Finance is the backbone of every organization. Adequate
finance is required besides the requirement of fixed as well as working capital
for undertaking any programme or expansion of the organization. In today’s time
both domestic and international markets are available for raising fund. These
Funds can be raised in the form of bonds, shares, debentures etc. The charge on
each source capital is known as cost of capital. The cost of capital of any
investment is the rate of return the suppliers of capital would expect to
receive if the capital were invested elsewhere in an investment of comparable
risk or simply the opportunity cost. The present study is to focus on factors
affecting it and comparing methods to calculate cost of capital which is
adequate for the firm.
Paper 1- Cost of Capital and
Profitability Analysis in Telecommunication Industry
industry has grown over the time yet they have to go a further distance to
compete globally. The Indian companies faced a high relative cost of capital as
compared to their international competitors.
Reason being, Indian telecom Industry give more emphasis on effects of
capital structure on cost of capital and on determinant of capital structure.
Moreover, no serious and systematic efforts have been made by these industries
in regard to relationship between cost of capital and companies financial
The main focus of this paper revolves around the “interrelationship and impact of Cost of capital on various
factors determining company’s performance and also to analyse the relationship
between cost of capital efficiency and
profitability of selected Telecommunication industry”. To show the
relation between different variables 4 Hypothesis is conducted with different
variables. Each Hypothesis has 2 sub parts, both being the null hypothesis and
the alternate hypothesis.
Hypothesis 1 has both significant and negative relation
between cost of capital and profitability. Hypothesis 2 has both significant
and negative relation between cost of capital and liquidity. Hypothesis 3 has
both significant and negative relation Between cost of capital and the
dividend. Hypothesis 4 has both significant and negative relation between cost
of capital and growth. To conduct this research Pearson’s Correlation Coefficient Analysis is used.
The research shows a negative relation in Hypothesis 1
i.e. Between cost of capital and
profitability. With increase in cost of capital profitability will decrease.
This is because profitable industry tends to acquire fund with cheaper cost. In
Hypothesis 2 there is a negative relation between cost of capital and
liquidity. This implies that highly liquid companies are acquiring the funds at
less amount of cost. On the other hand less risky companies in terms of
liquidity are spending less amount of money for mobilizing the capital for
their survival and growth. It is theoretically true that the investors
generally prefer to invest their funds in less risky companies. Hypothesis 3
also shows a negative relation between cost of capital and dividend. The
negative coefficient of variable suggests that investors have preference for
current dividend the investing in long term projects. Finally in Hypothesis 4
there is a positive relation between cost of capital and growth. The cost of
capital of the company is positively related with the growth of company
implying cost of capital is increasing because of constant growth of company in
its growing stage which imply as more fund is used for growth and expansion of
2- The effect of CEO ownership and shareholder rights on cost of equity capital
A) This paper gives us an analysis of effect of shareholder
rights and managerial ownership of the firm on cost of equity capital. The
ensurity of funds invested in the company by investor is by charging a high
rate so that the money is used appropriately and also by investing in equity
capital, therefore becoming owners they could keep an eye on managers so that
funds are properly used.
B) Agency problems and entrenchment affect is result of CEO
ownership on Shareholder’s right. Therefor resulting a conflict between
managers and shareholders as manager’s interest conflict with those of
shareholder’s. As we know shareholders being the owner of business can control
the conflict in 2 ways; first by keeping them in discipline and second by
giving them managerial ownership incentive to align the interest. But such is
highly dependable on CEO. CEO having a substantial ownership either can align the
The effect of CEO ownership and shareholder rights on cost of equity capital
interest or can substitute the shareholder’s right. And thus 2 hypotheses is
explained regarding the two above given situation.
C) Hypothesis 1 i.e.
alignment theory shows us the inverse relation between CEO ownership and cost
of capital whereas Hypothesis 2 i.e. substitution theory shows the effect of strong shareholder rights
in reducing the cost of equity capital is less pronounced for firms with high
managerial ownership. Since managers” interests are aligned with shareholder”,
shareholder scrutiny becomes less important. The only limitation of this theory
is that effect is only calculated considering agency cost whereas all other
variables such as profit, pricing, strategy etc were kept constant.
3- Analysis of the effects of ESOP adoption on the company cost of capital
A) The two types of ESOP evaluated here are leveraged ESOP and non-leveraged
ESOP. A leveraged ESOP is
recognized when a loan is obtained to set up an ESOP trust and as the debt is
repaid using employer contributions and dividends shares, funds are distributed
into the employee accounts and interest paid and principle both are tax
deductible. A non-leveraged ESOP is when the sponsoring firm contributes cash
or stock to the plan. The cash or stock contribution to the ESOP by the company
is a loan because the company contributions to the trust are tax deductible.
The analysis is about these 2 ESOP and their effect on firm with different
capital structure and resulting effect on cost of capital of the firm.
B) Firms adopting leveraged ESOP should have a decrease in cost
of capital as according to deficit reduction act 1984 they have to pay only 50%
taxes on interest and loan. Moreover a firm with more equity than debt if uses
leveraged ESOP plan will maintain a constant cost of debt and its WACC will
decrease it will get tax deductible benefit. Conversely a firm with a balanced
debt and equity, if Leveraged ESOP is adopted then the cost of debt increases
beyond its debt capacity which will further increase cost of equity and WACC resulting and
increase in cost of capital. In case of non-leveraged ESOP it gives us a
benefit of employee’s productivity and it aligns shareholders’ interests as
that of its employees. And this reduced risk of firm’s cash flow would decrease
the cost of capital if the ESOP is raised through stock. While in case of ESOP
funded with the cash of the firm could harm its liquidity, eventually increasing
its risk and therefor its cost of capital.
Paper 4- Applicability of the Classic WACC Concept in
A) This paper tells us about the trend of using discounted cash
flow for investment valuation and the common mistakes made by analyst while
using this. It tells us about the misuses of WACC(discounted cash
flow),interdependence of WACC and cash flows, Realistic assumptions made in comparison
to text assumption.
B) Starting with cash
flow, Analyst usually tends to make mistake in treatment in value of leverages.
And this point has major implication towards defining the cost of debt and
equity. While the more appropriate way is differences
is to numerically specify a particular cash flow, with its respective cost of
capital, and then compare the resulting profitability yardsticks from the
various cash flow streams.
C) While making assumptions Book assumptions are different as from
the realistic one. Assumption made tend to overlook the certain variables. Also
the example by the paper equity cash flow used during calculating NPV gives
more realistic view than Capital cash flow as it takes into account of changes
in working capital, depreciation, capital expenditure, amortisation etc.
D) While evaluating through WACC(Discounted cash flow) different
method yields different answer, therefore to get more accurate and realistic
adjusted present value should be used
5- Alternative Capital
Asset Pricing Models: A Review of Theory and Evidence
asset pricing model (CAPM) is an efficient mechanism for channelling savings
into profitable investments. This paper uses CAPM into stock market and
securities. The main objective of this study this study is to see the
application of three types of CAPM.
Here it is
assumed that all production is organised by firms. The objective is to analyse
nature of equilibrium in capital market.
First CAPM given by Sharpe and Lintner is: E(Ri ) = Rf + ?i ((E(Rm) ? Rf ). Second model
given i.e. BLACK VERSION : E(Ri ) = E(Rz ) + ?iE(Rm) ? E(Rz ). And the third model i.e. Conditional CAPM is:
E(Rit | ?t?1) = E(Rft | ?t ?1) + ?imt E(Rmt | ?tt ?1) ? E(Rft | ?t?1).
The study of
these model in capital market suggested a positive relation existed between
realised return and systematic risk as measured by ?. between risk and return
appeared to be linear. Sharpe-Lintner model have shown that earning-to-price
ratio have marginal explanatory power after controlling for ? and expected
returns are positively related to E/P. Also expected returns on small stocks
are too high and expected returns on large stocks are too low which is due to unusual
effect of ? . BLACK version model is tested
by time series regression analysis. The analysis shows that the intercept term is different from zero and in
fact is time varying. They have found when ? >1 the intercept is negative
and that it is positive when ? <1. Finally third model i.e. Conditional CAPM workerd out better than any other model. It assumes less assumptions and provide researchers and analyst a flexible method which give results near to planned results. References: 1) Sharma, A. (2012). Cost of capital and profitability analysis (A case study of telecommunication industry). Journal of Commerce and Accounting Research, 1(4), 42-50. Retrieved from https://ezproxy.svkm.ac.in:2301/docview/1490669200?accountid=32277 2) Huang, H., Wang, Q., & Zhang, X. (2009). The effect of CEO ownership and shareholder rights on cost of equity capital. Corporate Governance, 9(3), 255-270. doi:http://ezproxy.svkm.ac.in:2103/10.1108/14720700910964325 3) Ivanov, S. I., & Zaima, J. K. (2011). Analysis of the effects of ESOP adoption on the company cost of capital. Managerial Finance, 37(2), 173-188. doi:http://ezproxy.svkm.ac.in:2103/10.1108/03074351111103695 4) 4) Mian, M. A., & Velez-Pareja, I. (2005). Applicability of the classic WACC concept in practice. St. Louis: Federal Reserve Bank of St Louis. Retrieved from https://ezproxy.svkm.ac.in:2301/docview/1698179302?accountid=32277 5) Javed, A. Y. (2000). Alternative capital asset pricing models: A review of theory and evidence. St. Louis: Federal Reserve Bank of St Louis. Retrieved from https://ezproxy.svkm.ac.in:2301/docview/1698920762?accountid=32277