Ambuja Cements-Teaching Notes

109-053-8
Teaching Note
Ambuja Cements Limited:

Weighted Average Cost of Capital
Authorised for educator use only by V Annapurna, Siva Sivani Institute of Management. Expiry date 3-Mar-2024.
Usage permitted only within these parameters otherwise contact info@thecasecentre.org
Prerequisite Conceptual Understanding
• To understand the concept of WACC – “The Weighted Average Cost of Capital”, Ian Giddy, http:/
/pages.stern.nyu.edu/~igiddy/articles/wacc_tutorial.pdf
• To understand the impact of downturn on company’s cost of capital – Dobbs Richard, et al.,
“Why the crisis hasn’t shaken the cost of capital”, The McKinsey Quarterly, December 2008.
Educational material supplied by The Case Centre
Copyright encoded A76HM-JUJ9K-PJMN9I
Synopsis of the Case Study

The case study ‘Ambuja Cements: Weighted Average Cost of Capital’ provides fundamental understanding
of Weighted Average Cost of Capital (WACC). The case study is based on the discussion between a group
of 1st year MBA students and Dr. Martin, a professor of Finance. The discussion that starts on cost of capital
gradually leads towards WACC. The case study concludes with the setting of some parameters for students
to calculate the WACC for Ambuja Cements Limited (ACL).
Pedagogical Objectives
• To understand the relevance of cost of capital in financing decisions
• To understand how to estimate cost of equity, debt and cost of capital
• To understand the importance of capital mix, in WACC approach.
This teaching note was written by Manish Agarwal (Faculty Associate) and D. Satish (Professor of Finance), IBS, Hyderabad. It is only an
illustrative orchestration for the case study ‘Ambuja Cements Limited: Weighted Average Cost of Capital ’. It is never meant to limit the
learning outcomes.
© 2009, IBSCDC.
No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without
the permission of the copyright owner.
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109-053-8
Teaching Note Ambuja Cements Limited: Weighted Average Cost of Capital
Teaching Plan
Both the Teaching Note and the Structured Assignment follow a specific Teaching Plan [Annexure (TN)-
I].
Assignment Questions
I. Elaborate on the concept of Weighted Average Cost of Capital (WACC).
II. Calculate the cost of equity and cost of debt for ACL.
III. Ascertain the cost of capital for ACL using book value as well as market value of different sources
as weights.
Case Analysis Flow

To draw the attention of the students and to make them participate in the discussion, the faculty may use the
following set of questions, which are framed according to the pedagogical objectives. The classroom
discussion can depend on the faculty’s teaching techniques. However, I suggest the class should be started
with general questions like – What do you understand by the term ‘cost of capital’? Is it necessary to
calculate the cost of equity? Which methods do you use to estimate it?
Concept of Cost of Capital and its Relevance

“In such case, firms use ‘Weighted Average Cost of Capital’ (WACC),” replied Dr. Martin. “Professor,
what is that? Please explain to us,” asked all the students simultaneously. (page 2, para 1 of the case
study). Elaborate the concept of WACC.
WACC is the average cost of capital, which is financed from different sources. It can be calculated by
multiplying the cost of each source of capital with its weight and adding up all the multiplications values. It
can be expressed as follows:
× 1-t 
E D
WACC= ×K e +
TC TC
Where,
E = Market value of the firm’s equity
D = Market value of the firm’s debt
TC = Total Capital
Ke = Cost of Equity
Kd = Cost of Debt
T = Tax Rate
E/TC = Percentage of capital finance through Equity
D/TC = Percentage of capital finance through Debt
Point to be noted here is that, we assume that capital is financed by only two sources, equity and debt. If
there are more than two sources of finance, then we have to add them in the formula. For example, let us
assume that ABC Limited financed its capital from common stocks, preference stocks and debt. In such
case, the formula will be as follows: …Equation (2)
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 
E Ep D
WACC= ×K e + K × 1-t
TC TC p TC
Estimating Cost of Capital and Debt for ACL

“Use Capital Assets Pricing Model (CAPM) to estimate cost of capital, for market return take 10
years monthly return of index (Annexure II), use 10 years’ Indian government bond yield which was
around 6.83% as on December 31st 2008 as a risk free rate, use 3 years’ monthly return of ACL for
beta calculation.” (page 2, para 3 of the case study). Elaborate the different inputs of CAPM and
calculate them to estimate the cost of equity of ACL.
The calculation of cost of equity of ACL is as follows:

Calculation of Cost of Equity
In the case study, Dr. Martin instructed the students to use CAPM model for estimating the cost of capital.
We will use the same model to estimate the cost of capital. We already know that CAPM model uses the
following inputs:
• Risk free rate denoted as Rf
Beta coefficient denoted as 
•
• Market return denoted as Km

We will estimate each of this one by one.
Risk Free Rate Denoted as Rf

Theoretically, interest rate, which is free from all kinds of risk is known as risk free rate. For example,
interest rate carry by bonds issued by Indian government is known as a risk free rate.
Financial analysts use long-term government bonds, such as 10 years, 15 years or 20 years’ government
bonds yield to set the risk free rate to estimate cost of equity under CAPM model.
In the case study, Dr. Martin already mentioned that he will use the 10-year Indian government bonds yield,
which was around 6.83% as on December 31st 2008.
Beta Coefficient Denoted as 

Beta calculates the risk contributed by a stock in a well-diversified portfolio. In other words, Beta (â)
coefficient measures the sensitivity of a stock return to market return. As per CAPM, Beta coefficient is the
amount of risk that a stock contributes to the well-diversified portfolio. It can be estimated with the help of
the following equation:
3
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j 
Cov  K j K m 

 P  K  k  k  k 
j j m m
Var  K m   P k  k 
2
m m
Where, Cov (kj km) = Co-variance of stock ( j ) to (with) market (m)

Var (km) = Variance of the market
 = Beta of stock j
Stock, which is less volatile than market, has beta more than zero but less than one. When stock is as
volatile as market, then beta of the stock is equal to one. For example, Index or Index fund. Stocks, which
are more volatile than market have beta more than one.
In the case study, Dr. Martin already instructed the students to use 3 years’ monthly return of ACL for beta
calculation. Therefore, we will take 3 years’ BSE data for beta calculation [Exhibit (TN)-I].

Exhibit (TN)-I
Beta Calculation for ACL
Month/Year Sensex Stock Price RAmbuja Rsensex (RAmbuja - (Rsensex - (RAmbuja -

Average)2 Average)2 Average)
*(Rsensex -
Average)
January-2006 9,919.89 88.50

February-2006 10,370.24 88.20 -0.34 4.54 0.21 17.76 -1.95
March-2006 11,279.96 103.25 17.06 8.77 286.93 71.34 143.07
April-2006 12,042.56 124.05 20.15 6.76 400.83 41.40 128.82
May-2006 10,398.61 92.90 -25.11 -13.65 636.82 195.37 352.72
June-2006 10,609.25 99.50 7.10 2.03 48.72 2.89 11.86
July-2006 10,743.88 104.70 5.23 1.27 26.03 0.89 4.81
August-2006 11,699.05 112.35 7.31 8.89 51.58 73.35 61.51
September-2006 12,454.42 116.85 4.01 6.46 15.06 37.58 23.79
October-2006 12,961.90 117.25 0.34 4.07 0.05 14.05 0.82
November-2006 13,696.31 144.15 22.94 5.67 520.66 28.51 121.84
December-2006 13,786.91 141.30 -1.98 0.66 4.42 0.11 -0.70
January-2007 14,090.92 137.15 -2.94 2.21 9.37 3.53 -5.75
February-2007 12,938.09 115.95 -15.46 -8.18 242.80 72.38 132.56
March-2007 13,072.10 106.70 -7.98 1.04 65.64 0.50 -5.75
April-2007 13,872.37 117.95 10.54 6.12 108.56 33.59 60.39
Contd...
4
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May-2007 14,544.46 113.15 -4.07 4.84 17.59 20.42 -18.95

June-2007 14,650.51 124.55 10.08 0.73 99.02 0.16 4.01
July-2007 15,550.99 131.50 5.58 6.15 29.76 33.87 31.75
August-2007 15,318.60 133.45 1.48 -1.49 1.85 3.31 -2.47
September-2007 17,291.10 143.80 7.76 12.88 58.24 157.51 95.77
October-2007 19,837.99 144.65 0.59 14.73 0.22 207.45 6.72
November-2007 19,363.19 150.00 3.70 -2.39 12.77 7.40 -9.72
December-2007 20,286.99 146.90 -2.07 4.77 4.80 19.76 -9.74
January-2008 17,648.71 119.60 -18.58 -13.00 350.01 177.72 249.40
February-2008 17,578.72 120.95 1.13 -0.40 1.01 0.52 -0.73

March-2008 15,644.44 121.05 0.08 -11.00 0.00 128.36 0.47
April-2008 17,287.31 113.90 -5.91 10.50 36.37 103.53 -61.37
May-2008 16,415.57 95.20 -16.42 -5.04 273.65 28.82 88.81
June-2008 13,461.60 75.70 -20.48 -17.99 424.68 335.66 377.56
July-2008 14,355.75 81.20 7.27 6.64 50.99 39.89 45.10

August-2008 14,564.53 80.20 -1.23 1.45 1.84 1.27 -1.53

September-2008 12,860.43 78.40 -2.24 -11.70 5.61 144.64 28.49
October-2008 9,788.06 60.95 -22.26 -23.89 500.96 586.43 542.01
November-2008 9,092.72 52.30 -14.19 -7.10 204.96 55.21 106.37
December-2008 9,647.31 69.70 33.27 6.10 1,098.60 33.33 191.35
0.12 0.33 2,678.52 2,691.37
Beta 1.00
Prepared by the author
Market Return Denoted as Km

Return provided by the market or market portfolio or Index is known as market return. For example, return
provided by the National Association of Securities Dealers Automated Quotations (NASDAQ), Bombay
Stock Exchange (BSE) or National Stock Exchange (NSE).
In the case study, Dr. Martin already instructed the students to use 10 years’ monthly market return to set the
return on market portfolio. Therefore, we will use 10 years’ monthly return of BSE to get the return on
market portfolio [Exhibit (TN)-II].
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Exhibit (TN)-II
10 years’ Monthly Return of BSE to get the Return on Market Portfolio
Year BSE Sensex Closing Monthly Return (in %)
January-1998 3,224.36
February-1998 3,622.22 12.34
March-1998 3,892.75 7.47
April-1998 4,006.81 2.93
May-1998 3,686.39 -8.00
June-1998 3,250.69 -11.82
July-1998 3,211.31 -1.21

August-1998 2,933.85 -8.64
September-1998 3,102.29 5.74
October-1998 2,812.49 -9.34
November-1998 2,810.66 -0.07
December-1998 3,055.41 8.71
January-1999 3,315.57 8.51

February-1999 3,399.63 2.54
March-1999 3,739.96 10.01
April-1999 3,325.69 -11.08
May-1999 3,963.56 19.18
June-1999 4,140.73 4.47
July-1999 4,542.34 9.70
August-1999 4,898.21 7.83
September-1999 4,764.42 -2.73
October-1999 4,444.56 -6.71
November-1999 4,622.21 4.00
December-1999 5,005.82 8.30
January-2000 5,205.29 3.98
February-2000 5,446.98 4.64
March-2000 5,001.28 -8.18
April-2000 4,657.55 -6.87
May-2000 4,433.61 -4.81
June-2000 4,748.77 7.11
July-2000 4,279.86 -9.87
Contd...
6
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August-2000 4,477.31 4.61

September-2000 4,090.38 -8.64
October-2000 3,711.02 -9.27
November-2000 3,997.99 7.73
December-2000 3,972.12 -0.65
January-2001 4,326.72 8.93
February-2001 4,247.04 -1.84
March-2001 3,604.38 -15.13
April-2001 3,519.16 -2.36
May-2001 3,631.91 3.20

June-2001 3,456.78 -4.82
July-2001 3,329.28 -3.69
August-2001 3,244.95 -2.53
September-2001 2,811.6 -13.35
October-2001 2,989.35 6.32
November-2001 3,287.56 9.98

December-2001 3,262.33 -0.77
January-2002 3,311.03 1.49
February-2002 3,562.31 7.59
March-2002 3,469.35 -2.61
April-2002 3,338.16 -3.78
May-2002 3,125.73 -6.36
June-2002 3,244.7 3.81
July-2002 2,987.65 -7.92
August-2002 3,181.23 6.48
September-2002 2,991.36 -5.97
October-2002 2,949.32 -1.41
November-2002 3,228.82 9.48
December-2002 3,377.28 4.60
January-2003 3,250.38 -3.76
February-2003 3,283.66 1.02
March-2003 3,048.72 -7.15
April-2003 2,959.79 -2.92
May-2003 3,180.75 7.47
June-2003 3,607.13 13.41
Contd...
7
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July-2003 3,792.61 5.14

August-2003 4,244.73 11.92
September-2003 4,453.24 4.91
October-2003 4,906.87 10.19
November-2003 5,044.82 2.81
December-2003 5,838.96 15.74
January-2004 5,695.67 -2.45
February-2004 5,667.51 -0.49
March-2004 5,590.6 -1.36
April-2004 5,655.09 1.15

May-2004 4,759.62 -15.83
June-2004 4,795.46 0.75
July-2004 5,170.32 7.82
August-2004 5,192.08 0.42
September-2004 5,583.61 7.54
October-2004 5,672.27 1.59

November-2004 6,234.29 9.91

December-2004 6,602.69 5.91
January-2005 6,555.94 -0.71
February-2005 6,713.86 2.41
March-2005 6,492.82 -3.29
April-2005 6,154.44 -5.21
May-2005 6,715.11 9.11
June-2005 7,193.85 7.13
July-2005 7,635.42 6.14
August-2005 7,805.43 2.23
September-2005 8,634.48 10.62
October-2005 7,892.32 -8.60
November-2005 8,788.81 11.36
December-2005 9,397.93 6.93
January-2006 9,919.89 5.55
February-2006 10,370.24 4.54
March-2006 11,279.96 8.77
April-2006 12,042.56 6.76
May-2006 10,398.61 -13.65
Contd...
8
109-053-8
June-2006 10,609.25 2.03

July-2006 10,743.88 1.27
August-2006 11,699.05 8.89
September-2006 12,454.42 6.46
October-2006 12,961.9 4.07
November-2006 13,696.31 5.67
December-2006 13,786.91 0.66
January-2007 14,090.92 2.21
February-2007 12,938.09 -8.18
March-2007 13,072.1 1.04

April-2007 13,872.37 6.12
May-2007 14,544.46 4.84
June-2007 14,650.51 0.73
July-2007 15,550.99 6.15
August-2007 15,318.6 -1.49
September-2007 17,291.1 12.88

October-2007 19,837.99 14.73

November-2007 19,363.19 -2.39
December-2007 20,286.99 4.77
January-2008 17,648.71 -13.00
February-2008 17,578.72 -0.40
March-2008 15,644.44 -11.00
April-2008 17,287.31 10.50
May-2008 16,415.57 -5.04
June-2008 13,461.6 -17.99
July-2008 14,355.75 6.64
August-2008 14,564.53 1.45
September-2008 12,860.43 -11.70
October-2008 9,788.06 -23.89
November-2008 9,092.72 -7.10
December-2008 9,647.31 6.10
Monthly Market Return (From (January, 1998 - December, 2008) 1.15
Annual Nominal market return 13.74
Annual Effective market return 14.64
9
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Cost of Capital for ACL (as on December 31st 2008)
Beta 1.00
Risk Free Rate 6.83%
Market Return 14.64%
Market Risk Premium 7.81%
Cost of Equity (CAPM) 14.68%
“Sir, for cost of debt which cost should we take – pre-tax or post-tax,” asked Atul. “Of course, post-
tax,” replied Dr. Martin. (page 2, para 3 of the case study). Calculate the cost of debt for ACL with

the help of the data given in the case study.
Calculation of Cost of Debt for ACL assuming that the entire debt is being serviced in the CY08:
Total Loan fund as on December 31st 2008 = INR 2,886.7 million
Interest expenses as on December 31st 2008 = INR 326 million
Provision for tax as on December 31st 2008 = INR 5,679.3 million
s
Profit before Tax as on December 31 , 2008=INR19, 576.4 million
Tax rate = Provision for tax / Profit before tax
Tax rate = INR 5.679.3 / INR 19,576.4
Tax rate = 29.01%
Cost of debt = Interest expenses / Loan fund
Cost of debt = 326.0 / 2,886.7
Cost of debt = 11.29%
Cost of debt after tax shield = cost of debt x (1-t)
Cost of debt after tax shield = 11.29% x (1-29.01%)
Cost of debt after tax shield = 8.02%
Cost of Capital for ACL via WACC approach

He further added, “Now are you all ready to calculate the WACC for ACL?” (page 2, para 3 of the
case study). Calculate the weighted average cost of capital for ACL with the help of data given in the
case study, in the scenarios given below:
a. Take book value of equity and debt to find their weights in capital
b. Take market value of equity and debt to find their weights in capital.
10
109-053-8
Calculation of Weighted Average Cost of Capital for ACL

a. Using Book Value of Equity and Debt to find their Weights in Capital
In INR million In %
Book Value of Shareholders’ Funds 3,045.2 51.3
Book Value of Loan Funds 2,886.7 48.7
Total 5,931.9 100.0
Cost of capital (calculated above) = 14.68%
Cost of Debt (calculated above) = 8.02%

Using WACC formula,
WACC = 14.68% x 51.3% + 8.02% x 48.7%
WACC = 7.53%+3.91%
WACC = 11.44%
b. Using Market Value of Equity and Debt to find their Weights in Capital
in INR million in %
Market Value of Shareholders’ Funds:
No. of total shares outstanding as on December 31st,
2008xmarket value as on December 31st,
2008 (1,522.6 x INR 69.7)
106,125.2 97.4
Market Value of Loan Funds 2,886.7 2.6
Total 109,011.9 100.0
Cost of capital (calculated above) = 14.68%

Cost of Debt (calculated above) = 8.02%
Using WACC formula,
WACC= 14.68% x 97.4% + 8.02% x 2.6%
WACC= 14.30% + 0.21%
WACC= 14.51%
Big Picture
Understanding the Concept of WACC
Final Thoughts
The classroom discussion can be concluded by asking the students to calculate the cost of capital for ACL
using the data provided in case study. Further, they can analyse the importance of WACC.
11
109-053-8
Annexure I
Teaching Plan
Prerequisite Conceptual
Understanding
I. Introduction
 To understand the concept I. Relevance of cost of capital
of WACC – “The Weighted II. Importance of cost of
Average Cost of Capital”, capital
II. Understanding III. Estimating cost of equity
Weighted Average Cost http://pages.stern.nyu.edu/~i
IV. Pre-tax and post-tax cost of
of Capital giddy/articles/wacc_tutorial. debt
pdf V. Estimating cost of debt
III. Choosing a VI. Estimating cost of capital
Company  To understand the impact of using WACC.
downturn on company's cost

of capital – Dobbs Richard,
et al., “Why the crisis hasn’t
IV.Setting Parameters shaken the cost of capital”,
The McKinsey Quarterly,
December 2008
V. Appendix The Big Picture
 Company Details: Ambuja

Cements Limited Understanding the Concept

 10-year Sensex Closing of WACC
Price
Teaching Flow
 Three Years’ Share Price
Data I. Concept of Cost of Capital
and Its relevance
II. Estimating Cost of Capital
and Debt for ACL
III. Cost of Capital for ACL via
WACC approach.
Pedagogical Objectives Classroom Deliverables

To understand the relevance of cost of • What is cost of capital?
capital in financing decisions • Importance of estimating cost of capital
• Different sources of cost of capital
• What is WACC and how to use it to estimate cost of capital?
To understand how to estimate cost • Using CAPM to estimate cost of capital
of equity, debt and cost of capital • Tax shield on interest expenses
• Pre-tax and post-tax cost of debt.
To understand the importance of • Find weights using market value of different sources
capital mix in WACC approach. of capital
• Estimating the cost of capital using WACC concept.
12

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109-053-8

Ambuja Cements Limited:

Synopsis of the Case Study

Distributed by The Case Centre North America Rest of the world

Case Analysis Flow

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

Concept of Cost of Capital and its Relevance

Estimating Cost of Capital and Debt for ACL

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

• Market return denoted as Km

Risk Free Rate Denoted as Rf

Beta Coefficient Denoted as 

Where, Cov (kj km) = Co-variance of stock ( j ) to (with) market (m)

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

Month/Year Sensex Stock Price RAmbuja Rsensex (RAmbuja - (Rsensex - (RAmbuja -

January-2006 9,919.89 88.50

May-2007 14,544.46 113.15 -4.07 4.84 17.59 20.42 -18.95

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

July-2008 14,355.75 81.20 7.27 6.64 50.99 39.89 45.10

August-2008 14,564.53 80.20 -1.23 1.45 1.84 1.27 -1.53

Market Return Denoted as Km

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

January-1999 3,315.57 8.51

August-2000 4,477.31 4.61

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

November-2001 3,287.56 9.98

July-2003 3,792.61 5.14

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

October-2004 5,672.27 1.59

November-2004 6,234.29 9.91

June-2006 10,609.25 2.03

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

September-2007 17,291.1 12.88

October-2007 19,837.99 14.73

Prepared by the author

Cost of Capital for ACL (as on December 31st 2008)

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

Cost of Capital for ACL via WACC approach

Calculation of Weighted Average Cost of Capital for ACL

Book Value of Loan Funds 2,886.7 48.7

Total 5,931.9 100.0

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

Total 109,011.9 100.0

Cost of capital (calculated above) = 14.68%

Usage permitted only within these parameters otherwise contact info@thecasecentre.org

 Company Details: Ambuja

Cements Limited Understanding the Concept

Pedagogical Objectives Classroom Deliverables

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