ANALYSIS OF WORKING CAPITAL MANAGEMENT OF TATA

STEEL LTD

A PROJECT REPORT

Submitted by

NAME: Nabeel Nawab Khan

REG NO: RA2031207010029

of

BACHELOR OF COMMERCE (HONOURS) In

INTERNATIONAL ACCOUNTING AND FINANCE Of

COLLEGE OF SCIENCE AND HUMANITIES

SRM Nagar, Kattankulathur, Chengalpattu District

FEBRUARY 2022
 TABLE OF CONTENTS
S.NO CONTENT PAGE NO

1 COMPANY PROFILE 3

2 STATEMENT SHOWING CHANGES IN 4

WORKING CAPITAL

3 OPERATING CYCLE 5

4 CURRENT ASSETS TO FIXED ASSETS RATIO 6

5 RETURN ON TOTAL ASSETS 6

6 WORKING CAPITAL FINANCING POLICY 7

7 CONCLUDING REMARKS 8
COMPANY PROFILE: TATA STEEL Ltd.

Tata Steel Limited is an Indian multinational steel-making company based in Jamshedpur,

Jharkhand, and is headquartered in Mumbai, Maharashtra, India. It is a subsidiary of the
Tata Group.
Formerly known as Tata Iron and Steel Company Limited (TISCO), Tata Steel is among
the top steel producing companies in the world with an annual crude steel capacity of
34 million tonnes per annum. It is one of the world's most geographically-diversified steel
producers, with operations and commercial presence across the world. The group
(excluding SEA operations) recorded a consolidated turnover of US$19.7 billion in the
financial year ending 31 March 2020. It is the second largest steel company in India
(measured by domestic production) with an annual capacity of 13 million tonnes after Steel
Authority of India Ltd. (SAIL).

MISSION

Consistent with the vision and values of the founder Jamsetji

Tata, Tata Steel strives to strengthen India’s industrial base
through effective utilisation of staff and materials. The means
envisaged to achieve this are cutting-edge technology and
high productivity, consistent with modern management
practices.

Tata Steel recognises that while honesty and integrity are essential ingredients
of a strong and stable enterprise, profitability provides the main spark for
economic activity.
Overall, the Company seeks to scale the heights of excellence in
all it does in an atmosphere free from fear, and thereby reaffirms its
faith in democratic values.

VALUES
▪ Integrity
▪ Excellence
▪ Unity
▪ Responsibility
▪ Pioneering

VISION

We aspire to be the global steel industry benchmark for value creation and
corporate citizenship

STATEMENT SHOWING CHANGES IN WORKING CAPITAL

Previous year Current Year
31st March 31st March Effect on
2020 (in 2021 (in Working
Particulars crores ) crores ) Capital
Increase Decrease
Current Assets
Current Investments 3235.16 6404.46 3169.3 -
Inventories 10716.66 8603.79 2112.87
Trade Receivables 1016.73 3863.31 2846.58 -
Cash and Cash Equivalents 1226.87 1671.71 444.84 -
Short Term Loans and Advances 1607.32 1555.95 51.37
Other Bank Balances 233.33 170 63.33
Other Financial Assets 230.41 351.54 121.13 -
Other Current Assets 2206.45 1657.08 549.37
Gross Working Capital (A) 20472.93 24277.84 6581.85 2776.94

Current Liabilities
Trade Payables 10600.96 10638.59 37.63
Other Current Liabilities 11749.21 17600.3 5851.09
Other Financial Liabilities 293.59 413.66 120.07
Short Term Provisions 663.86 1074.43 410.57
Current Tax Liabilities 277.26 4093.26 3816
Total Current Liabilities(B) 23584.88 33820.24 10235.36
Net Working Capital (A-B) -3111.95 -9542.4 -3653.51 2776.94
Increase In Working Capital 6430.45 6430.45
Total -3111.95 -3111.95 2776.94 2776.94

OPERATING CYCLE

Avg stock of raw materials/Cost of Raw

Raw Materials Storage Period =
materials consumed per day

Work in Progress holding period = Avg WIP inventory/Cost of WIP per day

Avg stock of finished goods/Cost of

Finished Goods Storage Period =
Finished goods consumed per day
Avg stock of receiavbles/credit sales per
Receiavbles Collection Period =
day

Credit period allowed by Suppliers Avg payables inventory/Cost of credit

= purchases per day

Avg stock of raw materials/Cost of Raw

Raw Materials Storage Period =
materials consumed per day
(Opening Stock + Closing Stock)/2
Average Stock of Raw Materials = = (8603.79+10716.66)/2

= ₹9660.2
B12Cost of Raw Materials/360

Cost of Raw Materials per day = 9660.2/360

26.8
Raw Materials Storage Period = 360.4552239
Work in Progress holding period Avg WIP inventory/Cost of WIP per
= day
Average Stock of Work in Progress = 9063.795
Cost of WIP per day 25.17720833
WIP Storage Period 360

Avg stock of finished goods/Cost of

Finished Goods Storage Period =
Finished goods consumed per day
Avg stock of finished goods = 3.58
Cost of Finished goods = 0.009944444
Finished Goods 360

Receiavbles Collection Period = Avg receiavbles/credit sales per day

Average Receivables 8712.375
Credit Sales 26.49955556
Receivables Collection Period 328.774382

Credit period allowed by Suppliers Avg payables inventory/Cost of credit

= purchases per day
Average payables 23673.95
Credit Purchases 72.13305556
Credit period allowed by
328.1983526
Suppliers =
CURRENT ASSETS TO FIXED ASSETS RATIO
31.3.2021 ₹ 31.3.2020 ₹
Current Assets 23756.3 Current Assets 20009.19

Non Current Assets 141279.69 Non Current Assets 130383.37

CA to FA Ratio 0.17 CA to FA Ratio 0.17

RETURN ON TOTAL ASSETS

31.3.2021 ₹ 31.3.2020 ₹

EAT 13599 EAT 6748

Total Assets 165,035.99 Total Assets 150,392.56

Return on Total
8.240020858 Return on Total Assets 4.486924087
Assets
WORKING CAPITAL FINANCING POLICY

During the year 2020-21 the changes in working capital of Tata Steel shows a tremendous decrease
when compared with the previous year. The net working capital decrease is 6430.45 Crs. Even
though the net working capital is in negative figure, thetable shows an decrease in WC when
compared with previous year. This is due to increase in current liabilities.

When compared to 2020 it has been found that the inventories has been decreased also there was an
decrease in other current asset, but a increase in loans and advances in theyear 2020 in schedule of
changes in working capital. In the financial year 2020 – 2021 the changes in working capital of Tata
Steel shows decrease when compared with the previous year. The networking capital decrease is
6430.45 Crs in the financial year 2020 – 2021.This is because the company has reduced their current
asset and increasedtheir short term loan in the last two years which resulted in decrease in working
capital.

It can be said that its working capital financing policy appears to be an aggressivepolicy wherein
short-term finances are utilized not only to finance the temporary working capital but also a
reasonable part of the permanent working capital.

SUGGESTIONS
The company should improve its current assets and current liabilities in order to overcome its
negative impact. It has to make its working capital stable to further continue in the market. Working
capital shows negative impact and decreases year byyear. It is not good for the company as well as
the society so in order to increase the working capital turnover the society needs to increase its
sales.

CONCLUDING REMARKS

The study conducted on working capital management at “TATA STEEL LTD,” gives aview of
assessing the performance of working capital management by analysing the financial data with the
help of schedule of changes in working capital. The company has a huge market reputation which is
very evident with its high scale value but the company has a poor working capital management,
which is not a positive sign of a good financial performance of the company. The company has to
work towards improved capital management to increase its profits during the coming years by
maintaining a positive working capital which follows an increasing trend.
Receivable Management
Particular Working
Inventory turnover ratio = COGS / Avg Inventory
Opening Inventory + Purchases - Closing
COGS = Inventory
Avg Inventory = (Opening Inventory + Closing Inventory)/2
Workings COGS =

opening inventory 635.01

Purchases 1146.05
closing stock 632.94
1148.12
Average Inventory
opening inventory 632.94
closing inventory 635.01
2
633.97

Inventory Turnover Ratio 1.811000521

Receivable Turnover Ratio Credit Sales/ Average Receivables

Average trade recievables (Op. Rec +Cls. Rec) / 2

Credit Sale 26.499
Average trade receivables 2440
opening receivables 1016.73
closing receivables 3863.31
2
Receivables turnover ratio 0.010860246

Average Credit Period Avg Rec/ Credit Sales

Credit Sales 26.499
Average trade receivables 2440
Average credit period 92.07894638

Receivables to current assets

ratio Total Receivables / Current Assets x 100
Total receivables 910.87
Current Assets 524.83
Receivables to current assets
ratio 173.5552465

Receivables to Total Assets

Ratio Receivables / Total Assets x 100

Total receivables 3863.31

Total Assets 165035.99
 100
Receivables to current assets
ratio 2.340889402

Bad debts to Sales Bad Debts / Sales x 100

Bad Debts 359.5
Sales 64869
100
Bad debts to Sales 0.554193837

Bad debts to Receivables = Bad debts/ Receivables x 100

Bad Debts 359.5
Trade Receivable 3863.31
100
Bad debts to Receivables 9.305491923

Cash Proportion Ratio = Cash Balance / Current Assets

Cash Balance 1671.71
Current Asset 23756.3
Cash Proportion Ratio = 0.070369123

Cash Turnover = Sales/Cash Balance

Sales 64869
Cash balance 1671.71
Cash turnover 38.80397916

CASE 1
The capital budgeting decision is one of the most important financial decisions in business firms. In
this case, G Ltd is a manufacturer of a variety of electrical equipment. The existing machine is based
on old technology. In order to improve the quality of the product and bring down operating costs, it
is planning to replace the existing machine with a new one based on the latest technology.
EXHIBIT 1
Existing Machine
Purchased: 5 years ago; Depreciation: Straight Line Method
Remaining Life: 5 years; Current Book Value: ₹3,00,000
Salvage Value: ₹20000; Realizable market value: ₹3,50,000
Annual Depreciation: ₹28,000
New Replacement
Machine Capital Cost -
₹10,00,000 Estimated
Useful Life – 5 years
Estimated Salvage Value - ₹1,00,0000
The replacement machine would permit an output expansion. As a result, sales is expected to
increase by ₹1,00,000 per year, operating expenses would decline by ₹2,00,000 per year. It would
require an additional inventory of ₹2,00,000 and would cause an increase in accounts payable by
₹50,000.
Assuming a corporate tax rate of 30% and the cost of capital of 12%, Answer the following
questions
1. Calculate Initial Cash Outlay for G Ltd
2. Calculate Additional Depreciation
3. Compute Annual and Terminal Cash Flow
4. Advise the company about replacement of the existing machine. Is the project acceptable?
Briefly explain. Why is the NPV method superior to the other methods of capital
budgeting? Briefly explain

Solution:
1. Initial Cash Outlay for G ltd:
Initial Outlay = Fixed Capital Investment + Working Capital Investment – Salvage Value – (Salvage
Value – Book Value) * (Tax Rate)
= 10,00,000 + 1,50,000 – 20,000 – (20,000 – 3,00,000) * 30%
= 12,14,000

2. Additional Depreciation:
New Machine depreciation
10,00,000 – 1,00,000 = 9,00,000
9,00,000/5 = 1,80,000
Difference in depreciation = 1,80,000 – 28,000 = 1,52,000

3. Annual and Terminal Cashflow:

YEARS 1 2 3 4 5
Increase in 100000 100000 100000 100000 100000
sales
Decline in 200000 200000 200000 200000 200000
operating
expenses
Salvage 100000
Value
Working 150000
capital
Depreciation (180000) (180000) (180000) (180000) (180000)
Cash 120000 120000 120000 120000 370000
outflow after
depreciation
Tax (30%) (36000) (36000) (36000) (36000) (111000)
Add 180000 180000 180000 180000 180000
depreciation
Total Cash 264000 264000 264000 264000 439000
flow
PV @12% 0.893 0.797 0.712 0.636 0.567
 PV Cash 235752 210408 187968 167904 248913
flow

Cash outflow = 10,50,945

Cash inflow = 10,00,000
NPV = 50,945
4. Since the NPV is positive that is 50,945 the replacement of the machine is an appropriate
decision. The initial investment can be paid as there will be future profits.
Net present value is superior to other methods in Capital Budgeting as it takes into account the time
value of money. It uses cashflows and not profits. NPV uses discounted cash flows in the analysis,
which makes the net present value more precise and accurate than any of the other capital budgeting
methods as it considers both risk and time variables as mentioned above.

CASE 2
GSPC is a fast-growing profitable company. The company is situated in Western India. Its sales are
expected to grow about three times from `360 million in 2013 to `1,100 million in 2014. The company
is considering of commissioning a 35km pipeline between two areas to carry gas to a state electricity
board. The project will cost `500 million. The pipeline will have a capacity of 2.5 MMSCM. The
company will enter into a contract with the state electricity board (SEB) to supply gas. The revenue
from the sale to SEB is expected to be `240 million per annum. The pipeline will also be used for
transportation of LNG to other users in the area. This is expected to bring additional revenue of
`160million per annum. The company management considers the useful lifeof the pipeline to be 20
years. The financial manager estimates cash profit to sales ratio of 20 percent per annum for the first
12 years of the project’s operations and 17 per cent per annum for the remaining life of the project.
The project has no salvage value. The project being in a backwardarea is exempt from paying any
taxes.
The company requires a rate of return of 15 percent from the project.
Answer the Questions
1. What is the project’s payback and return on investment (ROI)?
2. Compute project’s NPV and IRR.
3. Should the project be accepted? Why?

Solution :
Current sales = 360 m , Future sales = 1,110 mProject
cost = 500 m
Revenue from sales to SEB = 240m/per annum
Additional revenue = 160 m /per annum
life of the project = 20 years
Sales ratio of 20 per cent per annum for the first 12 year17 per cent per annum for the remaininglife
of the project
 year Cash flow Cumulative
.cashflow (Rs
(Rs in
Particulars mm) in mm)
Cost of project (Rs in mm) 500 0 -500 -500
Revenue from SEB (Rs in mm) 240 1 80 -420
Additional Revenue (Rs in mm) 160 2 80 -340
Total Revenue (Rs in mm) 400 3 80 -260
Cash profit (1 to 12 years) 20% 80 4 80 -180
Cash profit ( 13 to 20)17% 68 5 80 -100
Average cash profit 75.2 6 80 -20
Average investment 250 7 80 60
ROI 30.1 % 8 80 140
9 80 220
discount (rate of return) 15% 10 80 300
5.421*80 = 11 80 380
PV of cash profit 1 to 12 years 433.68
68*4.487*0. 12 80 460
PV of cash 13 to 20 187 =57
NPV@15% -9.32 13 68 528
14 68 596
15 68 664
16 68 732

pay back = 𝒚𝒆𝒂𝒓 𝒐𝒇 𝒏𝒆𝒂𝒓𝒆𝒔𝒕 𝑪𝑭 +

𝑫𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒄𝒆𝒔 𝒊𝒏 𝒄𝒂𝒔𝒉 𝒇𝒍𝒐𝒘
6 years 3
𝑪𝒂𝒔𝒉 𝒇𝒍𝒐𝒘 𝒊𝒏 𝒔𝒖𝒃𝒔𝒆𝒒𝒖𝒆𝒏𝒕 𝒚𝒆𝒂𝒓 months

6+(20 /60) = 6+.03

17 68 800
18 68 868
19 68 936
In order to calculate the IRR we should find the positive NPV .So NPV @10 % at lower rate PV of
(1 -12 year ) - 6.814*80=54.12
PV of (13 -20 year )- 68*5.335*0.319= 115.73
NPV(@ 10%) =545.12+115.73-500 = 160.85

Internal Rate of Return = Lower Rate + (Positive NPV/Difference in PV of CFAT)*Difference in

Rate
= 10% + 160.85/(160.85- (-9.32))*5

= 10%+160.85/170.17 * 5

= 14.73%

1.Project Payback = 6 years 3 months & ROI = 30.1%

2. NPV = - 9.32 & IRR = 14.73%
3. Above problem shows the NPV value in negative. The project is expected to result in a
net loss for the company. As a result, and according to the rule, the company should not
pursue the project
 CASE 3

Case Details
Calmex is situated in North India. It specializes in manufacturing overhead water tanks. The
management of Calmex has identified a niche market in certain Southern cities that need a
particular size of water tank, not currently manufactured by the company. The company is
therefore thinking of producing a new type of overhead water tank. The survey of the
company’s marketing department reveals that the company could sell 120,000 tanks each year
for six years at a price of 700 each. The company’s current facilities cannot be used to
manufacture the new-size tanks. Therefore, it will have to buy new machinery. A manufacturer
has offered two options to the company. The first option is that the company could buy four
small machines with the capacity of manufacturing 30,000 tanks each at 15 million each. The
machine operation and manufacturing cost of each tank will be 535. Alternatively, Calmex can
buy a larger machine with a capacity of 120,000 units per annum for `120 million. The
machine operation and manufacturing costs of each tank will be `400. The company has a
required rate of return of 12 per cent. Assume that the company does not pay any taxes.

Questions
1. Which option should the company accept? Use the most suitable method of
evaluation to give your recommendation and explicitly state your assumptions.
2. Why do you think that the method chosen by you is the most suitable method in
evaluating the proposed investment? Give the computation of the alternative
methods

Solution
Alternative 1
Number of tanks 1,20,000
Price (Rs) 700

Revenue (Rs million)(1,20,000*700) 84

Small machines

Cost of four small machines (Rs million) 60

Op. and mfg. cost (Rs) 535

Total Op. and mfg. cost (Rs million) 64.2

(0.12 * 535)

Net revenue (Rs million) (84 - 64.2) 19.8

Discount rate 12%

Project life (years) 6

PVFA 6, 12% 4.1114

PV of cash inflows (Rs million) (19.8 * 4.114) 81.4

NPV (Rs million) (81.4 - 60) 21.4

IRR 24%

Alternative 2
Large machine

Cost of large machine (Rs million) 120

Op. and mfg. cost (Rs) 400

Total op. and mfg. cost (Rs million) 48

(0.12 * 400)
Net revenue (Rs million) (84-48) 36

Discount rate 12%

 Project life (years) 6

PVFA 6, 12% 4.1114

PV of cash inflows (Rs million) (36 * 4.114) 148

NPV (Rs million) (148 - 120) 28.0

IRR 20%

Observations
As we observe from the tables, NPV is greater when buying the larger machine. In contrast,
IRR is greater in the alternative of buying smaller machines. This leads to a conflicting
situation. While the NPV method is based on the total yield/earnings/NPV, IRR is concerned
with the rate of return/earnings on investment.
The NPV method is conceptually ideal to that of the IRR method. The former has the virtue of
having a uniform rate that can always be applied to all investment proposals. While the IRR
method is not consistent with the objective of financial decision making of the firm, the
recommendation of NPV is compatible with the goal of the firm of maximizing shareholders’
wealth.
The NPV method is the more suitable evaluation method, so we will select the alternative of
buying a larger machine.
As the IRR of differential cash flow exceeds the required rate of return so we would select the
project having greater investment outlays.
By this convention, we would choose the alternative of selecting the larger machine as it
involves greater investment outlays.
CASE 4
Weston company is planning to go in purchase of small equipment . purchase of additional
equipment can be decided respective of demand condition exist after 2 years

Calculation in high demand:

Year Cashflow P.v Factor (10 %) Adjusted cash flow

Year 1 8 .909 7.3

Year 2 8 .826 6.6

Calculation in Medium demand

Year Cashflow P.v Factor (10 %) Adjusted cash flow

Year 1 8 .909 7.3

Year 2 8 .826 6.6

Calculation in Low demand

Year Cashflow P.v Factor (10 %) Adjusted cash flow

Year 1 4 .909 3.6

Year 2 4 .826 3.3

On the basis of the NPV raised initial investment is not sufficient to raise the positive figure.
Further investment decisions are calculated based on the Demand.

On Expectation of higher demand further calculation has been

made : Further High demand:

Year CASH FLOW P V FACTOR ADJUDED C F (lakhs)

 3 1.8 0.751 1.3518

4 1.8 0.683 1.2294

5 1.8 0.621 1.1178

6 1.8 0.564 1.0152

7 1.8 0.513 0.9234

8 1.8 0.467 0.8406

9 1.8 0.424 0.7632

10 1.8 0.386 0.6948

Total of adjusted cash flow = 7.9362 lakhs

Further medium demand

Year CASH FLOW P V FACTOR AdjustedC F (lakhs)

3 1.4 0.751 1.0514

4 1.4 0.683 0.9562

5 1.4 0.621 0.8694

6 1.4 0.564 0.7896

7 1.4 0.513 0.7182

8 1.4 0.467 0.6538

9 1.4 0.424 0.5936

10 1.4 0.386 0.5404

Total of adjusted cash flow = 6.1726 lakhs

Further Low demand

year CASH FLOW P V FACTOR Adjusted Cash flow in lakhs
3 1 0.751 0.751
4 1 0.683 0.683
5 1 0.621 0.621
6 1 0.564 0.564
7 1 0.513 0.513
8 1 0.467 0.467
9 1 0.424 0.424
10 1 0.386 0.386

Total of adjusted cash flow = 4.4090 lakhs

On Expectation of Medium demand further calculation has been

made : Further high demand

Year CASH FLOW P V FACTOR AdjustedC F (lakhs)

3 1.4 0.751 1.0514

4 1.4 0.683 0.9562

5 1.4 0.621 0.8694

6 1.4 0.564 0.7896

7 1.4 0.513 0.7182

8 1.4 0.467 0.6538
9 1.4 0.424 0.5936

10 1.4 0.386 0.5404

Total of adjusted cash flow = 6.1726 lakhs

Further medium demand:

Adjusted Cash
year CASH FLOW P V FACTOR flow in lakhs

3 1 0.751 0.751

4 1 0.683 0.683

5 1 0.621 0.621
 6 1 0.564 0.564

7 1 0.513 0.513

8 1 0.467 0.467

9 1 0.424 0.424

10 1 0.386 0.386

Total of adjusted cash flow = 4.4090 lakhs

Further low demand:

Year Cash flow P V factor Adjusted cash flow

3 0.3 0.751 0.2253

4 0.3 0.683 0.2049

5 0.3 0.621 0.1863

6 0.3 0.564 0.1692

7 0.3 0.513 0.1539

8 0.3 0.467 0.1401

9 0.3 0.424 0.1272

10 0.3 0.386 0.1158

Total of adjusted cash flow = 1.3227 lakhs

On Expectation that consideration that no purchase of equipment :

Year Cash flow P V factor Adjusted cash flow lakhs

3 1.5 0.751 1.1265

4 1.5 0.683 1.0245

5 1.5 0.621 0.9315

6 1.5 0.564 0.846

7 1.5 0.513 0.7695

8 1.5 0.467 0.7005

 9 1.5 0.424 0.636

10 1.5 0.386 0.579

Total of adjusted cash flow = 6.6135 lakhs NPV = -6.5

Statement Showing profitability of additional equipment:
30 lakhs equipment

Demand condition Present value probability Certain cash flow

High 7.9362 0.6 5

Medium 6.1726 0.3 2

Low 4.4090 0.1 .4

Initial investment 30

NPV -22.6

Statement Showing profitability of additional equipment:

15 lakhs equipment
Demand condition Present value probability Certain cash flow

High 6.1726 0.6 3.7

Medium 4.4090 0.3 1.3

Low 1.3227 0.1 0.1

Initial investment 15

NPV -9.9

Decision Tree

Path No
7.932. 1

6.176. 2
 13.9. 4.4090. 3

6.1726. 4
Cash 13.9 4.4090. 5
O
u
tl
a
y
5
0
0
0
0
0
0
1.3227. 6
6.9. 6.6135 7

Statement showing expected NPV

Path NPV Joint probability Expected NPV
1 -28.2 0.3 -8.5
2 -29.9 0.15 -4.5
3 -31.7 0.05 -1.6
4 -14.9 0.24 -3.6
5 -16.7 0.12 -2
6 -19.8 0.04 -0.8
7 -6.5 0.1 -0.7

Recommendation:
Expected NPV is -21.7. it is not advised to buy additional equipment in Demand condition

CASE 5 – COST OF CAPITAL

Hindustan Unilever Limited (HUL) was known as Hindustan Lever Limited (HLL) until 18 May
2007. The company was set up in 1933. It completed 75 years of operations in India on 17 October
2007. It is an important subsidiary of Unilever. Unilever has a large number of subsidiary and
associate companies in more than 100 countries. HUL’s business areas include home and personal
care, foods and beverages, industrial, agricultural and other products. It is one of the largest producers
of soaps and detergents in India. The company has grown organically as well as through acquisitions.
HUL places equal focus on serving both the employees and the shareholders, and it is committed to
add value to both. Over years, the company has built diversified portfolio of powerful brands, a
number of them being household names.

The company requires the cost of capital estimates for evaluating its acquisitions, investment
decisions and the performance of its businesses and for determining the value added to shareholders.
It needs to develop a methodology of calculating costs of equity and debt and determine the weighted
average cost of capital.
HUL’s Performance
Table 9.1.1 contains a summary of HUL’s EPS, DPS, share price and market capitalization. The
company has been paying dividends regularly. HUL’s shares have enjoyed high price in the stock
market. The company’s sales and assets have shown significant growth, and company’s profitability
has also increased over years. The company is conservatively financed

HUL Financial Performance (₹ in

Millions)
Year 1 Year 2 Year 3
Gross Sales 202,854.40 228,003.20 266,797.60
PBIT 27,304.40 33,502.84 43,744.95

Interest 2.40 1.24 250.15

PAT 21,532.50 25,992.00 3,314.35

Share Capital 2,181.70 2,159.50 2,162.50

Reserves and Surplus 23,653.50 24,435.70 24,577.70

Loan Funds 17043.1 14711.1 560.94
Capital Employed 40,696.60 39,146.80 25,138.64

HUL: EPS, DPS, Share Price and MCAP

Year 1 2 3 4 5 6 7 8 9 10
EPS 8.05 5.44 6.40 8.41 8.73 11.46 10.10 10.58 12.46 17.56
DPS 5.50 5.00 5.00 6.00 9.00 7.50 6.50 6.50 7.50 18.50
Share 204.7 143.5 197.3 216.6 213.9 237.5 238.7 284.6 409.90 466.1
Price
MCAP 4505.9 3158.7 4341.9 4778.8 4657.5 5177 5207.7 6145.9 8860 10079.3
Cost of Capital Assumptions at HUL
The company considers cost of its debt as the effective rate of interest applicable to an ‘AAA’ rated
company. It thinks that considering the trends over years, this rate is 9.5 per cent at present. The risk-free
rate is assumed as the yield on long-term government bonds, which the company regards as about8 per cent.
HUL regards the market-risk premium to be equal to about 3 per cent. The company usesCAPM to
calculate its cost of equity. The alternative method is the constant growth model. HUL’s beta is 0.708.

Answer the following questions

1. Calculate HUL’s cost of equity by using the dividend-growth model.
2. Calculate HUL’s cost of equity by using the capital asset pricing model. Do you agree with
the company’s assumptions regarding the estimates of the risk-free rate and the market
premium?
3. Between the dividend-growth model and CAPM, which method do you recommend to HUL
and why?
4. Calculate HUL’s cost of assets reflecting only the business risk?
5. What is HUL’s before tax and after-tax weighted average cost of capital (WACC)?

Answers :
1) COE using Dividend growth model is calculated as follows :
Dividend just paid * growth/share price + growth
= 0.185*1.1442/4.661 + 0.1442
= 18.96%
Workings for calculation of growth :
Geometric Average Growth model :
(Dividend in the current year year/Dividend in the first year) ^ (1/9) = (18.5/5.5)^(1/9) = 14.42%
2) CAPM model :
COE = 8 + 0.708* ( 3) = 10.124%
The risk free rate is assumed as the yield on long-term government bonds, which the company regards as about 8
per cent. Theoretically, the starting point of the calculation of CAPM is attaining a risk free rate of return from a
long term government bond yield. The government bonds, treasury bills, are said to be free of any default risk
because of being backed by the government. Which is why, the yield on them, is considered to be risk free.
Therefore it is justified to assume that risk free rate is equal to yield on long term government bonds.

Market risk premium refers to a situation where the equity investors demand for a higher return in the form of
premium for the higher inherent risk that they have taken in stocks.
Its represented by subtracting Risk free rate of return from market rate of return, which is of course higher than the
risk free rate because it represents the risk undertaken by all the shareholders by investing in the stocks of the
market, as a whole. Therefore, getting a positive figure of 3% shows that the market return is more than the risk
free rate of return and is justified to use in the CAPM calculation.
3) Between CAPM model and Dividend growth model, the preference will be given to the CAPM model for cost of
equity because of the use of more realistic estimates and assumptions ( for example not using past figures like
DGM model) and linking the required rate of return to the market’s rate of return as a whole. Also because it
considers the systematic risk of investing in stocks of the market.
At the same time, although theoretically DGM model and CAPM model are supposed to give the same results, in
this situation there is comparably a higher rate of return for shareholders that we get under the DGM model. The
assumptions used under this model are not realistic because of the growth percentage of dividends considered to be
constant, and the basis of calculating growth being the historical dividends, i.e, the historical dividends are assumed
to find out the about the accurate future cost of equity and dividends, which is obviously not justified. Past figures
cannot decide about the future figures.
4)
PBIT is taken as the cash flow since its considered to be proxy of cash flows.
Growth rate = 14.42% as per 1st answer’s workings.
Cost of capital is the cost of equity under DGM model for each of the years.
Based on year 1 figures :
Cost of Assets = Cash flow/ (Cost of Capital – growth rate)
= 27304.4/(18.96%-14.42%) = Rs 601419
Based on year 2 figures :
Cost of Assets = 33502.84/(18.96%-14.42%)= Rs 737948
Based on year 3 figures :
Cost of Assets = 43744.95/(18.96%-14.42%)= Rs 963545
5) Before tax WACC :
Based on year 3 figures

Source of finance Values ( Rs in Cost of debt or Cost of capitals

millions) equity
Equity 2162.5 @10.124% 218.93
Shares (share capital
figure)
Loan Funds 560.94 @ 9.5% 53.29
Total 2723.44 272.22
WACC =272.22/2723.44*100
=10%

Based on year 2 figures

Source of finance Values ( Rs in Cost of debt or equity Cost of capitals
millions)
Equity shares 2159.5 10.124% 218.63
Loan funds 14711.1 9.5% 1397.55
Total 16870.6 1616.18
WACC =1616.18/16870.6*100=
9.58%

Based on year 1 figures

Source of finance Values ( Rs in Cost of debt or Cost of capitals
millions) equity
Equity shares 2181.7 10.124% 220.875
Loan funds 17043.1 9.5% 1619
Total 19224.8 1839.875
 WACC =1839.875/19224.8*100=
9.57%

After tax WACC

Based on year 3 figures :
Source of finance Values ( Rs in Cost of debt or Cost of capitals
millions) equity
Equity 2162.5 @10.124% 218.93
Shares (share capital
figure)
Loan Funds 560.94 @ 6.65% 37.3
Total 2723.44 256.23
WACC =256.23/2723.44*100
=9.4%

Based on year 2 figures

Source of finance Values ( Rs in Cost of debt or equity Cost of capitals
millions)
Equity shares 2159.5 10.124% 218.63
Loan funds 14711.1 6.65% 978.28
Total 16870.6 1196.91
WACC =1196.91/16870.6*100=
7.09%

Based on year 1 figures

Source of finance Values ( Rs in Cost of debt or Cost of capitals
millions) equity
Equity shares 2181.7 10.124% 220.875
Loan funds 17043.1 6.65% 1133.36
Total 19224.8 1354.235
WACC =1354.235/19224.8*100=
7.04%