MAHINDRA & MAHINDRA LTD

(2010-11)

Presented by: J.P.Pandey Sohan Lal Kathat Sudhir Thakur Dr.Barkha Gupta Harsha Jainwal

 It

is the required rate of return on invested funds It is also referred to as a hurdle rate because this is the minimum acceptable rate of return
The

cost of capital represents the overall cost of financing to the firm

 The

capital funding of a company is made up of two components: debt and equity. Lenders and equity holders each expect a certain return on the funds or capital they have provided. The cost of capital is the expected return to equity owners (or shareholders) and to debtholders, so WACC tells us the return that both stakeholders - equity owners and lenders - can expect. WACC, in other words, represents the investor's OPPORTUNITY COST of taking on the risk of putting money into a company.

 Capital

Assets Pricing Model(CAPM) Arbitrage Pricing Theory Model (APT) Buildup Model Discounted Cash Flow Model Fama-French Three Factor Model

 It

calculates the required rate of return on investment in a specific business as a simple sum: A risk-free rate of return A risk premium associated with the investment

ke Rf ( Rm Rf )
Cost of Equity Risk-free return Co-variance of returns against the portfolio (departure from the average)
B < 1, security is safer than average B > 1, security is riskier than average

Average rate of return on common stocks

 Advantage:

Evaluates risk Disadvantage: Need to estimate

Beta The risk premium (usually based on past data, not future projections) Use an appropriate risk free rate of interest

 Cost

Of Debt = kd kd is the interest paid to new bond holders.But since interest is tax deductible Effective cost of debt = after tax cost of debt = Earnings before tax - tax benefit Effective cost of debt =kd(1 - T)

Cost of Debt (kd)=Interest Expenses/Debt Value

=(70.86/12707.50) * 100
=0.55%

It is the rate of return investors require on an equity investment in a firm.

Ke = Rf + Beta (Rm-Rf). Rf Risk-free rate - This is the amount obtained from investing in securities considered free from credit risk, such as government bonds from developed countries. Beta is measures how much a company's share price reacts against the market as a whole (Rm Rf) =Equity Market Risk Premium - The equity market risk premium (EMRP) represents the returns investors expect to compensate them for taking extra risk by investing in the stock market over and above the risk-free rate.

Risk Free rate (Rf) = 7% Beta () = 1 Market Risk Premium (Rm) = 15%
Cost of Equity(Ke) = Rf - (Rf-Rm) =7- 1*(7-15) =15%

 The

total cost of the capital used to finance or purchase a business. It is computed from the respective costs of debt and equity and their relative proportion in the deal structure. The weighted average cost of capital (WACC) reflects the overall costs of combined debt and equity capital used to finance business operations or acquisition

Weight of Equity (WE)

Value of Equity(E) =34947.06 Cr. of Debt(D) = 12707.5 Cr.

Value WE=

E/D+E = 34947.06/(12707.50+ 34947.06)

WE = 0.733

Weight of Debt (WD)

Value of Equity(E) =34947.06 Cr. Value of Debt(D) = 12707.5 Cr. WD= D/D+E = 12707.50/ (12707.50+ 34947.06) WD = 0.2666

Tax Rate (T) Tax Expenses = 761.67 Cr. Earning Before Tax (EBT )= 3519.61 Cr. Tax Rate (T) =Tax Expenses/ Earning Before Tax (EBT)
Tax Rate (T) =761.67/3519.61 Tax Rate (T) = 21.64%

 WACC

weights the cost of equity and the cost of debt by the percentage of each used in a firms capital structure WACC= Ke*W + Kd*WD(1-T)
E

Ke=Cost of Equity WE=Weight of Equity Kd=Cost of Debt WD=Weight of Debt

(1-T)=After-tax % or reciprocal of corp tax rate Tc.

 WACC

weights the cost of equity and the cost of debt by the percentage of each used in a firms capital structure WACC= Ke*W + Kd*WD(1-T)
E

Ke=Cost of Equity WE=Weight of Equity Kd=Cost of Debt WD=Weight of Debt

(1-T)=After-tax % or reciprocal of corp tax rate Tc.

 WACC

weights the cost of equity and the cost of debt by the percentage of each used in a firms capital structure WACC= Ke*W + Kd*WD(1-T)
E

Ke=Cost of Equity WE=Weight of Equity Kd=Cost of Debt WD=Weight of Debt

(1-T)=After-tax % or reciprocal of corp tax rate Tc.

Ke=15% Kd = 0.55% WE= 0.733 WD= 0.266 T=21.64%

WACC = Ke*WE+ Kd*WD(1-T) = 15*0.733+ 0.55*0.266(1-21.64) =11.10%

WACC should be based on market rates and valuation, not on book values of debt or equity Book values may not reflect the current market place WACC will reflect what a firm needs to earn on a new investment. But the new investment should also reflect a risk level similar to the firms Beta used to calculate the firms RE. The WACC is not constant It changes in accordance with the risk of the company and with the floatation costs of new capital