Study of Capital Structure

STUDY OF CAPITAL STRUCTURE

Submitted to: Table of contents

Acknowledg Ackno wledgement ement

02

Certif Cer tifica icate te

03

Preface

04

Abstract

07

INTRO TO RANBAXY LABORATORIES LTD

Company Compan y Profile Profil e

08-10

Vision

10-11

Operating Joint Ventures and Subsidies Objectives Objec tives

16-18

Various divisions of Ranbaxy Intro of Ranbaxy Plant in India Product Produ ct Review Revie w

12-15

19-20 and various depts.

12-23 24-26

INTRO TO CAPITAL STRUCTURE THEORY AND ANALYSIS

Introducti Intro duction on

27-28 27-2 8

Literature of review on Capital Structure

29

Method Met hodolo ology gy

30

Theory Theor y and Analysis Analy sis

31-38 31-3 8

Optimal Capital Structure for Ranbaxy

39-58

Capital expenditure: an overview

59-80

Latest balance sheet and capital structure of Ranbaxy Recommendations and Suggestions for Industry Conclusion Biblog Bib lograp raphy hy

81-82 82-90 91-92 93

ABSTRACT A projec projectt work work is a manda mandator tory y requi requirem rement ent for the Busin Business ess Manag Managem ement ent Programme. This type of study aims at exposing the young prospective executive to the actual business world. This Th is proj projec ectt give givess me know knowle ledg dgee abou aboutt the the capi capita tall stru struct ctur uree and and theo theory ry analysis analysis.Fi .Financ nancing ing decision decisionss involve involve raising raising funds for the firm. firm. It is concerne concerned d with with formulation and designing of capital structure or leverage. The most crucial decision of  any company is involved involved in the formulation of its appropriate appropriate capital structure. structure. The best design or structure of the capital of a company helps the management to achieve its ultimate objectives of minimising overall cost of capital, maximising profitability and also maximising the value of the firm. organization. It is very effective way to judge a company’s cash flow prospects, as cash is like blood life for any company. The report initially begins with the company profile, followed by the detailed analysis of company, like businesses of the company, products offered by the company, financials of the company, etc The report involves a lot of research to understand what exactly capital structure of  the company should be.thats , why companies require appropriate capital structure. The purpose is to develop an action plan that creates such a capital structure that will upgrades and standardize the quality of business analysis.

INTRODUCTION TO RANBAXY COMPANY PROFILE “A company empowered by one mission –to place itself on the world map. An

enterprise propelled by one force-that synergizes its energies to charter unexplored  markets. Organizations fuelled

by one dream-to transform competition

into

opportunity.” 

Ranbaxy Laboratories Ltd. was incorporated in June 1961, in the name of M/S LEPITIT RANBAXY LABORATORIES LTD and it commenced its business in MARCH 1962, in technical and financial collaboration with an international company named LEPTIT SPA, MILAN, ITALY. Ranbaxy Laboratories Pvt. Ltd. merged with “Leptit Ranbaxy Laboratories Pvt. Ltd.” in 1962

Ranbaxy and company also merged with this company in 1966. The

collaboration arrangement with M/S LEPTIT was terminated in 1966; after which Indian nationals acquired the entire share capital of the company. Therefore the word Leptit was removed from the name of the company. The name is known as RANBAXY LABORATORIES LIMITED. In 1973 the company issued shares to the general public and became a full fledged PUBLIC LIMITED COMPANY. Today, Ranbaxy has emerged as a Leading Pharmaceutical Company on the Indian firmament, with the second largest market share and enjoys an enviable reputation for its high standard of ethics and quality around its core strength of anti-infective, it has  produced new brands in emerging therapeutic areas like cardiovascular, central nervous system and nutritional. supporting this expansion, the company has invested in world class manufacturing infrastructure that leverages India’s comparative cost advantage and skilled manpower, while delivering international quality.

The company’s drive for Internationalism is guided by the well planned brand strategy that covers some of the world emerging markets like China, cis, Central Europe and Latin America . Its position today is in league of the Top Ten Pharmaceutical companies of three world an decent ranking as the eleventh largest company in the international generics space is the resounding endorsement of its strategic mind. It is clear that for a long time, the dominant share of revenues of the company would continue to come from the ever expanding global generics market. Hence the intent of Ranbaxy mission is to achieve a sustained growth rate through the continuous pursuit of innovation phase one trials for pervasion, a compound for treating prosthetic males have been completed. Phase 1 trials with clafrinast, an asthma compound is an important step towards research based value creation. This company also had success with Ciplofloxacine, an ingenious form, created through the novel drug delivery systems research. As the demand of the bulk drugs inside the country and abroad was increasingly rapidly a new, plant was set up at Toansa near  Ropar in 1987. This was a higher capacity plant designed to cater to the present and future needs, initially

antibiotics

like Ampicillin,

Trihydrate

and

Doxycycline

were

manufactured. Later, on the other drugs like Cephalexin monohydrate and Ranitidine were also  prepared. The plant at Toansa was designed to meet the stringent standards set by the Food and Drug Administration (FDA) of U.S.A. This plant has been approved by FDA and this will open up American and other newer markets for Ranbaxy’s products At present Ranbaxy have four plants for the manufacture of bulk drugs two at Mohali, one at Dewas (M.P) AND Another at Toansa near ROPAR. At present, Ranbaxy is the second most Indian company engaged in the manufacturing of Pharmaceuticals, Bulk Drugs and Fine Chemicals. RANBAXY’s vast range of highly pure laboratory reagent and chemicals enjoy a place of   pride in the market. IT trends, has rebuilt As a step towards leveraging information for  value creation using its information backbone around an ERP application, along the focus on reengineering several business processes around the internet and has putting place  business solutions that challenge existing ways of doing Business. The undying spirit of  the company’s human assets and their intensive competitive and entrepreneurial energy

has played a great part in transforming the company into a multicultural and multiracial team. Today, Ranbaxy is the largest exporter accounting for 12% of the industry exports  pharmaceutical substance and dosages forms to over 50 countries with the internationals sales comprising of 45% of the total turnover. VISION: GARUDA

During the year 2002, the company has evolved a 10-year vision till 2012, for sustaining significant growth consistent with its mission to be an international research based Pharmaceutical Company, under the rubric ‘Vision Garuda’, with increasing emphasis on Novel Drug Delivery Systems Research (DDR) .

In licensing and out licensing, relationship with other important pharmaceutical entities, expansion of manufacturing facilities both in India and strategic overseas locations, revamping of organizational structures to cater to the wider and more dispersed span of  operations, and streamlining and standardizing the business processes through out the global organization, are other areas that receive focus and attention of management on  priority.

Mission

“To become a Research based   International pharmaceutical company”  Vision-2012

 Achieve significant business in  Proprietary prescription products  By 2012 With a strong presence in developed markets Aspirations-2012

 Aspire to be a$5 billion company  Become a Top 5

global generics player 

 Significant income from Proprietary products

OPERATING JOINT VENTURES AND SUBSIDIARIES BRAZIL

:

Ranbaxy S.P. Medicamentos Ltd.

CHINA

:

Ranbaxy (Guangzhou China) Ltd.

EGYPT

:

Ranbaxy Egypt Ltd.

GERMANY

:

HONG KONG INDIA

Basics Gmb H. :

:

Ranbaxy (Hong Kong) Ltd.

Rexcel pharmaceuticals Ltd., Solus pharmaceuticals Ltd.,

Vidyut Travel Services ltd. IRELAND MALAYSIA

: :

Ranbaxy Ireland Ltd.

Ranbaxy (Malaysia) Sdn. Bhd.

NETHERLANDS

:

Ranbaxy Pharmaceuticals B.V.

NIGERIA

:

Ranbaxy Nigeria Ltd.

PANAMA

:

Ranbaxy Panama SA.

POLAND

:

Ranbaxy Poland Sp. Zo.

SOUTH AFRICA

:

Ranbaxy (SA) (Pty.) Ltd.

THAILAND

:

Unichem pharmaceuticals LTD., Unichem Distributors Ltd. Part, Ranbaxy Unichem CO.Ltd.

U.K

:

Ranbaxy (UK) Ltd

USA

:

Ranbaxy pharmaceuticals Inc. Ohm Laboratories Inc., Ranbaxy Schein Pharma, LLC

VIETNAM

:

Ranbaxy Vietnam Company Ltd.

ALLIED BUSINESSES Ranbaxy Animal Health

`The Animal Health division saw an encouraging growth despite the prevailing  poor market conditions. The division grew at twice the growth rate recorded in the industry. On the basis of having a vast dome satiated animal population, the livestock,  poultry business and pets business are among the fastest growing sectors in India. A vast v ast infrastructure of veterinary colleges, agricultural institutes, technologists and researchers are helping farmers to source healthy, cost effective products. In conjunction with the  present scenario, the AHC division of Ranbaxy Laboratories Limited has introduced several latest generation products. Ranbaxy Fine Chemicals Limited (RFCL)

The division ranked 4th in the industry and captured 11% market share. RANKEM RANKEM is establ establis ished hed as a powerf powerful ul brand, brand, RFCL RFCL's 's brand brand for its range range of Reage Reagent ntss is now synonymous with excellence in reagents and fine chemicals in the country. The focus of   business remains on developing extensive extensiv e customer relations; enhancing en hancing service levels lev els and enriching enriching the product mix with the help of a qualified qualified and competent competent marketing and sales team

Diagnostics

The diagnost diagnostics ics division division has aggr aggres essi sive vely ly

focu focuse sed d

on

mark market et

expansion activities based on strategy of reli reliabi abilit lity, y, quali quality ty produ products cts and and

efficient efficient service. service. Introduction of products in ‘Point of Care’ markets has expanded market  presence and over o ver the next 1 – 2 years this segment s egment will see considerable cons iderable expansion expansio n in line with world trends. The Dade Behring segment has increased its installation base by 60% in leading hospitals and laboratories. Plans are afoot for the introduction of more parameters for the ‘Point of Care’ market and the launch of Special Special Chemistries, a range of drug assays, plus an entry into automated microbiology in both the Base and Dade Behring business areas.

The company has also witnessed significant milestones in the area of Novel Drug Delivery Systems (NDDS). The company has entered into strategic business arrangements with companies such as Bayer AG, Glaxo-Wellcome, Eli-Lilly etc. for production and comarketing operations. Many innovative developments have been taking place in recent times. The company’s research team is capable of developing one NDDS product every 12 to 18 months. Also, two new products: Roletra-D and Altiva-D, will soon be launched in India. In order to expand and promote global growth, the company opened several new markets during the year, notably in Brazil, where 25 filings were undertaken in a span of  2-3 months. The company has planned to build and protect intellectual property with the help of  IPC, IPC, which hich addr addres esse sess all all matt matter erss pert pertai aini ning ng to pate patent nts. s. CQA super upervi vise sess the the implem implementa entation tion of standard standard operati operating ng procedur procedures es (SOP) (SOP) and ensures ensures complia compliance nce to corporate quality assurance assurance policy in all technological technological operations of the organization. organization. The company is committed to invest 6% of the sales in R and D by 2003, of which 7% of the

expenditure will be earmarked for research on New Drug Discovery and Novel Drug Delivery Systems. There will be continuous emphasis on augmenting R and D  performance and productivity with advanced scientific and technological tools.

VALUES OF RANBAXY LABORATORIES LIMITED

1. Achieving customer satisfaction is fundamental to their business. 2. Practice dignity and equity in relationships and provide opportunities for people to realize their full potential. 3. Ensure profitable growth and enhance wealth of shareholders. 4. Foster mutually beneficial relationships with all their business partners. 5. Manage their operations with concern for safety and environment. 6. Be a responsible corporate citizen.

OBJECTIVES OF RANBAXY LABORATORIES LTD.

1.

To be a leader in the Pharmaceutical industry.

2.

To be a profitable company with a steady growth in earnings.

3.

To set an example as a socially responsible company.

4.

To diversify in health care related areas.

5.

To strive for excellence and continuous improvement in all spheres.

6.

To improve the quality of life of people by providing better services and quality  products.

Environment, Health and Safety [EHS]

Caring for the Environment is a core corporate value and as a part of this commitment. The Company enunciated its EHS policy in 1993. The Company’s EHS policy provides for the creation of a safe and healthy workplace and a clean environment for employees and the community. It aims at higher international standards in plant design, equipment selection, maintenance and operations. The policy seeks to manufacture products safely and in an environmentally responsible manner. The implementation of the EHS Policy is ensured by institutionalizing a robust EHS Management system, adequately supported by well defined organizational structure. As a part of EHS processes at the corporate level, besides laying down guidelines on systems, policy and training, the corporate EHS office monitors compliance, maintains and disseminates information on laws and regulations. EHS performance review meetings are held on regular basis to monitor the progress against agreed EHS improvement plans. Close cooperation between all units and individuals is the key to maintaining high standards of environment protection and safety in all the plants. The key processes at location level comprise of regular safety surveillance, inspections & audits, Permit to work system for operational / maintenance safety, Fire

 prevention & protection activities, operation of the ETP/Incinerator, disposal activities related to hazardous wastes, regular monitoring of the environment internally and also through approved laboratories. Monthly reports address EHS initiatives, compliance & various records under the statutory requirement, training of employees including contract employees on EHS awareness, interaction with the residential associations/nearby community etc., celebration of National safety day, fire day, Environment day etc. for  EHS awareness among employees. The manufacturing facilities for bulk drugs and dosage forms comply with the stringent requirements of Good Manufacturing Practices (GMP) and Good Laboratory Practices (GLP) and are approved by International health and regulatory Agencies like FDA - USA, MCA – UK, WHO etc. These practices and approvals ensure that an effective framework is always in place, not only for manufacture of high quality products,  but also for effective use of resources and reduction of wastes as well as high safety & hygiene standards. Ranbaxy has made significant improvements in process safety of the existing manufacturing facilities by providing extensive instrumented safety protection systems. The intended safety features are incorporated in the basic design of the new projects. Investments have been made on process improvements as well as effluent treatment plant up-gradation using the latest membrane based technology, multi-effect thermal evaporation system and state-of-the-art Incinerator. These investments have helped to reduce discharges of contaminants into the environment. With the facilities installed at Toansa for recycling of the treated effluent, the site has achieved the status of “zero discharge site”. The Company also engages with the concerned authorities and industry in devising responsible laws, regulations and standards and thus making safety, occupational health & environmental information and expertise available to its employees and the community at large. Ranbaxy has made EHS concerns and practices a necessary factor in appraising its employee performance. The Company also accords a very high priority to hygiene monitoring at work   place and health assessment of all employees at site. The plant and processes are

continuously upgraded to improve hygiene and health standards. Necessary training is imparted to the employees to enhance their awareness towards health related matters. Safety knowledge of the employees is constantly updated through various external and in-house training programs, including special training programs by overseas experts & consultants. Moving up the value chain, the company identified Consumer Healthcare as its new business area in the year 2001. Ranbaxy Global Consumer Healthcare (RGCH) was launched in October 2002 with a portfolio of 4 switch brands: Revital, Pepfiz, Gesdyp & Garlic Pearls. Since these brands were already popular amongst consumers and represented the leading common ailment categories like VMS (Vitamins & Minerals Supplement), this portfolio was carefully created for the introduction of RGCH to the Indian market. Subsequently in 2004, RGCH launched its first herbal range of products through New Age Herbals (NAH) with products offering remedy in categories of Cough & Cold (Olesan Oil & Cough Syrups) and Appetite Stimulant (Eat Ease).

VARIOUS DIVISIONS OF RANBAXY LABORATORIES LTD. 1.

Chemical Division

2.

Diagnostic Division

3.

Stan care Division

4.

Curradia Division

5.

International Division

6.

Pharmaceutical Division

7.

Technical Division

8.

Corporate Division

9.

Animal Health Care Division

DIVISIONS IN VARIOUS GEOGRAPHICAL AREAS 1. India and Middle East 2. Europe, CIS and Africa 3. Asia Pacific and Latin America 4. North America

JOINT VENTURE OF THE COMPANY.

2000

Ranbaxy files IND Application for Asthma MoleculeRBx4638, after successful completion of pre-clinical studies.Ranbaxy acquires Bayer’s Generics business (trading under the Name of Basics) in Germany. Ranbaxy forays into Brazil, the largest pharmaceutical market in South America and achieves global sales of U.S. $ 2.5 million in this market.

2001

Ranbaxy took a significant step forward in Vietnam by initiating the Setting up of a new manufacturing facility with an investment of U.S. $ 10 million.

Ranbaxy achieved a turnover of U.S. $ 502 million for the year 2002 and moved closer to achieving a target of 1 billion dollar by 2004. 2002

Receives approval from FDA to market Midazolam Hydrochloride Syrup 2 Mg base/ ml. Ranbaxy receives and approval

from

FDA

to

manufacture

and

market

Cefpodoxime Proxetil for Oral Suspension, Lisinopril + Hydrochlorothiazide Tablets Us, Terazosin Hydrochloride Capsules and Amoxcillin Oral suspension USP.Heralding the company’s entry into the Indian OTC market. 2003

Ranbaxy received the economic times award for corporate excellence-for the company for year.ranbaxy signed an agreement toacquire RPG(aventis) SA along with its fully owned subsidiary,OPIH SARL,in france

2004

Ranbaxy launched its first range of herbal projects.

2005

Acquisition of additional stake in Ranbaxy Farmaceutica Ltda., Brazil Ranbaxy announced the acquisition of Be-

Tabs Pharmaceuticals (Pty) Limited 2008

Acquired by the Japanese giant, the $9.62 billion Daiichi Sankyo, ranked No. 3 in Japan

BRIEF INTRO OF RANBAXY PLANTS IN INDIA

In the chemical division, various bulk drugs are manufactured. The chemical division had three units in Punjab. One is located at Toansa, two are located at Mohali and one unit is located at Dewas near Indore in Madhya Pradesh, where Ciprofloxacine is manufactured. In the plant of the chemical division, various drugs like Antibiotics, Antimalarial, Antibacterial and Anti-ulcer are manufactured. One of the older plants of  Ranbaxy was closed after the accident in June 2003.the second one is still working The 1991, the Toansa plant started functioning in 1992 and the Dewas plant started functioning in 1999. Various plant heads independently manage all these plants.

In each unit, separate facilities with respect to the manufacture of drugs, along with their manufacturing areas have been provided. This is required to reduce the chances of  any cross contamination under the drug laws and to comply with good manufacturing  practices. At Mohali plant, separate blocks have been provided for the preparation of each drug .The Toansa, Mohali and Dewas plants are planned in such a way that their system, facilities, manufacturing practices and standards meet the requirements of FDA. Mohali Plant also mainly in the manufacturing of Active Pharmaceutical Ingredients (API). The Plant is divided into two plant areas A8 and A9 HE VARIOUS DEPARTMENTS Human Resource Department

The basic function of the human resource department in the modern corporate world is knowledge management. The HR department strives to maintain cohesiveness among employees. It also ensures interdepartmental cooperation in achieving targets. The appraisal system is also taken care by this department. The HR department delves deep into the employee’s psyche to analyze the positives and negatives of each employee, so that a proper system of delegation and / or empowerment can be evolved. Finance Department

The finance department takes care of the regular financial needs of the company it ensures proper allocation of funds and takes care of the working capital requirements. It verifies capital raised by different departments and sends them for approval to the higher  authorities. Stores Department

The function of this department is to provide adequate and proper storage and  preservation of various items to meet the demand of various other departments by proper  issues and maintaining accounts of consumption. It also keeps a track of stock  accumulation and abnormal consumption. Erection and Fabrication Department

As the name suggests, this department identifies new projects and helps in erecting them. This department also undertakes major modifications of equipment. ERP Department

ERP department helps to integrate the entire enterprise starting from the supplier to the customer, covering financial and human resources. This will enable the enterprise to increase productivity by reducing costs. It also ensures a single solution to the information needs of the whole organization. Production Department

As a part of their ongoing commitment to produce hi-tech quality drugs and  pharmaceuticals that take care of the specific needs of markets around the world, Ranbaxy Laboratories Limited has increased the investment in the production department. It is the most important department of the company and has the following objectives: 1. Improving volume of production. 2. Reducing rejection rate. 3. Maintaining rework rate. Engineering Department

This department undertakes building, construction and maintenance. Maintaining service facilities such as water, gas, heating, ventilation, air conditioning, painting and  plumbing are some of the other areas dealt by this department. This department also helps in maintaining electrical equipments such as generators, transformers, telephone system and electrical installation. Purchase Department

The purchase department provides material to the factory without which the wheels of  machines cannot move. The various functions performed by this department include: Securing good vendor performance, including prompt deliveries of supplies of acceptable qualities.

1. To develop satisfactory sources of supply and maintaining good relationships with the suppliers. 2. To pay reasonably low prices. Quality Control/Quality Assurance Department

The purpose of QC & QA departments is to ensure that the desired quality standard is achieved. It also ensures that the processing or fabrication of material conforms to the specific characteristics selected, to assure that the resulting product will in fact perform its intended function. PRODUCT REVIEW

Ranbaxy’s therapeutic width covers five of the top six categories including Antiinfective, Gastrointestinal, Nutritionals, Cardiovascular, Central Nervous System, Respiratory, Dermatological and others. While anti-infective contribute 56% of the total sales, Ranbaxy’s other brands like Simvotin and Storvas in the cardiovascular segment, Serlift in CNS and Revital and Riconia in Nutritionals, are on their way to success in multiple markets. During Jan - Dec 2000, amongst the top products of Ranbaxy, Sporidex (Cephalexin) was the Number 1 brand, closely followed by Cifran (Ciprofloxacin). Anti - Infectives

Anti- infective has been the main driver of Ranbaxy’s sales. The important brands in

this

category

are

Cifran (Ciprofloxacin),

Sporidex

(Ciphalexin),

Enhancin

(Amoxyclav), Crixan (Clarithromycin), Vercef (Cefaclor), Oframax (Ceftriaxone), Cepodem (Cefpodoxime Proxetil), Zanocin (Ofloxacin), Ceroxim (Cefuroxime Axetil), and Loxof (Levofloxacin). Cifran (Ciprofloxacin) is the key brand in the anti- infective portfolio, with estimated sales of US $ 32 Mn, currently being marketed in 15 countries. Development of  Ciprofloxacin once a day has been an important landmark achieved by Ranbaxy. The  product has been licensed to Bayer. Cifran continues to be a dominant player in the quinolones market in India, China and Russia.

Sporidex is another leading brand in Ranbaxy’s product portfolio with worldwide annual sales of US $ 35 Mn. It is available in eight different dosage forms including capsules, dry powder for suspension, redimix, dispersible tablets, paediatric drops, soft gelatin capsules, sachet and advanced formulation for twice-daily administration. It is currently marketed in 15 countries. In India, Sporidex is the leading brand with a market share of 36% of the Cephalexin segment. Keflor is available in seven different dosage forms and is the third-largest selling  brand for Ranbaxy worldwide. The dosage forms list includes capsules, dry syrup, modified release tablets, dispersible tablets, drops and redimix. Enhancin is expected to be the leading product in Ranbaxy’s product portfolio with estimated sales of US $ 45 Mn by the year 2005. The product will be rolled out to about 20 important markets during this period. Zanocin, with approximate sales of US $ 10 Mn, is the seventh-largest contributor  to Ranbaxy’s total sales. Cepodem is currently available in three different countries outside India, and will  be rolled out to 13 different countries in the near future.

Cardiovasculars

Cardiovascular is projected to be the second-best category for Ranbaxy. Statins have been the key drivers for this segment. The sale of Simvastatin has grown substantially in the past few years, a trend that is likely to continue in the future. In India, Simvotin (Simvastatin) is the market leader in the cholesterol reducer segment. Another  leading brand in this category is Storvas (Atorvastatin). Storvas has been one of the fastest-ever to enter the top-300 brands list of the Indian pharma industry. Other global cardiovascular brands are Covance (Losartan) and Caslot (Carvedilol). Central Nervous System

The Central Nervous Segment is one of the important focus areas identified by Ranbaxy, with Serlift being the key brand. In India, Serlift is number 1 amongst Sertraline  brands. New product introductions will be drivers of growth in this category. Gastrointestinal

Currently, gastrointestinal drugs are the second-largest category for Ranbaxy. The key brands in this category include Histac and Romesac. The current annual sales of  Ranitidine are estimated to be around US $ 16 Mn and the product is marketed in more than 20 countries. Rheumatologicals

The first generation Cox-2 inhibitors principally drive worldwide growth in rheumatology. This category is estimated to grow exponentially for Ranbaxy, with brands like Celecoxib. This year, Rofibax (Rofecoxib) introduced in India, has established itself  as a leader in the Cox-2 inhibitor category and has overtaken all Celecoxib brands. It has  been identified as a key Global brand for the future. Nutritonals

 Nutritionals have been a major contributor to Ranbaxy’s sales. Two of the important products in this category are Revital and Riconia. With annual sales estimated at about US $ 10 Mn, Revital contributes a significant share of total sales. It is a leading  brand in India and has done exceedingly well in some parts of the world as an OTC  product. Dermatologicals

The dermatology category is mainly driven by India region and is likely to show a good growth pattern in the future. Some of the key brands doing well in this segment are Mobizox, Silverex, Moisturex, etc.

INTRODUCTION

TO

CAPITAL STRUCTURE

THEORY AND

ANALYSIS

This is a Report on the ‘Capital Structure and Capital Expenditure of Ranbaxy Laboratories Ltd.’. The purpose and scope of the project can be listed as: •

Understanding the organizational structure and functioning of Ranbaxy Laboratories Ltd.

•

Analysing and comparing the financial health of the firms in the Indian Pharma Industry.

•

Identifying and analysing the capital structure of Ranbaxy.

•

Conducting a Review of the Capital Expenditure done at Ranbaxy Laboratories Ltd.

•

Identifying loopholes in the functioning and in the area of study and recommending the suggestions for the same.

Following are the limitations of the study: •

Balance sheets of only 3 years have been studied but the company is in operation for so many years.

•

Only specific tools (i.e. ratio analysis) have been used for data analysis, while so many other tools are also there.

•

Organizational rules & regulations.

•

Availability of data. Financial figures for 2008 of Ranbaxy were not available.

•

Limitations of the financial tools used.

Literature of review on Capital Structure

capital structure is a mix of debt and equity capital maintained by a firm. Capital structure is also referred as financial structure of a firm. the capital structure of a firm is very important since it related to the ability of the firm to meet the needs of its stakeholders. Modigliani and miller (1958) were the first ones to landmark the topic of  capital structure and they argued that capital structure was irrelevant in determining the firm’s value and its future performance. on the other hand, lubatkin and chatterjee (1994) as well as many other studies have proved that there exists a relationship between capital structure and firm value. modigliani and miller (1963) showed that their model is no more effective if tax was taken into consideration since tax subsidies on debt interest payments will cause a rise in firm value when equity is traded for debt. in more recent literatures, authors have showed that they are less interested on how capital structure affects the firm value. Instead of the firm. modigliani and miller (1963) argued that the capital structure of a firm should compose entirely of debt due to tax deductions on interest payments. However, brigham and gapenski (1996) said that, in theory, the modigliani-miller (mm) model is valid. But, in practice, bankruptcy costs exist and these costs are directly proportional to the debt level of the firm. hence, an increase in debt level causes an increase in bankruptcy costs. therefore, they argue that that an optimal capital structure can only be attained if the tax sheltering benefits provided an increase in debt level is equal to the bankruptcy costs. in this case, managers of the firms should be able to identify when this optimal capital structure is attained and try to maintain it at the same level. this is the only way that the financing costs and the weighted average cost of capital (wacc) are minimized thereby increasing firm value and corporate performance.

BOODHOO Roshan ASc Finance, BBA (Hons) Finance, BSc (Hons) Banking & International Finance (Email: [email protected] ; Tel: +230-7891888)

Methodology The methodology adopted for the study was as follows:

•

Familiarization, examination and evaluation of the procedures relating to capital structure and capital expenditure.

•

•

Collection of relevant data form company records and cross checking of this data.

Calculations of financial ratios, parameter and norms, as also their financial implications.

•

Broadly the data were collected for the report on the project work has been through the primary and secondary sources. The primary data is collected by various approaches so as to give a precise, accurate, realistic and relevant data. The main goal in the mind while gathering  primary data was investigation and observation. The ends were thus achieved by a direct approach and personal observation from the officials of the company. The other staff members and the employees were interviewed for the sake of  maintaining reasonable standard of accuracy.The secondary data as it has always  been important for the completion of any report provides a reliable, suitable equate and specific knowledge. The annual reports, the fixed asset register and the Capex register provided the knowledge and information regarding the relevant subjects.

The valuable cooperation and continued support extended by all associated  personnels, head of the department, division and staff members contributed a lot to fulfil the requirement in the collection of data in order to present a complete report on the project work.

Capital Structure: Theory and Analysis Capital Structure

Financing decisions involve raising funds for the firm. It is concerned with formulation and designing of capital structure or leverage. The most crucial decision of any company is involved in the formulation of its appropriate capital structure. The best design or  structure of the capital of a company helps the management to achieve its ultimate

objectives of minimising overall cost of capital, maximising profitability and also maximising the value of the firm. The capital structure decision of a firm is concerned with the determination of debt equity composition. Capital structure ordinarily implies the proportion of debt and equity in the total capital of a company. The term capital may be defined as the long – term funds of the firm. Capital is the aggregation of the items appearing on the left hand side of the balance sheet minus current liabilities. In other words capital may be expressed as follows: Capital = Total Assets – Current Liabilities. Further, capital of a company may broadly be categorised into equity and debt. The total capital structure of a firm is represented in the following figure:

Established companies generally have track record of their profit earning capacity, which helps them to create their creditworthiness. The lenders feel safe to invest their funds in such companies. Thus, there is ample scope for this type of companies to collect debt. But a company cannot freely i.e. without having any limit. The company must have to chalk  out a plan to collect a debt in such a way that the acceptance of debt becomes beneficial for the company in terms of increase in EPS, profitability and value of the firm. If the cost of capital is greater than the return, it will have an adverse effect on company’s  profitability, value of the firm and its EPS. Similarly, if company is unable to repay the debt within the scheduled period it will affect the goodwill of the company in the credit market and consequently may create problems in future for collecting further debt. Other  factors remaining constant, the company should select its appropriate capital structure with due consideration.

Capital structure involves a choice between risk and expected return. The optimal capital structure strikes the balance between these risks and returns and thus examines the price of  the stock. Significant variations with regard to capital structure can easily be noticed among industries and firms within the same industry. So it is difficult to generate the model capital structure for all business undertakings. The following is an attempt to consolidate the literature on various methods to suggested by researchers in arriving at optimal capital structure. Notations used: •

V = value of firm

•

FCF = free cash flow

•

WACC = weighted average cost of capital

•

rs and rd are costs of stock and debt

•

r e and wd are percentages of the firm that are financed with stock and debt.

Operating and Financial Leverages

The term leverage refers to the ability of a firm in employing long – term funds having a fixed cost, to enhance returns to the owners. In other words leverage is the employment of  fixed assets or funds for which a firm has to meet fixed costs or fixed rate of interest obligation irrespective of the level of activities attained or the level of operating profit earned. Higher the leverage, higher the profits and vice – versa. But a higher leverage obviously implies higher outside borrowings and hence riskier if the business activity of the firm suddenly takes a dip. But a low leverage does not necessarily indicate prudent financial management, as the firm might be incurring an opportunity cost for not having borrowed funds at a fixed cost to earn higher profits.

Operating Leverage

Operating leverage is concerned with the operation of any firm. The cost structure of any firm gives rise to operating leverage because of the existence of fixed nature of costs. This leverage relates to the sales and profit variations.

Contributio Operating

n

Leverage = EBIT

Contribution = Sales – Variable Costs EBIT = Earnings Before Interest and Taxes.

Disadvantages of Operating Leverages −

The reliability of operating ratios rests to a large extent on the correctness of the fixed costs identified with a product. Faulty apportionment would distort the usefulness of the ratio.

−

The published accounts does not give details of the fixed cost incurred and the contribution from each product and for an outsider it is difficult to calculate the firm’s operating leverage.

Firm’s cost structure and nature of the firm’s business affects operating leverage. A degree change in sales volume results in more than proportionate change (+/-) in operating (or loss) can be observed by use of operating leverage.

Financial Leverage

This ratio indicates the effects on earnings by rise of fixed cost funds. It refers to use the use of debt in the capital structure. Financial leverage arises when a firm deploys debt funds with fixed charge. The ratio is calculated with the following: •

Earnings before interest and tax / Earnings after interest –  The higher the ratio,

the lower the cushion for paying interest on borrowings. A low ratio indicates a low interest outflow and consequently lower borrowings. A high ratio is risky and constitutes a strain on profits. This ratio is considered along with the operating ratio, gives a fairly and accurate idea about the firm’s earnings, its fixed costs and the interest expenses on long term borrowings. •

Earnings per Share –  Higher financial leverage leads to higher  EBIT  resulting in

higher   EPS, if other things remain constant. Financial leverage affects the variability and expected level of  EPS . The more debt the firm employs the higher  its financial leverage. Financial leverage generally raises expected EPS , but it also increases the riskiness of securities as the debt / asset ratio rises.

Financial Leverage EBIT =

EBT

EBIT – Earnings Before Interest and Tax EBT – Earnings Before Taxes. Consider Two Hypothetical Firms

Firm U

Firm L  No debt

10,000 of 12% debt

20,000 in assets

20,000 in assets

40% tax rate

40% tax rate

Both firms have same operating leverage, business risk, and EBIT of 3,000. They differ  only with respect to use of debt.  Impact of Leverage on Returns

Firm U

Firm L

3,000

3,000

0

1,200

EBT

3,000

1,800

Taxes (40%)

1, 200

720

1,800

1,080

EBIT Interest

 NI

(Fig. in Rs’000)

 ROE

9.0%

10.8%

More EBIT goes to investors in Firm L. Total dollars paid to investors: •

U: NI = Rs.1,800.

•

L: NI + Int = Rs.1,080 + Rs.1,200 = Rs.2,280.

•

Taxes paid:

•

U: Rs.1,200; L: Rs.720.

 Now consider the fact that EBIT is not known with certainty. Determining the impact  of uncertainty on stockholder profitability and risk for Firm U and Firm L Firm U: Unleveraged 

Economy

(Fig. in Rs’000)

Bad

Avg.

Good

Prob.

0.25

0.50

0.25

EBIT

2,000

3,000

4,000

0

0

0

2,000

3,000

4,000

Interest EBT

Taxes (40%)  NI

800

1,200

1,600

1,200

1,800

2,400

Firm L: Leveraged 

Economy

(Fig. in Rs’000)

Bad

Avg.

Good

 Prob.*

0.25

0.50

0.25

EBIT*

2,000

3,000

4,000

Interest

1,200

1,200

1,200

EBT

800

1,800

2,800

Taxes (40%)

320

720

1,120

 NI

480

1,080

1,680

*Same as for Firm U. Firm U

Bad

Avg.

Good

BEP

10.0%

15.0%

20.0%

ROIC

6.0%

9.0%

12.0%

ROE

6.0%

9.0%

12.0%

TIE

n.a.

n.a.

n.a.

Firm L

Bad

Avg.

Good

BEP

10.0%

15.0%

20.0%

ROIC

6.0%

9.0%

12.0%

ROE

4.8%

10.8%

16.8%

TIE

1.7x

2.5x

3.3x

U

L

Profitability Measures:

 E(BEP)

15.0%

15.0%

 E(ROIC)

9.0%

9.0%

E(ROE)

9.0%

10.8%

sROIC

2.12%

2.12%

sROE

2.12%

4.24%

Risk Measures:

Conclusions •

Basic earning power (EBIT/TA) and ROIC (NOPAT/Capital = EBIT(1-T)/TA) are unaffected by financial leverage.

•

L has higher expected ROE: tax savings and smaller equity base.

•

L has much wider ROE swings because of fixed interest charges. Higher  expected return is accompanied by higher risk.

In a stand-alone risk sense, Firm L’s stockholders see much more risk than Firm U’s. U and L: sROIC = 2.12%. U: sROE = 2.12%. L: sROE = 4.24%. •

L’s financial risk is sROE - sROIC = 4.24% - 2.12% = 2.12%. (U’s is zero.)

•

For leverage to be positive (increase expected ROE), BEP must be > r d.

•

If r d > BEP, the cost of leveraging will be higher than the inherent profitability of the assets, so the use of financial leverage will depress net income and ROE.

In the example, E(BEP) = 15% while interest rate = 12%, so leveraging “works.”

Choosing the Optimal Capital Structure for Ranbaxy Laboratories Ltd.

Based on the ratio analysis done above it can be concluded that Ranbaxy is an unleveared firm with very less debt component in its capital structure. The company is in a position to increase its debt component by resorting to external debt financing. However it should be kept in mind that, there could be two opposite effects if debt is increased in the capita structure. The first effect may be an overall reduction in the cost of capital as the  proportion of debt increases in the capital structure due to low cost of debt. On the other  hand, because of fixed contractual obligation the financial risk of the company increases. Thus, it is said that the optimum capital structure implies a ratio of debt and equity at which weighted average cost of capital would be least and the market value of the firm would be highest. Keeping the above thought in mind I have tried to compute what would be the optimal capital structure for Ranbaxy

Laboratories Ltd., based on the following information as per the Annual Report 2005: EBIT being 37,273,800; Assuming that the firms expects zero growth 225,557,810 shares outstanding; r s = 12%; T = 35%; b = 1.0; r RF = 6%; RPM = 6%.

Estimates of Cost of Debt Percent financed with debt, wd

0%

r d

-

20%

8.0%

30%

8.5%

40%

10.0%

50%

12.0%

If company recapitalizes, debt would be issued to repurchase stock. The Cost of Equity at Different Levels of Debt: Hamada’s Equation •

MM theory implies that beta changes with leverage.

•

 bU is the beta of a firm when it has no debt (the unlevered beta)

•

 bL = bU [1 + (1 - T)(D/S)]

The Cost of Equity for wd = 20%

Use Hamada’s equation to find beta: bL

= bU [1 + (1 - T)(D/S)] = 1.0 [1 + (1-0.35) (20% / 80%) ] = 1.16

Use CAPM to find the cost of equity: r s

= r RF + bL (RPM)

= 6% + 1.16 (6%) = 12.98%

Cost of Equity vs. Leverage

wd

D/S

bL

r s

0%

0.00

1.00

12.00%

20%

0.25

1.16

12.98%

30%

0.43

1.28

13.67%

40%

0.67

1.43

14.60%

50%

1.00

1.65

15.90%

The WACC for wd = 20%

WACC = w d (1-T) r d + we r s WACC = 0.2 (1 – 0.35) (8%) + 0.8 (12.98%) WACC = 11.42% Repeat this for all capital structures under consideration.

WACC vs. Leverage wd

r d

r s

WACC

0%

0.0%

12.00%

12.00%

20%

8.0%

12.98%

11.42%

30%

8.5%

13.67%

11.23%

40%

10.0%

14.60%

11.36%

50%

12.0%

15.90%

11.85%

Corporate Value for wd = 20% V = FCF / (WACC-g) g=0, so investment in capital is zero; so FCF = NOPAT = EBIT (1-T).  NOPAT = (Rs.37,273,800)(1-0.35) = Rs.24,227,970

V = Rs.24,227,970/ 0.1142 = Rs.212,153,852.89 Corporate Value vs. Leverage wd

WACC

Corp. Value

0%

12.00%

Rs.201,899,750.00

20%

11.42%

Rs.212,153,852.89

30%

11.23%

Rs.215,791,315.97

40%

11.36%

Rs.213,274,383.80

50%

11.85%

Rs.204,455,443.04

Debt and Equity for wd = 20% The value of debt is: = wd V = 0.2 (Rs.212,153,852.89) = Rs.42,430,770.58. S=V–D S = Rs.212,153,852.89 – Rs.42,430,770.58 = Rs.169,723,082.31

Debt and Stock Value vs. Leverage wd

Debt, D

Stock Value, S

0%

0

Rs.201,899,750.00

20%

Rs.42, 430,770.58

Rs.169,723,082.31

30%

Rs.64, 737,394.79

Rs.151,053,921.18

40%

Rs.85, 309,753.52

Rs.127,964,630.28

50%

Rs.102, 227,721.52

Rs.102,227,721.52

Wealth of Shareholders

Value of the equity declines as more debt is issued, because debt is used to repurchase stock. But total wealth of shareholders is value of stock after the recap plus the cash received in repurchase, and this total goes up (It is equal to Corporate Value on earlier slide). Stock Price for w d = 20%

The firm issues debt, which changes its WACC, which changes value. The firm then uses debt proceeds to repurchase stock. Stock price changes after debt is issued, but does not change during actual repurchase (or  arbitrage is possible).

The stock price after debt is issued but before stock is repurchased reflects shareholder wealth: S, value of stock 

Cash paid in repurchase.

D0 and n0 are debt and outstanding shares before recap. D - D0 is equal to cash that will be used to repurchase stock.

S + (D - D 0) is wealth of shareholders’ after the debt is issued but immediately before the repurchase.

P = S + (D – D 0) n0 P = Rs.169,723,082.31+ (Rs. 42,430,770.58– 0) 225,557,810 P = Rs.94.06 per share. # Repurchased = (D - D0) / P # Rep. = (Rs.42,430,770.58 – 0) / Rs.94.06 = 45,116. # Remaining = n = S / P n

= Rs.169,723,082.31 / Rs.94.06 = 1,804,462.

Price per Share vs. Leverage # shares

# shares

wd

P

Repurch.

Remaining

0%

Rs.89.51

0

2,255,578

20%

Rs.94.06

451,116

1,804,462

30%

Rs.95.67

676,673

1,578,905

40%

Rs.94.55

902,231

1,353,347

50%

Rs.90.64

1,127,789

1,127,789

Optimal Capital Structure

wd = 30% gives: •

Highest corporate value

•

Lowest WACC

•

Highest stock price per share

But wd = 40% is close. Optimal range is pretty flat. Modigliani and Miller Theory (Modern View)

The traditional view of capital structure explained in weighted average cost of capital  is rejected by the proponents Modigliani and Miller (MM) (1958). According to them, under  competitive conditions and perfect markets, the choice between equity financing and  borrowing does not affects a firm’s market value because the individual investor can alter  investment to any mix of debt and equity the investor desires.

Assumptions of MM Theory

The MM Theory is based on the following assumptions: •

Perfect capital markets exist where individuals and companies can borrow unlimited amounts at the same rate of interest.

•

There are no taxes or transaction costs.

•

The firm’s investment schedule and cash flows are assumed constant and  perpetual.

•

Firms exist with the same business or systematic risk at different levels of gearing.

•

The stock markets are perfectly competitive.

•

Investors are rational and except other investors to behave rationally.

MM Theory: No Taxation

The debt is less expensive than equity. An increase in debt will increase the required rate of return on equity. With the increase in the levels of debt, there will be higher level of interest payments affecting the cash flow of the company. Then equity shareholders will demand for more returns. The increase in cost of equity is just enough to offset the benefit of low cost debt, and consequently average cost of capital is constant for  all levels of leverage as shown in Figure 1.

r 

Cost of  Equity

Cost of Capital

Average cost of  Capital

Cost of  Debt

Figure 1: MM view of Capital Structure

In MM theory the following notations will be used:

Vu

=

Mark Market et valu valuee of unge ungear ared ed com company pany i.e. i.e. com company pany wit with h 100 100% % equ equit ity y financing.

Vg

=

Market value of a geared company i.e. capital structure of the company includes both debt and equity capital.

D

=

Market value of debt in a geared company.

Ve

=

Market ket val value of equit uity in a gear eared com ompa pan ny.

Vg

=

Ve + D

K u

=

Cost of equity in an ungeared company.

K g

=

Cost of equity in a geared company.

K d

=

Cost of Debt.

 M M Theory: Proposition I

The market value of any firm is independent of its capital structure, changing the gearing ratio cannot have any effect on the company’s company’s annual cash flow. The assets in which the company has invested and not how those assets are financed determine the market value. Thus, the market value of a firm is unaffected by its financing decisions, its capital structure, or its debt-equity ratio. In simple words, words, M & M theory theory views the value of the the company as a whole whole pie. The size of the pie does not depend on how it is sliced i.e. the firm’s capital structure but rather the size of the pie pan i.e. the firm’s present value based on its future cash flows and its asset base. The value of the geared company is as follows:

Vg

=

Vu

Vg

=

Profit before interest WACC

Vg

=

Vu

=

Earnings in ungeared company K u

WACC is independent of the debt / equity ratio and equal to the cost of capital which the firm would have with no gearing in its capital structure. Proof by example •

Consider holding 1% of stock in an all-equity firm with value VU.

•

Then your wealth is 0.01VU.

•

Also, you receive a cash flow of 0.01CFt every period.

•

Alternatively, consider holding 1% equity and 1% debt in levered version of the same firm with value Vg=E+D.

•

Your wealth then is [0.01E+0.01D] = 0.01Vg.

•

Cash Flows each period? [0.01(Int)+0.01(CFt-Int)]=0.01CFt.

•

As the inherent risk of the firm is the same, then the discounted value of the cas cash flows must ust be the the same, i.e., e., Vg= VU.

WACC

 Prop. I 

M&M

Traditional

E

MM Theory: Proposition I

 M M Theory: Proposition II

The rate of return required by shareholders increases linearly as the debt / equity ratio is increased i.e. the cost of equity rises exactly in line with any increase in gearing to  precisely offset any benefits conferred by the use of apparently cheap debt.  MM  went on arguing that the expected return on the equity of a geared company is equal

to the return on a pure equity stream plus a risk premium dependent on the level of capital structure. The premium for financial risk can be calculated as debt / equity ratio multiplied by the difference between the cost of equity for ungeared company and risk – free cost of debt.

The cost of equity depends on the following three variables: 1. The 2.

required The

required

rate

of

rate

of

return

on

return

on

u −

d 

the

the firm’s

firm debt

(Ku ). (Kd  ).

3. The firm’s debt/equity ratio ( D/E )

 g  =

u +

D Vg

(

)

 MM proposition II can be summed up in following points: •

Equity holders require a premium over what everyone is paid if the firm has debt.

•

The premium DOES depend upon the firm’s financing mix.

•

The wealth of equity holders, however, is unaffected.

•

Any increase in leverage raises both the risk of equity and its required return.

•

Stockholders are indifferent to capital structure and to change in leverage.

 R E 

Prop. II M&M Slope = R A –  R D

 R A

Traditional

 B  E 

MM Theory: Proposition II M M Theory: Proposition III

 MM theory’s third proposition asserts that the cut-off rate for new investment will in all

cases be average cost of capital and will be un affected by the type of security used to finance the investments. M M Theory: Arbitrage

The cost of equity will rise by an amount just sufficient to offset any possible saving or  loss. The lenders determine the supply of debt. The optimal level is simply the maximum amount of debt which lenders are prepared to subscribe in any given circumstances e.g. level of inflation, rate of economic growth, level of profits etc. the investors will exercise their own leverage by mixing their own portfolio with debt and equity. The investors call this the arbitrage process. Under these conditions of investment the average cost of capital is constant. If two different firms with same level of business risk but different levels of gearing sold for different values, then shareholders would move from over valued firm to the under 

value firm and adjust their level of borrowing through the market to maintain financial risk  at the same level. The shareholders would increase their income through this method while maintaining their net investment and risk at the same level. This process of arbitrage would drive the price of the two firms to a common equilibrium total value. The word ‘arbitrage’  is a technical term referring to a situation where two identical commodities are selling in the same market for different prices, then the market will reach equilibrium by the dealers start at the lower price and sell at the higher price, thereby making profit. The increase in demand will force up the price of the lower priced goods and increase in supply will force down the price of the high priced commodities. The arbitrage in  MM theory shows that the investors will move quickly to take advantage and will make profit in an equilibrium capital market, then this would represent an arbitrage opportunity. MM Theory: Corporate Taxation

In above discussion, MM theory has ignored the tax relief on debt interest. MM has further  modified their theory by considering tax relief available to a geared company when the debt component exists in the capital structure. The tax burden on the company will lessen to the extent of relief available on interest payable on the debt, which makes the cost of  debt cheaper, which reduces the weighted average capital  of the lower where capital structure of a company has debt component. Consider a firm with no debt (i.e. all equity or unlevered) with a value of V u. Suppose firm changes capital structure by issuing debt and retiring some equity. The f irm will realize gain since interest payments on debt are tax-deductible, so tax liability will decline! For perpetual debt: Yearly Tax Savings (Tax Shield) = Interest × TC = r ×D × T C = R D × B × TC

Tax shield will be realized each year forever. Since it goes to bondholders, it should be discounted at R D, thus PV of tax shield = (R D × B × TC)/ R D = B × TC Value of firm with debt VL (i.e. “levered firm”) will be : VL = Vu + B × T C Value increases by PV of tax shield. Tax advantage of debt increases as TC increases. In M&M world (TC = 0), VL = V

Slope = TC

VL

PV of Tax Shield

VU

M&M Value

B MM Theory: Corporate Taxation

Under the assumption of tax relief being available on debt interest, the total market value of the company is increasing function of the level of gearing.  MM theory cost of equity formula for a geared company:

 K  g  = K u + (1 – T) (K u – K d ) 

 MM theory assumes that the value of the geared company will always be greater than an

ungeared company with similar business risk but only by the amount of debt – associated tax saving of the geared company. Value of geared company: V  g = V u + DT 

When corporation taxation is introduced, the tax deductibility of debt interest creates value for shareholders via the tax shield, but this is a wealth transfer from taxpayers. The value of a geared company equals the value of an equivalent ungeared company’s shareholders is less than that in the all equity company, reflecting the tax benefits. A further effect of  corporate taxation is to lower WACC , which falls continuously as gearing increases. MM Theory: Personal Taxation

 MM theory considered only corporate taxes. It was left to a subsequent analysis by Miller  (1977) to include the effects of personal as well as corporate taxes. He argued that the

existence of tax relief on debt interest but not on equity dividends would make debt capital more attractive than equity capital to companies. The market for debt capital under the laws of supply and demand, companies would have to offer a higher return on debt in order to attract greater supply of debt. When the company offers after personal tax return on debt at least as equal to the after personal tax return on equity, the equity supply will switch over to supply debt to the company. It is assumed that, from the angle of the company, it will be indifferent between raising debt or equity as the effective cost of each will be the same and there is no advantage to gearing.

Financial Distress and Capital Structure

The assumption is that when firm has very high level of borrowing they are more likely to run into the cost of final distress and cost of bankruptcy. When the leverage of the firm is extremely high then it is very likely that at some stage it will not be able to make annual interest payments and loan repayments. Dividends for shareholders can be bypassed but failure to pay interest on loans often gives the lender the right to claim on the firms operating assets thereby preventing the firm’s continuity of activity. The following illustrative list of activities which may cause increase in cost of the firm. •

Successive borrowings beyond the company’s target debt – equity ratio.

•

Borrowing higher levels of interest

•

Skip off or cut in dividend which may cause the fall of market rate of shares.

•

Loss of trade credit from suppliers

•

Distress sale of highly profitable instruments.

•

Abandonment of promising new projects.

•

Reduced credit period resulting in loss of business.

•

Corporate image may be tarnished.

•

Demand for withdrawal of loans made to the firm previously.

•

Reduction in stock levels result in reduction in sales etc.

Bankruptcy Costs

The cost of bankruptcy may be of two types: •

Direct costs  — Those directly associated with bankruptcy, both legal and administrative.

•

Indirect costs  — Costs associated with a firm experiencing financial distress (creditors,  bankers, customers, employers, etc.)

Bankruptcy costs = direct costs + indirect costs

An increase in debt is associated with increased tax savings but also an increased  probability of running into cost of financial distress and bankruptcy. The value of the leveraged firm is it’s capitalised after tax operational cash flow  plus the present value of  the tax savings incorporating the anticipated cost of financial distress and bankruptcy. V = X + DT – BC  R Where,

V

=

Value of leverage firm

X

=

Anticipated net operational cash flows

R

=

Capitalisation Rate

D

=

Market Value of Debt

T

=

Corporate tax rate

BC

=

Anticipated costs of bankrupting

V

PV of Bankruptcy Cost

PV of Tax Shield VU

B

Cost of Equity

Optimum Capital Structure

Figure: Optimum Capital Structure and Costs of Financial Distress

The existence of tax benefit for modest amounts of debt, and the need to avoid the costs of  financial distress, suggest that there is an optimal capital structure as illustrated in figure

which shows that there is an optimal capital structure at the point where the market value of the firm is maximized, that is where (DT – BC) is maximized. Debt Financing and Agency Costs

Agency theory models a situation in which a principal (a superior) delegates decision making authority to an agent (the subordinate) who receives reward in return for   performing some activity on behalf of the principal. The outcome of the agents effects the  principals welfare in some way, for example sales revenue, output or contribution margin. The principal attempts to combine a reward system with an information system, in order to motivate the agent to choose the action, which maximizes the principal’s welfare. In respect of debt finance, the suppliers of debt are much concerned, about their  investment in the company, about their investment in the company, about the risk involved in financing debt to the company. In order to minimize the risks in debt finance, the suppliers of loan will impose restrictive conditions in loan agreements that constraint management’s freedom of action and it is known as agency costs. The more money the suppliers of debt lend to the company – then the more constraints they are likely to impose on the managements in order to secure their investments. Therefore, agency costs are more in highly geared firms.

Difficult to identify and estimate, but exist V = VU + BTC – PVBC – PV of agency costs PVBC + PVAC eventually dominate over PV of tax shield. PV of agency costs , as B generally.

V

PVBC + PVAC

PV of Tax Shield VU

B

Debt Financing and Agency Cost Signaling Theory

In a pioneering study published in 1961, Gordon Donaldson examined how companies actually establish their capital structure. The findings of his study are summarised below: 1. Firms prefer to rely on internal accruals, i.e. on retained earnings and depreciated cash flow. 2. Expected future investments oppurtunities and expected future cash flow influence target dividend payout ratio. Firms set the target pay out ratio at such a level that capital expenditures, under normal circumstances, are covered by internal accruals. 3. Dividends tend to be sticky in the short run. Dividends are raised only when the firm is confident that the higher dividend can be maintained; dividends are not lowered unless things are very bad. 4. If a firm’s internal accruals exceed its capital expenditure requirements, it will invest in marketable securities, retire debt, raise dividends, resort to acquisitions, or   buyback its shares. 5. If a firm’s internal accruals are less than its non-postponable capital expenditure, it will first draw down its marketable securities portfolio and then seek external finance.  Noting the inconsistencies in the trade – off theory, Myers proposed a new theory, called the  signalling, or asymmetric information, theory of capital structure. The main points of  the theory are:

♦

Managers often have better information.

♦

Sell stock if stock is overvalued.

♦

Sell bonds if stock is undervalued.

♦

Investors understand this, so view new stock sales as a negative signal.

Corporate Finance Practices

The capital structure decision is a difficult decision that involves a complex trade – off  among several considerations like income, risk, flexibility, etc. given the over – riding objective of maximising the market value of a firm, the following guidelines should be kept in mind while hammering out the capital structure of the firm. •

Avail of the Tax Advantage of Debt.

Interest on debt finance is a tax – deductible expense. Hence finance scholars and  practitioners agree that debt financing gives rise to tax shelter which enhances the value of the firm. •

Preserve Flexibility

Flexibility implies that the firm maintains reserve borrowing power to enable it to raise debt capital to respond to unforeseen changes in business and political environment. Hence the firm must maintain some unused debt capacity as an insurance against adverse future developments. •

Ensure that the Total Risk Exposure is Reasonable

The affairs of the firm should be managed in such a way that the total risk borne by the equity shareholders is not unduly high. •

Subordinate Financial Policy to Corporate Strategy

Financial policy and corporate strategy are often not integrated well. This may be  because financial •

Mitigate Potential Agency Costs.

Due to separate ownership and control in modern corporations, agency problems arise. Shareholders scattered and dispersed as they are not able to organise themselves effectively. Hence, very little monitoring takes place in the security markets. Since agency costs are borne buy shareholders and the management, the financing strategy of a firm should seek to minimise these cost by employing external agents who specialise in low cost – monitoring. •

Issue innovative Securities

Thanks to SEBI guidelines introduced in 1992, issues have considerable freedom in designing financial instruments. There is greater scope for employing innovative securities to the advantage of the firm. The important securities innovations have  been as follows: floating rate bonds (or notes), collateralised mortgage obligations, dual currency bonds, extendible notes, medium term notes. •

Widen the Range of Financing Sources

In as dynamically evolving financial environment, traditional sources of financing may diminish in importance. They may not be adequate or optimal. Hence, it  behoves on a firm to employ new modes of finance like commercial paper, factoring, Euro issues, and securitisation.

Capital expenditure: an overview Factors Of Capex

Organizations engaged in manufacturing and marketing of goods or services require assets in their operations. An asset can be thought of as any expenditure, which creates or aids in creation of a revenue-generating base. Companies incur 

various expenditure to carry on standard flow of work, expenditure intended to yield returns over a period of time, and usually exceeding one year is regarded as capital expenditure. Various factors are considered before Board of Directors approves any expenditure. All that factors can further be divided into: Operational Factors

I. To meet future requirements based on market forecast. II. To maintain coordination with the vision of the company as Ranbaxy vision Garuda states to be top five generic players in the world by 2012 and achieve sales of 5 billion. To achieve this target company has to incur heavy expenditure on acquisition of fixed assets. III. To increase market penetration. IV. To maintain, renew, expand, upgrade existing physical assets that helps to facilitate and enhance revenue-generating capacity. V. To create, acquire and develop revenue generating activities/ capacities that is imperative for an organization’s healthy growth and existence.

Financial Factors

In deciding which assets to create, acquire or develop, the benefits to be gained from the expenditure have to be weighed against the costs that will be incurred. While costs can always be expressed in financial terms, the benefits may or may not be similarly quantifiable. Nevertheless, an attempt must be made to express the benefits expected, in a manner that facilitates comparison with costs and helps formulate a rational basis for the decision making process. Following are the financial tools that are taken into account for approving capital expenditure.

 Discounted Cash Flow (DCF)

This is one of the techniques for financial evaluation of Capex’s. DCF techniques are based on the concept of time value of money and provide a methodology of  taking into account the timing of cash proceeds and outlays over the life of the investment. The procedure underscores the need to state cash flow streams arising in different time periods thus differing in value and, hence comparable only in terms of a common denominator viz. present values.

 I. Discounted Payback Period (DPP)

DPP is the number of years it takes for the present value of inflows to equal the initial investment. Apart from giving due importance to time value of money it serves as a reasonable tool of risk approximation. It favors projects, which generate substantial cash inflows in initial years, and discriminates against those that bring in substantial inflows in later years (risk tending to increase with tenure). Thereby implying that an early resolution of uncertainty enables the decision maker to take prompt corrective action by modifying/ changing other  investment decisions. However, by the same logic it cannot be used as a principal tool for analysis  because it ignores any substantial cash flows arising after the pay back period.

 II. Internal Rate of Return (IRR)

IRR is the discount rate that equates the present value of the expected future cash inflows to the present value of the expected future cash outflows. It is the post tax return from investment and hence the excess of IRR over the cost of capital indicates a surplus after paying for the capital employed. IRR presupposes an equivalent rate of return on the cash flows generated during the life of the asset i.e., it assumes re-investment of intermediate cash flows at the rate of return equal to the project's IRR.

Internal rates of return are most often used as useful additions to NPV computations. This has in turn justified the use of IRR as a good substitute to  NPV. IRRs have the merit of indicating whether a project is worthwhile, in that - an IRR above the cost of capital represents a positive NPV project, an IRR  equal to the cost of capital is a zero NPV project and an IRR less than the cost of  capital is associated with a negative NPV project. Inspite of its merits, it needs to be understood that IRRs helps only to identify  projects that maximizes the ratio of rupee-value to rupee-capital in percentage terms. What NPV will help in determining is the projects that maximizes the rupee-spread between value and capital.

 III. Net Present Value (NPV)

 NPV is equal to the present value of cash inflows minus the present values of  cash outflows. A positive NPV is a prerequisite for the 'acceptance' of the project. The primary tool of appraisal would be the NPV method. Its superiority over  other methods arises out of its principal merit of incorporating all benefits and costs occurring over the life of the asset

 IV. Profitability Index (PI)

The Profitability Index essentially measures the Present value of benefits times the initial investment. Under unconstrained conditions, the profitability index will accept and reject the same projects as the NPV criterion. It is possible that a project may have no critical risks. Or the financial are extremely favorable (high NPV, high IRR, high PI, low DPP etc.) and the occurrence of consequent risks may not compromise the success of the project. It is also possible that there is a conscious corporate decision to accept certain risks. In such cases, no measures are required. These risks, in any case, must be explicitly stated in the Quantitative assessment of Risk Capital investments are

essentially committed in expectation rather than in certainty, which implies that investments are subject to risk contribute to removing the shortcomings of an unstructured workings.

INTRODUCTION

The term 'Capital expenditure'  refers to expenditure intended to yield returns over a period of time, usually exceeding one year. This basically implies that any expenditure, which results in the creation of a new asset or substantially increases the capacity/benefits of an existing asset and is of a "long term" nature, should be classified as Capital expenditure. Since, the expression 'Capital expenditure' is not exhaustively defined, the facts of a particular case would decide whether expenditure is capital or revenue. Generally speaking, the expenditure should be tested on the following criteria to facilitate classification between capital and revenue.

Expenditure would be deemed to be capital, if incurred for 



Initiation of business



Extension of business: Entry into new markets & products (including R&D and regulatory expenses).



Modification of asset/ equipment resulting in increased benefits from the existing asset



Bringing into existence a new asset.



Conversely, expenditure would be deemed to be revenue, if  incurred for 



Routine repairs and maintenance of existing plant.



Replacement of any part of the existing plant with capacities remaining unchanged



Shifting of plants



Making alterations or renovations on rented premises



Assets having life of less than one year 

Classification Of Capital Investments

Since the analysis for appraisal of the proposed capital expenditure will largely depend upon the kind of investment, it is necessary to classify capital investments into the following categories: 1) Cost Reduction, Modernisation and Rationalisation.

Expenditure to replace serviceable, but obsolete equipment. This may  become necessary because of the expiry of normal life or change in technology. The purpose of this expenditure is to improve productivity, increase efficiency or  reduce cost of labour, material or other items such as power. 2) Expansion of Existing Products/ Capacity

Expenditures to increase plant capacity for existing products/equipment or  enhance multi-purpose flexibility. 3) Expansion into New Products/New Product Packs

Expenditure necessary to produce new products/new product pack. This also includes expenditure on existing facilities to handle new products which may result in incremental realizations / value additions. 4) New market development and Market Entry

This would include expenditure made for entering and developing new markets. Such proposals would require the business case to be accompanied with detailed financial analysis. 5) Replacement: Maintenance of Business

Expenditure necessary to replace worn-out or damaged equipment. They are not likely to increase capacity or alter production significantly. Capital spares are included here. 6) Quality, Good Manufacturing Practices, Safety, Health and Environment.

Expenditures necessary to upgrade quality, compliance of GMPs, government regulations, labour agreements, insurance policy terms, and environmental safety requirements. Financial evaluation/benefits from such expenditure may to the extent quantifiable, be provided. 7) Research & Development

Expenditure on R&D projects/ equipment/ facilities. Financial evaluation/benefits from such expenditure may to the extent quantifiable, be provided. 8) Information Technology

Expenditure on procurement of IT infrastructure (Hardware) and/or application software. Financial evaluation/benefits from such expenditure may to the extent quantifiable, be provided.

9) Others

This includes office buildings, vehicles, furniture, office equipment, InfoTech related equipment and utilities, and all such assets, which provide infrastructures support. This also includes any capital expenditure not explicitly covered in the above classifications.

Capital Expenditure proposals are not applicable for 1] Employee entitlements

Capital expenditure necessary to meet the commitments in respect of provision of  assets to the employees in terms of personnel policies. Financial evaluation of  such expenditure is not required. Assets purchased by employees against their  hard/soft furnishing entitlements do not fall within the scope of this manual and hence, will not be included here as they are per policy. 2] Amounts less than Rs.10, 000/ $1,000

Segregation of Capex and Revenue Expenditure Broadly, the following shall be considered as Revenue: 

All repairs to equipment in the normal course of business.



All annual maintenance contracts (AMC) to keep the said equipment/assets in working condition.



All expenditures, which do not result in an enduring/permanent benefit to the assets.



Modification to the existing assets, which does not result in enduring benefit, are to be treated as Revenue after taking ratification of Technical Head of  Plant.



Piping and insulation of the nature of minor repair or replacement.



Re-arrangement of assets or minor structural changes for regulatory batches.



All accessories / dies & punches which are procured subsequent to purchase of  assets

In case of certain expenditure the treatment of which is in doubt, the decision in this respect shall be exercised by the Plant Account Manager in consultation with the User/Technical Head.

Date Of Capitalisation

Date of Capitalisation would be the date when the assets is certified by the concerned Engineering / E&F Department as ready to use or GRN date in case of  assets which do not need commissioning (that is computers, furniture, fixtures etc.). Authority for fixing date of capitalisation would be with E&F department. Lead-time between certification and Commencement of commercial production will not normally exceeds 30 days In case of lead-time exceeding 30 days to take specific approvals from the Plant Head.

Capitalization of Expenditure other than basic cost of assets

All expenditure directly related to the assets capitalized including freight, Entry tax, Octroi, custom duty, and any such amount, which does not form part of the original invoice, is to be capitalized along with the relevant assets. All installation cost, service charges and labour cost, trial run cost (net of  realizable value of the product), technician fee and any other expenditure directly attributable to the installation.

Cenvat /CVD credits will be netted off from the cost of assets. As per accounting standard we have to capitalise the assets net of Modvat. E&F department operational cost will be directly identified with the projects or  allocated to the projects on equitable basis. For all this expenditure it is important to book at the stage of initiation at SAP locations through the same capital internal order number, which has been uniquely given to the Capex proposal at the time of initiation of the particular  asset. Regarding Cenvat/ CVD credits netting off, special care is required to be taken towards year ends to ensure meeting technical requirements as per the Accounting Standards and ensure maximum depreciation (including higher  depreciation allowed is accounted for on capitalization, as applicable & there is no Cenvat (cash flow) loss.

Capex Numbering

The numbering scheme is as under  Entity/Division/Cost Center No./ Year/ Serial No. of CEP raised by that

RCC/ Running Serial No. of Capex of the Division/ Plant, to be given by the Accounts department. In case of Head Office, H.O will appear against division's name.

At the beginning of the year capital budget prepared by every cost center (RCC) for  the particular year in every business area. This budget prepared every department and submitted to the division. Then division decided and finalized the budget and given to the management committee for the final approval. Capital budget is three type  prepared by the company. Divisional

Info tech Employee entitlement The whole process works in a very systematic manner where firstly engineers working at operational level locate the requirement of any new machinery. After  identifying need at operational level process of capital budgeting commence. Currently whole Capex system is followed manually. The whole organization is divided plant wise. Plants located at Mohali 1 &2, Toansa, Dewas are handled division wise. Division consists of head from each department and they control API Manufacturing plants from one division. API manufacturing acts as a coordinator between above 4 plants. They are responsible for communicating reports generated by each plant head that comes under API manufacturing to higher authorities. For each Plant responsible cost center head are assigned who looks after operational need. Different RCC’s are  prepared depending upon the functions. These head can be divided into following categories 

Production



Engineering



Personnel/security



Safety/ETP



QA/QC



Stores

For above different functions RCC’s head prepared their requirement chart specifying 

RCC’s number 



Description (whether production, engineering, QA/QC)



Classification (Replacement, Upgradation)



Kind of expenditure (capital or revenue)



Justification



VED



Quantity

RCC’s number is unique for each function. Description about the function whether it falls in production, engineering, personnel etc. Revenue or capital expenditure can be further divided as per RCC’s requirements:

CAPITAL EXPENDITURE

Regulation GMP (Goods Manufacturing Practices) EHS (Environment Health Safety) Replacement Capacity Upgradation Additional REVENUE EXPENDITURE

Operating Expenses

Stores Repairs Building Repairs and Maintenance Staff Welfare VED is a management science tool, which is used by various department depicting vitality of particular need raised at operational level where V stands for VITAL E stands for ESSENTIAL D stands for DESIRABLE The above requirement chart prepared by RCC head then consolidated by Divisional Finance Accounts Department and budgets are prepared. For each  plant this chart is prepared where requirement of various functions are shown and also respective RCC head gives justification. Finance department review the expenditure type whether capital or revenue again as it could be classified wrong  by RCC head. Finance department then modifies this chart into budget based on Plant wise requirement Kind of function

In plant wise requirement various excel files are prepared which is as follows Summery statement Revenue expenditure Capital expenditure RCC wise

Similarly depending upon the functions various budgets is prepared. Basically here for production and engineering requirements send by RCC head is provided in plant wise description chart but for others such as Personnel/security Safety/ETP QA/QC Stores

In above functions division wise budgets are also made for example

QA/QC -> Division -> PDL QA Contract Manufacturing

Personnel/security -> Division -> Personnel/security Division Management Division Accounts

Separate budgets are prepared and then sanctioned by respective head.  Now the budgets prepared by finance department is further send to respective departmental head. Then plant heads, followed by Vice President & onwards as  per the Capex amount, approves these capex’s.

As explained earlier Finance manager maintain the budget information, following manufacturing locations of API are catered at Mohali Division MOHALI TOANSA DEWAS After preparation of Budgets, BOD approves Capital Expenditure by initiating CAPEX form by Plant head that is appropriately signed by requisite authorities. In CAPEX Form itself amount is classified into various categories A. Replacement/Cost Reduction B. Expansion into New Product/New Product Packs C. Quality, Safety, Environmental D. Expansion of Existing Products Packs E. Replacement: Maintenance of Business F. Others All kinds of expenditure are classified into above head for API Manufacturing for  approval of Capital Expenditure

Accounting Route for API Manufacturing Capital Expenditure

When top authorities approve the Capex requirement then an internal order number is created by Plant department. After the creation of internal order number finance department inform respective accounts department about the same. On receipt of the IO, indenter will create the purchase requisition that subsequently go to purchase department. Purchase department will float enquires and prepare comparative charts for at least 3 vendors. After selecting the vendor, purchase department will place a

 purchase order (PO) on the vendor for supply of the asset. In case, as per the terms of  the PO, any advance is to be given to vendor, the same is released by accounts department, after passing the necessary entries in the vendor account under respective  business area (BA). The purchase department while preparing the PO would ensure to mention complete name as “RANBAXY LABORATORIES LIMITED, API MANUFACTURING” and address/ location of delivery of the asset. On receipt of the goods, the Stores department will arrange to prepare the GRN and get the same approved by the user department. On approval of the GRN, the stores department will send the bill to accounts for invoice verification. The accounts department will verify the invoice with PO and release the balance payment to vendor.

Material Cost

The purchase requisition (PR) for domestic materials i.e. Solvents, Chemicals and other Consumables required for project completion will be raised by scientists after  obtaining approval from the respective head, the purchase requisition (PR) will be send to purchase department for procurement of the material. Purchase department will float enquires and prepare comparative charts for at least 3 vendors. The purchase department will place the PO on the vendor for supply of the materials. In case, as per  the terms of the PO, any advance is to be given to vendor, the same will be released  by accounts department after passing the necessary entries in the vendor account under Business Area (BA). The purchase department while preparing the PO would ensure to mention complete name as “RANBAXY LABORATORIES LIMITED, API MANUFACTURING” and address/ location of delivery of the asset. On receipt of the goods, the stores department will arrange to prepare the GRN and do the respective head approve the same. On approval of the GRN, the stores department will send the  bill to accounts department for invoice verification. The accounts department verifies the invoice with PO and releases the balance payment to vendor. The cost of material will be booked in the API MANUFACTURING cost center under Business Area 1000. In case of imported material on receipt of approved PR from the API MANUFACTURING, purchase department, Mohali will send the PR to international

 purchasing department (ID Purchase) at Devika Tower, Delhi. The ID Purchase, while  preparing the PO would ensure to mention the complete as “RANBAXY LABORATORIES LIMITED, API MANUFACTURING” and address/ location of  delivery of the asset. On receipt of the material, the purchase department will arrange to prepare the GRN and do the respective head approve the same. On approval Of the GRN, the ID Purchase department will send the bill to accounts department will only verify for invoice verification. The accounts department will verify the invoice with PO .the verification of Custom duty; Overseas fright etc. will be done by ID accounts and will arrange to release the payment to vendor. The cost of material will be booked in the API MANUFACTURING cost center under Business Area 1000. In the SAP system, a separate storage location (Storage Location 1075 plant 1030) for  material required by API MANUFACTURING should be created so that at any given  point the material purchased & consumed may be identified. Physically, the capital assets as well as the materials purchased for API MANUFACTURING should be stored in a separate storage preferably within API MANUFACTURING storage location. Revenue Expenditure

Apart from material, to carry on the API MANUFACTURING, certain expenses will  be incurred under various accounting heads. These expenses either may be incurred directly by API MANUFACTURING, or may be incurred by other locations. The accounting of these expenses would be made as under: The manpower i.e. lab technician and other supporting staff working for the API MANUFACTURING should be identified. All direct & indirect expenses incurred in connection with recruitment, salaries, allowances and other benefits related the said manpower be charged to the cost center for API MANUFACTURING e.g. Repairs & maintenance of building, AMC’s housekeeping, Horticulture, Books & Periodicals, Conference & Meeting, training, traveling lab assistant, Gifts & presents etc, should  be charged to the cost center of API MANUFACTURING.

Utilities cost such as Electricity, Water, Power, and Stream etc, incurred for API MANUFACTURING, based upon the actual bills received from the supplier. In case the utilities are provided by any of the existing manufacturing facilities, the supply should be monitored by separate meter/sub meter etc, and charges for the same based upon the actual units consumed should be debited to the cost center of API MANUFACTURING. The other supplies/facilities such as Telephone, Fax, Telex etc., should be directly in the name of API MANUFACTURING. In case, any common facility is used, charges on reasonable basis should be debited to the cost center of API MANUFACTURING, Mohali. The supplies from common canteen should also be charged on a reasonable  basis i.e. linked to the number of employees working in API MANUFACTURING. The charges for Tea, coffee, snakes etc, consumed by API MANUFACTURING. Guest would be charged on reasonable basis to the Cost Center of API MANUFACTURING. In case any materials/consumables are provided by any of the manufacturing location to the API MANUFACTURING. A stock transfer note will be raised on API MANUFACTURING. Similarly if any services are provided by marketing facility to API MANUFACTURING, cost there of at arms length basis will be debited to the API MANUFACTURING. Statutory Compliances (For Duties & Taxes):

[a] Excise:

1. The CENVAT credit shall not be available in respect of the Inputs received from the vendors. 2. Transfer of any excisable inputs as such or intermediate from manufacturing locations the same should be on payment/reversal of  appropriate duty, on which CENVAT is not applicable [b] Sales Tax :

1. The premises stand already declared for the purpose of sales tax registration.

2. As no direct sale activity is involved from the premises, hence no  payment on account of sales taxes. [c] Other taxes:

As applicable on the items procured for the purpose (Octroi, etc.)

SAP Programming Route For Approval Of Capex

SAP stands for System Application Products in Data Processing. Before giving the route of SAP for Capex an introduction about what actually is SAP Ranbaxy is an ERP organization that uses the SAP software system in their  organization. Ranbaxy has adopted SAP R/3 version. System Application Product (SAP) is a product of GERMANY that helps in data processing. In this SAP software there are various modules, which deal with different business activities. Configuration of inventory under SAP system In the SAP system various materials master codes are maintained to identify the materials whether it is raw material, work in progress, finished goods or semi finished goods. For this purpose a 7-digit code is maintained. RAW MATERIAL

3******

PACKING MATERIAL

5******

WORK IN PROGRESS

8******

FINISHED GOODS

1******

STORE AND SPARES

4******

Material module under SAP consist of the following 

Organization structure



Master data



Procurement process



Inventory management

Organization structure

Client Company code Business Area Plant Controlling area Operating concern Cost center 

Client & Company Code

Client - Application-independent unit: Top level Physical structure

Client is a self-contained unit in SAP R/3 System with Separate Master Records and its own set of tables Company Code Represents an independent legal accounting unit, wherein a Balance sheet, and P&L statement can be prepared. Several company codes can be set up for 

each client, thus enabling accounting data to be managed simultaneously for several independent organizations. Example: a subsidiary company, member of a corporate group RANBAXY organization has different client and company codes for its companies. Such as Ranbaxy laboratories LTD Ranbaxy fine chemical LTD Ranbaxy UK LTD  Business Area

Line of Business: e.g. API Manufacturing, Pharmaceuticals.

An organizational entity that is not independent from a Legal standpoint. Internal  balance sheets and income Statements can be created at Business Area level. Business Area configured in RLL •

API MANUFACTURING

•

API MARKETING

•

FORMULATION MANUFACTURING

•

FORMULATION MARKETING

•

TRADING

•

ALLIED BUSINESS

•

PHARMA BUSINESS SUPPORT

•

REASEARCH & DEVELOPMENT

 Plant 

A plant is an organizational unit within a company. A plant produces goods; render  services, or makes goods available for distribution. A plant can be one of the following types of locations Manufacturing facility e.g. MFG (Mohali) Warehouse distribution center  Branch office

Controlling Area

This is organizational controlling unit. Transactions within Controlling area is  possible

Operating Concern

Top-level logical unit in SAP. It is superset of all Cost Center, Business Area and Controlling Area etc Cost Center 

Cost center is the smallest unit in Phase I. In SAP for handling various costs, there are different types of cost centers. Examples, Personal Cost Center, Amoxy Cost Center, Utility Cost Center. For Financial purposes Cost Center are classified into various heads such as administrative cost center, works cost center, Utility / Production cost center.  SAP Route

SAP functioning in the system begins by creating internal order. Internal order number is created by finance department by using SAP command is Accounting -> Investment Management -> internal order -> Master data -> special functions -> KO02 The above path command is KO02 that creates an internal order for which following information need to be filled General data, Applicant, Person Responsible, Processing group, Estimated costs, Application data, Department, Control data, System status, User status, Assignments, Company code, Business area, Plant, Object class To make certain changes in internal order the command is Accounting -> Investment Management -> internal order -> Budgeting -> Original Budget -> KO22

In above command is used to verify the amount and text of internal order. The report created by finance department can be viewed by using command S_ALR_8701301. It is not mandatory to fill up certain fields in the internal order at the time of its creation with the result that the cost over-runs are not reflected automatically by SAP systems. For example, the system provides that where the expenditure under any internal order exceeds 2.5% of the budgeted amount, the same is reflected in the reports. After creating the internal order the finance manager will mail the CAPEX amount sanctioned by higher authorities and also the internal order number to respective Plant Head. Indenter will indent the required material. Indenter is the person who at operational level requires the material In SAP next step is creation of Purchase Requisition that can further be prepared in 2 ways Cost Center 

CAPEX-IO For the purpose of capitalization we have to focus on CAPEX route. Here, after  getting mail from finance department Plant Head will authorizes the indenter to raise indent that is the indenter will create Purchase Requisition. From the department the SAP route comes to Purchase Department that in Mohali handles the Purchase Requisition for Mohali and Toansa. In purchase department three documents are  prepared in order to raise final PURCHASE ORDER that is initiate to supplier. 1 REQUEST FOR QUOTATION (RFQ) – Purchase Department after receiving the Purchase Requisition will place order depending upon requirements. In system, for  different items different staff person receives particular Purchase requisition that is differentiated by unique purchasing group. For Example 505 is the purchasing group that handled Purchase Requisition for items related to Electrical and instruments. For each item Purchase Department is required to send RFQ to 3 vendors. Three is the minimum limit for every item but in case where Purchase Requisition (PR) specify the brand of particular need to be acquired, in that case only one RFQ need to send. For example if PR specifies one LG T.V then only one RFQ need to send to dealers dealing in LG commodities. For CAPEX PR starts from 3000001987. RFQ is the 10digit number. In SAP for creating a RFQ ME41 is the command used by purchase department. Then a applet window comes where information regarding RFQ type Language key RFQ date Quotation deadline RFQ Organizational data Purchase organization Purchasing group

Default data for items Item category Delivery date Plant Material Group Storage location.

Balance sheet Dec ' 08 Dec ' 07 Dec ' 06 Dec ' 05 Dec ' 04 Sources of funds Owner's fund

Equity share capital

210.19

186.54

186.34

186.22

185.89

Share application money

175.66

1.18

0.88

0.28

2.83

Preference share capital

-

-

-

-

-

Reserves & surplus

3,330.92 2,350.68 2,162.79 2,190.80 2,320.79

Loan funds Secured loans

162.07

Unsecured loans

3,563.30 3,137.96 2,954.31 676.31

Total

7,442.14 6,041.42 5,528.61 3,407.10 2,645.38

365.07

224.29

353.49

133.37 2.49

Uses of funds Fixed assets

Gross block

2,386.75 2,261.48 2,133.57 1,799.32 1,402.79

Less : revaluation reserve

-

-

-

-

-

Less : accumulated depreciation

930.07

791.96

699.54

599.35

525.21

 Net block

1,456.68 1,469.52 1,434.03 1,199.97 877.58

Capital work-in-progress

428.77

432.84

264.16

Investments

3,618.03 3,237.55 2,679.95 762.78

679.07

Net current assets Current assets, loans & advances

6,509.97 2,922.42 2,620.99 2,409.08 2,366.89

Less : current liabilities & provisions

4,571.31 1,915.49 1,508.24 1,397.56 1,542.33

Total net current assets

1,938.67 1,006.93 1,112.76 1,011.52 824.57

Miscellaneous expenses not written

-

Total

7,442.14 6,041.42 5,528.61 3,407.10 2,645.38

Notes:

327.42

-

301.88

-

-

-

Dec ' 08 Dec ' 07 Dec ' 06 Dec ' 05 Dec ' 04

Book value of unquoted investments

3,372.60 3,106.69 2,659.94 762.77

679.07

Market value of quoted investments

-

280.46

14.27

0.01

0.01

Contingent liabilities

252.85

201.00

159.40

202.40

307.95

 Number of equity sharesoutstanding (Lacs) 4203.70 3730.71 3726.87 3724.42 1858.91

Capital structure

From

To

Year

Year

2008

2008

Class Of  Authorized Share

Equity Share Equity

2007

2007

2006

2006

2005

2005

2004

2004

2003

2003

2002

2002

2001

2001

2000

2000 Equity

Share Equity Share Equity Share Equity Share Equity Share Equity Share Equity Share

Capital

Issued

Paid Up

Capital

Shares (Nos)

Paid Up Face Value

Paid Up Capital

299.00

210.18

420369753

5

210.18

299.00

186.54

373070829

5

186.54

299.00

186.34

372686964

5

186.34

299.00

186.22

372442190

5

186.22

199.00

185.89

185890742

10

185.89

199.00

185.54

185543625

10

185.54

199.00

185.45

185452098

10

185.45

150.00

115.90

115895478

10

115.90

150.00

115.90

115895478

10

115.90

From

To

Year

Year

Class Of  Authorized Share

Capital

Issued

Paid Up

Capital

Shares (Nos)

Paid Up Face Value

Paid Up Capital

Share 1999

1999

1997

1998

1996

1997

1995

1996

1995

1996

1994

1995

1993

1994

1992

1993

Equity Share Equity Share Equity Share Equity Share Equity Share Equity Share Equity Share Equity Share

150.00

115.90

115895250

10

115.90

69.00

53.73

53726252

10

53.73

69.00

49.41

49414717

10

49.41

69.00

48.13

43132253

10

43.13

69.00

48.13

5000000

3

1.25

69.00

43.13

43132253

10

43.13

69.00

35.33

35330269

10

35.33

49.00

21.79

21793050

10

21.79

Recommendations and Suggestions for the Indian Pharma Industry.

The achievements of the Indian pharmaceutical industry are spectacular in recent times and are praise worthy, which has evolved as model industry of the country in performance. But, in the 21st century, the pharmaceutical value chain would depend on the ability of   pharmaceutical companies to make the technological shift necessary to maintain and increase their competitive positions. Also for the MNCs, India provides not just the possibility – but the unique & tangible opportunity to make the desired ‘technological shift’ – in process, and in location! The

question before Pharma Company CEOs the world over today is not: ‘Should my company go to India?’ but ‘Can my company afford not to go to India’?”

STEPS REQUIRED TO BOOST THE COMPETITIVENESS OF THE PHARMA INDUSTRY •

Extension of deduction of 150% of R&D expenses. This would encourage more

and more companies to invest in R&D. •

The government has earmarked 150 crores for R&D. This is just not enough. It should be augmented to at least 2000 crores.

•

To rationalize Drug Price Control Order (DPCO). The objective of the price

control was to ensure adequate availability of quality medicines at affordable  prices. The product patent regime will make it obligatory for Indian companies to compete in R&D if they want to survive. Similarly, WTO led global trading system will result in import tariffs coming down. For Indian companies to compete with cheap imports, they will have to invest in cost effective technology and  processes. Therefore, it is imperative that the pharma industry has surplus for  investment. In this context, a liberalized price control regime becomes more important. •

An academic –industrial relationship can be further explored , on the lines of 

the US model, where the universities are the sites of innovation and the industry commercializes the product. The universities are permitted to own the Intellectual Property Rights (IPR) and get a share of the profits. Academic institutions will then become the engines of entrepreneurship. This also requires setting up of  greater number of centres of academic excellence throughout India in different states, so that people from across the country can avail of such education and make their contributions without feeling the need to look beyond India for achieving academic excellence.

•

Income tax exemptions should be given on clinical trials and contract research done outside the company and abroad. This is because India is seen as emerging

as a major centre for outsourcing of clinical trials for the Pharmaceutical MNCs.

•

The problem of spurious drugs has to be tackled. 

The procedure for procurement of licence should be made more stringent, including extensive disclosure of detailed personal, financial and business information and a thorough background check. There is a strong need to strengthen

and streamline

the Central and

State

Drug Control

Organizations. State drug controllers should take measures like setting up of separate intelligence-cum-legal machinery with police assistance. Faking should be made non-bailable and cognizable offence and the prosecution should be instituted by any police or Central Bureau of Investigation officer  not less than the rank of a sub-inspector (instead of an inspector in the extant provision). 

Most of the cases relating to spurious drugs remain undecided for years. Hence there is a strong need for setting up separate courts for speedy trials of such offences. The case should be tried by the court of the rank of a Session Judge or above whereas the extant provision provides for a trial by a metropolitan magistrate or a first class judicial magistrate or above.



Each state should set up accredited testing laboratories that are well equipped and adequately staffed. The staff should be trained well for  drawing samples for test and monitoring the quality of drugs and cosmetics moving in the State. It is most important and essential to have training  programmes for technical staff of central and state drug control laboratories and private testing laboratories as it is based on the report of these testing laboratories that a manufacturer releases his product or otherwise. Legal action against the manufacturer is likely to be taken on the basis of the test report given by a government analyst.

•

India should exploit its know-how in herbal medicines. Since these medicines

do not come under the purview of the TRIPS regime and the research in new chemical entities involves millions of dollars of investment, the Indian companies should engage in R&D in herbal medicine. The companies should try to exploit the Indian traditional knowledge in ayurveda and herbal cures and file as many patents for herbal medicine as they can. For this the government should set up R&D laboratories undertaking research exclusively in the area of herbal medicines and support the companies in their research and patent filing. •

The government should encourage setting up of USFDA-compliant plants by providing tax holidays for a specified period (as given in regions like Baddi),

so that the Indian companies can exploit the opportunity arising out of patented drugs and take up marketing of generics in the developed countries like USA.

TRENDS AND STRATEGIES

The Indian domestic pharmaceutical industry is increasingly becoming globally competitive to counter the weaknesses and threats. The key trends and strategies being adopted by the local pharmaceutical industry are: Increased R&D Focus

Driven by the imminent change to a product patent regime at home from 2005 the leading  pharmaceutical companies in India have been increasing their R&D budgets over the years. Indian pharmaceutical companies are likely to double their expenditure on R&D over the next 2 years. Exports Driven Growth

Indian pharmaceutical companies are on a global beat. Currently, exports contribute more than half the total revenues for most of the Indian pharmaceutical majors. Exports have increased in recent years as Indian pharmaceutical companies have made deep inroads into the regulated generic markets of the US and Europe, in addition to unregulated markets. MNCs Showing Growing Interest in India

The share of MNCs in the Indian pharmaceuticals market is expected to increase with the recognition of product patents in the country from 2005, as they will be able to freely introduce top of the line, patented products in the domestic market. Moreover, with the new price control order expected to be passed soon, DPCO coverage will be substantially reduced and margins of most MNCs with strong brands will drastically improve. The Indian Government’s decision to allow 100 per cent Foreign Direct Investment into the drugs and pharmaceutical industry is expected to aid increased investment in R&D infrastructure by MNCs in India.

Recommendations and Suggestions for Ranbaxy Laboratories Ltd.

This paper describes a methodology for deriving the optimum capital structure for an unlevered equity driven firm. Using a hypothetical model for computing optimal capital structure, the idea is to determine the optimum level of debt which Ranbaxy can for  maximisising its market value and shareholders wealth. Various methods through which Ranbaxy can raise debt are: Debentures

Debentures are loans that are usually secured and are said to have either fixed or floating charges with them. A secured debenture is one that is specifically tied to the financing of a particular asset such as a building or a machine. Then, just like a mortgage for a private house, the debenture holder has a legal interest in that asset and the company cannot dispose of it unless the debenture holder agrees. If the debenture is for land and/or buildings it can be called a mortgage debenture. Debenture holders have the right to receive their interest payments before any dividend is  payable to shareholders and, most importantly, even if a company makes a loss, it still has to pay its interest charges. If the business fails, the debenture holders will be preferential creditors and will be entitled to the repayment of some or all of their money before the shareholders receive anything.

Other Loans

The term debenture is a strictly legal term but there are other forms of loan or loan stock. A loan is for a fixed amount with a fixed repayment schedule and may appear on a balance sheet with a specific name telling the reader exactly what the loan is and its main details. Overdraft Facilities

Many companies have the need for external finance but not necessarily on a long-term  basis. A company might have small cash flow problems from time to time but such  problems don't call for the need for a formal long-term loan. Under these circumstances, a company will often go to its bank and arrange an overdraft. Bank overdrafts are given on current accounts and the good point is that the interest payable on them is calculated on a daily basis. So if the company borrows only a small amount, it only pays a little bit of  interest. Lines of Credit from Creditors

This source of finance really belongs under the heading of working capital management since it refers to short term credit. By a 'line of credit' we mean that a creditor, such as a supplier of raw materials, will allow us to buy goods now and pay for them later. Why do we include lines of credit as a source of finance? Well, if we manage our creditors carefully we can use the line of credit they provide for us to finance other parts of our   business. Grants

Grants can be an attractive aspect of a company's financing structure. If a company has a specific issue that it wants or needs to deal with then it could find that there are grants available from local councils and other bodies that will help to pay for it. Venture Capital

Venture Capital has become a vital aspect of the source of finance market over the last 10 to 15 years. Venture Capital can be defined as capital contributed at an early stage in the development of a new enterprise, which may have a significant chance of failure but also a significant chance of providing above average returns and especially where the provider of 

the capital expects to have some influence over the direction of the enterprise. Venture Capital can be a high risk strategy. Factoring

Factoring allows you to raise finance based on the value of your outstanding invoices. Factoring also gives you the opportunity to outsource your sales ledger operations and to use more sophisticated credit rating systems. Once you have set up a factoring arrangement with a Factor, it works this way: Once you make a sale, you invoice your customer and send a copy of the invoice to the factor and most factoring arrangements require you to factor all your sales. The factor pays you a set proportion of the invoice value within a pre-arranged time - typically, most factors offer you 80-85% of an invoice's value within 24 hours. Leasing

Leasing is a contract between the leasing company, the lessor, and the customer (the lessee). The leasing company buys and owns the asset that the lessee requires. The customer hires the asset from the leasing company and pays rental over a pre-determined  period for the use of the asset. There are two types of leases: •

Finance Leases

Under a finance lease the rental covers virtually all of the costs of the asset therefore the value of the rental is equal to or greater than 90% of the cost of the asset. The leasing company claims writing down allowances, whilst the customer  can claim both tax relief and VAT on rentals paid. •

Operating Leases

The lease will not run for the full life of the asset and the lessee will not be liable for its full value. The lessor or the original manufacturer or supplier will assume the residual risk. This type of lease is normally only used when the asset has a  probable resale value, for instance, aircraft or vehicles.

The most common form of operating lease is known as contract hire. Essentially, this gains the customer the use of the asset together with added services. A very common example of an asset on contract hire would be a fleet of vehicles. Indian pharmaceutical scene is fast changing. Consumer expectations are going up leading to more difficulties for pharmaceutical marketing professionals. Change in the character   profile of the doctors with socio-economic changes have also affected many  pharmaceutical companies. Thus Ranbaxy should also concentrate on following areas to strengthen market position:

Do Market Audit

The company should carryout an audit of all its activities. This activity analyses different marketing activities and suggest the bench mark for the company. This is a self supportive study as the marketing audit gives lot of avenues in streamlining the operations and cutting the cost. It also helps to remove unnecessary activities, which may be redundant for  tomorrow. This gives also an insight to the future scenario.

Sales Management Audit and Preparation of New Sales Strategy

Sales Management plays a very important role in pharmaceutical industry. Medical Representative or Area Manager is the key person in improving the sales. Medical Representative and Manager, if are not happy, and not properly directed can lead to chaotic conditions.

Training

Reorientation of the field force and manager is a must. Training plays a very important role in motivating representatives as well as managers. It helps them to sharpen their tools and develop confidence. A series of refresher course should be organized in order to update managers on the medical skills and the selling skills. The net benefits of a training  program may be summarized as under:

i.

Confidence level of the medical representatives goes up. They added lot of key customers whom they were not meeting earlier. Increase in customer base with also regular visit to key customers led to improvement in output.

ii.

Improvement in strike rate – converting Non Prescribing Potential Doctors to Irregular Prescribing Doctors Quicker. This leads to improvement in the

 productivity. iii.

Training helps in accelerating productivity and overall growth in the Company.

Morale of the people if kept high then anything can be achieved. Today as per the study conducted in India, majority of the people works at 40% of its energy level. A positive attitude with proper work culture will not come only through lectures but there should be adequate reward systems. Optimization of Resources

Resources available today are becoming scarce. Therefore, for turning around the company, optimization of resources does play a very important role. The activities like rationalizing of tour programme, defining the head quarters working norms, proper   planning of input plans like samples, gifts based on contribution, core doctors visit analysis, application of ACE approach and input-output model led to increase in  profitability.

CONCLUSION

The successful strategy for Ranbaxy Laboratories Ltd. in a post 2010 world will include: (a) Attain right product-mix (b) Augment skills

(c) Use M&A options for either companies or products. (d) Building ‘Innovation’ Engine at R&D (e) Sustain growth momementum in USA. (f) Attain critical mass in Europe and Latin America. (g) Specialty products focus for “Brand” marketing. (h) Fortifying home business – leverage India Base. (i) Seeding the Japanese market. (j) Networking, licensing and acquisitions. (k) Technology, new market entry vehicles, brands/ proprietary products (l) Global talent pool to fuel growth.

The increasing importance of biotech industry and its symbiotic relationship to pharma will also be very relevant in Ranbaxy’s strategy. However Ranbaxy should not close its eyes on the ever increasing Global competition, which is a big threat for the company. The entry of international and new domestic players would intensify the competition significantly. Further there is threat from other low cost countries like China and Israel. However, on the quality front, India is better placed relative to China. So, differentiation in the contract manufacturing side may wane.

The short-term threat for the pharma industry is the

uncertainty regarding the implementation of VAT. Though this is likely to have a negative impact in the short-term, the implications over the long-term are positive for the industry. The Indian pharmaceutical industry is at the center stage in the global healthcare arena and Ranbaxy endeavors to be at the forefront in delivering the India centric advantages to the advanced and developing countries of the world.

From a small domestic company at inception, Ranbaxy has grown formidably to be a Billion dollar institution that was envisioned by Late Dr Parvinder Singh, Chairman and Managing Director, Ranbaxy in early 90's. It is with the unwavering ' dedication ' and the ' will to win ' of Team Ranbaxy across the globe that Ranbaxy has traversed this journey so far. The management feels that the next league is a greater challenge, as the company has other milestones to achieve. Whilst Ranbaxy continues to enhance the momentum of its generics business in its key geographies, parallel to that it is also accelerating its drug discovery program. The company is committed to provide quality generics at affordable prices to the patients worldwide with a view to help bring down the healthcare costs. Ranbaxy’s management is confident that its efforts would see the Company emerge as a leading player in the global generic space in the years to come. As the company moves ahead towards its mission to become a Research based International Pharmaceutical Company. The management believes that, it is the spirit of  Team Ranbaxy that would enable Ranbaxy to reach out to Vision 2012

Bibliography

•

WEBSITES:-

•

www.ranbaxy.com

ONLINE JOURNALS:-

-

Cygnus Business Consulting & Research  Indian Pharmaceutical Industry-Oct-Dec 2008

-

FICCI Report for National manufacturing Competitiveness Council (NMCC)