Capital Structure & Financial Leverage Analysis Of Software Industry

Capital Structure & Financial Leverage Analysis of Software Industry: Group No. 6: Anuj Surana Gautam Malhotra Karan malhotra Kush Shrimali Nidhi Mittal

OBJECTIVES OF THE STUDY: To study as to why the Capital Structure of Software Companies is different from other Industries. • To study the reasons as to why software companies are not using component of Debt Capital to financially leverage their Earnings. •

Capital Structure: 

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Capital Structure is the mixture of sources of funds a firm uses. Sources of Funds: Debt Preferred stock Common Stock A firm with a lot of debt in its Capital Structure is said to be highly levered.

Comparison: Company Name

Equity Share Capital

Debt capital (S.L. + U.L) 0

DebtEquity Ratio

2860

Retain ed Earnin gs 132040

Infosys Technologies Pvt. Ltd. Satyam Computer Services Pvt. Ltd.

1359

72217

236

0.04

Tech Mahindra Ltd. WIPRO Ltd.

1214

11070

950

0.08

3503

112604

38224

0.33

HCL Technologies Ltd.

1350

30800

253

0.01

0

Financial Leverage: 

Financial leverage occurs whenever a firm finances with interest-bearing debt.

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It occurs due to the Fixed Interest Charge.

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To ascertain whether management is able to earn more on the debt funds than the funds cost.

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If a firm does not have any interest-bearing debt financing, then it does not have any financial risk and cannot realize financial leverage.

Comparison:

Particula Infosys rs EBIT 4417

Satyam Tech Mahindra 2222 7658

WIPRO

HCL

32596

10090

(-) INT

(0)

(6)

(283)

(1168)

(249)

PBT

4417

2216

7375

31428

9841

DFL

1

1.003

1.038

1.037

1.025

Compan y

Quick Assets

Infosys

Quick Ratio (200708)

Quick Quick Ratio Ratio (2006-07) (200506)

1,23,26 37,310 0 74,511 14,467

3.30

4.5

2.96

5.15

5.76

6.18

Tech Mahindra

14,880

6,342

2.35

2.25

2.18

WIPRO

120,58 1 28,581

33,616

3.58

3.15

2.89

18,218

1.57

1.89

1.46

Satyam

HCL

Current Liabiliti es

How Much Cash Does Your Company Need?  

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HBR Article by Richard Passov. He proposes that Traditional Capital Structure model should account for complications faced by companies in Knowledge Based Industries. Knowledge-Intensive Companies experience relatively high volatility of their intangible assets. Reasons for High Volatility: Assets are company specific & require considerable investment to exploit, Intangible assets cannot be hedged.

How Much Cash Does Your Company Need? 

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These Intangible assets cannot be easily valued and are more vulnerable to financial distress than firms with preponderance of tangible assets. To ensure against this Risk, Knowledge Intensive Firms need to maintain large positive Cash Balances. Also, only by investing in their intangible assets can knowledge-based industries hope to preserve the value of these assets. In a nutshell, the business risk of these firms is really HIGH.

REASONS FOR NOT USING LONGFUNDS: •TERM Software Firms don’t require much LongTerm Funds operations.

once they have initiated their

Their Business Risk is high. Thus, to reduce their overall risk, they like to minimize their Financial Risk. •

Internal Accruals & Internal Cash Flows funds their Operations. •

They want to ensure High Liquidity as it enables them to make rapid shifts. •

Observations from the Study: 

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Software Firms maintain more of Cash Balances as their require short term funds. These Firms are not directly impacted by changes in Monetary Policy. To reduce their overall risk, they maintain huge cash balances. Capital Structure depends on the Nature of Industry. Service industry normally does not leverage their earnings financially. It cannot be taken as a rule of thumb, as many organizations have raised External Long-Term

Exception: Bidding of Axon  

Two major bidders: Infosys & HCL Technologies Pvt. Ltd. Difference in Structure of Financing.

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Infosys: Bid Amount: £ 407 million To be raised through: Cash Reserves.

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HCL Bid Amount: £ 441 million To be raised through: £400-million loan commitment from Standard Chartered @ 6.5%.

Hidden Benefit(HCL): 

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Infosys would lose 10 % interest that it would have earned, had the Cash been with the Bank. HCL would be paying 6.5 % interest to Standard Chartered to raise the amount. Thus, HCL had a 3.5 % advantage over Infosys. The term of the loan was 2.5 years. Hence, it had a total advantage of 8.75 % over Infosys. This allowed HCL to raise their Bid Amount to £ 441 million, 8.3 % higher than Infosys. HCL’s current Debt- Equity Ratio is 0.65:1