Ambuja Ambuja Cements Cements:: WeightedAv eightedAverag eragee Cost Cost of Capital Capital Ref.No.: Ref.No.: FM0011 FM0011
Ambuja Ambuja Cement Cements: s: Weight eighted ed Averag veragee Cost Cost of Capita Capitall “Good “Good eveni evening ng all of you… you…”” said said Dr Martin Martin,, profe professo ssorr of Finan Finance ce,, to the first first year year MBA MBA stude students nts standi standing ng in the corri corridor dor leadin leading g towar towards ds the camp campus us librar library y of Alien Alien Busin Busines esss Scho School, ol, Mumb Mumbai. ai. For For a few few seco second nds, s, the the corrido rridorr echo echoed ed with with the voic voices es of the the stud studen ents ts wish wishin ing g their their prof profes esso sorr. Dr. Dr. Marti Martin n is one of the favourite faculty in the college and each and every student likes his friendly nature. “Professor, would you like to join us in the discussion on the basic concepts of finance to prepare oursel ourselve vess for the upcom upcoming ing financ financee class, class,”” aske asked d Atul. Atul. “Oh, “Oh, really really!! That’ That’ss great, great,”” replie replied d Dr Marti Martin. n. “By “By the the way way, whic which h conc concep eptt are are you you tryin trying g to unde unders rsta tand nd?” ?” aske asked d Dr. Dr. Marti Martin. n. “Cos “Costt of capi capita tal, l,”” said said Ashwa Ashwani. ni. “Ok, “Ok, fine. fine. We will will discus discusss it in the confer conferenc encee room, room,”” said said Dr. Dr. Martin. Martin. Five Five minut minutes es later later,, arou around nd 10 stude student ntss and and the the prof profes esso sorr were were sitti sitting ng in the the conf confer eren ence ce room room next next to the cam campus pus libra library ry and were discussing the concept of cost of capital. “Professor, are cost of capital and cost of equity the same?” asked Harsh. “It depends on the structure of capital. If the capital is financed only through equity, then the cost of equity would be equal to the cost of capital. Otherwise not,” said Dr. Martin. “It means a firm can finance capital throu through gh othe otherr sour sources ces too? too?”” aske asked d Gopa Gopal. l. “Yes “Yes.. ...w .wou ould ld any any one one of you you like like to answ answer er his his ques questio tion, n,”” asked Dr. Martin, giving a chance to the fellow students to answer. “Yes Professor, Shall I?” said Ankita Ankita,, taking taking the initiati initiative ve.. “Grea “Great. t. Go ahead, ahead,”” said said Dr Martin Martin.. “Othe “Otherr source sourcess of financi financing ng capita capitall are debentures, term loans, and preference capital,” said Ankita. “Good. Apart from these, a few others are rights issue, private placement, Global Depository Receipts issue, internal accruals and last but not the least, bought out deals,” added Dr. Dr. Martin. All the students were delighted and their curiosity increased to some extent. However, Puneet, who always thinks ahead, asked, “Professor, when firms use different sources to finance the capital, how do they estimate cost of capital?”
This case study was written by Manish Agarwal (Faculty Associate) and D. Satish (Professor of Finance), IBS, Hyderabad. It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. The case was compiled compiled from published published sources. © 2009, IBSCDC No part of this publication may be copied, stored, transmitted, reproduced or di stributed in any form or medium whatsoever without the permission of the copyright owner.
1
Ambuja Cements: WeightedAverage Cost of Capital
Understanding Weighted Average Cost of Capital “In such case, firms use ‘Weighted Average Cost of Capital’ (WACC),” replied Dr. Martin. “Sir, what is WACC? Please explain to us,” asked all the students simultaneously. “Sure, why not? WACC is the expected average cost of serving the existing capital,”You can get it by multiplying the cost of each source with its weight in capital and adding up the former results,” replied Dr. Martin to all. He further added, “WACC uses market value of each source to find out the weight of a particular source in capital.” “Sir, where can we use this?” asked Harsh. “Good question,” said Dr. Martin. “It is an appropriate discount rate to find out present value of future cash flows. It is also used in capital budgeting analysis and firm valuation.”
Choosing a Company “We will do an exercise to get a better understanding of WACC,” said Dr. Martin. “We will take up real time data of some company and find out its WACC.” “Which company, Sir?” asked Ankita. “Any suggestions,” said Dr. Martin throwing it open for the students to select a company. “Sir, shall we take Reliance?” asked Puneet. “No Sir, that is too complex as it is a conglomerate company. We have to take some company which is into one industry only,” said Harsh. “Yes, to start with, take a company which has exposure in one or two industries only,” Dr. Martin repli ed. “Then we will take Ambuja Cements. It is an Index company and has exposure to cement industry only,” said Alok, who was quiet until now. “OK, then Ambuja Cements Limited (ACL) (Annexure I) is final,” said Dr. Martin.
Setting Parameters “Before you start, I would like to set some parameters. Use CapitalAssets Pricing Model (CAPM) to estimate the cost of capital, for market return take 10 years’ monthly returns of index (Annexure II), use 10 years’ Indian government bond yield which was around 6.83% as on December 31st 2008 as risk free rate and use 3 years’ monthly return of ACL for beta calculation (Annexure III),” said Dr. Martin. “Sir, for cost of debt, which cost should we take pre-tax or post-tax?” asked Atul. “Ofcourse, post-tax” replied Dr. Martin. He further added, “Now, are you all ready to calculate WACC for ACL?” “Yes Professor, we are. Thanks a lot,” replied all the students together.
2
Ambuja Cements: WeightedAverage Cost of Capital
Annexure I Company Details: Ambuja Cements Limited ACL is one of the most cost efficient cement companies in India. It is a part of Switzerland-based Holcim Group, one of the leading cement suppliersin theworld with a total capacity of 194.4 million tonnes at the end of Calendar Year (CY) 2008. The company was established by Narotam Satyanarayan Sekhsaria (Sekhsaria), a businessman from Gujarat (Western India). Sekhsaria started Ambuja Cements Private Limited (ACPL) in 1981. The company went for public issue in 1983. The company grew rapidly from just 0.7 million tonnes per annum (mtpa) capacity in 1982 to 22 mtpa capacity by the end of CY08. Financial Performance
The company reported 9.5% growth in sales (net to excise duty) in CY08, which increased to INR 62,617.9million in CY08 from57,186.0 million in CY07. However,the company’s Profit BeforeTax (PBT) decreased by 29.8% from INR 27,893.6 million in CY07 to INR 19,576.4 million in CY08, mainly due to substantial increase in manufacturing and other expenses (22.2%). Even downward movement in interest expenses (57.7% from INR 770.9 million in CY07 to INR 326.0 million in CY08) was not able to was not able to stop PBT to shrink into red zone. Persuaded by the decline in profit, the company provided only INR 5,679.3 million as taxes in CY08, which is 39.8% lower than theprovisions made in CY07.Ultimately, thenet profitplunged by 24.7%, from INR 18,461.1 million in CY07 to 13,897.1 million in CY08. At the end of CY08, the company had INR 3,045.2 million of shareholders’ capital (divided into 1,522.6 million shares of INR 2 each) and INR 2,886.7 million of loan funds.
Compiled by the author from “Ambuja Cements Limited: Annual Report, 2008”, http://www.gujaratambuja.com/GujAmbu-ar08-full.pdf
3
Ambuja Cements: WeightedAverage Cost of Capital
Annexure II 10-year Sensex Closing Price Year
BSE Sensex Closing
Year
BSE Sensex Closing
January-1998
3,224.36
March-2000
5,001.28
February-1998
3,622.22
April-2000
4,657.55
March-1998
3,892.75
May-2000
4,433.61
April-1998
4,006.81
June-2000
4,748.77
May-1998
3,686.39
July-2000
4,279.86
June-1998
3,250.69
August-2000
4,477.31
July-1998
3,211.31
September-2000
4,090.38
August-1998
2,933.85
October-2000
3,711.02
September-1998
3,102.29
November-2000
3,997.99
October-1998
2,812.49
December-2000
3,972.12
November-1998
2,810.66
January-2001
4,326.72
December-1998
3,055.41
February-2001
4,247.04
January-1999
3,315.57
March-2001
3,604.38
February-1999
3,399.63
April-2001
3,519.16
March-1999
3,739.96
May-2001
3,631.91
April-1999
3,325.69
June-2001
3,456.78
May-1999
3,963.56
July-2001
3,329.28
June-1999
4,140.73
August-2001
3,244.95
July-1999
4,542.34
September-2001
August-1999
4,898.21
October-2001
2,989.35
September-1999
4,764.42
November-2001
3,287.56
October-1999
4,444.56
December-2001
3,262.33
November-1999
4,622.21
January-2002
3,311.03
December-1999
5,005.82
February-2002
3,562.31
January-2000
5,205.29
March-2002
3,469.35
February-2000
5,446.98
April-2002
3,338.16
2,811.6
Contd...
4
Ambuja Cements: WeightedAverage Cost of Capital
Year
BSE Sensex Closing
May-2002
3,125.73
June-2002
3,244.7
July-2002
Year
BSE Sensex Closing
September-2004
5,583.61
October-2004
5,672.27
2,987.65
November-2004
6,234.29
August-2002
3,181.23
December-2004
6,602.69
September-2002
2,991.36
January-2005
6,555.94
October-2002
2,949.32
February-2005
6,713.86
November-2002
3,228.82
March-2005
6,492.82
December-2002
3,377.28
April-2005
6,154.44
January-2003
3,250.38
May-2005
6,715.11
February-2003
3,283.66
June-2005
7,193.85
March-2003
3,048.72
July-2005
7,635.42
April-2003
2,959.79
August-2005
7,805.43
May-2003
3,180.75
September-2005
8,634.48
June-2003
3,607.13
October-2005
7,892.32
July-2003
3,792.61
November-2005
8,788.81
August-2003
4,244.73
December-2005
9,397.93
September-2003
4,453.24
January-2006
9,919.89
October-2003
4,906.87
February-2006
10,370.24
November-2003
5,044.82
March-2006
11,279.96
December-2003
5,838.96
April-2006
12,042.56
January-2004
5,695.67
May-2006
10,398.61
February-2004
5,667.51
June-2006
10,609.25
5,590.6
July-2006
10,743.88
March-2004 April-2004
5,655.09
August-2006
11,699.05
May-2004
4,759.62
September-2006
12,454.42
June-2004
4,795.46
October-2006
July-2004
5,170.32
November-2006
13,696.31
August-2004
5,192.08
December-2006
13,786.91
12,961.9
Contd...
5
Ambuja Cements: WeightedAverage Cost of Capital
Year
BSE Sensex Closing
Year
BSE Sensex Closing
January-2007
14,090.92
January-2008
17,648.71
February-2007
12,938.09
February-2008
17,578.72
March-2008
15,644.44
March-2007
13,072.1
April-2007
13,872.37
April-2008
17,287.31
May-2007
14,544.46
May-2008
16,415.57
June-2007
14,650.51
June-2008
13,461.6
July-2007
15,550.99
July-2008
14,355.75
August-2007
15,318.6
August-2008
14,564.53
September-2007
17,291.1
September-2008
12,860.43
October-2007
19,837.99
October-2008
9,788.06
November-2007
19,363.19
November-2008
9,092.72
December-2007
20,286.99
December-2008
9,647.31
Compiled by the author from Centre for Monitoring Indian Economy (CMIE) Prowess Database.
Annexure III Three Years’ Share Price Data of Ambuja Cements Month-Year
Stock Price
January-2006
88.50
February-2006
88.20
March-2006
103.25
April-2006
124.05
May-2006
92.90
June-2006
99.50
July-2006
104.70
August-2006
112.35
September-2006
116.85 Contd...
6
Ambuja Cements: WeightedAverage Cost of Capital
October-2006
117.25
November-2006
144.15
December-2006
141.30
January-2007
137.15
February-2007
115.95
March-2007
106.70
April-2007
117.95
May-2007
113.15
June-2007
124.55
July-2007
131.50
August-2007
133.45
September-2007
143.80
October-2007
144.65
November-2007
150.00
December-2007
146.90
January-2008
119.60
February-2008
120.95
March-2008
121.05
April-2008
113.90
May-2008
95.20
June-2008
75.70
July-2008
81.20
August-2008
80.20
September-2008
78.40
October-2008
60.95
November-2008
52.30
December-2008
69.70
Compiledby the author fromCentrefor MonitoringIndian Economy(CMIE) Prowess Database.
7
