Biocon

Indian Institute of Management, Lucknow

Financial Management
Biocon: Cost of Capital

Submitted to:
Prof. M. Karmakar

Submitted on: 16th February’ 2011

by
Group 3, Section C

Annie Nishank PGP26135

Bhushika Ahuja PGP26142
Binesh K PGP26143
Madhuri Baxla PGP26153
Rohit Kumar PGP26163
Sandipta Mandal PGP26164

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ACKNOWLEDGEMENT

We thank Prof. M. Karmakar for giving us the opportunity to learn and work on this project report
submission and provide valuable inputs and guidance.

We acknowledge and thank all those individuals instrumental in managing and maintaining IIM
Lucknow Library. The information we gathered from e-journals and databases was immensely helpful
in understanding concepts and formation of this report analysis.

We also acknowledge the work of numerous people and organizations collecting the financial data
referred to in this report.

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Contents
ACKNOWLEDGEMENT................................................................................................................2
Introduction and company background....................................................................................4
Biocon versus Competitors........................................................................................................5
Cost of Capital for BIOCON........................................................................................................6
Weighted Average Cost of capital (WACC) for Biocon...........................................................6
Cost of Debt for Biocon (Rd):..................................................................................................6
Cost of Equity for Biocon........................................................................................................8
Systematic Risk of Biocon (Beta β).....................................................................................8
Calculation of Beta β...........................................................................................................9
Calculation of Rm (Expected market return).....................................................................10
Calculation of Rf (risk free rate)........................................................................................11
Applying the WACC formula.............................................................................................11
Analysis.....................................................................................................................................12
Reference and Sources.............................................................................................................12

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 Biocon

Introduction and company background

Biocon Limited (Biocon) is a global biopharmaceutical company with products and research
services ranging from pre-clinical to clinical development through to commercialization.
Within biopharmaceuticals, the Company manufactures generic active pharmaceutical
ingredients (APIs) like Statins and Immunosuppressants that are sold in the developed
markets of the United States and Europe. It also manufactures biosimilar Insulins, which are
sold in India as branded formulations and in both bulk and formulation forms. In research
services, Syngene International Limited (Syngene) is engaged in the business of custom
research in drug discovery while the other fully owned subsidiary Clinigene International
Limited (Clinigene) is in the clinical development space. In December 2009, Biocon acquired
the the Active Pharma Ingredients (API) undertaking from IDL Speciality Chemicals Ltd., a
subsidiary of Gulf Oil Corporation Limited.

Products & Services Offered by Biocon:

1. Biopharmaceuticals: Today, Biocon is a leading biopharmaceutical company with strong

capabilities in statins, immunosuppressants, recombinant insulin and a wide product range
across key therapeutic segments including diabetology, cardiology and oncology. Following
biopharmaceutical products are offered by Biocon:

 Small molecules: Biocon produces anti-diabetic agents, anti-hypertensive agents,

anti-inflammatory agents, anti-oxidants, cardiovascular agents, digestive-aid
enzymes, and neutraceuticals.
 Biologicals: In the field of Biogenerics, Biocon is currently working on products that
include: Insulin, Streptokinase, and Monoclonal Antibodies.
 Dosage Forms: Biocon provides products in the therapeutic segments of cardiology
and diabetes.

2. Enzymes: Biocon is India's largest producer and exporter of enzymes. It manufactures and

markets a broad range of industrial enzymes, food additives and process aids. Biocon is the
first enzyme company globally to receive the ISO 9001 accreditation. Enzymes
manufactured by Biocon are: Amylases, Amyloglucosidases, Cellulases, Catalase and Lipases.

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3. Custom Research: Biocon subsidiary Syngene conduct high value R&D in early stage drug
discovery and development for a diverse global clientele.

4. Clinical Research: Biocon subsidiary Clinigene offers global biotechnology and

pharmaceutical major’s strong clinical trial services, regulatory and laboratory capabilities
for clinical drug development. Its value added services include value-added services include
patient registries and clinical databases in diabetes, lipidemia, oncology, cardiovascular
diseases. 

Biocon versus Competitors

  Valuation Dividend Financial ratios

Company name Price Earnings Market Dividend Lt debt Total debt
per shar Cap yield to assets to equity
e
341.
Biocon Limited 5 17.58 68.30B 1.08 17.49 29.6
Panacea Biotec Limited 178   10.99B 0.14 41.73 110.03
Celestial Biolabs 26.5
Limited 5 -3.41 312.84M 2.18 7.4 8.26
126.
Hester Biosciences Ltd 1 13.06 654.61M 2.32 24.88 49.31
Bharat
Immunologicals& 14 -1.9 604.52M   0 0
Transgene Biotek Ltd 41.9 0.12 629.34M   11.34 12.95
Bilcare Limited 478 67.7 11.25B 0.54 34.5 68.67
Piramal Life Sciences 89 -53.16 2.27B   60.84 176.62
ABL Bio Technologies
Ltd 9.44 -0.67 77.41M      
Vimta Labs Ltd 26.8 0.52 592.49M 3.21 15.07 20.96

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Cost of Capital for BIOCON

We have calculated the cost of capital for Biocon using the CAPM Model for cost of equity
and weighted average cost of capital. The method and calculations are explained below.

Weighted Average Cost of capital (WACC) for Biocon

The capital funding of a company is made up of two components: debt and equity. Lenders
and equity holders each expect a certain return on the funds or capital they have provided.
The cost is the expected return to equity owners (or shareholders) and to debt holders, so
WACC tells us the return that both stakeholders - equity owners and lenders - can expect.

The WACC equation is the cost of each capital component multiplied by its proportional
weight and then summing: 

Where: 
Re = cost of equity 
Rd = cost of debt 
E = market value of the firm's equity 
D = market value of the firm's debt 
V = E + D 
E/V = percentage of financing that is equity 
D/V = percentage of financing that is debt 
Tc = corporate tax rate 

Cost of Debt for Biocon (Rd):

There are three methods for calculating the cost of debt.

a. Using the publicly traded debentures
b. Using the Credit rating of the company and deducing the interest rate from there
c. Using the interest expense paid by the company on the loans outstanding

Here we have used the third approach as debentures for Biocon are not traded. The tax rate
is calculated by dividing the tax paid by the company in a financial year with the PBT. This
will give the average tax paid irrespective of any deferred taxes. The total loans outstanding
have increased for Biocon in Year 2010 as compared to year 2009. This is because of

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increase in the unsecured loans and decrease in the secured loans (increased bank
borrowings as per the financial report). Interest and finance charges have decreased from
Rs 49,371,000 in fiscal 2009 to Rs 19,910,000 in fiscal 2010 due to decrease in average
quantum borrowings to finance the working capital.

2006 2007 2008 2009 2010

Operating
Profit 180.06 187.58 176.3 209.3 263.25
PBDIT 186.22 236.83 586 193.7 357.95
Interes t 2.48 8.16 3.09 4.94 1.99
PBDT 183.74 228.67 583 188.8 355.96
Depreciation 22.85 57.61 69 74.28 79.73
Other Written
Off 0 0 0 0 0
Profit Before
Tax 160.89 171.06 514 114.5 276.23
Extra-ordinary
item s 0 0 -68.39 7.73 0
PBT (Pos t
Extra-ord
Item s ) 160.89 171.06 445.6 122.2 276.23
Tax 27.39 12.7 10.64 10.4 27.87
Reported Net
Profit 133.48 158.35 434.9 111.8 248.36
Tax Rate(%) 20.52% 8.02% 2.45% 9.30% 11.22%

Figure1: Tax Rates applicable to Biocon ( From P/L Statement ) Source: Biocon Website,
www.biocon.com

  2008 2009 2010

Interest Expense 3.09 4.94 1.99
Total Borrowing 143.89 163.94 191.81
0.02147473 0.03013297 0.0103748
Cost of Debt 8 5 5
0.02094937 0.02732990 0.0092106
Cost of Debt after tax 4 8 2
Cost of Debt after tax (%) 2.09% 2.73% 0.92%

Average cost of debt: 1.92 %

Interpretation:
 The cost of debt for 2010 has decreased from 2009, the reason being the interest
expenses have reduced and also, the total borrowings for 2010 have increased vis-a-
vis 2009

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 They have raised a substantial debt capital but have not started paying interest on it
in 2010 and therefore interest expense have come down
 We have taken average cost of debt for the last three years because the debts
structure of company changed substantially during 2010 and it reduced the cost of
debt below 0.92 %. Therefore averaging will reduce the fluctuation and smoothen
out the cost of debt.

Cost of Equity for Biocon

The cost of equity can be calculated using CAPM Model. According to this model, the Cost of
equity is defined by the following:

Systematic Risk of Biocon (Beta β)

Beta is a measure of the volatility or systematic risk, of a security or a portfolio in
comparison to the market as a whole. Beta is used in the capital asset pricing model
(CAPM), a model that calculates the expected return of an asset based on its beta and
expected market returns.

The formula for the beta of an asset within a portfolio is

where ra measures the rate of return of the asset, rp measures the rate of return of the
portfolio, and cov(ra,rp) is the covariance between the rates of return. The portfolio of
interest in the CAPM formulation is the market portfolio that contains all risky assets, and so
the rp terms in the formula are replaced by rm, the rate of return of the market.

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For the calculation of beta we have used the stock prices of Biocon from NSE and the NSE
closing prices. These have been used to determine the returns of the stock and market.

Calculation of Beta β

For calculation of Beta β, we have calculated the correlation between the stock’s return and
the market return of NSE (beta is the slope of the characteristic line). The Biocon stock was
listed in 2004. The compacted data (to avoid large table for monthly data) is shown below.

Biocon
  Nifty     on NSE    
Opening Closing Opening Closing
Year Value Value Return r Value Value Return r
0.14885
2005 1771.9 2035.65 2 425 410 -3.52941
0.67148 9.65853
2006 2035.65 3402.55 1 410 449.6 7
0.12314 5.42704
2007 3402.55 3821.55 3 449.6 474 6
0.23889
2008 3821.55 4734.5 5 474 427 -9.91561
2009 4734.5 3020.95 -0.36193 427 141.1 -66.9555
0.73756 104.110
2010 3020.95 5249.1 6 141.1 288 6
0.04417 22.5520
2011 5249.1 5481 9 288 352.95 8

Table 1 Nifty and Biocon Stock Returns (source NSE website)

Covariance (Rm, Rb) 1317.6573

Variance(Rm) 1425.852
Beta = Cov/Var 0.9241193

Table 2 Covariance and Beta calculations

Therefore the beta β for Biocon is 0.924 (implying a low systematic risk). The industry beta
for Pharmaceutical industry is 0.98.

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Calculation of Rm (Expected market return)

The expected market return for the S&P Nifty index can be calculated by taking the
geometric means of the monthly returns of the index over a period of last 10 years. Shown
here are the yearly values for the Index for last ten years (to avoid large printout for
monthly data)

  Nifty    
Opening Closing
Year Value Value Return r
2000 1546.2 1371.7 -0.11285733
2001 13717.7 1075.4 -0.92160493
2002 1075.4 1041.85 -0.03119769
0.73705427
2003 1041.85 1809.75 8
0.13695261
2004 1809.75 2057.6 8
2005 2057.6 2035.65 -0.01066777
0.67148085
2006 2035.65 3402.55 4
0.12314293
2007 3402.55 3821.55 7
0.23889521
2008 3821.55 4734.5 3
2009 4734.5 3020.95 -0.3619284
0.73756599
2010 3020.95 5249.1 7
0.04417900
2011 5249.1 5481 2

Table 3 Expected Market Return for Last 10 years

Geometric Mean of Monthly Data = (1 + R) = 1.17506

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Expected Market Return = Geometric Mean -1 = .17506

Rm = 17.51 %

Calculation of Rf (risk free rate)

The Risk free rates are the same used in 10-year government securities (sourced from RBI
website).

Governme
Year nt Bonds
2005 6.60
2006 7.50
2007 8.70
2008 7.90
2009 7.96
2010 6.82
2011 7.83
Averag
e 7.62
Table 4 Risk Free rate using Government Bonds (Source RBI Website)

Rf bar Average return for government securities = 7.62%

Rf Latest return for government securities = 7.83 %

Applying the WACC formula

Total Capital 1757.14

Equity 1465.34
Debt 291.8
Equity Proportion 0.833934689
Debt Proportion 0.166065311
Rf ( risk free ) 7.83
Rf(average risk free) 7.62
Rm (market return) 17.51
Equity risk Premium ( Market 9.89
return – average risk free

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return)
Cost of Equity 16.96953982
WACC 14.47033331

Table 5 WACC Calculation

Analysis

We have calculated the cost of capital using the market value approach. Market-value
weights are theoretically superior to book-value weights, yet the managers usually prefer
the book value approach because the book value information can be easily derived from the
published sources. The book-value weights are based on arbitrary accounting policies that
are used to calculate retained earnings and value of assets. Thus, they do not reflect
economic values.
Using the book value approach the cost of capital is: 8.46 %
Market value approach revolves around the economic values and is not influenced by
accounting policies, hence it is preferred theoretically. Also, the market prices of securities
fluctuate widely and frequently and hence book value is used practically. The WACC
calculated based on the book value approach is 8.46%, while the WACC calculated from the
market value approach is 14.47% ( reason being low cost of Debt). Since the market value
approach is calculated based on the reserves and equity, the value is more than that of the
book value approach.

Reference and Sources

 Capitaline Plus Online Databases
 ICICI Direct: http://content.icicidirect.com/newsiteContent/Market/

 http://www.vccircle.com/columns/

 http://in.finance.yahoo.com/

 http://www.moneycontrol.com

 www.nseindia.com

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 www.reuters.co.in

 www.bloomberg.com

 http://rbi.org.in

 Brealey, R.A.; Myers, S.C.; Allen, F.; Mohanty, P.; Principles of Corporate Finance e8;
McGraw Hill

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