Case Study 12-11-09
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Case Study Cost of capital analysis of Larsen & Toubro Limited (L&T). The capital structure of L&T for the year 2004-05 is shown in Table no. 1. The average market Price of L&T’s one share was Rs. 900. The market value of the company’s equity is obtained by multiplying the number of the outstanding shares (13 ooe) by the average share price. However, the market value of debt is assumed to be equal to the book value.
Table no. 1. L&T’s capital Structuring Sources of Capital Short- term debt Long- term debt Total debt Net worth Total capital
Book value (B.V.) erove 1,660.90 293.10 1,954.00 3,369.00 5,323.00
B V weights Proportion 0.31 0.06 0.37 0.63 1.00
2004-05 Market value Rs. 1,660.90 293.10 1,954.00 11,700.00 13,654.00
MV Weight Proportion 0.13 0.02 0.15 0.85 1.00
Sources : Annual Return Estimation of L&T’s cost of Equity. The formula for ascertaining the cost of equity is : D Ke = P + g Where, Ke = Cost of E. S. c D = Dividend per share P = Net proceeds per share G =Expected growth in dividends L&T’s dividend yield in 2004-05 is 3.5%.The dividend yield of the company has varies between 1.5 per cent to 3.5. per cent with an average yield of 2.2 per cent. It is assumed that the current dividend yield of 3.5 per cent is a fair approximation of L&T’s expected yield. Estimation of Growth Rate Growth may be approximated by ascertaining the product of retention ratio and return on equity (ROE) g
= Retention ration * ROE
L&T payout ratio has fluctuated over year. However, on an average it has distributed about 45 per cent of its net profit and retained 55 per cent in the past decode, In the most recent period 2004-05 about 59 per cent, of its profit, the ROE of L&T in 2004-05 is 30.6 per cent and 10 year average is 7.9%. Assuming that the current Relation ratio of 59% and ROE of 30.6% will continue in the future, Then the dividend of L&T is expected to grow at 18.1 per cent per year. g
= Retention ration x ROE = 0.59 x 0.306
= 0.181 Or
18.1%
Thus, Ke cost of equity of L&T is current dividend yield +growth rate 3.5%+18.1% = 21.6%
Table no. 1. L&T’s capital Structuring Sources of Capital Short- term debt Long- term debt Total debt Net worth Total capital
Book value (B.V.) erove 1,660.90 293.10 1,954.00 3,369.00 5,323.00
B V weights Proportion 0.31 0.06 0.37 0.63 1.00
2004-05 Market value Rs. 1,660.90 293.10 1,954.00 11,700.00 13,654.00
MV Weight Proportion 0.13 0.02 0.15 0.85 1.00
Sources : Annual Return Estimation of L&T’s cost of Equity. The formula for ascertaining the cost of equity is : D Ke = P + g Where, Ke = Cost of E. S. c D = Dividend per share P = Net proceeds per share G =Expected growth in dividends L&T’s dividend yield in 2004-05 is 3.5%.The dividend yield of the company has varies between 1.5 per cent to 3.5. per cent with an average yield of 2.2 per cent. It is assumed that the current dividend yield of 3.5 per cent is a fair approximation of L&T’s expected yield. Estimation of Growth Rate Growth may be approximated by ascertaining the product of retention ratio and return on equity (ROE) g
= Retention ration * ROE
L&T payout ratio has fluctuated over year. However, on an average it has distributed about 45 per cent of its net profit and retained 55 per cent in the past decode, In the most recent period 2004-05 about 59 per cent, of its profit, the ROE of L&T in 2004-05 is 30.6 per cent and 10 year average is 7.9%. Assuming that the current Relation ratio of 59% and ROE of 30.6% will continue in the future, Then the dividend of L&T is expected to grow at 18.1 per cent per year. g
= Retention ration x ROE = 0.59 x 0.306
= 0.181 Or
18.1%
Thus, Ke cost of equity of L&T is current dividend yield +growth rate 3.5%+18.1% = 21.6%
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