A STUDY ON CAPITAL STRUCTURE OF FIVE SELECTED

COMPANIES IN AUTO-ANCILLARY INDUSTRY

Summer Project Report

Submitted to Bharathiar University in partial fulfilment
Of the requirement for the Degree of
Master of Business Administration
BY
ARAVINDH.S
Reg.No.0835F1404

Under the Guidance of

PROF. DR. C. NATESON M.COM., M.B.A., M.PHIL, F.D.P.M - IIMA, PH. D.

AUGUST 2009

JANSONS SCHOOL OF BUSINESS

Approved by AICTE & Affiliated to Bharathiar University
Karumathampatti, Coimbatore-641659.

Ph: 0421-2336161

Fax: 0421-2334742 E-Mail us at: info@jsb.ac.in

BONOFIDE
CERTIFICATE

THE B SCHOOL
JANSONS SCHOOL OF BUSINESS
BONAFIDE CERTIFICATE

This is to certify that the Summer Project Report entitled as A

STUDY ON CAPITAL STRUCTURE OF FIVE SELECTED
COMPANIES

IN AUTO-ANCILLARY INDUSTRY

is

bonafide record of work done by S.ARAVINDH (0835F1404) and

submitted in partial fulfilment of the requirement of the
requirement for the award of degree of MASTER OF BUSINESS
ADMINISTRATION

OF

BHARATHIAR

UNIVERSITY,

COIMBATORE.

DIRECTOR

FACULTY GUIDE

Viva-voice held on

INTERNAL EXAMINER

EXTERNAL EXAMINER

PROJECT COMPLETION
CERTIFICATE

DECLARATION

DECLARATION

This is to declare that the Summer Project Report entitled as A

STUDY ON CAPITAL STRUCTURE OF FIVE SELECTED
COMPANIES IN AUTO-ANCILLARY INDUSTRY submitted
to BHARATHIAR UNIVERSITY is a record of original project
work done by me during my period of study in JANSONS
SCHOOL OF BUSINESS, COIMBATORE, Under the Guidance
of PROF. DR. C. NATESON M.COM., M.B.A., M.PHIL, F.D.P.M
- IIMA, PH. D.

DATE:

S.ARAVINDH

ACKNOWLEDGEM
ENT
ACKNOWLEDGEMENT

I hereby acknowledge my sincere gratitude to the JANSONS SCHOOL

OF BUSINESS and its CEO S.MOHAN and the management for giving this
opportunity to undergo M.B.A Degree course and to undertake this project
work.

I owe my thanks to PROF. DR. C. NATESON M.COM., M.B.A.,

M.PHIL, F.D.P.M - IIMA, PH. D, Department of Management Studies whose
guidance made this project an enlightening educational experience.

I express my heartfelt thanks to Mr.N.Sampath Kumar, Associate Head

Training & Development, ROOTS INDUSTRIES INDIA LTD, for having
provided me this opportunity to complete the project.

I wish to convey my gratitude to Mr.G.BALASUBRAMANIAM the

company secretary of ROOTS INDUSTRIES INDIA LTD who guide and
encouraged with details during the project course.

Finally I extend my personal thanks to my parents and friends for helping

me to complete this project work successfully.

TABLE OF
CONTENTS

1.
INTRODUCTION
1.1 Introduction to Industry

Overview of Indian Automobile Industry

Since the first car rolled out on the streets of Mumbai (then Bombay) in 1898, the
Automobile Industry of India has come a long way. During its early stages the auto industry was
overlooked by the then Government and the policies were also not favorable. The liberalization
policy and various tax reliefs by the Govt. of India in recent years has made remarkable impacts
on Indian Automobile Industry. Indian auto industry, which is
Currently growing at the pace of around 18 % per annum, has become a hot destination for global
auto players like

Volvo

General Motors and

Ford.

Global Scenario of Auto-Components Industry

The global automotive component manufacturing industry is estimated to have a market size
of around $1trillion. Ford Motors, Delphi Corporation, Caterpillar, Cummins, International Truck
and Engine Corporation and last but not the least General Motors (GM) are some of the leading

global auto component manufacturers of the world. With importations of components worth $69
billion a year, the US stands at the top of all the auto component markets the world over.
Overview of Global Market for Auto-Components Industry
The auto-components Industry contribute $15 billion in the year 2006-07, US Autocomponents contribute $ 2.9 billion. The Auto components Industry has experienced high growth
in the past few years
Domestic market CAGR of 30% in the last four years
Exports CAGR of 40% in the last four years
Indias share of 0.9% of the global auto components Industry is growing rapidly

Overview of Auto Components Industry in India

A well developed transportation system plays a key role in the development of an economy,
and India is no exception to it. With the growth of transportation system the Automotive Industry
of India is also growing at rapid speed, occupying an important place on the 'canvas' of Indian
economy. The Indian automotive component industry manufactures a wide range of parts including
castings, forging, finished and semi-finished components, assemblies and subassemblies.
India's automotive components industry is being urged by the government to partner with
overseas firms with the aim of making India a platform for outsourcing as well as a global R&D
hub. As the Indian vehicle production industry has grown, so has the domestic supplier industry.
But the global auto industry's search for lower cost and more international outsourcing has led to a
sharp growth in component output and exports in recent years.
Factors such as superior engineering skills, modest domestic market growth, the
sophistication of its IT industry and increasing free trade agreements in addition to low cost, are
expected to boost India's auto-component sector growth over other countries in the environment of
off-shoring to low-cost countries.
A recent study conducted by McKinsey suggests that India's auto-components exports has the
potential to grow from $1 bn in 2003 to $20-25 bn in 2015.

Structure:

Auto components Industry is highly fragmented with 500 organized and 5000 unorganized
players. In Auto-Components Industry less than 5 domestic players have contribute revenues over
us$250 million. Indian manufacturers are gaining recognition as global Quality players in the
global market.
Over 60% of Indian Auto-components are exported to Europe & USA
5 Indian companies in the automotive sector have received the coveted Deming
award.

1.2 INTRODUCTION TO THE ORGANIZATION

ORGANISATION PROFILE
ROOTS Industries Ltd. is a leading manufacturer of
HORNS in India and the 11th largest Horn Manufacturing Company in the world.
Headquartered in Coimbatore - India, ROOTS has been a dominant player in the manufacture
of Horns and other products like Castings and Industrial Cleaning Machines.
ROOTS Industries Ltd was establishment in 1970, ROOTS has had a vision and
commitment to produce and deliver quality products adhering to International Standards.
Since its establishment it is maintained by excellent team of path-breakers, chief among them
being the Chairman,
Mr. K. RAMASAMY, a masters Degree Holder in Automobile Engineering from
Lincoln Technical institute, USA.

The Company Mission is coded in his own words

We believe that if something is worth doing, it is worth doing well. And this attitude
is reflected in every realm of our activities. As a customer, your naturally expect the best. We
are fully geared, in spirit and method, to meet your requirements.
The Company Vision

We will stand technologically ahead of others to deliver world-class innovative

products useful to our customers. We will rather lose our business than our customers'
satisfaction. It is our aim that the customer should get the best value for his money.
Every member of our company will have decent living standards. We care deeply for our
families, for our environment and our society. We promise to pay back in full measure to the
society by way of selfless and unstinted service.

Key for Success.

With a strong innovative base and commitment to Quality, Roots Industries
Limited has occupied a key position in both international and domestic market as suppliers to
leading OEMs and after market. Similar to products, Roots has leading edge over competitors
on strong quality system base. Now, RIL is the first Indian Company and first horn
manufacturing company in the world to get ISO/TS 16949 certification based on effective
implementation of QS 9000 and VDA 6.1 system requirement earlier. RIL has entered into
technical collaboration with Robert Bosch, SA to further enhance the technical competence.
Roots' vision is to become a world class company manufacturing world class product,
excelling in human relation.
In a dynamic world that is driven by technology, a successful presence depends on the way
you mould that technology to fit popular needs. Indigenous talent, a daring attitude, courage
to

accept

and

learn

new

That is the genesis of ROOTS.

things

and

the

simple

spark

of

an

idea.

It all started with just a honk. Encouraged by the response, we kept on moving ahead. In the
beginning, we did not realize that we would make such an impact. Slowly but surely, the
reverberations were felt far and wide. Indian automobile market responded to our call. Soon
the global market too followed suit. Roots horns, in a very short span of time, got a place of
pride in millions of vehicles across the globe.
What more could we ask for? But we did ask more. We indeed made a sound beginning but
we could not rest on our laurels. The journey has to go on. There are more miles to go and
more challenging territories to explore.
Roots Spread Beyond Borders.
Roots products have successfully made their presence heard loud and clear
in the global market. Roots horns are exported to over 15 countries worldwide. A major share
of the exports goes to USA, Japan, Middle East and South America. Root is the only Indian
company that meets the demanding standards of the Japanese markets. Roots cleaning
equipment and die cast parts, etc. are exported to USA, Europe, Australia, Japan, Far East,
South America and several other advanced countries.
Global Alliance for Competitive Advantage.
Roots is a leading Original Equipment supplier to major vehicle
manufacturers like Mercedez Benz, Mitsubishi, Mahindra & Mahindra, Toyota, Fiat, TELCO,
TVS, Kinetic, etc. The technical collaboration with Robert Bosch S.A. of Spain starting from
1995 has strengthened the R&D activities and increased Roots' technical competence to
international standards.
Roots Multiclean Ltd. (RMCL) is a joint venture with Hako
Werke GmbH & Co., Germany, one of the largest cleaning machine manufacturers with
global operations. RMCL is the sole representative in India and SAARC countries for Hako
Werke's entire range of cleaning equipment. The quality of RMCL products is so well
established that Hako buys back a major portion for their global market.
RMCL also represents several global manufacturers of cleaning products and is gearing itself
up to provide customized, total cleaning solutions.

Roots group of Companies

Roots Industries Limited
Roots Auto Products Private Limited

Roots Multiclean Limited

Roots Cast Private Limited

Roots Precision Products

Roots Metrology Laboratory

Roots Polycraft

R K Nature Cure Home

Satchidananda Jothi Nikethan

Roots Auto Products Private Limited

Roots Auto Products Private Limited (RAPPL), the largest supplier of
Air Horns in India caters to the needs of several OEMs: Ashok Leyland, Caterpillar India and
JCB Escorts. Roots Air Horns also find a place of pride in Passenger vehicles, Trucks, Earth
moving

equipment,

Material

Handling

equipment,

etc.

Commercial transportation plays a crucial role in the economic development of nations.

Roots Air Horns ensures safe and smooth passage of thousands of heavy vehicles on the
move. Roots Air Horns are exported to countries in North America, Europe, Middle East,
Africa and SAARC region.

Roots Multiclean Limited

The genesis of Roots Multiclean Ltd., (RMCL) is due to the vision of the
promoter of Roots group of company about the requirement of sophisticated cleaning
equipment in the country following globalization of business and entry of Multi Nationals
who have very high standard of housekeeping. RMCL, situated in the suburbs of Coimbatore,
is a Joint Venture with Hako Werke Gmbh & Co., Germany. It commenced manufacture of
cleaning equipment in early 90s at its modern factory located amidst natural greenery.
RMCL is the sole representative of Hako Werke Gmbh & Company's
entire range of cleaning equipment for India and SAARC countries. To improvise and
facilitate a better service to its customers, RMCL has established Regional offices in all
Metros

and

huge

dealer

network

in

bigger

Cities

and

States.

The superior quality products and the added advantage of good after sales service has
established the company as the country's largest manufacturer of floor cleaning equipment.
Roots Cast Private Limited
Roots Cast Pvt. Ltd., (RCPL) (formerly known as Aruna Auto Castings
Private Limited) was established in 1984 to meet the captive requirements of the Roots
group. With its ever probing eye on the needs of the market, the company in the late 80s
expanded its operations to manufacture High Pressure Die Cast Aluminium and Zinc
components to the exacting needs of various customers in Automobile and Textile Industries
with a high degree of Quality and Perfection.
RCPL now has established itself as a major player in the die cast component
manufacturing thanks to the expertise built in the core activities like tool design, tool making
and pressure die cast component manufacturing. RCPL supplies machined castings and subassemblies as per customer requisitions.
Roots Precision Products
Roots Precision Products was established in 1987 to address the in-house
tooling needs of the diverse industries in Roots group. Owing to continuous improvement and
investment into better resources, the company has become self-sufficient. It is catering to the

needs of various industries. RPP acts as a one-stop solution for tooling and precision
machining.
Specialized in design and manufacture of:

Press tool

Injection moulds

Die-casting die

Jigs and fixtures

Roots Metrology Laboratory

Roots' state-of-the-art Metrology Laboratory is a comprehensive
calibration centre in South India that offers mechanical, electrical, torque, pressure and
vacuum calibration instruments - all under one roof. The laboratory is equipped with
advanced facilities traceable to national & international standards. RMTL is accredited by
National accreditation Board for Testing and Calibration laboratory as per ISO/IEC 17025:
2005 standards in the field of Mechanical Dimensions, Pressure/Vacuum, & Force. The
laboratory offers on-site calibration facility and serves the industry to calibrate surface table,
coordinate measuring machine, profile projector, Toolmakers Microscope, Pressure switches,
Pressure gauges, Temperature indicators, RTDs, Temperature sensors/scanners, Electronic
transmitters,

Pressure

reducing

valves,

Ovens,

etc.

The expertise of the laboratory has attracted many renowned Public and Private Sector
undertakings.
Roots Polycraft
Roots Polycraft (PC) was established in 1988 to manufacture
precision plastic components. It is equipped with latest microprocessor injection moulding
machines to maintain consistent process parameters. Over the years, Polycraft has gained
skills and unique techniques to manufacture small and medium size components for
Automotive, Pump, Textile, and Medical Industries besides meeting the captive requirements
of Roots Group. Being fully equipped to provide the best service, Polycraft has satisfied

customers

who

have

helped

augment

its

technological

advances.

The Company's commitment towards the customer is demonstrated with quality products and
service. This has resulted in continuous growth and product diversification. The process is
closely monitored with proven techniques to obtain consistently good quality parts.
R K Nature Cure Home.
RK Nature Cure Home is the brainchild of Dr.Krishnaswamy
Gounder. The Home was inaugurated and blessed by His Holiness, Sri Swami Satchidananda
Maharaj, and Yogaville, Virginia, USA. For the past 20 years, RK Nature Cure Home has
treated thousands of people including eminent personalities from USA, France, Italy,
Singapore,

The

Gulf

Countries,

Germany

and

UK.

"The Self cannot be known by one who is dull or restless, who is not strong, disciplined and
self-controlled. Neither can it be known by much learning nor by reasoning. It can be known
only through calmness of mind, through practice of Yoga and through meditation"
-Upanishads
Satchidananda Jothi Nikethan
The school, Satchidananda Jothi Nikethan, is a Matriculation, English
medium, co-educational, residential public school, secular in nature, which lays emphasis on
our great Indian culture, high moral values and universal brotherhood. It provides, in addition
to high quality education, excellent facilities for various Co-Curricular Activities, Computer
Education, Art, Yoga, Swimming, Karate, Music, Dance, Ham Radio and various other club
activities.
MILE STONES

RIL Promotes American Auto Service for manufacture of Electric Horns in 1970
RIL Started manufacturing Servo Brakes for Light Motor Vehicles from 1972
Roots Auto Products Private Limited was established to manufacture Air Horns in 1984
Die Casting Unit commences commercial operations in 1984

 Polycraft, a unit for Plastic Injection Moulding was established in the year 1988
Roots Industries Private Limited takes over Electric Horn business in 1990
RMCL enters into Techno-Financial collaboration with M/s. Hako Werke GmbH, Germany
in the year 1992
Roots Industries Private Limited obtains the National Certification - ISI mark of quality in
1992
Production of floor cleaning equipment commences. Roots Industries Private Limited wins
American International Quality Award in the year 1994
In 1999 RIL becomes the first horn manufacturer in Asia to obtain QS 9000
In 2000 RIL becomes the first horn manufacturer in Asia to obtain VDA 6.1 and the first in
the world to win ISO / TS 16949
Also in 2000 RIL was the first to introduce digitally controlled air horns and low frequency,
low decibel irritation free Jumbo Air Horns.
In 2003 Roots Industries Ltd., Horn Division is accredited with ISO 14001 : 1996
Roots Industries Ltd., upgraded its ISO / TS 16949 from 1999 version to 2002 version
Roots Industries Limited (RIL) in 2004 opens its 100% exclusive Export Oriented Unit at
their Horn Division, Thoppampatti, Coimbatore to cater the needs of Ford North America.
In 2004 RIL's EOU commences its supplies to Ford, North America
In 2004 RMCL inaugurates its 100% EOU Plant at Kovilpalayam, Coimbatore
In 2004 Roots Cast Private Limited (RCPL) inaugurates its Unit II at Arugampalayam,
Coimbatore
In 2004 Roots Auto Products Pvt Ltd (RAPPL) expands with its Machining Division at
Arugampalayam, Coimbatore
RIL successfully launches its Malaysian Plant in 2004
In 2004 RIL group company American Auto Service is accredited with ISO 9001 : 2000
Roots Industries Ltd., is certified with MS 9000, a pre-requisite for Q1 award for Ford
Automotive Operations Suppliers. Focus on Systems and Processes in 2005
Roots Metrology & Testing Laboratory has been accredited by National Accreditation Board

for testing & calibration in the field of Mechanical Linear & Angular also in 2005
Roots Industries Ltd., is awarded Q1 by Ford Motor Company in 2005
Roots Industries Ltd., Horn Division upgraded its ISO : 14001 from 1996 version to 2004
version in the year 2005

2.OBJECTIV
ES
2. OBJECTIVE OF STUDY

To identify various factors influencing the capital structure of Roots

industries India ltd.
To study the efficiency in utilization of funds during

the period of

study in Roots industries India ltd.

To study the effects of capital structure on profitability of in Roots
industries India ltd.
To study the effect of leverages in Roots industries India ltd.

4. RESEARCH
METHODOLOGY

4. RESEARCH METHODOLOGY
4.1 Research Design:
A study on Capital structure of five selected companies in Auto-ancillary industry

belongs to Analytical research design.

4.2 Data collection:

The data related to the study A study on Capital structure of five selected
companies in Auto-ancillary industry" with special reference to Roots Industries India
Limited has been collected from the Annual reports of the five companies. The data
collected has been compiled with care for the purpose of the study.

4.3 Period of study:

A study on Capital structure of five selected companies in Auto-ancillary industry with
special reference to Roots Industries India Limited covers a period of five years from 2003-2007.

4.4 Review of Literature:

Han-suck of cesis has done a study on Determinants of capital structure. This paper
studies the explanatory power of some of the theories that have been proposed in the
literature to explain variations in capital structures across firms. In particular, this study
investigates capital structure determinants of Swedish firms based on a panel data set from
1992 to 2000 comprising about 6000 companies.
Malcolm baker of Hardward University and Jeffery wurgler of Newyork University
conducted research on Market timing and Capital structure and it has been published in
Journal of Finance on Feb 2002. This paper studies how equity market timings affect the
capital structure decision of the organization.

Cross-country determinants of capital structure choice: a survey of European firms

by Franck Bancel, Usha R. Mittoo, they have said Financial flexibility and
earnings per share were primary concerns of managers, after surveying them in 16
European countries on the determinants of capital structure. It was been published
in Financial Management (Financial Management Association), 04 Aug 2004.
Determinants of capital structure choice: a study of the Indian corporate sector by
Saumitran, this paper mainly addresses the measurement problem that arises due to
the unobservable nature of the attributes influencing the optimal capital structure,
it comprised of 363 companies from various sectors. This appeared in Applied
Financial Economics, 02.

4.5 Tools used for Analysis:

Ratio analysis
Correlation
Regression

4.6 Limitations of the study:

The study is based on secondary data.
Study is limited only to 5 years hence time period may affect the findings.
The study is limited to five companies only and hence the findings cannot be
generalized to other similar concerns.

4.7 Opportunity for further Analysis:

Through this study various factors that influence the Debt and Equity component in the
capital structure of Automobile Industry with Reference to Roots Industries India Limited has been
analyzed, but further study to identify the optimal mix of Debt and Equity in the capital structure
can be made which will enable the organizations to have a flexible capital structure.

5. THEORETICAL
CONCEPT
5. Theoretical Concepts
5.1 Overview of Capital Structure
Solomon defines Financial Management is concerned with the efficient use
of an important economic resource, namely capital funds; this definition clearly reveals that
the prime objective of Financial Management is Procurement of funds and Effective use of
these funds to achieve business objectives.
A scientific analysis of these instruments and its mobilization has a considerable
significance in the real life situation. An unplanned capital structure may yield good result in
the short run but it is dangerous in the long run. Hence the study of capital structure is
become more relevance.

Capital structure planning keyed to the objective of profit maximization ensures the
minimum cost of capital and the maximum rate of return to equity holders. The proper mix of
debt and equity play major part in capital structure, capital structure analysis helps to identify
how much that organization raise their fund in the form of equity and debt. A financial
manager determines the proper capital structure for the firm.

Meaning of Capital structure

Capital Structure refers to the mix of sources from where the long term funds required
in a business may be raised, i.e. what should be the proportions of the equity share capital,
preference share capital, internal sources, debentures, and other sources of funds in the total
amount of capital which an undertaking may raise for establishing its business.

Features of Appropriate Capital Structure

1. Profitability:

The most profitable capital structure is one which tends to minimize the cost
of financing and maximize earnings per share.

2. Flexibility:

The capital structure should such that company can raise funds whenever
needed.

3. Conservation:

The debt content in the capital structure should not exceed the limit which a
company can bear.

4. Solvency:

The capital structure should be such that the firm does not run the risk of
becoming insolvent.

5. Control:

The capital structure should be so devised that it involves minimum risk of

loss of control.

Factors Determining Capital Structure

The capital structure decisions have to be planned in the initial stages of a company. It is a
management decision aims at supplying the required amount of capital. The role of finance
manager in deciding the amount of capital structure is significant he has to study and analyze the
benefits and defects of issuing each type of securities.

Factors influencing capital structure:

1. Financial leverage
The use of fixed bearing securities, such as debt and preference capital along with
owners equity in the capital structure is described as Financial leverage. This decision is most

important from the point of view of financing decision. By having debt and equity in the capital
mix, accompany will have an opportunity of deployment certain amount of debt with an intention
enjoy the benefit of reduction in the percentage tax. The benefit so enjoyed will be passed on to the
equity shareholders in the form of high percentage of dividend.

2. Risk
Ordinarily, debt securities increase the risk, while equity securities reduce the risk.
Risk can be measured to some extent by the use of ratio, measuring gearing and time interest
earned. The risk attached to the use of leverage is called Financial risk. Financial risk is added
with the use of debt because of increased variability in the shareholders earnings. A firm can avoid
the risk by doesnt employ debt capital in the capital mix.

3. Growth and Stability

In the initial stages, a firm can meet its financial requirement through long-term
sources, particularly by raising equity shares when a company starts getting good response and
cash inflow capacity is increased through sales, company can raise debt or preference capital for
growth and expansion programmes of the company. The company which is having high sales
revenue will opt for more amount of debt for their financial requirement. In contrast to this when
company which having less sales revenue must reduce its burden towards debt.
4. Retaining control
The attitude of the management towards retaining the control over the company will
have direct impact on the capital structure. If the existing shareholder wants to continue the same
holding on the company, they may not encourage the issue of additional equity shares. The issue of
debenture and preference share also influenced by the reputation that is enjoyed by the company. If
the credit worthiness of a firm is good; it can raise the funds according to the desire of the existing
shareholders.
5. Cost of capital
The cost of capital refers to the expectation of suppliers to funds. The objective of
knowing the cost of capital is to increase the return on investment, so that, a firm should earn

sufficient profits to repay the interest and instalment of principal to the lenders. The market value
of equity share does not fall because of minimum rate of return. The cost of debenture is assessed
by taking the assured percentage of interest. The fund borrowed from bank or financial institutions
will have the cost of interest. The source of preference share capital will have cost of percentage of
dividend. Debt is the cheaper source of fund when compared to other sources. Careful decision has
to be made in selecting the size of debt, because, beyond a particular ratio debt increase the risk of
the firm. Hence cost of capital influences the capital structure.
6. Cash flows
Cash flow ability of a company will have direct impact on the capital structure. Cash
flow generation capacity of a firm increases the flexibility of the capital structure. Cash flow
permits the company to meet its short term obligations. A firm will have the obligation to pay
dividend to equity share holders, interest to bankers and debenture holders. Sound cash flow
facilitates the company to raise funds through debt. Insufficient availability of cash or cash inflow
takes the company to a disastrous situation.

5.2 CAPITAL STRUCTURE THEORIES

Capital Structure Theories:

The objective of a firm should be directed towards the maximization of the value of the
firm, the capital structure, or the leverage decision should be examined from the point of view of
its impact on the value of firm, there are broadly three approaches or theories to study the capital
structure they are as below:

1. Net Income Approach.

2. Net Operating Income Approach.
3. Modigliani and Miller Approach.

These approaches analyses the relationship between the leverage, cost of capital, and the
value of firm in different ways, however the following assumptions are made to understand these
relationship.

1. There are only two sources of Finance i.e. Debt and Equity.
2. The degree of leverage can be changed by selling debt to repurchase shares or selling
shares to retire debentures.
3. There are no retained earnings; it implies that entire profit is distributed to
shareholders.
4. The Operating profit of the firm is given and it is expected to grow.
5. The business risk is assumed to be constant and is not affected by the financing mix
decisions.
6. There are no corporate or personal taxes.
7. The investors have same subjective probability distribution of expected earnings.

Net Income Approach

This Approach has been suggested by Durand. According to this approach a firm can increase
its value or lower the overall cost of capital by increasing the proportion of debt in the capital
structure. In other words if the degree of financial leverage increases the weighted average cost of
capital will decline with every increase in the debt content in total funds employed, while the value
of the firm will increase. Reverse will happen in converse situation. Under this approach the value
of a firm will be maximum at a point where weighted average cost of capital is minimum.

o The use of debt does not change the risk perception of investors.
o Debt capitalization rate is less than the equity capitalization rate.
o Corporate income taxes do not exist.

Net Operating Income Approach

According to net operating approach, the overall capitalization rate and the cost of debt
remain constant for all degrees of leverage. The cost of debt, equity and overall capitalization in
response to change in market value of debt and equity. The critical premise of this approach is that
the market capitalizes the firm as a whole at a discount rate which is independent of the firms
debt-equity ratio is a consequence, the division between debt and equity is irrelevant. An increase
in the use of debt funds which are apparently cheaper is offset by an increase in the equity
capitalization rate. This approach follows certain assumptions

The market capitalizes the value of the firm as a whole (split between debt and
equity is not important)
The market uses an overall capitalization rate depending on business risk
Use of less costly debt funds increases the risk of shareholders
Debt capitalization rate is a constant
Corporate income taxes do not exist

Modigliani and Miller Position

The Modigliani miller results indicate that the firm cannot change the value of a firm by
repacking the firms securities. This approach argues that the firms overall cost of capital cannot
be reduced as debt is substituted for equity, even though debt appears to be cheaper than equity.
The reason for this is that as firm adds debt. As this risk rises, the cost of equity capital rises as a
result. MM prove that the two effects exactly offset each other, so that the value of the firm and the
firms overall cost of capital are invariant to leverage. The following are the assumptions followed
by MM approach.

The market capitalizes the value of the firm as a whole, which makes the split
between debt and equity unimportant
The market uses an overall capitalization rate to capitalize the NOI. This overall
capitalization depends on the business risks.
The use of less costly debt funds increases the risk of shareholder which causes the
increase of overall capitalization rate.
The debt capitalization rate is constant.
The corporate Income-tax does not exist.

5.3 Sources of Long term Fund

Different sources of Finance:

The different sources of finance can be classified into the following categories;
Security Financing

Financing through Shares and Debentures

Internal Financing

Financing through retained earnings.

Loans Financing

Includes both short and long term loans.

Long Term Sources of Finance:

There are different sources of funds available to meet the long term financial needs of the
business. These sources may be broadly classified into share capital (both preference and equity
share capital) and Debt.

Preference share
Long term funds from preference shares can be raised through a public issue of shares.
Such shares are normally cumulative i.e. dividend payable in a year of loss gets carried over to the
next year till there is adequate profit to pay cumulative dividends. Most of the preference shares
these days carry a stipulation of period and the funds have to be repaid at the end of a stipulated
period.

Preference share capital is a hybrid form of financing which partakes some characteristics
of equity capital and some attributes of debt capital. It is similar to equity because preference

dividend is not a tax deductible payment. It resembles debt capital because the rate of preference
dividend is fixed. Typically, when preference dividend is skipped it is payable in future because of
the cumulative feature associated with most of the preference shares.

Advantages
There is no legal obligation to pay preference dividend. A company does not face
bankruptcy or legal action if it skips dividend
Preference capital is generally regarded as part of net worth. Hence, it enhances the
creditworthiness of the firm
Preference shares do not, under normal circumstances, carry voting right. Hence, there is no
dilution of control
No assets are pledged in favour of preference shareholders. Hence, the mortgage able assets
of the firm are conserved
Dis-advantages
Compared to debt capital, it is very expensive source of financing because the dividend
paid to preference shareholders is not, unlike debt interest, a tax-deductible expense
Compared to equity shareholders, preference shareholders have a prior claim on the assets
and earnings of the firm.

Equity capital
Equity capital represents ownership capital, as equity shareholders collectively own the
company. They enjoy the rewards and bear the risks of ownership. However, their liability, unlike
the liability of the owner in a proprietary firm and the partners in a partnership concern, is limited
to their capital contribution.
Advantages
There is no compulsion to pay dividends. If the firm has insufficiency of cash it can skip
equity dividends without suffering any legal consequences
Equity capital has no maturity date and hence the firm has no obligation to redeem.

 Presently, dividends are tax-exempt in the hands of investors.

The company paying equity dividend, however, is required to pay a dividend distribution
tax.

Dis-Advantages
Sales of equity shares to outsiders dilutes the control of existing owners
The cost of equity capital is high, usually the highest. The rate of return required by
equity shareholders is generally higher than the rate of return required by other
investors
Equity dividends are paid out of profit after tax, whereas interest payments are taxdeductible expenses. This makes the relative cost of equity more. Partially offsetting
this advantage is the fact that equity dividends are tax-exempt, whereas interest
income is taxable, in the hands of investors

Retained Earnings:
Long term funds may be also provided by accumulating the profits of the company and
by ploughing back the profit into the business. Such funds belong to the ordinary share holders and
increase the net worth of the company. A public limited company must plough back a reasonable
amount of profit every year keeping in view of legal requirements, these funds entail no risk and
the control of the owners is not diluted.

5.4 LEVERAGE

A firm can make use of different sources of financing whose costs are
different. These sources may be, for the purpose of exposition, classification into those which
carry a fixed rate of return and those on which the returns vary. The fixed returns of some
sources of finance have implications for those who are entitled to a variable return. Thus,
since these debts involves the payment of a stated rate of interest, the return to the ordinary
share holders is affected by the magnitude of debt in the capital structure of the firm.
The employment of an asset or source of funds for which the firm has to
pay a fixed cost or fixed return may be termed as Leverage.
Consequently, the earnings available to the shareholders as also affected. If the earnings less
the variable cost exceed the fixed cost or earnings before interest and taxes exceeds the fixed
return requirements, the leverage is called as Favourable Leverage. When they do not, the
result is Unfavourable Leverage.
There are two types of leverage-Operating and Financial. The leverage
associated with investment activities is referred to as Operating leverage. The leverage
associated which is associated with financing activities is known as Financial Leverage,
while leverage associated with financial leverage for purpose of the financial decision of a
firm, the discussion of operating leverage is to serve as a background to the understanding of
financial leverage because the two are closely related.
Operating leverage is determined by the relationship between the firms sales
revenues and its earnings before interest and taxes (EBIT). The earnings before interest and
taxes are also generally called as Operating profit. Financial leverage represents the
relationship between the firms earnings before interest and taxes (Operating profit) and the
earnings available for ordinary shareholders. The operating profits (EBIT) are, thus, used as
the pivotal point in defining operating and financial leverages. In a way, Operating and
Financial leverage represents two stages in the process of determining the earning available
to the equity shareholders.

Operating leverage;
Operating leverage results from the existence of fixed operating expenses in the firms
income stream. The operating cost of a firm fall into three categories; (i) fixed cost which
may be defined as those which do not vary with sales volumes; they are a function of time
and are able; (ii) variable cost which vary directly with the sales volume; and (iii) semivariable or semi-fixed costs are those which are partly fixed and partly variable. They are
fixed over a certain range of sales volume and increase to higher levels for higher sales
volumes components, the costs of the cost of a firm, in operational terms, can be divided into
(a) fixed, and (b) variable.
The operating leverage may be defined as the firms ability to use fixed operating
costs to modify the effect of changes in sales on its earnings before interest and taxes.
Operating leverage occurs any times a firm has fixed cost that must meet regardless of
volume. We employ assets with fixed cost in the hope that volume will produce revenues
more than sufficient to cover all fixed and variable cost. In the other words, with fixed costs,
the percentage change in profits accompanying a change in the volume is greater than the
percentage change in the volume. This occurrence is known as operating leverage. Operating
leverage is calculated by using the following formula;

Sales Variable cost

Operating leverage =
EBIT

Degree of Operating Leverage - DOL; This is more precise measurement in terms of

degree of operating leverage (DOL). The DOL measures in quantitative terms to extend or
degree of operating leverage. The higher the degree of operating leverage, the more volatile
the EBIT figure will be relative to a given change in sales, all other things remaining the
same. The formula is as follows:
Percentage change in EBIT
DFL=

>1
Percentage change in SALES

This ratio is useful as it helps the user in determining the effects that a given level of
operating leverage has on the earnings potential of the firm. This ratio can also be used to
help the firm determine the most appropriate level of operating leverage in order to maximize
the company's EBIT.

Financial leverage;
Financial leverage relates to the financing activities of a firm. The sources from which
funds can be raised by a firm, from the point of view of the cost/charges, can be categorised
into (i) those which carry a fixed financial charges, and (ii) those which do not involve any
fixed charges. The sources of funds in the first category consist of various types of long-term
interest which is a contractual obligation for the firm. Although the dividend on preference
shares is not a contractual obligation, it is a fixed charge and must be paid before anything is
paid to the ordinary shareholders. The equity shareholders are entitled to remember of the
operating profits of the firm after all the prior obligations are met. We assume in the
subsequent discussions that all preference dividends are paid in order to ascertain the
operating profits available for distribution to ordinary shareholders.
Financial leverage results from the presence of fixed financial charges in the
firms income stream. These fixed charges do not vary with the earning before interest and
taxes (EBIT) or operating profit. They are to be paid regardless of the amount of EBIT
available to pay them. After paying them, the operating profit (EBIT) belongs to ordinary
share holders. Financial leverage is concerned with the effect of changes in EBIT on the
earning available to equity shareholders. It is defined as the ability of the firm to use fixed
financial charges to magnify the effect of changes in EBIT on the earnings per share. In the
other words, financial leverage involves the use of funds to obtain at a fixed cost in the hope
of increasing the returns to the shareholders.
Favourable leverage occurs when earns more on the assets purchased with
the funds, than the fixed cost of their use. Unfavourable or Negative leverage occurs when
the firm does not earn as much as the fund cost. Thus, financial leverage is based on the
assumption that the firm is to earn more on the assets that are required by the use of funds on
which a fixed rate of interest/dividend is to be paid. Financial leverage is calculated by the
following formula;
EBIT
Financial leverage =
EBIT - Interest

Degree of Financial Leverage - DFL; Financial leverage can be more precisely expressed in
terms of the degree of financial leverage (DFL). The DFL can be calculated by
Percentage change in EPS
DFL=

>1
Percentage change in EBIT

A leverage ratio summarizing the affect a particular amount of financial leverage

has on a company's earnings per share (EPS). Financial leverage involves using fixed costs to
finance the firm, and will include higher expenses before interest and taxes (EBIT). The
higher the degree of financial leverage, the more volatile EPS will be, all other things
remaining the same.

Combined leverage;
The operating leverage has it effects on the operating risk and is measured by
the percentage change in EBIT due to the percentage change in sales. The financial leverage
has its effects on financial risk and is measured by the percentage change in EPS due to
percentage change in EBIT.
Since both these leverages are closely concerned with ascertaining the ability
to cover fixed financial charges (fixed-operating coat in the case of operating leverage and
fixed-financial costs in case of financial leverage), if they are combined, the result is total
leverage and the risk associated with Combined Leverage is known as total risk. Combined
leverage can be calculated by multiplying both Operating leverage and Financial leverage.
The following formula can also be used to calculate combined leverage.

Sales Variable cost

Combined Leverage =
EBIT - Interest

Degree of Combined Leverage DCL; A leverage ratio that summarizes the combined
effect the degree of operating leverage (DOL), and the degree of financial leverage has on
earnings per share (EPS), given a particular change in sales. This ratio can be used to help
determine the most optimal level of financial and operating leverage to use in any firm.

% change in EBIT
DCL =

% change in EPS
X

% change in SALES

% change in EPS
=

% change in EBIT

% change in SALES

This ratio can be very useful, as it summarizes the effects of combining both
financial and operating leverage, and what effect this combination, or variations of this
combination, has on the corporation's earnings.

6. ANALYSIS AND
INTERPRETATION
6. ANALYSIS AND INTERPRETATION
Efficiency in Utilization of Funds:

Capital structure decision is considered as one of the important decision to be made by

any firm. The contents of Capital structure comprise of a mix of long term funds like Debentures,
preference shares and equity shares.

A company must have a well planned capital structure which can help companies to
achieve Economies in the use of funds. A well planned capital structure will help a company to
maximize the use of funds and to adapt easily to changing conditions.

The following ratios are studied to judge the long term financial position of the firm.
These ratios indicate the mix of funds provided by the owners and the lenders in general there
should be an appropriate mix to debt and owners equity in financing the assets.

Capital and Long term funds to fixed assets.

Proprietors ratio
Capital to reserves
Capital employed to net worth.

These ratios are studied to achieve the objective of analysing the Efficiency with which
the funds of the organization has been used during the period of study.

Capital and Long Term Fund to Fixed Asset

This ratio establishes the relationship between fixed asset and long -term funds. The objective
of calculating this ratio is to ascertain the proportion of long-term funds invested in the fixed
assets. The formula used to calculate long- term fund to fixed asset is

Fixed asset
Capital and long term fund to fixed asset =

-------------------Long term funds

Long term fund= Share capital + reserves +long term loans

Table No: 1
Capital and long term funds to fixed assets:

Year

ROOTS

PRICOL

LUCAS

SUNDRAM

MINDA

TVS

CLAYTON

HUF

2004

0.70

0.60

0.30

0.64

0.84

2005

0.62

0.52

0.31

0.67

0.78

2006

0.66

0.51

0.33

0.65

0.83

2007

0.59

0.46

0.37

0.56

0.67

2008

0.50

0.48

Chart No: 1
Capital and long term funds to fixed assets

Inference

0.46

0.44

0.53

From the ratio we can find that on an average 50% of long term fund was invested as
fixed assets in all the companies except Lucas-Tvs Limited. During the years 2007 and 2008 the
ratios get reduced in all the companies it shows that all the organization is moving towards
expansion of its operation.
The ratio of Roots industries India limited slightly higher than Lucas Tvs Limited on an
average Roots Industries invest 60% of long term funds in the form of fixed assets, it may chance
to act as hurdle for expansion of its operation so the company could reduce the investment of longterm funds in the fixed assets as it presently doing but over reduction will also have an after effect.
So Roots industries must have a check on its investment on fixed assets.

PROPRIETORS RATIO

This ratio compares the shareholders fund and total tangible assets. In other words this ratio
expresses the relationship between the proprietors funds and the total tangible assets. Proprietors
ratio below 0.5 is alarming for the creditors. The formula used to calculate long-term fund to fixed
asset is

Proprietors fund
Proprietors Ratio =

------------------------Total asset

Proprietors funds= Share capital + Reserves

Table No: 2
Proprietors Ratio

Year

ROOTS

PRICOL

LUCAS

SUNDRAM

MINDA

TVS

CLAYTON

HUF

2004

0.35

0.30

0.72

0.56

0.36

2005

0.27

0.30

0.76

0.47

0.30

2006

0.31

0.28

0.67

0.47

0.24

2007

0.32

0.28

0.66

0.48

0.29

2008

0.30

0.27

0.61

0.40

0.31

Chart No: 2
Proprietors Ratio

Inference
From the above chart we find that the proprietors ratio of Lucas-Tvs Limited is higher it
shows that the proprietors contribution is higher when compare with other companies. In the case

of Pricol, Sundaram Clayton Ltd and Minda HUF on an average for each one rupee invested by the
lenders on the Assets of the company the owners have invested around 25 to 35 paisa.
In ratio is RIL on an average of 30 paisa has invested by the owners but still the
contribution from the owners is less. Since the organizations has a plan to go for expansion it is
essential for the owners to contribute more as more debt financing will make the organization an
unsecured option for potential investors.

CAPITAL TO RESERVES RATIO

This ratio describes amount of reserves that has been maintain by the company from the
capital every year. High ratio shows the soundness of the company. If the reserves are higher when
compared to capital it will be better as future losses if any can be absorbed. The formula used to
calculate capital to reserves ratio is
Share capital
Capital to reserves ratio =

----------------Reserves

Table No: 3
Capital to reserves ratio

Year

ROOTS

PRICOL

LUCAS

SUNDRAM

MINDA

TVS

CLAYTON

HUF

2004

0.17

0.07

0.10

0.10

0.14

2005

0.16

0.05

0.08

0.09

0.12

2006

0.13

0.04

0.07

0.07

0.11

2007

0.11

0.04

0.05

0.06

0.10

2008

0.09

0.05

0.03

0.04

0.31

Chart No: 3
Capital to reserves ratio

Inference
The company should maintain high reserves to meet immediate cash needs. High
ratio shows high liquidity position of the company. The reserves maintain by Roots industries
limited is higher than other companies. Pricol Limited, Lucas Tvs, Sundaram Clayton Ltd are
maintaining a reserve on an average of 7% , Minda-HUF Limited are maintain a reserves that equal
to Roots industries limited from the profit But in the last two years the percentage of reserves to
capital has decreased drastically for all the companies expect Minda-HUF.
The Reserve ratio of Roots Industries Limited is better than other companies. The
companies have enough liquidity position to meet future financial needs on an average RIL
maintain 13% of fund as a reserves.

CAPITAL EMPLOYED TO NET WORTH

This ratio used to determine the relationship between debt and equity. In other words this ratio
helps to determine the fund contribution of share holders towards capital of the company. The
formula used to calculate capital employed to net worth ratio is

Capital employed to

Net Worth ratio

Net fixed asset + Net current asset Current liability

= ------------------------------------------------Net worth

Net worth = Share capital + Reserves

Table No: 4
Capital employed to net worth

Year

ROOTS

PRICOL

LUCAS TVS

SUNDRAM

MINDA

CLAYTON

HUF

2004

2.09

2.18

1.06

1.22

2.00

2005

2.71

2.24

1.04

1.45

2.68

2006

2.21

2.57

1.03

1.50

2.33

2007

2.06

2.71

1.03

1.63

2.31

2008

2.06

2.74

1.10

2.12

2.66

Chart No: 4
Capital employed to net worth

Inference
Through this ratio we find that in Roots Industries Limited the lenders have contributed
nearly Rs.2 against the owners contribution of Re.1 it shows that the lenders contribution is higher
in Roots Industries Limited.
In the case of Lucas-Tvs limited and Sundaram Clayton Ltd the lenders contribution is
below Re.1 against the owners contribution of Re.1 it shows that the lender contribution is lower
in these companies, the ratio of Pricol and Lucas-Tvs also matches the Roots industries ltd the
lenders have contributed nearly Rs.2 against the owners contribution of Re.1 it shows that the
lenders contribution is higher.
The ratio of Roots Industries Limited shows that lenders contribution is maintained at
same level (i.e.) Rs.2 against the owners contribution of Re.1. It leads increase the threat of
creditors. The company should plan the capital structure with equal contribution of owners and
lenders.

DETERMINANCE OF CAPITAL STRUCTURE

Factors determining capital structure:

The capital structure of a company is determined by taking into consideration of various

factors. There have been several studies conducted with reference to Indian context regarding the
determinants of capital structure of an organization;
The following are some quantitative factors
Financial risk
Profitability
Dividend policy
Growth
Size of business

Apart from the above quantitative factors the qualitative factors determining the capital structure
are:

Control

Flexibility

Marketability

Market conditions

Capacity of raising funds

Even though the qualitative factors determine the capital structure of an organization its

very difficult to pinpoint the quantitative factors.

For determining the quantitative factors the following ratios are calculated & other tests are
performed as follows:
Total debt to equity ratio
Asset composition ratio
Compounded annual growth rate
Earnings rate
Collateral value of asset

Total Debt to Equity

This ratio used to ascertain general soundness of long term finance of the company. In
other words this ratio is used to ascertain long term solvency position of the company. The ratio
indicates the %of funds being financed through borrowings. Generally higher the ratio more risky a
creditor will perceive its exposure in business making it harder to obtain credit. The formula used
to calculate total debt equity is

Total liabilities
Total debt equity ratio=

------------------Net worth

Table No: 5
Total Debt to Equity

Year

ROOTS

PRICOL

LUCAS -

SUNDRAM

MINDA

TVS

CLAYTON

HUF

2004

0.89

1.18

0.05

0.22

0.99

2005

1.47

1.24

0.21

0.40

1.68

2006

1.01

1.58

0.45

0.50

1.22

2007

0.90

1.71

0.50

0.63

1.24

2008

0.95

1.74

0.49

1.12

0.95

Chart: 5
Total Debt to Equity

Inference
In Pricol Limited the creditors have contributed around Rs.1.50 for each one rupee
contributed by the share holders. In Minda HUF Limited the creditors contribute on an
average Rs.1.20 for each one rupee contributed by the share holders.
The ratio of Lucas Limited is better than other companies it shows the creditors
contribution is minimum and reduces the threat from the creditors, Sundram Clayton Ltd is
also comparatively better than other companies.
On the whole the average amount of Debt equity ratio is 0.9 for Roots Industries
Limited, the ratio is reduced over the years which shows that the organization is trying to
have an equal contribution from the owners as well as from the creditors.

ASSET COMPOSITION RATIO

This ratio is used to ascertain the % of current assets contribution to the total assets of the
company. Its a financial ratio that considers the composition of an organization's total assets to
evaluate solvency. The higher the ratio the greater the organization's ability to raise money to pay
debt. The formula used to calculate assets composition ratio is

Total Current Assets

Asset composition ratio =

----------------------------Total assets

Total asset = Current assets + Fixed assets

Table No: 6
Asset composition ratio

Year

ROOTS

PRICOL

LUCAS-TVS SUNDRAM

MINDA

CLAYTON

HUF

2004

0.50

0.58

0.55

0.35

0.46

2005

0.52

0.54

0.57

0.35

0.46

2006

0.57

0.57

0.64

0.39

0.44

2007

0.61

0.57

0.66

0.43

0.46

2008

0.62

0.59

0.58

0.49

0.29

Chart No: 6
Asset composition ratio

Inference
In general maintain of high position of current asset is good for the company. On an average
all the companies maintain 45% of assets as current assets from the total assets of the company. It
shows that company maintain a good Composition of current and fixed assets, this helps the
company to meet the financial needs.
On an average Roots Industries Limited maintain 50% of current assets, it helps to meet the
future financial needs. Roots should reduce the investment of funds in fixed assets it helps for
liquidity of the company. Minda HUF ratio level of 30% level in the year 2008 shows that the
companies increasing liquidity to meet the financial needs.

COLLATERAL VALUE OF ASSET

This ratio takes in to account of net fixed assets and accounts receivable with total assets.
This ratio explains how much amount company can give security to the bank from the total assets.
The formula used to calculate the collateral value of asset is

Net fixed assets + Account receivable

Collateral asset ratio

= ----------------------------------------------------Total assets

Table No: 7
Collateral value of asset

Year

ROOTS

PRICOL

LUVAS -

SUNDRAM

MINDA

TVS

CLAYTON

HUF

2004

0.64

0.59

0.48

0.65

0.77

2005

0.62

0.53

0.46

0.65

0.75

2006

0.68

0.59

0.42

0.65

0.77

2007

0.66

0.55

0.47

0.63

0.71

2008

0.59

0.58

0.54

0.51

0.55

Chart No: 7
Collateral value of asset

Inference
From the above chart we conclude that on an average all the companies will maintain
50% of collateral value this shows that companies have high ability to provide security of assets.
The Minda HUF Limited maintain high collateral ratio than other companies on an average the
company have ability to provide 70% of assets as a security to the bank.
Roots industries Limited have an ability to give 60% of assets as security it shows that
the company will use the funds for expansion process rather than investment in fixed assets. But
the ratio of Roots industries Ltd and Minda HUF is reduced but Lucas-Tvs and Sundram Clayton is
increased.

EARNINGS RATE
This ratio helps us to determine the relationship between EBIT and
total assets of the company. Higher ratio shows more efficiency and lower ratio shows that assets
are unproductive. The formula used to calculate earnings rate is

EBIT
Earnings rate =

-------------Total assets

EBIT- Profit before interest and tax

Table No: 8
Earnings Rate

Year

ROOTS

PRICOL

LUCAS

SUNDRAM

MINDA

TVS

CLAYTON

HUF

2004

0.12

0.10

0.25

0.18

0.16

2005

0.06

0.17

0.25

0.16

0.14

2006

0.11

0.11

0.17

0.20

0.18

2007

0.11

0.11

0.17

0.20

0.18

2008

0.10

0.07

0.12

0.08

0.12

Chart: 8
Earnings Rate

Inference
The earnings rate of RIL is low when compare to other companies, the RIL earnings rate
is on an average of 8%.The ratio of Lucas-Tvs Limited is above 20%in the first two years but in
the last three years the ratio get reduced to 15% this shows the earnings will get reduced. The ratio
of Sundaram Clayton Ltd is also around 15% it shows the company have a consistent earnings but
it also have reduced in the year 2008.
The earnings rate of RIL is on an average of 8%. It shows that assets are not efficiently
used by the company. Thus RIL should take necessary step to utilize the assets.

COMPOUNDED ANNUAL AVERAGE GROWTH RATE

This ratio helps to find out the annual growth rate of the company based on the annual sales
of the company. The following formula is used to calculate the annual average growth rate.

1
----------------No. of. Years
Ending value
Annual Average Growth Rate =

---------------------

Beginning value

Beginning value = Sales during the year 2003

Table: 9
Compounded Annual Average Growth Rate

Year

2004
2005
2006
2007
2008

ROOTS

0.27
0.91
1.01
1.09
1.10

PRICOL

0.23
0.69
0.84
0.98
1.00

LUCAS TVS

0.07
0.48
0.88
1.02
1.04

SUNDRAM

MINDA

CLAYTON

HUF

0.41
0.89
1.05
1.15
0.84

0.31
0.99
1.10
1.19
1.06

Chart No: 9
Compounded Annual Average Growth Rate

Inference
The annual average growth rate of Sundaram Clayton and Minda HUF is high when
compared to other companies it shows that the sales position of the company is high. The growth
rate of Sundaram Clayton Ltd is reduced when compared to the pervious year 2007; it shows that
the company sales rate is increased at the same time EBIT of the company also get increased
The annual average growth rate of RIL also has a periodical growth. The annual average
growth rate of RIL in the year 2007 is 3%. RIL annual growth rate is high and consistent when
compared to other companies. The company must increase the sales to get high consistent growth
rate.

EFFECTS ON CAPITAL EMPLOYED

Return on Capital Employed

This ratio helps to measures the sufficiency or of profit in relation to capital employed. It helps to
determine how efficiently the long-term funds of the owners and creditors being put into use. The
formula used to calculate return on employed is

Operating profit
Return on capital employed =

------------------------Capital employed

Chart No: 10
Return on capital employed

Year

ROOTS

PRICOL

LUCAS TVS

SUNDRAM

MINDA

CLAYTON

HUF

2004

0.21

0.26

0.33

0.33

0.27

2005

0.15

0.32

0.32

0.29

0.21

2006

0.23

0.22

0.24

0.33

0.27

2007

0.24

0.21

0.26

0.32

0.26

2008

0.23

0.16

0.23

0.15

0.23

Chart No: 10
Return on capital employed

Inference
The return on capital employed for Sundaram Clayton and Lucas-Tvs is high when compared to
other companies on an average 25% and 20% respectively of return the company get from the
capital employed. In Pricol Limited the ratio for first two years is around 30% but it gets reduced in
the following years it shows that the return get reduced.
The ratio of RIL is around to 15% it shows that the company gets only 15% of returns from their
investment. The company should take necessary step to increase the sales and operating profit.

ANALYSIS
The following tools are used to measure the effect of Capital structure decision on the
profitability Roots Industries Limited and other four companies
Correlation
Regression
Correlation:
Correlation helps to measure and analyse the degree or extent to which the two
variables fluctuate with reference to each other .two variables may have a positive or negative
correlation.
In order to measure the effect of capital structure (i.e.) Debt and equity on
profitability of the organization the following ratios are correlated with each other.
Total Debt to Equity
Return on Capital Employed.
Here Debt equity ratio is considered to be an Independent variable and Return on
Capital employed is considered to be a Dependent variable.
Correlation and Regression equation between Debt Equity and Return on Capital Employed
has been calculated through SPSS- software and the values are as below:
Correlation Matrix
Table No: 10
Effects of capital structure
COMPANY

CORRELATION(r)

ROOTS INDUSTRIES LIMITED

-0.91914

PRICOL LIMITED

-0.86599

LUCAS LIMITED

-0.93902

SUNDARAM CLAYTON LTD

-0.88111

MINDA HUF

-0.55921

Inference:
The debt equity ratio and return on capital employed are negatively correlated for Roots
Industries India Limited which shows that any increase in debt and equity component will
lead to a decrease in profit and decrease in the debt and equity component will increase the
Earning correspondingly.
In other companies expect Lucas Ltd the correlation is not significance it shows there is no
strong relationship between increase or decrease in debt equity and return on capital
employed.
Regression
Regression helps us to estimate one variable or the dependent variable from the other variable
or the independent variable.

The following regression equation is formed to identify the exact level of influence of Debt and
equity decision on Profitability of the organizations.

Roots Industries:
Return on Capital Employed = 0.355 - 0.138 Debt equity ratio
Inference:
The profitability of Roots Industries India Limited is influenced by its Capital Structure
decision to a marginal extent. For one unit of increase in Debt equity ratio the Return on
capital employed increases by 0.355 units. In other words the operating income increases
by 0.355 units as and when the Debt equity proportion in the capital structure increases by
one unit.

 Due to the influence of various other factors the Return on capital employed decreases
marginally to extent of 0.138 units, which is the constant coefficient in the Regression
equation.

Lucas - TVS:
Return on Capital Employed = 0.339 - 0.216 Debt equity ratio
Inference:
The profitability of Lucas - Tvs influenced by its Capital Structure decision to a marginal
extent. For one unit of increase in Debt equity ratio the Return on capital employed
increases by 0.339 units. In other words the operating income increases by 0.339 units as
and when the Debt equity proportion in the capital structure increases by one unit.
Due to the influence of various other factors the Return on capital employed decreases
marginally to extent of 0.216 units, which is the constant coefficient in the Regression
equation.

Regression equation cannot be formed for Pricol limited, Sundaram Clayton Ltd and
Minda-HUF Limited companies because correlation value is not significance it shows that there is
no strong effect to return on capital employed while increase or decrease of debt equity.
The regression equation obtained with the help of SPSS software. The regression equation
and test of dependency are found out with the help of this Regression.

Correlation
Correlation refers to the relationship of two or more variables; correlation is the
statistical analysis which measures and analysis the degree or extent to which two variables
fluctuates with reference to each other. Two variables may have a positive correlation or a negative
correlation.
Positive correlation:
Two variables are said to be positively correlated when,
1. Increase in one variable causes increase in value of other variable or
2. Decrease in one variable causes decrease in value of other variable.

Negative correlation:
Two variables are negatively correlated when:
1. Increase in one variable decreases the other variable or
2. Decrease in one variable increases the other.
For the purpose of study the following ratios are correlated with each other to know the
degree of relationship that exists between the ratios. It is essential to know the degree of
relationship that exists between the ratios as it will enable as to decide the ratios which
Increase or decrease the debt and equity component in the capital structure of the industry with
reference to Roots Industries India Limited.
Ratios for correlation are:
Total debt to equity ratio

 Asset composition ratio(A.C.R)

Collateral value of asset(C.V.A)
Earnings rate(E.R)
Compounded annual average growth rate.(C.A.A.G.R)
Return on capital employed(R.O.C.E)
From the above ratio Return on capital employed ratio has been correlated with all other
ratios to find out the degree of relationship between Return on capital employed and all other ratios.
Here Return on capital employed ratio has been considered as dependent variable while all other
ratios are considered to be independent variable.
Similarly all other ratios are correlated with each ratio to find out their degree of
relationship with each other ratio; by correlating all the ratios the following correlation matrix has
been formed.
CORRELATION MATRIX FOR ROOTS INDUSTRIES LIMITED:
Table No: 11
Ratios
Debt

A.C.R

C.V.A

E.R

C.A.A.G.R R.O.C.E

equity
Debt equity

1.000

-0.406

-0.238

-0.961

0.152

-0.919

A.C.R

-0.406

1.000

-0.102

0.200

0.819

0.680

C.V.A

-0.238

-0.102

1.000

0.427

-0.046

0.319

E.R

-0.961

0.200

0.427

1.000

-0.307

0.904

C.A.A.G.R

0.152

0.819

-0.046

-0.307

1.000

0.229

ROCE

-0.919

0.680

0.319

0.904

0.229

1.000

Inference
By Correlating Debt equity ratio with other Ratios we infer the following

 Return on capital employed ratio which is negatively correlated with Debt equity ratio
which shows that whenever there is an increase in the debt equity components the
return on capital employed will decrease.
Earnings rate ratio which is negatively correlated with Debt equity ratio which shows
that whenever there is an increase in the debt equity components the Earnings rate
will decrease.
By correlating other ratios we infer the following:
Earnings rate ratio is positively correlated with return on capital employed it shows
that whenever there is a increase in earnings rate it leads to increase in Return on
capital employed.

CORRELATION MATRIX FOR PRICOL LIMITED:

Table No: 12

Ratios
Debt

A.C.R

C.V.A

E.R

C.A.A.G.R ROCE

equity
Debt equity

1.000

0.477

0.131

-0.572

0.895

-0.866

A.C.R

0.477

1.000

0.797

-0.993

0.068

-0.849

C.V.A

0.131

0.797

1.000

-0.764

-0.246

-0.539

E.R

-0.572

-0.993

-0.764

1.000

-0.183

0.904

C.A.A.G.R

0.895

0.068

-0.246

-0.183

1.000

-0.583

ROCE

-0.866

-0.849

-0.539

0.904

-0.583

1.000

Inference
By Correlating Debt equity ratio with other Ratios we infer the following
The correlation between debt equity ratio and other ratio is not significant it shows that there is no
strong relationship between debt equity ratio and other ratios.
By correlating other ratios we infer the following:
Earnings rate which is negatively correlated Asset composition ratio which shows that
whenever the Asset composition increases the Earnings rate will decrease.

CORRELATION MATRIX FOR LUCAS-TVS LIMITED;

Table No: 13

Ratios
Debt

A.C.R

C.V.A

E.R

C.A.A.G.R ROCE

equity
Debt equity

1.000

0.772

0.098

-0.902

0.995

-0.939

A.C.R

0.772

1.000

-0.438

-0.502

0.729

-0.628

C.V.A

0.098

-0.438

1.000

-0.400

0.148

-0.165

E.R

-0.902

-0.502

-0.400

1.000

-0.896

0.968

C.A.A.G.R

0.995

0.729

0.148

-0.896

1.000

-0.721

ROCE

-0.939

-0.628

-0.165

0.968

-0.721

1.000

By Correlating Debt equity ratio with other Ratios we infer the following

 Earnings rate ratio which is negatively correlated with Debt equity ratio which shows
that whenever there is an increase in the debt equity components the Earnings rate
will decrease.
Compounded annual average growth rate is positively correlated with Debt to equity
ratio shows that increase in Debt equity leads to increase in compounded average
annual growth rate.
Return on capital employed ratio which is negatively correlated with Debt equity ratio
which shows that whenever there is an increase in the debt equity components the
return on capital employed will decrease.
By Correlating Debt equity ratio with other Ratios we infer the following;
Earnings rate ratio is positively correlated with return on capital employed it shows that
whenever there is a increase in earnings rate it leads to increase in Return on capital
employed.
CORRELATION MATRIX FOR SUDRAM CLAYTON LIMITED;
Table No: 14
Ratios
Debt

A.C.R

C.V.A

E.R

C.A.A.G.R

ROCE

equity
Debt equity

1.000

0.966

-0.935

-0.760

0.376

-0.881

A.C.R

0.966

1.000

-0.890

-0.630

0.384

-0.772

C.V.A

-0.935

-0.890

1.000

0.809

-0.025

0.964

E.R

-0.760

-0.630

0.809

1.000

0.205

0.977

C.A.A.G.R

0.376

0.384

-0.025

0.205

1.000

0.015

ROCE

-0.881

-0.772

0.964

0.977

0.015

1.000

Inference
By Correlating Debt equity ratio with other Ratios we infer the following:

 Compounded annual average growth rate is negatively correlated with debt equity ratio
which shows that whenever there is an increase in the debt equity components the
Compounded annual average growth rate is decreasing.
Assets composition rate is positively correlated with Debt to equity ratio shows that increase
in Debt equity leads to increase in Assets composition rate.

By Correlating Debt equity ratio with other Ratios we infer the following;
Collateral value of assets is positively correlated with return on capital employed it shows
that whenever there is a increase in earnings rate it leads to increase in Return on capital
employed.
Earnings rate ratio is positively correlated with return on capital employed it shows that
whenever there is a increase in earnings rate it leads to increase in Return on capital
employed.

CORRELATION MATRIX FOR MUNDA HUF LIMITED;

Table No: 15

Ratios
Debt

A.C.R

C.V.A

E.R

C.A.A.G.R

ROCE

equity
Debt equity

1.000

0.523

0.443

0.063

0.341

-0.559

A.C.R

0.523

1.000

0.943

0.728

-0.242

0.329

C.V.A

0.443

0.943

1.000

0.703

-0.346

0.402

E.R

0.063

0.728

0.703

1.000

0.060

0.772

C.A.A.G.R

0.341

-0.242

-0.346

0.060

1.000

-0.300

ROCE

-0.559

0.329

0.402

0.772

-0.300

1.000

Inference
By Correlating Debt equity ratio with other Ratios we infer the following
The correlation between debt equity ratio and other ratio is not significant it shows that there is no
strong relationship between debt equity ratio and other ratios.
By correlating other ratios we infer the following:
Asset composition rate is positively correlated with Collateral value of assets it shows that

increase in Asset composition rate leads to increase in Collateral value of assets and vise
versa.

Regression
Regression helps us to estimate the value the dependent variable from the known value or the
independent variable.

To identify the exact value of influence of other ratios on Debt equity ratio a multiple
regression equation has been formed with the help of SPSS software through this equation we
can determine the level of influence of other variables on the components of the capital structure of
the company (i.e.)the debt and equity.

Regression Equation for Roots Industries Limited

Debt equity ratio = 2.309-9.955E.R
Inference:
Earnings rate also influences the debt equity component much. For every one unit of
increase in Earnings rate the debt and equity component in the capital structure decrease by
9.955 units.
Even if other ratios doesnt influence debt equity ratio there will be a change in debt equity
ratio by 2.309 units which is the constant co-efficient in the regression equation

Debt equity ratio = 2.347-6.144ROCE

Inference:
Return on capital employed influences the debt equity component much. For every one unit
of increase in Return on capital employed the debt and equity component in the capital
structure decrease by 6.397 units.
Even if other ratios doesnt influence debt equity ratio there will be a change in debt equity
ratio by 2.347 units which is the constant co-efficient in the regression equation.

Regression Equation for Lucas TVS

Debt equity ratio = 1.750-3.191E.R
Inference:

 Earnings rate also influences the debt equity component much. For every one unit of
increase in Earnings rate the debt and equity component in the capital structure decrease by
9.955 units.
Even if other ratios doesnt influence debt equity ratio there will be a change in debt equity
ratio by 2.309 units which is the constant co-efficient in the regression equation

Debt equity ratio = 0.006+0.479CAAGR

Inference
Compounded annual average growth rate influence the debt equity components much. For
one unit of increase in Compounded annual average growth rate the debt and equity
component in the capital structure increases by 0.221 units.
Even if other ratios doesnt influence debt equity ratio there will be a change in debt equity
ratio by 0.129 units which is the constant co-efficient in the regression equation.
Debt equity ratio = 1.447-4.085ROCE
Inference:
Return on capital employed influences the debt equity component much. For every one unit
of increase in Return on capital employed the debt and equity component in the capital
structure decrease by 6.397 units.
Even if other ratios doesnt influence debt equity ratio there will be a change in debt equity
ratio by 2.347 units which is the constant co-efficient in the regression equat

Regression Equation for Sundaram Clayton;

Debt equity ratio = 3.759-5.212CVA
Inference:

 Earnings rate also influences the debt equity component much. For every one unit of
increase in Earnings rate the debt and equity component in the capital structure decrease by
9.955 units.
Even if other ratios doesnt influence debt equity ratio there will be a change in debt equity
ratio by 2.309 units which is the constant co-efficient in the regression equation

The regression equation cannot be formed for Pricol Limited, Minda HUF because there is no
strong correlation between debt Equity and other ratios.

CALCULATIONS OF LEVERAGE
Operating Leverage;

Table No: 16

Year

ROOTS

2004
2005
2006
2007
2008

Chart: 11
Operating Leverage;

PRICOL

LUCAS TVS

SUNDRAM

MINDA

CLAYTON

HUF

4.06

7.62

3.74

3.11

7.62

3.17

5.86

2.2

3.09

5.86

5.22

3.7

2.1

3.07

3.7

5.06

4.71

4.03

2.8

4.71

5.42

4.53

4.34

2.68

4.53

Financial Leverage;
Table No: 17

Year

ROOTS

2004
2005
2006
2007
2008

Chart: 12
Financial Leverage;

PRICOL

LUCAS TVS

SUNDRAM

MINDA

CLAYTON

HUF

1.17

1.93

1.06

1.93

1.11

1.34

1.03

1.02

1.34

1.59

1.12

1.02

1.06

1.12

1.34

1.28

1.03

1.08

1.28

1.28

1.37

1.04

1.13

1.37

Combined Leverage;
Table No: 18

Year

ROOTS

2004
2005
2006
2007
2008

Chart: 13
Combined Leverage;

PRICOL

LUCAS TVS

SUNDRAM

MINDA

CLAYTON

HUF

4.75

14.71

3.96

3.11

14.71

3.52

7.85

2.27

3.15

7.85

8.30

4.14

2.14

3.25

4.14

6.78

6.03

4.15

3.02

6.03

6.94

6.21

4.51

3.03

6.21

7. FINDINGS AND
SUGGESTIONS
7. FINDINGS AND SUGGESTIONS
FINDINGS
The capital structure of the Roots Industries India Ltd has more debt in it rather
than equity.
The RIL has used major portion of its funds to finance its fixed assets.
The RIL has more reserve funds to take care of its future financial needs.
The RIL had sufficient liquidity to meet its regular financial needs.
The half of the total asset is fixed assets in RIL.
Share holders contribution is low in roots capital structure when compare to
other companies.
The debt equity ratio and return on capital employed are negatively correlated
which shows that any increase in debt and equity component will lead to an

decrease in profit and decrease in the debt and equity component will increase
the Earnings correspondingly.
For one unit of increase in Debt equity ratio the Return on capital employed
increases by 0.259units in RIL
Due to the influence of various other factors the Return on capital employed
decreases marginally to extent of 0.129 units.
Return on capital is high it shows funds are properly used by the RIL than other
companies.
Earnings rate and Return on capital employed are major factor influencing the
capital structure of RIL.
For every one unit of increase in the debt and equity component in the capital
structure the return on capital employed decrease by 6.397 units.

SUGGESTIONS

The RIL should maintain good reserve position to meet the future financial
uncertainties.
The contribution by the owners and the lenders should be equal in RIL.
In RIL the Investment of funds in fixed assets has increased gradually over the
period of year it will affect the liquidity in the long run, hence such investment
has to be structured properly.

 The return on capital employed is major factor influencing capital structure so

company should increase the sales by utilizing the assets efficiently for high
productivity.

Increasing debt is acting as a hurdle for the RIL profitability, and hence well planned
capital structure will fetch the organization more returns.

8. CONCLUSION

8. CONCLUSION

From the comparative study on determinants of capital structure for automobile

industry with special reference to Roots Industries Limited it can be concluded that the
Return on capital employed of the company is the major factor which influences the capital
structure of Roots Industries India Limited.
To conclude the RIL has been efficient in using funds properly, it becomes
better when company minimize the usage of debt in the capital structure.

ANNEXURE

BIBLIOGRAPHY

BIBLIOGRAPHY
Books Referred

Financial Management- Prasana Chandra.

Financial and Management Accounting- T.S. Reddy & Y.Hari Prasad
Reddy.
Industrial Finance - B.G. Satya prasad, Satish Bhat.
Research Methodology C.R. Kothari

Websites referred
http://www.rootsindia.com
http://www.investopedia.com
http://www.fadaweb.com