CORPORATE FINANCE

RELIANCE CAPITAL
Group-2

Ankit Chadha, Gaurav Vijay Shah, Mohit Dhand,

Sandeep Aggrawal, Tamal Taru
Contents:
1. Acknowledgement 1
2. History of the Company 2
3. Overview of the Company 2
4. Objective of study 3
5. Methodology 3
6. Cost of Equity 3
6.1. Calculation of Beta 4
6.2. Calculation of Market Return 4
6.3. Risk free rate of return 4
7. Cost of Retained Earnings 5
8. Cost of Debt 5
8.1. Bank loans 5
8.2. Debentures 6
9. Cost of Preference Capital 7
10. Weighted Average Cost of Capital 8
11. Problems in calculation cost of capital 9
12. Findings 9
13. Bibliography 10
14. Appendix 10

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 Acknowledgement

At the successful completion of our project, we would like to express our sincere gratitude
to all the people without whose support this project would not have been completed.

At the onset, we would like to thank our institute “FORE School Of Management” for giving
us the opportunity to undergo this project.

We would also like to acknowledge the constant help and encouragement of our Corporate
Finance-I faculty Prof. Vineet Gupta, who has given his valuable suggestions, expert
guidance and support.

We would also like to thank all those who have directly or indirectly helped us in the
preparation of this report.

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History of Reliance Capital:

Reliance Capital Limited was incorporated in year 1986 at Ahmedabad in Gujarat as Reliance
Capital & Finance Trust Limited. The name RCL came into effect from January 5, 1995. In
2002, RCL shifted its registered office to Jamnagar in Gujarat before it finally moved to
Mumbai in Maharashtra, in 2006.In 2006, Reliance Capital Ventures Limited merged with
RCL and with this merger the shareholder base of RCL rose from 0.15 million shareholders to
1.3 million.RCL entered the Capital Market with a maiden public issue in 1990 and in
subsequent years further tapped the capital market through rights issue and public issues.
Presently the shares are listed on The Stock Exchange Mumbai and the NSE of India.

Overview of the business:

Reliance Capital, a constituent of S&P CNX Nifty and MSCI India, is a part of the Reliance Anil
Dhirubhai Ambani Group and is one of India's leading, most valuable and fastest growing
privates sector financial services companies. RCL in the initial years engaged itself in steady
annuity yielding businesses such as leasing, bill discounting, and inter-corporate deposits.
Later, in 1993 diversified its business in the areas of portfolio investment, lending against
securities, custodial services, money market operations, project finance advisory services,
and investment banking. Reliance Capital has a net worth of Rs. 7,669 crore (US$ 1.6 billion)
and total assets of Rs. 25,606 crore (US$ 5 billion) as on September 30, 2009.

Business mix of Reliance Capital

Area Business mix

Asset Management Mutual Fund, Portfolio Management, Offshore Fund

Insurance Life Insurance, General Insurance

Consumer Finance Mortgages, , Loans against shares, Vehicle & Business Loans
Broking and Stocks Commodities and Derivatives, Wealth Management Services,
Distribution Portfolio Management Services, Investment Banking, Foreign
Exchange and Offshore Investment, Third Party Products

Other Businesses Asset Reconstruction, Institutional Broking, Private Equity, Exchanges

Subsidiary companies forming part of consolidated financial statement of Reliance Capital
Ltd

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1 Reliance Capital Asset Management Ltd.

2 Reliance Capital Trustee Co. Ltd.

3 Reliance General Insurance Company Ltd.

4 Reliance Gilts Ltd.

5 Reliance Asset Management (Mauritius) Ltd.

6 Reliance Asset Management (Singapore) Pte. Ltd.

7 Reliance Money Express Ltd.

8 Medybiz Pvt. Ltd.

9 Net Logistics Pvt. Ltd.

10 Reliance Capital Research Pvt. Ltd.

11 Reliance Technology Ventures Pvt. Ltd.

12 Reliance Equity Advisors (India) Ltd.

13 Reliance Capital Asset Management (UK) Plc.

14 Reliance Capital Markets Pvt. Ltd.

15 Reliance Equities International Pvt. Ltd.

16 Reliance Home Finance Pvt. Ltd.

17 Reliance Capital Services Pvt. Ltd.

18 Reliance Capital (Singapore) Pte. Ltd.

19 Reliance Consumer Finance Pvt. Ltd.

20 Reliance Securities Ltd.

21 Reliance Prime International Ltd.

22 Reliance Commodities Ltd.

23 Reliance Financial Ltd.

24 Reliance Alternative Investments Services Pvt. Ltd.

Objective of study:

To calculate the cost of capital of Reliance Capital Limited

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Methodology:

 Cost of equity is calculated by the Capital Asset Pricing Model (CAPM)

 Cost of retained earnings is calculated same as the cost of equity
 Capital structure as on 31st march, 2009 has been determined from information
taken from annual report 2008-09
 Data related to share prices and market indexes is taken from various sources like
Capitaline database, www.bseindia.com, www.moneycontrol.com,
www.money.rediff.com
 Risk Free rate of return has been taken from http://www.rbi.org.in/
 Daily share prices of Reliance Capital ltd from SENSEX has been collected for the past
95 months from 1-1-2002 to 31-03-2009
 Cost of capital has been calculated by weighted average method

Cost of equity:

Firms raise equity capital by issuing shares. The shareholders required rate of return
which equates the present value of the expected dividends with the market value of the
shares is the cost of equity.

We have calculated the cost of equity by CAPM based approach which takes into
consideration three parameters:

 Risk free rate - Rf

 Market return - Rm
 Beta (Measure of risk) - β

The formula is

Re = Rf + β ( Rm - Rf)

We have collected the share prices of Reliance Capital ltd and BSE SENSEX from Capitalline
database. By using MS Excel we have calculated the percentage rate of returns on daily
basis for both of them.

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Calculation of Beta (β):

We applied regression for calculating the value of Beta by taking percentage return of
market as the independent variable and the percentage return of security as the dependent
variable.
The Beta (β) was found to be 1.521
Calculation of Market return:
We have calculated the market return by calculating average daily return on SENSEX for a
period of 95 months and then multiplied it with 250. We have taken 250 as average number
of trading days in an year during which stock market is open for trading of shares. It comes
out to be:
=0.074893 * 250
= 18.72314

Risk free rate of return (Rf):

For calculating the risk free rate of return, we have taken three government securities of
more than six years of different coupon rates from the website of Reserve Bank of India.
First we calculated the average of yields for a period of 5 years for each security and then
calculated the average of these three average yields. Hence, Rf is calculated to be 7.732%

Cost of Equity:

Substituting the values of Rf, Rm and β in the formula we get;

Particulars Value
Cost of equity 24.6369847
Market return 18.72314
Risk free rate of return 7.372
Beta 1.52099089
Re = 7.732 + 1.521(18.72314–7.732) = 24.64%

Cost of retained earnings:

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Theoretically, the cost of retained earnings is calculated same as the cost of equity using the
formula

Re = Rf + β ( Rm - Rf)
But the cost of external equity is more than cost of retained earnings due to the presence of
flotation cost. These costs include fees paid to merchant bankers, underwriting commission,
administrative cost, etc.

Cost of retained earnings = cost of external equity *(1- flotation cost)

However, due to the unavailability of data about the floatation cost, cost of retained
earnings is considered to be equal to the cost of equity.

And hence, cost of retained earnings, Re = 24.64 %

Cost of debt:

The firms raise the capital in the form of debts from debenture holders, banks, financial
institutions, subscribers to commercial paper, etc. and pay them a fixed rate of return.
This interest rate the company pays on all of its debt is called as the cost of debt.

i. Bank loans

The amount of the loan which the company has borrowed has been taken from Schedule ‘C’
of the Consolidated Balance Sheet of the Annual Report 2008 – 2009. The interest paid on
this loan is got from Schedule ‘L’ of the Annual Report 2008 – 2009. It is reported to be:

Bank loan amount = short term + long term loans = Rs.7023.09 crores

Long term bank loans = Rs 1855.56 crores

Interest on bank loans = Rs 595.41

Out of the total term loans, Rs. 598 crore is payable within a year as found from the notes to
the account. Other short term sources of finance were commercial papers, unsecured bank
loans and short term loans. This cannot be considered as a part of cost of loan because it is

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of short term nature. So this should be deducted from the total loans. The interest is
calculated for the whole amount of term loans so it should be proportionately reduced.

We have also included working capital loans in the bank loans. Working Capital Loans have
reduced from 1378.24 crore in 2007-08 to 1010.29 crore in 2008-09. This can be concluded
from the fact that some part of the loan has been repaid during the year. Still company is
using Working Capital Loan for a period more than 1 year. Company might be using roll over
facility of bank. Therefore, we are taking this amount as a long term source  of capital

Proportion of long term in total bank loans = 26.41 %

Interest = 595.41 * 26.41 %

= Rs. 157.27 crore

Cost of term loan = Long term interest * (1 – t)

Long term loan amount

Where t = tax rate.

The corporate tax rate is 33.99%.

So now by substituting the values, we get

Cost of term loan = 157.27 * (1 - 0.3399)

1855.56

= 5.60%

ii. Debentures:

Cost of debenture is calculated on long term debentures. In the year 2007-08 NCD were
884.32 which rose to 1181.90 in 2008-09. Long term debentures issued by the company are
repaid in year 2008-09, whereas new debentures issued are of short tenure i.e. 360 days
which we found out from information memorandum submitted by RCL with SEBI. So we are
taking proportion of debentures in capital structure to be zero. Hence, the cost of
debentures is also zero.

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So, our total cost of debt comes out to be 5.60 %

Cost of preference capital:

Company is having a authorized preference capital of Rs 100 crores. But there are no
preference shares issued by the company till now, so when we are calculating our cost of
capital we will consider the cost of preference capital to be zero.

Hence we tabulate the results found so far:

Particulars (In %)
Cost of equity (Ke) 24.63
Cost of retained earnings 24.63
Cost of preference capital (Kp) 0
Cost of debt (Kd) 5.60

The total capital raised by the company is:

Particulars Amount (in crore)

Equity Capital 246.16
Retained Earnings 7207.00
Preference Capital 0.00
Debt 1855.56
Total 9308.72

Proportions of respective capital are:

Particulars Weight
Equity Capital 0.0264
Retained Earnings 0.7742
Preference Capital 0.00
Debt 0.1993

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Weighted Average Cost of Capital (WACC):

Company finances its project by raising capital from different sources based on factors like
cost of capital, ease of raising capital, market condition, etc. Capital structure have different
components i.e. Debentures, equity shares, preference shares and loans. The component
costs are multiplied by the weights of the various sources of capital to obtain the weighted
average cost of capital. The composite or overall cost of capital is the weighted average of
the costs if various sources of funds, weights being the proportions of each source of funds
in the capital structure. WACC is calculated as:

1. Cost of the specific sources of funds is calculated.

2. The cost of each source is multiplied by its proportion in the capital structure.
3. The weighted component costs are added to get the firm’s weighted average cost of
capital.
WACC = Equity Proportion * Ke + Retained earnings proportion * Ke + Preference
stock proportion* Kp +Debt proportion*Kd

Weighted component cost:

Particulars Value
Equity Capital 0.65
Retained Earnings 19.069
Preference Capital 0.00

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 Debt 1.12
WACC 20.84

So, the Weighted Average Cost of Capital for Reliance Capital Limited comes out to be
20.84 % as on 31 March 2009.

Problems and limitations in calculation of Cost of Capital

 Flotation cost was not known which we required in the calculation of cost of
retained earnings
 Limitation of CAPM lies in the assumptions taken.
 Coupon rates as well as terms of loans were not available.
 No information about working capital loans

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  Interest was given for all the loans together.

Findings

 Major part of the capital structure is retained earnings. This shows that company is
using its own funds to finance its projects and do not rely much on outside debt. This
also reduces the chance of bankruptcy. This can also be due to ability of company to
generate returns upto expectations of shareholders.

 RCL has less equity as compared to debt. Company has included debt to get the tax
benefit on interest paid which reduces the cost to company. Company might be
using debt to increase the return to shareholders.

 Preference stock was not there in their capital structure. Debentures issued by the
company were short term as interest rates were high, company may not want to
carry the burden for a long period.

 Cost of retained earnings and equity was equal.

 Loans have smallest cost whereas cost of equity as well as retained earnings was the
largest. From this we can conclude that cost of retained earnings is not zero and cost
of debt is smallest. This does not implies that company should include high debt in
its capital structure. Cost of debt increases with increase in proportion of debt in the
capital structure as credit rating of company falls due increase in financial risk of the
company

 Cost of capital of Reliance capital Limited is 20.84%

Bibliography

1. http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/FHB100909_Full.pdf , November
28,2009
2. http://www.madaan.com/taxrates.htm, December 02,2009
3. http://www.bseindia.com, November 27, 2009
4. http://www.moneycontrol.com, November 27, 2009

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5. http://www.money.rediff.com, November 27, 2009
6. http://www.reliancecapital.co.in/idf_areports.html , December 03, 2009
7. http://www.reliancecapital.co.in/idf_qresults.html , December 03, 2009
8. http://bseindia.com/downloads/ipo/200931814558Information%20Memorandum%20RCL
%20NCD%20Listing2009.pdf ,November 30, 2009
9. Pandey, I. M. Financial Management: Vikas Publishing House Pvt. Ltd, 1995
10. Srivastava Rajiv, and Misra Anil. Financial Management: Oxford University Press,
2009

Appendix
1. Calculation Of Beta

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SUMMARY OUTPUT

Regression Statistics
Multiple R 0.7091645
R Square 0.5029143
Adjusted R Squar 0.5026398
Standard Error 2.5658485
Observations 1813

ANOVA
df SS MS F Significance F
Regression 1 12062.6622 12062.66 1832.235 3.5E-277
Residual 1811 11922.8603 6.583578
Total 1812 23985.5225

CoefficientsStandard Error t Stat P-value Lower 95%Upper 95%

Lower 95.0%
Upper 95.0%
Intercept 0.0574583 0.06031914 0.952572 0.340934 -0.06084 0.175761 -0.06084 0.175761
X Variable 1 1.5209909 0.03553334 42.80461 3.5E-277 1.4513 1.590682 1.4513 1.590682

2. P 84 and P89 of Annual report of Reliance Capital Limited 2008-09

3. Calculation of Risk free rate of return:

YIELDS (IN %)
Securities 2004-05 2005-06 2006-07 2007-08 2008-09 Average
8.07% 2017 6.4 7.22 7.8 7.93 7.29 7.328
5.69% 2018 6.39 7.29 7.95 7.99 7.54 7.432
6.25% 201 6.46 7.23 7.91 8.03 7.15 7.356
average 7.372

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