes debt. As the business risk increases the optimal debt ratio decreases. Example, if we compare a utility company with a retail apparel company, the utility company will have less risk as there is stability in earnings.

Whereas, in retail apparel company there is more risk as the sales of this company is driven by trends in fashion. Thus, a retail apparel company will have a lower optimal debt ratio so that investors can rely on the company’s ability to meet its responsibilities with the capital structure at all times. 2. Company’s Tax Exposure Debt payments are tax deductible. If a company’s tax rate is high, then debt is more likely to be used for financing a project as debt payments are tax deductible which protects income to be given as tax. 3. Financial Flexibility Financial flexibility is the ability of a firm to raise capital at bad times.

A company can easily raise capital when the cash inflows are strong and when the sales is growing. Companies should be prudent and raise capital at good times. If the debt level of the company will be low, the more will be its financial flexibility. 4. Management style Management styles adopted by the management can range from aggressive to conservative. A conservative manager is less inclined to use debt to increase its profits whereas an aggressive manager tries to grow the firm quickly as by using significant amount of debt, the earning per share also increases. 5. Market condition

There is a significant impact of market conditions on a company’s capital structure condition. For example, a company wants to borrow funds for a new plant. If the investors are not willing to invest due to market conditions, the interest rate to borrow would be higher than what companies are willing to pay. Therefore, companies should be prudent enough to wait for the market to be in normal condition before borrowing funds. Capital Structure of Patni Computers :- (Rs. Crore) Dec ‘ 09Dec ‘ 08Dec ‘ 07Dec ‘ 06Dec ‘ 05 Sources of funds Owner’s fund Equity share capital25. 8325. 6227. 8027. 6627. 56

Share application money11. 880. 030. 180. 27- Preference share capital—– Reserves & surplus3,165. 922,495. 422,530. 072,180. 182,013. 57 TOTAL EQUITY3203. 632521. 072558. 052208. 112041. 13 Loans fund Secured loans0. 941. 752. 383. 063. 18 Unsecured loans—– TOTAL DEBT 0. 941. 752. 383. 063. 18 DEBT/EQUITY0. 00030. 00070. 00090. 00140. 0015 From the above table we can see that the debt- equity ratio of Patni Computers is consistently 0. 0. This means that there is no debt. They generate a lot of cash and thus do not have to borrow from banks and other sources. They therefore have very less or no risk.

Moreover, the portion of secured loans has also been decreasing, which means that they have paid the due loans against security. CAPITAL ASSET PRICING MODEL (CAPM) The Capital Asset Pricing Model (CAPM) expresses the relationship between risk and the expected return that is used in the pricing of risky securities. The general ideology is that the investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by Rf which determines the ‘risk free’ factor. It compensates the investors for placing money in any investment over a period of time.

The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf). CAPM= Re= Rf + ? (Rm – Rf) Here, Rf is the rate of ‘risk-free’ investment ? is equal to the stock’s beta Rm is the return rate of market Therefore, Re = 4% + (-0. 034)(17. 23% ¬¬- 4%) = 0. 04 + (-0. 034)(0. 1723 – 0. 04) = 0. 04 + (-0. 034)(0. 1323) = 0. 04 – 0. 0044 = 0. 0356 or 3. 56% Here, Rf = 4% or 0. 04 Rm = 17. 23% or 0. 1723 = (-0. 034) ? WEIGHTED AVERAGE COST OF CAPITAL (WACC) Weighted Average Cost of Capital is the calculation of a firm’s cost of capital in which each category of capital is proportionately weighted. All capital sources – common stock, preferred stock, bonds and any other long-term debt – are included in a WACC calculation. Everything remaining equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk. It is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation.

By using the weighted average, it shows how much interest is to be paid for every dollar that the company finances. The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing: Post Tax Pre Tax Where: Re = cost of equity => 3. 56% Rd = cost of debt – Interest paid/ Total debt = 1534/0. 94=>16. 31% E = market value of the firm’s equity =; 3203. 63 D = market value of the firm’s debt => 0. 94 V = E + D = 3203. 63+0. 94 => 3204. 57 E/V = percentage of financing that is equity = 3203. 63/3204. 57=> 0. 99 D/V = percentage of financing that is debt = 0. 94/3204. 57=> 0. 0 Tc = corporate tax rate = tax charges/PBT = 39. 06/581. 79 => 0. 067 or 6. 7% Pre Tax WACC = E/V* Re + D/V* Rd = (0. 99*0. 035) + (0. 00*0. 16) = 0. 0346 + 0 = 0. 0346 or 3. 46% Post Tax WACC = E/V* Re + D/V* Rd *(1-tc) = (0. 99*0. 035) + (0. 00*0. 16) (1-0. 067) = 0. 0346 + (0. 00*0. 16) (0. 933) = 0. 0346 + 0 = 0. 0346 or 3. 46% Therefore, we can see that the company has very minimal proportion of debt as compared to its equity and the pre-tax WACC equals the post-tax WACC. This further means that the company does not have an advantage of taking debt as there is no interest tax shield. DIVEDEND POLICY Dividend history:-

Year EndDividend AmountDividend %Dividend Yield %Dividend per Share(Rs)Face Value(Rs) Dec-200938. 74150. 000. 623. 002. 00 Dec-200838. 45150. 002. 333. 002. 00 Dec-200741. 82150. 000. 903. 002. 00 Dec-200641. 48150. 000. 723. 002. 00 Dec-200534. 47125. 000. 502. 502. 00 Dec-200425. 00100. 000. 522. 002. 00 Dec-200312. 4850. 001. 002. 00 Dec-20023. 9130. 000. 602. 00 Source DateDividend %Dividend Yield %Dividend per Share(Rs)Face Value(Rs)Dividend DateRecord DateDividend Type 13/8/2010315013. 8563230/8/201031/8/2010Interim Total315013. 8563 Record Date – 30th August 2010 Ex- Dividend Date – 26th August 2010

Dividend Declaration Date – 17th September 2010 Patni Computer Systems have been very consistent in declaring dividends. The dividend percentage has gone up for the financial year 2005 and 2006 by 25%. And from the financial year 2006 to 2009 it has remained consistent at 150%. ? EVENT ANALYSIS Patni declares interim dividend of Rs 63; shares up 8 per cent on BSE PTI, Aug 14, 2010, 12. 13pm IST MUMBAI: Shares of IT firm Patni Computers on Friday settled with a gain of over 8 per cent on the Bombay Stock Exchange after the company declared an interim dividend of Rs 63 per share for shareholders of the company.

Shares of Patni Computers closed at Rs 516. 85, up 8. 35 per cent on the BSE. During the session, the stock surged nearly 16 per cent to touch an intra-day high of Rs 551. 70. The board of directors of the company, at its meeting held today, declared a special interim dividend of Rs 63 per share of Rs 2 face value. “Shareholders were expecting something from the company in the form of an interim dividend. The company is having surplus cash, which it has passed on to its shareholders, which is good,” CNI Research CMD Kishore P Ostwal said. On the National Stock Exchange, the stock settled up 8. 78 per cent at Rs 518. 75.

A total of over 2. 58 crore shares of Patni Computers changed hands on both the bourses. Last month, the company had reported a growth of nearly 8 per cent in net profit to Rs 146. 74 crore for the quarter ended June 30 due to foreign exchange gains. The company had posted a net profit of Rs 135. 96 crore for the same quarter of the previous year. Therefore, by studying all of the above we can say that Patni Computer System is a self sufficient firm. It has minimal amount of debt which makes it less risky and has high cash liquidity. It has been very consistent in declaring dividends and there is not much fluctuation in the share prices.