Table of contents

Acknowledgement
Certificate
Preface
Abstract

INTRO TO HDFC BANK

Company Profile
Vision
Operating Joint Ventures and Subsidies
Objectives
Various divisions of Ranbaxy
Intro of Ranbaxy Plant in India and various depts.
Product Review

INTRO TO CAPITAL STRUCTURE THEORY AND ANALYSIS

Introduction
Literature of review on Capital Structure
Methodology
Theory and Analysis
Optimal Capital Structure for Ranbaxy
Capital expenditure: an overview
Latest balance sheet and capital structure of Ranbaxy
Recommendations and Suggestions for Industry
Conclusion
Biblography
 INTRODUCTION TO RANBAXY

CHAPTER 2-ORGANIZATION PROFILE

2.1 COMPANY HISTORY: The Housing Development Finance Corporation Limited

(HDFC) was amongst the first to receive an 'in principle' approval from the Reserve Bank
of India (RBI) to set up a bank in the private sector, as part of the RBI's liberalization of the
Indian Banking Industry in 1994. The bank was incorporated in August 1994 in the name of
'HDFC Bank Limited', with its registered office in Mumbai, India. HDFC Bank
commenced operations as a Scheduled Commercial Bank in January 1995.

PROMOTER

HDFC is India's premier housing finance company and enjoys an impeccable track record in
India as well as in international markets. Since its inception in 1977, the Corporation has
maintained a consistent and healthy growth in its operations to remain the market leader in
mortgages. Its outstanding loan portfolio covers well over a million dwelling units. HDFC
has developed significant expertise in retail mortgage loans to different market segments and
also has a large corporate client base for its housing related credit facilities. With its
experience in the financial markets, a strong market reputation, large shareholder base and
unique consumer franchise, HDFC was ideally positioned to promote a bank in the Indian
environment.

BUSINESS FOCUS

HDFC Bank's mission is to be a World-Class Indian Bank. The objective is to build sound
customer franchises across distinct businesses so as to be the preferred provider of banking
services for target retail and wholesale customer segments, and to achieve healthy growth in
profitability, consistent with the bank's risk appetite. The bank is committed to maintain the

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highest level of ethical standards, professional integrity, corporate governance and regulatory
compliance. HDFC Bank's business philosophy is based on four core values - Operational
Excellence, Customer Focus, Product Leadership and People.

CAPITAL STRUCTURE

The authorized capital of HDFC Bank is Rs550 crore (Rs5.5 billion). The paid-up capital is
Rs424.6 crore (Rs.4.2 billion). The HDFC Group holds 19.4% of the bank's equity and about
17.6% of the equity is held by the ADS Depository (in respect of the bank's American
Depository Shares (ADS) Issue). Roughly 28% of the equity is held by Foreign Institutional
Investors (FIIs) and the bank has about 570,000 shareholders. The shares are listed on the
Stock Exchange, Mumbai and the National Stock Exchange. The bank's American
Depository Shares are listed on the New York Stock Exchange (NYSE) under the symbol
'HDB'.

DISTRIBUTION NETWORK

HDFC Bank headquartered is in Mumbai. The Bank at present has an enviable network of
over 1229 branches spread over 444 cities across India. All branches are linked on an online
real-time basis. Customers in over 120 locations are also serviced through Telephone
Banking. The Bank's expansion plans take into account the need to have a presence in all
major industrial and commercial centers where its corporate customers are located as well as
the need to build a strong retail customer base for both deposits and loan products. Being a
clearing/settlement bank to various leading stock exchanges, the Bank has branches in the
centers where the NSE/BSE has a strong and active member base. The Bank also has a
network of about over 2526 networked ATMs across these cities. Moreover, HDFC Bank's
ATM network can be accessed by all domestic and international Visa/MasterCard, Visa
Electron/Maestro, Plus/Cirrus and American Express Credit/Charge cardholders.

STRONG NATIONAL NETWORK

WORK PLACE TRANSFORMATION

FIVE “S” PART OF KAIZEN

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 Focus on effective work place organization
believe in
“Small changes lead to large improvement”
Every successful organization have their own strategy to win the race in the competitive
market. They use some technique and methodology for smooth running of business. HDFC
BANK also acquired the Japanese technique for smooth running of work and effective work
place organization.
Five ‘S’ Part of Kaizen is the technique which is used in the bank for easy and systematic
work place and eliminating unnecessary things from the work place.

BENEFIT OF FIVE “S”

 It can be started immediately.
 Every one has to participate.
 Five “S” is an entirely people driven initiatives.
 Brings in concept of ownership.
 All wastage are made visible.

FIVE ‘S’
S-1 SORT SEIRI
S-2 SYSTEMATIZE SEITON
S-3 SPIC-N-SPAN SEIRO
S-4 STANDARDIZE SEIKETSU
S-5 SUSTAIN SHITSUKE

1. SORT:
It focus on eliminating unnecessary items from the work place. It is excellent way to free up
valuable floor space. It segregate items as per “require and wanted”.

2. SYSTEMATIZE:

Systematize is focus on efficient and effective Storage method. That means it identify,
organize and arrange retrieval. It largely focus on good labeling and identification practices.
Objective: “A place for everything and everything in its place”.

3. SPIC- n - SPAN:

Spic-n-Span focuses on regular clearing and self inspection. It brings in the sense of
ownership.

4. STANDERDIZE:

It focuses on simplification and standardization. It involves standard rules and policies. It

establish checklist to facilitate autonomous maintenance of workplace. It assigns
responsibility for doing various jobs and decides on Five S frequency.

5. SUSTAIN:

It focuses on defining a new status and standard of organized work place. Sustain means
regular training to maintain standards developed under S-4. It brings in self- discipline and
commitment towards workplace organization.
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COLOR CODING

In the HDFC BANK each department has their different color coding apply on the different
file. Due to this everyone aware about their particular color file which is coding on it and
they save their valuable time. It is a part of Kaizen and also included in the system of the
Five ‘S’. Logic behind it that, the color coding are always differentiate the things from the
similar one.

DEPARTMENT

Welcome Desk

Personal Banker
HUMAN RESOURCES
Teller
The Bank’s staffing needs continued to
increase during the Relationship Manager year particularly in
the retail banking businesses in line
with the business Branch Manager growth. Total number
of employees increased from 14878
as of March31, 2006 Demat to 21477 as of March
31, 2008.The Bank continues to focus on
training its Others employees on a
continuing basis, both on the job and through training programs conducted by internal and
external faculty.

The Bank has consistently believed that broader employee ownership of its shares has a
positive impact on its performance and employee motivation. The Bank’s employee stock
option scheme so far covers around 9000 employees.

MANAGEMENT

Mr. Jagdish Capoor took over as the bank's Chairman in July 2001. Prior to this, Mr. Capoor
was a Deputy Governor of the Reserve Bank of India. The Managing Director, Mr. Aditya
Puri, has been a professional banker for over 25 years and before joining HDFC Bank in
1994 was heading Citibank's operations in Malaysia. The Bank's Board of Directors is
composed of eminent individuals with a wealth of experience in public policy,
administration, industry and commercial banking. Senior executives representing HDFC are
also on the Board. Senior banking professionals with substantial experience in India and
abroad head various businesses and functions and report to the Managing Director. Given the
professional expertise of the management team and the overall focus on recruiting and
retaining the best talent in the industry, the bank believes that its people are a significant
competitive strength.

TECHNOLOGY

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HDFC Bank operates in a highly automated environment in terms of information technology
and communication systems. All the bank's branches have online connectivity, which enables
the bank to offer speedy funds transfer facilities to its customers. Multi-branch access is also
provided to retail customers through the branch network and Automated Teller Machines
(ATMs). The Bank has made substantial efforts and investments in acquiring the best
technology available internationally, to build the infrastructure for a world class bank. The
Bank's business is supported by scalable and robust systems which ensure that our clients
always get the finest services we offer. The Bank has prioritized its engagement in
technology and the internet as one of its key goals and has already made significant progress
in web-enabling its core businesses. In

each of its businesses, the Bank has succeeded in leveraging its market position, expertise
and technology to create a competitive advantage and build market share.

HDFC BANK business strategy emphasizes the following:

Increase market share in India’s expanding banking and financial services industry by
following a disciplined growth strategy focusing on quality and not on quantity and
delivering high quality customer service. Leverage our technology platform and open
scaleable systems to deliver more products to more customers and to control operating costs.
Maintain current high standards for asset quality through disciplined credit risk
management.Develope innovative products and services that attract the targeted customers
and address inefficiencies in the Indian financial sector. Continue to develop products and
services that reduce bank’s cost of funds. Focus on high earnings growth with low volatility.

2.2 PRODUCT SCOPE:

HDFC Bank offers a bunch of products and services to meet the every need of the people.
The company cares for both, individuals as well as corporate and small and medium
enterprises. For individuals, the company has a range accounts, investment, and pension
scheme, different types of loans and cards that assist the customers. The customers can
choose the suitable one from a range of products which will suit their life-stage and needs.
For organizations the company has a host of customized solutions that range from funded
services, Non-funded services, Value addition services, Mutual fund etc. These affordable
plans apart from providing long term value to the employees help in enhancing goodwill of
the company. The products of the company are categorized into various sections which are as
follows:

 Accounts and deposits.

 Loans.
 Investments and Insurance.
 Forex and payment services.
 Cards.
 Customer center.

2.3 PRODUCTS AND SERVICES AT A GLANCE

1. PERSONAL BANKING SERVICES

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A. Accounts & Deposits
Savings Account

 Regular Savings Account

 Savings Plus Account
 Savings Max AccountSenior Citizens Account
 No Frills Account
 Institutional Savings Account
 Payroll Salary Account
 Classic Salary Account
 Regular Salary Account
 Premium Salary Account
 Defence Salary Account
 Kid's Advantage Account
 Pension Saving Bank Account
 Family Savings Account
 Kisan No Frills Savings Account
 Kisan Club Savings Account
Current Account
 Plus Current Account
 Trade Current Account
 Premium Current Account
 Regular Current Account
 Apex Current Account
 Max Current Account
 Reimbursement Current Account
Fixed Deposit
 Regular Fixed Deposit
 Super Saver Account
 Sweep-in Account
Recurring Deposit
Demat Account
Safe Deposit Locker

B. Loans
 Personal Loans
 Home Loans
 Two Wheeler Loans
 New Car Loans
 Used Car Loans
 Overdraft against Car
 Express Loans
 Loan against Securities
 Loan against Property
 Commercial Vehicle Finance
 Working Capital Finance
 Construction Equipment Finance

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C. Investments & Insurance
 Mutual Funds
 Insurance
 Bonds
 Financial Planning
 Knowledge Centre
 Equities & Derivatives
 Mudra Gold Bar

D. Forex Services
 Trade Finance
 Traveler’s Cheques
 Foreign Currency Cash
 Foreign Currency Drafts
 Foreign Currency Cheque Deposits
 Foreign Currency Remittances
 Forex Plus Card

E. Payment Services
 Net Safe
 Prepaid Refill
 Bill Pay
 Direct Pay
 Visa Money Transfer
 E-Monies Electronic Funds Transfer
 Excise & Service Tax Payment

F. Access Your Bank - One View

 Insta Alerts
 Mobile Banking
 ATM
 Phone Banking
 Branch Network

G. Cards
 Silver Credit Card
 Gold Credit Card
 Woman's Gold Credit Card
 Platinum plus Credit Card
 Titanium Credit Card
 Value plus Credit Card
 Health plus Credit Card
 HDFC Bank Idea Silver Card
 HDFC Bank Idea Gold Card

2. WHOLESALE BANKING SERVICES

 Funded Services
 Non Funded Services
 Value Added Services

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  Internet Banking
 Clearing Sub-Membership
 RTGS – sub membership
 Fund Transfer
 ATM Tie-ups
 Corporate Salary a/c
 Tax Collection
 Financial Institutions
 Mutual Funds
 Stock Brokers
 Insurance Companies
 Commodities Business
 Trusts

3. NRI BANKING SERVICES

 Rupee Saving a/c
 Rupee Current a/c
 Rupee Fixed Deposits
 Foreign Currency Deposits
 Accounts for Returning Indians
 Payment Services
 Net Safe
 Bill Pay
 Insta Pay
 Direct Pay
 Visa Money
 Online Donation
 Remittances

2.4 MILESTONES IN THE HISTORY

HDFC Bank began its operations in 1995 with a simple mission to be a "World-class Indian
Bank". They realized that only a single-minded focus on product quality and service
excellence would help us get there. Today, they are proud to say that they are well on our
way towards that goal. It is extremely gratifying that their efforts towards providing customer
convenience have been appreciated both nationally and internationally.

2009

Asia Money 2009 Awards 'Best Domestic Bank in India'

IBA Banking Technology Awards 'Best IT Governance Award - Runner up'
2009

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Global Finance Award 'Best Trade Finance Bank in India for 2009
IDRBT Banking Technology 'Best IT Governance and Value Delivery'
Excellence Award 2008
Asian Banker Excellence in Retail 'Asian Banker Best Retail Bank in India Award
Financial Services 2009 '

2008

Finance Asia Country Awards for 'Best Bank and Best Cash Management Bank'
Achievement 2008
CNN-IBN 'Indian of the Year (Business)'
Nasscom IT User Award 2008 'Best IT Adoption in the Banking Sector'
Business India 'Best Bank 2008'
Forbes Asia Fab 50 companies in Asia Pacific
Asian Banker Excellence in Retail Best Retail Bank 2008
Financial Services
Asiamoney Best local Cash Management Bank Award voted by
Corporates
Microsoft & Indian Express Group Security Strategist Award 2008
World Trade Center Award of honour For outstanding contribution to international trade services.
Business Today-Monitor Group One of India's "Most Innovative Companies"
survey
Financial Express-Ernst & Young Best Bank Award in the Private Sector category
Award
Global HR Excellence Awards - Asia 'Employer Brand of the Year 2007 -2008' Award -
Pacific HRM Congress: First Runner up, & many more
Business Today 'Best Bank' Award

2007

Dun & Bradstreet – American Express 'Corporate Best Bank' Award

Corporate Best Bank Award 2007
The Bombay Stock Exchange and 'Best Corporate Social Responsibility Practice'
Nasscom Foundation's Business for Award
Social Responsibility Awards 2007
Outlook Money & NDTV Profit Best Bank Award in the Private sector category.
The Asian Banker Excellence in Best Retail Bank in India
Retail Financial Services Awards
Asian Banker Our Managing Director Aditya Puri wins the Leadership

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 Achievement Award for India

2.5 MERGER

HDFC Bank and Centurion Bank of Punjab merger at share swap ratio of 1:29 The Boards of
HDFC Bank and Centurion Bank of Punjab met on 25 February, 2008 and approved, subject
to due diligence, the share swap ratio for the proposed merger of Centurion Bank of Punjab
with HDFC Bank. The Scheme of Amalgamation envisages a share exchange ratio of one
share of HDFC Bank for twenty nine shares of Centurion Bank of Punjab. The combined
entity would have a nationwide network of 1,148 branches (the largest amongst private sector
Banks) a strong deposit base of around Rs. 1,200 billion and net advances of around Rs.
850billion. The balance sheet size of the combined entity would be over Rs. 1,500 billion.
Commenting on the proposed merger, Mr. Deepak Parekh, Chairman, HDFC said, “We were
amongst the first to get a banking license, the first to do a merger in the private sector with
Times Bank in 1999, and now if this deal happens, it would be the largest merger in the
private sector banking space in India. HDFC Bank was looking for an appropriate merger
opportunity that would add scale, geography and experienced staff to its franchise. This
opportunity arose and we thought it is an attractive route to supplement HDFC Bank’s
organic growth. We believe that Centurion Bank of Punjab would be the right fit in terms of
culture, strategic intent and approach to business.” Mr. Aditya Puri, Managing Director,
HDFC Bank said, “These are exciting times for the Indian banking industry. The proposed
merger will position the combined entity to significantly exploit opportunities in a market
globally recognized as one of the fastest growing. I’m particularly bullish about the potential
of business synergies and cultural fit between the two organizations. The combined entity
will be an even greater force in the market.” Mr. Rana Talwar, Chairman, Centurion Bank of
Punjab stated, “Over the last few years, Centurion Bank of Punjab has set benchmarks for
growth. The bank today has a large nationwide network, an
extremely valuable franchise, 7,500

talented employees, and strong leadership positions in the market place. I believe that the
merger with HDFC Bank will create a world class bank in quality and scale and will set the
stage to compete with banks both locally as well on a global level.”

Mr. Shailendra Bhandari, Managing Director and CEO, Centurion Bank of Punjab said, “We
are extremely pleased to receive the go ahead from our board to pursue this opportunity. A
merger between the banks provides significant synergies to the combined entity. The
proposed merger would further improve the franchise and customer proposition offered by
the individual banks.”

2.6 QUALITY POLICY

SECURITY: The bank provides long term financial security to their policy. The bank does
this by offering life insurance and pension products.

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TRUST: The bank appreciates the trust placed by their policy holders in the bank. Hence, it
will aim to manage their investments very carefully and live up to this trust.

INNOVATION: Recognizing the different needs of our customers, the bank offers a range
of innovative products to meet these needs.
INTEGRITY CUSTOMER CENTRIC PEOPLE CARE “ONE FOR ALL AND ALL FOR
ONE” TEAM WORK JOY AND SIMPLICITY

INTRODUCTION
TO
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 CAPITAL
STRUCTURE
THEORY AND
ANALYSIS

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This is a Report on the ‘Capital Structure and Capital Expenditure of
Hdfc bank.’. The purpose and scope of the project can be listed as:
 Understanding the organizational structure and functioning of
Hdfc bank.
 Analysing and comparing the financial health of the firms in the
Indian Pharma Industry.
 Identifying and analysing the capital structure of Ranbaxy.
 Conducting a Review of the Capital Expenditure done at Hdfc
bank.
 Identifying loopholes in the functioning and in the area of study
and recommending the suggestions for the same.

Following are the limitations of the study:

 Balance sheets of only 3 years have been studied but the company is
in operation for so many years.
 Only specific tools (i.e. ratio analysis) have been used for data
analysis, while so many other tools are also there.
 Organizational rules & regulations.

 Availability of data. Financial figures for 2008 of Ranbaxy were not

available.
 Limitations of the financial tools used.

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Litreture of review on Capital Structure
CAPITAL STRUCTURE IS A MIX OF DEBT AND
EQUITY CAPITAL MAINTAINED BY A FIRM. CAPITAL
STRUCTURE IS ALSO REFERRED AS FINANCIAL STRUCTURE OF
A FIRM. THE CAPITAL STRUCTURE OF A FIRM IS VERY
IMPORTANT SINCE IT RELATED TO THE ABILITY OF THE FIRM
TO MEET THE NEEDS OF ITS STAKEHOLDERS. MODIGLIANI
AND MILLER (1958) WERE THE FIRST ONES TO LANDMARK
THE TOPIC OF CAPITAL STRUCTURE AND THEY ARGUED THAT
CAPITAL STRUCTURE WAS IRRELEVANT IN DETERMINING THE
FIRM’S VALUE AND ITS FUTURE PERFORMANCE. ON THE
OTHER HAND, LUBATKIN AND CHATTERJEE (1994) AS
WELL AS MANY OTHER STUDIES HAVE PROVED THAT THERE
EXISTS A RELATIONSHIP BETWEEN CAPITAL STRUCTURE AND
FIRM VALUE. MODIGLIANI AND MILLER (1963)
SHOWED THAT THEIR MODEL IS NO MORE EFFECTIVE IF
TAX WAS TAKEN INTO CONSIDERATION SINCE TAX
SUBSIDIES ON DEBT INTEREST PAYMENTS WILL CAUSE A
RISE IN FIRM VALUE WHEN EQUITY IS TRADED FOR DEBT.
IN MORE RECENT LITERATURES, AUTHORS HAVE
SHOWED THAT THEY ARE LESS INTERESTED ON HOW
CAPITAL STRUCTURE AFFECTS THE FIRM VALUE. INSTEAD
OF THE FIRM. MODIGLIANI AND MILLER (1963) ARGUED
THAT THE CAPITAL STRUCTURE OF A FIRM SHOULD
COMPOSE ENTIRELY OF DEBT DUE TO TAX DEDUCTIONS
ON INTEREST PAYMENTS. HOWEVER, BRIGHAM AND
GAPENSKI (1996) SAID THAT, IN THEORY, THE
MODIGLIANI-MILLER (MM) MODEL IS VALID. BUT, IN
PRACTICE, BANKRUPTCY COSTS EXIST AND THESE COSTS
ARE DIRECTLY PROPORTIONAL TO THE DEBT LEVEL OF THE
FIRM. HENCE, AN INCREASE IN DEBT LEVEL CAUSES AN
INCREASE IN BANKRUPTCY COSTS. THEREFORE, THEY
ARGUE THAT THAT AN OPTIMAL CAPITAL STRUCTURE CAN
ONLY BE ATTAINED IF THE TAX SHELTERING BENEFITS
PROVIDED AN INCREASE IN DEBT LEVEL IS EQUAL TO THE
BANKRUPTCY COSTS. IN THIS CASE, MANAGERS OF THE
FIRMS SHOULD BE ABLE TO IDENTIFY WHEN THIS
OPTIMAL CAPITAL STRUCTURE IS ATTAINED AND TRY TO
MAINTAIN IT AT THE SAME LEVEL. THIS IS THE ONLY
WAY THAT THE FINANCING COSTS AND THE WEIGHTED
AVERAGE COST OF CAPITAL (WACC) ARE MINIMISED
THEREBY INCREASING FIRM VALUE AND CORPORATE
PERFORMANCE.

BOODHOO Roshan
ASc Finance, BBA (Hons) Finance, BSc (Hons) Banking & International Finance
(Email: [email protected] ; Tel: +230-7891888)

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 Methodology
The methodology adopted for the study was as follows:
 Familiarization, examination and evaluation of the procedures
relating to capital structure and capital expenditure.
 Collection of relevant data form company records and cross checking
of this data.
 Calculations of financial ratios, parameter and norms, as also their
financial implications.
Broadly the data were collected for the report on the project work has been
through the primary and secondary sources.

The primary data is collected by various approaches so as to give a precise,

accurate, realistic and relevant data. The main goal in the mind while
gathering primary data was investigation and observation. The ends were
thus achieved by a direct approach and personal observation from the
officials of the company. The other staff members and the employees were
interviewed for the sake of maintaining reasonable standard of accuracy.

The secondary data as it has always been important for the completion of
any report provides a reliable, suitable equate and specific knowledge. The
annual reports, the fixed asset register and the Capex register provided the
knowledge and information regarding the relevant subjects.

The valuable cooperation and continued support extended by all associated

personnels, head of the department, division and staff members contributed
a lot to fulfil the requirement in the collection of data in order to present a
complete report on the project work.

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 Capital Structure: Theory and
Analysis
Capital Structure
Financing decisions involve raising funds for the firm. It is concerned
with formulation and designing of capital structure or leverage. The
most crucial decision of any company is involved in the formulation
of its appropriate capital structure. The best design or structure of the
capital of a company helps the management to achieve its ultimate
objectives of minimising overall cost of capital, maximising
profitability and also maximising the value of the firm.
The capital structure decision of a firm is concerned with the
determination of debt equity composition. Capital structure ordinarily
implies the proportion of debt and equity in the total capital of a
company. The term capital may be defined as the long – term funds
of the firm. Capital is the aggregation of the items appearing on the
left hand side of the balance sheet minus current liabilities.
In other words capital may be expressed as follows:
Capital = Total Assets – Current Liabilities.
Further, capital of a company may broadly be categorised into equity
and debt. The total capital structure of a firm is represented in the
following figure:

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 TOTAL CAPITAL

EQUITY CAPITAL DEBT CAPITAL

EQUITY SHARE CAPITAL TERM LOANS

PREFERENCE SHARE DEBENTURES
CAPITAL DEFERRED PAYMENTS
SHARE PREMIUM LIABILITIES
RETAINED EARNINGS OTHER LONG TERM DEBT

Established companies generally have track record of their profit

earning capacity, which helps them to create their creditworthiness.
The lenders feel safe to invest their funds in such companies. Thus,
there is ample scope for this type of companies to collect debt. But a
company cannot freely i.e. without having any limit. The company
must have to chalk out a plan to collect a debt in such a way that the
acceptance of debt becomes beneficial for the company in terms of
increase in EPS, profitability and value of the firm.
If the cost of capital is greater than the return, it will have an adverse
effect on company’s profitability, value of the firm and its EPS.
Similarly, if company is unable to repay the debt within the scheduled
period it will affect the goodwill of the company in the credit market
and consequently may create problems in future for collecting further
debt. Other factors remaining constant, the company should select its
appropriate capital structure with due consideration.

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Capital structure involves a choice between risk and expected return.
The optimal capital structure strikes the balance between these risks
and returns and thus examines the price of the stock.

Significant variations with regard to capital structure can easily be

noticed among industries and firms within the same industry. So it is
difficult to generate the model capital structure for all business
undertakings. The following is an attempt to consolidate the literature
on various methods to suggested by researchers in arriving at optimal
capital structure.
Notations used:

 V = value of firm

 FCF = free cash flow

 WACC = weighted average cost of capital

 rs and rd are costs of stock and debt

 re and wd are percentages of the firm that are financed with

stock and debt.

Operating and Financial Leverages

The term leverage refers to the ability of a firm in employing long –
term funds having a fixed cost, to enhance returns to the owners. In
other words leverage is the employment of fixed assets or funds for
which a firm has to meet fixed costs or fixed rate of interest
obligation irrespective of the level of activities attained or the level of
operating profit earned.
Higher the leverage, higher the profits and vice – versa. But a higher
leverage obviously implies higher outside borrowings and hence
riskier if the business activity of the firm suddenly takes a dip. But a
low leverage does not necessarily indicate prudent financial
management, as the firm might be incurring an opportunity cost for
not having borrowed funds at a fixed cost to earn higher profits.

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Operating Leverage
Operating leverage is concerned with the operation of any firm. The
cost structure of any firm gives rise to operating leverage because of
the existence of fixed nature of costs. This leverage relates to the sales
and profit variations.

Operating Contribution
Leverage = EBIT

Contribution = Sales – Variable Costs

EBIT = Earnings Before Interest and Taxes.

Disadvantages of Operating Leverages

 The reliability of operating ratios rests to a large extent on the
correctness of the fixed costs identified with a product. Faulty
apportionment would distort the usefulness of the ratio.
 The published accounts does not give details of the fixed cost
incurred and the contribution from each product and for an
outsider it is difficult to calculate the firm’s operating leverage.

Firm’s cost structure and nature of the firm’s business affects

operating leverage. A degree change in sales volume results in
more than proportionate change (+/-) in operating (or loss) can be
observed by use of operating leverage.

Financial Leverage

This ratio indicates the effects on earnings by rise of fixed cost funds.
It refers to use the use of debt in the capital structure. Financial
leverage arises when a firm deploys debt funds with fixed charge. The
ratio is calculated with the following:
 Earnings before interest and tax / Earnings after interest –
The higher the ratio, the lower the cushion for paying interest on

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 borrowings. A low ratio indicates a low interest outflow and
consequently lower borrowings. A high ratio is risky and
constitutes a strain on profits. This ratio is considered along
with the operating ratio, gives a fairly and accurate idea about
the firm’s earnings, its fixed costs and the interest expenses on
long term borrowings.
 Earnings per Share – Higher financial leverage leads to higher
EBIT resulting in higher EPS, if other things remain constant.
Financial leverage affects the variability and expected level of
EPS. The more debt the firm employs the higher its financial
leverage. Financial leverage generally raises expected EPS, but
it also increases the riskiness of securities as the debt / asset
ratio rises.

Financial EBIT
Leverage = EBT

EBIT – Earnings Before Interest and Tax

EBT – Earnings Before Taxes.
Consider Two Hypothetical Firms

Firm U Firm L

No debt 10,000 of 12% debt

20,000 in assets 20,000 in assets

40% tax rate 40% tax rate

Both firms have same operating leverage, business risk, and EBIT of
3,000. They differ only with respect to use of debt.

Impact of Leverage on Returns

Firm U Firm L (Fig.
in Rs’000)
EBIT 3,000 3,000
Interest 0 1,200
Page 21 of 81
EBT 3,000 1,800
Taxes (40%) 1, 200 720
NI 1,800 1,080
ROE 9.0% 10.8%

More EBIT goes to investors in Firm L.

Total dollars paid to investors:

 U: NI = Rs.1,800.

 L: NI + Int = Rs.1,080 + Rs.1,200 = Rs.2,280.

 Taxes paid:

 U: Rs.1,200; L: Rs.720.

Now consider the fact that EBIT is not known with certainty.
Determining the impact of uncertainty on stockholder profitability
and risk for Firm U and Firm L
Firm U: Unleveraged
Economy (Fig.
in Rs’000)

Bad Avg. Good

Prob. 0.25 0.50 0.25

EBIT 2,000 3,000 4,000

Interest 0 0 0
EBT 2,000 3,000 4,000
Taxes (40%) 800 1,200 1,600
NI 1,200 1,800 2,400
Firm L: Leveraged

Page 22 of 81
 Economy
(Fig. in Rs’000)

Bad Avg. Good

Prob.* 0.25 0.50 0.25

EBIT* 2,000 3,000 4,000
Interest 1,200 1,200 1,200
EBT 800 1,800 2,800
Taxes (40%) 320 720 1,120
NI 480 1,080 1,680
*Same as for Firm U.

Firm U Bad Avg. Good

BEP 10.0% 15.0% 20.0%
ROIC 6.0% 9.0% 12.0%
ROE 6.0% 9.0% 12.0%
TIE n.a. n.a. n.a.
Firm L Bad Avg. Good
BEP 10.0% 15.0% 20.0%
ROIC 6.0% 9.0% 12.0%
ROE 4.8% 10.8% 16.8%
TIE 1.7x 2.5x 3.3x

U L
Profitability Measures:
E(BEP) 15.0% 15.0%
E(ROIC) 9.0% 9.0%
E(ROE) 9.0% 10.8%

Risk Measures:
sROIC 2.12% 2.12%
sROE 2.12% 4.24%

Page 23 of 81
Conclusions
 Basic earning power (EBIT/TA) and ROIC (NOPAT/Capital
= EBIT(1-T)/TA) are unaffected by financial leverage.

 L has higher expected ROE: tax savings and smaller equity

base.

 L has much wider ROE swings because of fixed interest

charges. Higher expected return is accompanied by higher
risk.

In a stand-alone risk sense, Firm L’s stockholders see much more risk
than Firm U’s.

U and L: sROIC = 2.12%.

U: sROE = 2.12%.

L: sROE = 4.24%.

 L’s financial risk is sROE - sROIC = 4.24% - 2.12% =

2.12%. (U’s is zero.)

 For leverage to be positive (increase expected ROE), BEP

must be > rd.

 If rd > BEP, the cost of leveraging will be higher than the

inherent profitability of the assets, so the use of financial
leverage will depress net income and ROE.

In the example, E(BEP) = 15% while interest rate = 12%, so

leveraging “works.”

Page 24 of 81
Choosing the Optimal Capital Structure for Hdfc bank.
Based on the ratio analysis done above it can be concluded that
Ranbaxy is an unleveared firm with very less debt component in its
capital structure. The company is in a position to increase its debt
component by resorting to external debt financing. However it should
be kept in mind that, there could be two opposite effects if debt is
increased in the capita structure. The first effect may be an overall
reduction in the cost of capital as the proportion of debt increases in
the capital structure due to low cost of debt. On the other hand,
because of fixed contractual obligation the financial risk of the
company increases. Thus, it is said that the optimum capital structure
implies a ratio of debt and equity at which weighted average cost of
capital would be least and the market value of the firm would be
highest.
Keeping the above thought in mind I have tried to compute what
would be the optimal capital structure for Ranbaxy
Laboratories Ltd., based on the following information as per the
Annual Report 2005:
EBIT being 37,273,800;
Assuming that the firms expects zero growth
225,557,810 shares outstanding; rs = 12%;
T = 35%; b = 1.0; rRF = 6%;
RPM = 6%.

Estimates of Cost of Debt

Percent financed
with debt, wd rd

0% -
20% 8.0%

Page 25 of 81
 30% 8.5%
40% 10.0%
50% 12.0%

If company recapitalizes, debt would be issued to repurchase stock.

The Cost of Equity at Different Levels of Debt: Hamada’s Equation

 MM theory implies that beta changes with leverage.
 bU is the beta of a firm when it has no debt (the unlevered
beta)
 bL = bU [1 + (1 - T)(D/S)]

The Cost of Equity for wd = 20%

Use Hamada’s equation to find beta:
bL = bU [1 + (1 - T)(D/S)]
= 1.0 [1 + (1-0.35) (20% / 80%) ]
= 1.16
Use CAPM to find the cost of equity:
rs = rRF + bL (RPM)
= 6% + 1.16 (6%) = 12.98%

Cost of Equity vs. Leverage

wd D/S bL rs
0% 0.00 1.00 12.00%
20% 0.25 1.16 12.98%
30% 0.43 1.28 13.67%
40% 0.67 1.43 14.60%
50% 1.00 1.65 15.90%

Page 26 of 81
The WACC for wd = 20%
WACC = wd (1-T) rd + we rs
WACC = 0.2 (1 – 0.35) (8%) + 0.8 (12.98%)
WACC = 11.42%
Repeat this for all capital structures under consideration.
WACC vs. Leverage
wd rd rs WACC

0% 0.0% 12.00% 12.00%

20% 8.0% 12.98% 11.42%
30% 8.5% 13.67% 11.23%
40% 10.0% 14.60% 11.36%
50% 12.0% 15.90% 11.85%
Corporate Value for wd = 20%
V = FCF / (WACC-g)
g=0, so investment in capital is zero; so FCF = NOPAT = EBIT (1-
T).
NOPAT = (Rs.37,273,800)(1-0.35) = Rs.24,227,970

V = Rs.24,227,970/ 0.1142 = Rs.212,153,852.89

Corporate Value vs. Leverage

wd WACC Corp. Value
0% 12.00% Rs.201,899,750.00
20% 11.42% Rs.212,153,852.89
30% 11.23% Rs.215,791,315.97
40% 11.36% Rs.213,274,383.80
50% 11.85% Rs.204,455,443.04
Page 27 of 81
Debt and Equity for wd = 20%
The value of debt is:
= wd V = 0.2 (Rs.212,153,852.89) = Rs.42,430,770.58.
S=V–D
S = Rs.212,153,852.89 – Rs.42,430,770.58 = Rs.169,723,082.31

Debt and Stock Value vs. Leverage

wd Debt, D Stock Value, S

0% 0 Rs.201,899,750.00
20% Rs.42, 430,770.58 Rs.169,723,082.31
30% Rs.64, 737,394.79 Rs.151,053,921.18
40% Rs.85, 309,753.52 Rs.127,964,630.28
50% Rs.102, 227,721.52 Rs.102,227,721.52

Wealth of Shareholders
Value of the equity declines as more debt is issued, because debt is
used to repurchase stock.
But total wealth of shareholders is value of stock after the recap plus
the cash received in repurchase, and this total goes up (It is equal to
Corporate Value on earlier slide).

Page 28 of 81
Stock Price for wd = 20%
The firm issues debt, which changes its WACC, which changes value.
The firm then uses debt proceeds to repurchase stock.
Stock price changes after debt is issued, but does not change during
actual repurchase (or arbitrage is possible).
The stock price after debt is issued but before stock is
repurchased reflects shareholder wealth:
S, value of stock

Cash paid in repurchase.

D0 and n0 are debt and outstanding shares before recap.
D - D0 is equal to cash that will be used to repurchase stock.
S + (D - D0) is wealth of shareholders’ after the debt is issued but
immediately before the repurchase.

P = S + (D – D0)
n0
P = Rs.169,723,082.31+ (Rs. 42,430,770.58– 0)
225,557,810
P = Rs.94.06 per share.
# Repurchased = (D - D0) / P
# Rep. = (Rs.42,430,770.58 – 0) / Rs.94.06
= 45,116.
# Remaining = n = S / P
n = Rs.169,723,082.31 / Rs.94.06
= 1,804,462.

Price per Share vs. Leverage

Page 29 of 81
 # shares # shares
wd P Repurch.
Remaining

0% Rs.89.51 0 2,255,578
20% Rs.94.06 451,116 1,804,462
30% Rs.95.67 676,673 1,578,905
40% Rs.94.55 902,231 1,353,347
50% Rs.90.64 1,127,789 1,127,789

Optimal Capital Structure

wd = 30% gives:
 Highest corporate value
 Lowest WACC
 Highest stock price per share
But wd = 40% is close. Optimal range is pretty flat.

Modigliani and Miller Theory (Modern View)

The traditional view of capital structure explained in weighted

average cost of capital is rejected by the proponents Modigliani and
Miller (MM) (1958). According to them, under competitive
conditions and perfect markets, the choice between equity financing
and borrowing does not affects a firm’s market value because the
individual investor can alter investment to any mix of debt and equity
the investor desires.

Page 30 of 81
Assumptions of MM Theory
The MM Theory is based on the following assumptions:
 Perfect capital markets exist where individuals and companies
can borrow unlimited amounts at the same rate of interest.
 There are no taxes or transaction costs.
 The firm’s investment schedule and cash flows are assumed
constant and perpetual.
 Firms exist with the same business or systematic risk at
different levels of gearing.
 The stock markets are perfectly competitive.
 Investors are rational and except other investors to behave
rationally.

MM Theory: No Taxation
The debt is less expensive than equity. An increase in debt will
increase the required rate of return on equity. With the increase in the
levels of debt, there will be higher level of interest payments affecting
the cash flow of the company. Then equity shareholders will demand
for more returns. The increase in cost of equity is just enough to
offset the benefit of low cost debt, and consequently average cost of
capital is constant for all levels of leverage as shown in Figure 1.

Cost of

Cost of Capital
r Equity

Average cost of
Capital
Cost of
Debt

Level of leverage

Figure 1: MM view of Capital Structure

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In MM theory the following notations will be used:
Vu = Market value of ungeared company i.e. company
with 100% equity financing.
Vg = Market value of a geared company i.e. capital
structure of the company includes both debt and
equity capital.
D = Market value of debt in a geared company.
Ve = Market value of equity in a geared company.
Vg = Ve + D
Ku = Cost of equity in an ungeared company.
Kg = Cost of equity in a geared company.
Kd = Cost of Debt.

M M Theory: Proposition I

The market value of any firm is independent of its capital structure,

changing the gearing ratio cannot have any effect on the
company’s annual cash flow. The assets in which the company has
invested and not how those assets are financed determine the
market value. Thus, the market value of a firm is unaffected by its
financing decisions, its capital structure, or its debt-equity ratio.
In simple words, M & M theory views the value of the company as
a whole pie. The size of the pie does not depend on how it is
sliced i.e. the firm’s capital structure but rather the size of the pie
pan i.e. the firm’s present value based on its future cash flows and
its asset base.
The value of the geared company is as follows:
Vg = Vu
Vg = Profit before interest
WACC
Vg = Vu = Earnings in ungeared company
Ku
WACC is independent of the debt / equity ratio and equal to the cost
of capital which the firm would have with no gearing in its capital
structure.

Page 32 of 81
Proof by example -
 Consider holding 1% of stock in an all-equity firm
with value VU.
 Then your wealth is 0.01VU.
 Also, you receive a cash flow of 0.01CFt every
period.
 Alternatively, consider holding 1% equity and 1%
debt in levered version of the same firm with value
Vg=E+D.
 Your wealth then is [0.01E+0.01D] = 0.01Vg.
 Cash Flows each period? [0.01(Int)+0.01(CFt-
Int)]=0.01CFt.
 As the inherent risk of the firm is the same, then the
discounted value of the cash flows must be the same,
i.e., Vg= VU.
WACC Prop. I

M&M

Traditional

B
E

Page 33 of 81
 MM Theory: Proposition I

M M Theory: Proposition II

The rate of return required by shareholders increases linearly as the

debt / equity ratio is increased i.e. the cost of equity rises exactly in
line with any increase in gearing to precisely offset any benefits
conferred by the use of apparently cheap debt.
MM went on arguing that the expected return on the equity of a
geared company is equal to the return on a pure equity stream plus a
risk premium dependent on the level of capital structure.
The premium for financial risk can be calculated as debt / equity ratio
multiplied by the difference between the cost of equity for ungeared
company and risk – free cost of debt.

The cost of equity depends on the following three variables:

1. The required rate of return on the firm (Ku).
2. The required rate of return on the firm’s debt (K d).
3. The firm’s debt/equity ratio (D/E)

MM proposition II can be summed up in following points:

 Equity holders require a premium over what everyone is paid if
the firm has debt.
 The premium DOES depend upon the firm’s financing mix.
 The wealth of equity holders, however, is unaffected.
 Any increase in leverage raises both the risk of equity and its
required return.
 Stockholders are indifferent to capital structure and to change
in leverage.

Page 34 of 81
 RE Prop. II
M&M
Slope = RA – RD

Traditional
RA
B
E

MM Theory: Proposition II
M M Theory: Proposition III

MM theory’s third proposition asserts that the cut-off rate for new
investment will in all cases be average cost of capital and will be un
affected by the type of security used to finance the investments.

M M Theory: Arbitrage
The cost of equity will rise by an amount just sufficient to offset any
possible saving or loss. The lenders determine the supply of debt. The
optimal level is simply the maximum amount of debt which lenders
are prepared to subscribe in any given circumstances e.g. level of
inflation, rate of economic growth, level of profits etc. the investors
will exercise their own leverage by mixing their own portfolio with
debt and equity. The investors call this the arbitrage process. Under
these conditions of investment the average cost of capital is constant.
If two different firms with same level of business risk but different
levels of gearing sold for different values, then shareholders would
move from over valued firm to the under value firm and adjust their
level of borrowing through the market to maintain financial risk at the
same level. The shareholders would increase their income through
this method while maintaining their net investment and risk at the
same level. This process of arbitrage would drive the price of the two
firms to a common equilibrium total value.

Page 35 of 81
The word ‘arbitrage’ is a technical term referring to a situation where
two identical commodities are selling in the same market for different
prices, then the market will reach equilibrium by the dealers start at
the lower price and sell at the higher price, thereby making profit. The
increase in demand will force up the price of the lower priced goods
and increase in supply will force down the price of the high priced
commodities.
The arbitrage in MM theory shows that the investors will move
quickly to take advantage and will make profit in an equilibrium
capital market, then this would represent an arbitrage opportunity.

MM Theory: Corporate Taxation

In above discussion, MM theory has ignored the tax relief on debt

interest. MM has further modified their theory by considering tax
relief available to a geared company when the debt component exists
in the capital structure. The tax burden on the company will lessen to
the extent of relief available on interest payable on the debt, which
makes the cost of debt cheaper, which reduces the weighted average
capital of the lower where capital structure of a company has debt
component.
Consider a firm with no debt (i.e. all equity or unlevered) with a value
of Vu.
Suppose firm changes capital structure by issuing debt and retiring
some equity. The firm will realize gain since interest payments on
debt are tax-deductible, so tax liability will decline!
For perpetual debt:
Yearly Tax Savings (Tax Shield)
= Interest × TC = r ×D × TC
= RD × B × TC
Tax shield will be realized each year forever. Since it goes to
bondholders, it should be discounted at RD, thus
PV of tax shield = (RD × B × TC)/ RD
= B × TC
Value of firm with debt VL (i.e. “levered firm”) will be : V L = Vu +
B × TC

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Value increases by PV of tax shield.
Tax advantage of debt increases as TC increases.
In M&M world (TC = 0), VL = V

Slope = TC
VL

PV of Tax Shield

VU M&M Value

B
MM Theory: Corporate Taxation
Under the assumption of tax relief being available on debt interest,
the total market value of the company is increasing function of the
level of gearing.
MM theory cost of equity formula for a geared company:

Kg = Ku + (1 – T) (Ku – Kd)

MM theory assumes that the value of the geared company will always
be greater than an ungeared company with similar business risk but
only by the amount of debt – associated tax saving of the geared
company. Value of geared company:
Vg = Vu + DT
When corporation taxation is introduced, the tax deductibility of debt
interest creates value for shareholders via the tax shield, but this is a
wealth transfer from taxpayers. The value of a geared company equals
the value of an equivalent ungeared company’s shareholders is less
than that in the all equity company, reflecting the tax benefits. A
further effect of corporate taxation is to lower WACC, which falls
continuously as gearing increases.

Page 37 of 81
MM Theory: Personal Taxation

MM theory considered only corporate taxes. It was left to a

subsequent analysis by Miller (1977) to include the effects of
personal as well as corporate taxes. He argued that the existence of
tax relief on debt interest but not on equity dividends would make
debt capital more attractive than equity capital to companies. The
market for debt capital under the laws of supply and demand,
companies would have to offer a higher return on debt in order to
attract greater supply of debt. When the company offers after personal
tax return on debt at least as equal to the after personal tax return on
equity, the equity supply will switch over to supply debt to the
company. It is assumed that, from the angle of the company, it will be
indifferent between raising debt or equity as the effective cost of each
will be the same and there is no advantage to gearing.

Financial Distress and Capital Structure

The assumption is that when firm has very high level of borrowing
they are more likely to run into the cost of final distress and cost of
bankruptcy. When the leverage of the firm is extremely high then it is
very likely that at some stage it will not be able to make annual
interest payments and loan repayments. Dividends for shareholders
can be bypassed but failure to pay interest on loans often gives the
lender the right to claim on the firms operating assets thereby
preventing the firm’s continuity of activity.
The following illustrative list of activities which may cause increase
in cost of the firm.
 Successive borrowings beyond the company’s target debt –
equity ratio.
 Borrowing higher levels of interest
 Skip off or cut in dividend which may cause the fall of market
rate of shares.
 Loss of trade credit from suppliers
 Distress sale of highly profitable instruments.
Page 38 of 81
  Abandonment of promising new projects.
 Reduced credit period resulting in loss of business.
 Corporate image may be tarnished.
 Demand for withdrawal of loans made to the firm previously.
 Reduction in stock levels result in reduction in sales etc.

Bankruptcy Costs

The cost of bankruptcy may be of two types:

 Direct costs
— Those directly associated with bankruptcy, both legal and
administrative.
 Indirect costs
— Costs associated with a firm experiencing financial
distress (creditors, bankers, customers, employers, etc.)
Bankruptcy costs = direct costs + indirect costs

An increase in debt is associated with increased tax savings but also

an increased probability of running into cost of financial distress and
bankruptcy. The value of the leveraged firm is it’s capitalised after
tax operational cash flow plus the present value of the tax savings
incorporating the anticipated cost of financial distress and
bankruptcy.

V = X + DT – BC
R
Where,
V = Value of leverage firm
X = Anticipated net operational cash flows
R = Capitalisation Rate
D = Market Value of Debt
T = Corporate tax rate
BC = Anticipated costs of bankrupting

Page 39 of 81
 Cost of Debt
V PV of Bankruptcy Cost

PV of Tax Shield

VU

Cost of Equity

Optimum Capital
Structure
B

Figure: Optimum Capital Structure and Costs of Financial

Distress

The existence of tax benefit for modest amounts of debt, and the need
to avoid the costs of financial distress, suggest that there is an optimal
capital structure as illustrated in figure which shows that there is an
optimal capital structure at the point where the market value of the
firm is maximized, that is where (DT – BC) is maximized.

Debt Financing and Agency Costs

Agency theory models a situation in which a principal (a superior)
delegates decision making authority to an agent (the subordinate) who
receives reward in return for performing some activity on behalf of
the principal. The outcome of the agents effects the principals welfare
in some way, for example sales revenue, output or contribution
margin. The principal attempts to combine a reward system with an
information system, in order to motivate the agent to choose the
action, which maximizes the principal’s welfare.
In respect of debt finance, the suppliers of debt are much concerned,
about their investment in the company, about their investment in the
company, about the risk involved in financing debt to the company.
In order to minimize the risks in debt finance, the suppliers of loan
Page 40 of 81
will impose restrictive conditions in loan agreements that constraint
management’s freedom of action and it is known as agency costs. The
more money the suppliers of debt lend to the company – then the
more constraints they are likely to impose on the managements in
order to secure their investments. Therefore, agency costs are more in
highly geared firms.

Difficult to identify and estimate, but exist

V = VU + BTC – PVBC– PV of agency costs
PVBC + PVAC eventually dominate over PV of tax shield.
PV of agency costs , as B generally.

V PVBC + PVAC

PV of Tax Shield

VU

Debt Financing and Agency Cost

Signaling Theory

In a pioneering study published in 1961, Gordon Donaldson

examined how companies actually establish their capital structure.
The findings of his study are summarised below:
1. Firms prefer to rely on internal accruals, i.e. on retained
earnings and depreciated cash flow.

Page 41 of 81
 2. Expected future investments oppurtunities and expected future
cash flow influence target dividend payout ratio. Firms set the
target pay out ratio at such a level that capital expenditures,
under normal circumstances, are covered by internal accruals.
3. Dividends tend to be sticky in the short run. Dividends are
raised only when the firm is confident that the higher dividend
can be maintained; dividends are not lowered unless things are
very bad.
4. If a firm’s internal accruals exceed its capital expenditure
requirements, it will invest in marketable securities, retire debt,
raise dividends, resort to acquisitions, or buyback its shares.
5. If a firm’s internal accruals are less than its non-postponable
capital expenditure, it will first draw down its marketable
securities portfolio and then seek external finance.
Noting the inconsistencies in the trade – off theory, Myers proposed a
new theory, called the signalling, or asymmetric information, theory
of capital structure. The main points of the theory are:
 Managers often have better information.
 Sell stock if stock is overvalued.
 Sell bonds if stock is undervalued.
 Investors understand this, so view new stock sales as a
negative signal.

Corporate Finance Practices

The capital structure decision is a difficult decision that involves a

complex trade – off among several considerations like income, risk,
flexibility, etc. given the over – riding objective of maximising the
market value of a firm, the following guidelines should be kept in
mind while hammering out the capital structure of the firm.

 Avail of the Tax Advantage of Debt.

Interest on debt finance is a tax – deductible expense. Hence
finance scholars and practitioners agree that debt financing
gives rise to tax shelter which enhances the value of the firm.
 Preserve Flexibility

Page 42 of 81
 Flexibility implies that the firm maintains reserve borrowing
power to enable it to raise debt capital to respond to unforeseen
changes in business and political environment. Hence the firm
must maintain some unused debt capacity as an insurance
against adverse future developments.

 Ensure that the Total Risk Exposure is Reasonable

The affairs of the firm should be managed in such a way that the
total risk borne by the equity shareholders is not unduly high.

 Subordinate Financial Policy to Corporate Strategy

Financial policy and corporate strategy are often not integrated
well. This may be because financial

 Mitigate Potential Agency Costs.

Due to separate ownership and control in modern corporations,
agency problems arise. Shareholders scattered and dispersed as
they are not able to organise themselves effectively. Hence, very
little monitoring takes place in the security markets.
Since agency costs are borne buy shareholders and the
management, the financing strategy of a firm should seek to
minimise these cost by employing external agents who
specialise in low cost – monitoring.

 Issue innovative Securities

Thanks to SEBI guidelines introduced in 1992, issues have
considerable freedom in designing financial instruments. There
is greater scope for employing innovative securities to the
advantage of the firm. The important securities innovations have
been as follows: floating rate bonds (or notes), collateralised
mortgage obligations, dual currency bonds, extendible notes,
medium term notes.
 Widen the Range of Financing Sources

Page 43 of 81
In as dynamically evolving financial environment, traditional
sources of financing may diminish in importance. They may not
be adequate or optimal. Hence, it behoves on a firm to employ
new modes of finance like commercial paper, factoring, Euro
issues, and securitisation.

Page 44 of 81
Capital expenditure: an overview

Factors Of Capex

Organizations engaged in manufacturing and marketing of

goods or services require assets in their operations. An asset
can be thought of as any expenditure, which creates or aids in
creation of a revenue-generating base. Companies incur
various expenditure to carry on standard flow of work,
expenditure intended to yield returns over a period of time, and
usually exceeding one year is regarded as capital expenditure.
Various factors are considered before Board of Directors
approves any expenditure. All that factors can further be
divided into:

Operational Factors
I. To meet future requirements based on market forecast.
II. To maintain coordination with the vision of the
company as Ranbaxy vision Garuda states to be top
five generic players in the world by 2012 and achieve
sales of 5 billion. To achieve this target company has
to incur heavy expenditure on acquisition of fixed
assets.
III. To increase market penetration.
IV. To maintain, renew, expand, upgrade existing physical
assets that helps to facilitate and enhance revenue-
generating capacity.
V. To create, acquire and develop revenue generating
activities/ capacities that is imperative for an
organization’s healthy growth and existence.

Financial Factors
In deciding which assets to create, acquire or develop, the
benefits to be gained from the expenditure have to be weighed
against the costs that will be incurred. While costs can always
be expressed in financial terms, the benefits may or may not be
similarly quantifiable. Nevertheless, an attempt must be made
Page 45 of 81
 to express the benefits expected, in a manner that facilitates
comparison with costs and helps formulate a rational basis for
the decision making process. Following are the financial tools
that are taken into account for approving capital expenditure.

Discounted Cash Flow (DCF)

This is one of the techniques for financial evaluation of
Capex’s. DCF techniques are based on the concept of time
value of money and provide a methodology of taking into
account the timing of cash proceeds and outlays over the life of
the investment. The procedure underscores the need to state
cash flow streams arising in different time periods thus
differing in value and, hence comparable only in terms of a
common denominator viz. present values.

I. Discounted Payback Period (DPP)

DPP is the number of years it takes for the present value of
inflows to equal the initial investment. Apart from giving due
importance to time value of money it serves as a reasonable
tool of risk approximation. It favors projects, which generate
substantial cash inflows in initial years, and discriminates
against those that bring in substantial inflows in later years
(risk tending to increase with tenure). Thereby implying that an
early resolution of uncertainty enables the decision maker to
take prompt corrective action by modifying/ changing other
investment decisions.
However, by the same logic it cannot be used as a principal
tool for analysis because it ignores any substantial cash flows
arising after the pay back period.

II. Internal Rate of Return (IRR)

IRR is the discount rate that equates the present value of the
expected future cash inflows to the present value of the
expected future cash outflows. It is the post tax return from
investment and hence the excess of IRR over the cost of capital
indicates a surplus after paying for the capital employed. IRR
presupposes an equivalent rate of return on the cash flows
generated during the life of the asset i.e., it assumes re-

Page 46 of 81
 investment of intermediate cash flows at the rate of return
equal to the project's IRR.
Internal rates of return are most often used as useful additions
to NPV computations. This has in turn justified the use of IRR
as a good substitute to NPV. IRRs have the merit of indicating
whether a project is worthwhile, in
that - an IRR above the cost of capital represents a positive
NPV project, an IRR equal to the cost of capital is a zero NPV
project and an IRR less than the cost of capital is associated
with a negative NPV project.
Inspite of its merits, it needs to be understood that IRRs helps
only to identify projects that maximizes the ratio of rupee-
value to rupee-capital in percentage terms. What NPV will
help in determining is the projects that maximizes the rupee-
spread between value and capital.

III. Net Present Value (NPV)

NPV is equal to the present value of cash inflows minus the
present values of cash outflows. A positive NPV is a
prerequisite for the 'acceptance' of the project.
The primary tool of appraisal would be the NPV method. Its
superiority over other methods arises out of its principal merit
of incorporating all benefits and costs occurring over the life of
the asset

IV. Profitability Index (PI)

The Profitability Index essentially measures the Present value
of benefits times the initial investment. Under unconstrained
conditions, the profitability index will accept and reject the
same projects as the NPV criterion.
It is possible that a project may have no critical risks. Or the
financial are extremely favorable (high NPV, high IRR, high
PI, low DPP etc.) and the occurrence of consequent risks may
not compromise the success of the project. It is also possible
that there is a conscious corporate decision to accept certain
risks. In such cases, no measures are required. These risks, in
any case, must be explicitly stated in the Quantitative
assessment of Risk Capital investments are essentially
committed in expectation rather than in certainty, which
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implies that investments are subject to risk contribute to
removing the shortcomings of an unstructured workings.

INTRODUCTION
The term 'Capital expenditure' refers to expenditure intended
to yield returns over a period of time, usually exceeding one
year. This basically implies that any expenditure, which results
in the creation of a new asset or substantially increases the
capacity/benefits of an existing asset and is of a "long term"
nature, should be classified as Capital expenditure.

Since, the expression 'Capital expenditure' is not exhaustively

defined, the facts of a particular case would decide whether
expenditure is capital or revenue. Generally speaking, the
expenditure should be tested on the following criteria to
facilitate classification between capital and revenue.

Expenditure would be deemed to be capital, if incurred

for

 Initiation of business

 Extension of business: Entry into new markets &

products (including R&D and regulatory expenses).

 Modification of asset/ equipment resulting in

increased benefits from the existing asset

 Bringing into existence a new asset.

 Conversely, expenditure would be deemed to be

revenue, if incurred for

 Routine repairs and maintenance of existing plant.

 Replacement of any part of the existing plant with

capacities remaining unchanged

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  Shifting of plants

 Making alterations or renovations on rented

premises

 Assets having life of less than one year

Classification Of Capital Investments

Since the analysis for appraisal of the proposed capital

expenditure will largely depend upon the kind of investment, it
is necessary to classify capital investments into the following
categories:

1) Cost Reduction, Modernisation and Rationalisation.

Expenditure to replace serviceable, but obsolete
equipment. This may become necessary because of the expiry
of normal life or change in technology. The purpose of this
expenditure is to improve productivity, increase efficiency or
reduce cost of labour, material or other items such as power.

2) Expansion of Existing Products/ Capacity

Expenditures to increase plant capacity for existing
products/equipment or enhance multi-purpose flexibility.

3) Expansion into New Products/New Product Packs

Expenditure necessary to produce new products/new product
pack. This also includes expenditure on existing facilities to
handle new products which may result in incremental
realizations / value additions.

4) New market development and Market Entry

This would include expenditure made for entering and
developing new markets. Such proposals would require the
business case to be accompanied with detailed financial
analysis.

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5) Replacement: Maintenance of Business
Expenditure necessary to replace worn-out or damaged
equipment. They are not likely to increase capacity or alter
production significantly. Capital spares are included here.

6) Quality, Good Manufacturing Practices, Safety, Health and

Environment.
Expenditures necessary to upgrade quality, compliance of
GMPs, government regulations, labour agreements, insurance
policy terms, and environmental safety requirements. Financial
evaluation/benefits from such expenditure may to the extent
quantifiable, be provided.

7) Research & Development

Expenditure on R&D projects/ equipment/ facilities. Financial
evaluation/benefits from such expenditure may to the extent
quantifiable, be provided.

8) Information Technology
Expenditure on procurement of IT infrastructure (Hardware)
and/or application software. Financial evaluation/benefits from
such expenditure may to the extent quantifiable, be provided.

9) Others
This includes office buildings, vehicles, furniture, office
equipment, InfoTech related equipment and utilities, and all
such assets, which provide infrastructures support. This also
includes any capital expenditure not explicitly covered in the
above classifications.

Capital Expenditure proposals are not applicable

for

1] Employee entitlements
Capital expenditure necessary to meet the commitments in
respect of provision of assets to the employees in terms of
personnel policies. Financial evaluation of such expenditure is
not required. Assets purchased by employees against their
hard/soft furnishing entitlements do not fall within the scope of
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 this manual and hence, will not be included here as they are per
policy.

2] Amounts less than Rs.10, 000/ $1,000

Segregation of Capex and Revenue Expenditure

Broadly, the following shall be considered as Revenue:

 All repairs to equipment in the normal course of business.
 All annual maintenance contracts (AMC) to keep the said
equipment/assets in working condition.
 All expenditures, which do not result in an
enduring/permanent benefit to the assets.
 Modification to the existing assets, which does not result in
enduring benefit, are to be treated as Revenue after taking
ratification of Technical Head of Plant.
 Piping and insulation of the nature of minor repair or
replacement.
 Re-arrangement of assets or minor structural changes for
regulatory batches.
 All accessories / dies & punches which are procured
subsequent to purchase of assets
In case of certain expenditure the treatment of which is in
doubt, the decision in this respect shall be exercised by the
Plant Account Manager in consultation with the
User/Technical Head.

Date Of Capitalisation
Date of Capitalisation would be the date when the assets is
certified by the concerned Engineering / E&F Department as
ready to use or GRN date in case of assets which do not need
commissioning (that is computers, furniture, fixtures etc.).
Authority for fixing date of capitalisation would be with E&F
department.
Lead-time between certification and Commencement of
commercial production will not normally exceeds 30 days
In case of lead-time exceeding 30 days to take specific
approvals from the Plant Head.

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Capitalization of Expenditure other than basic cost of assets
All expenditure directly related to the assets capitalized
including freight, Entry tax, Octroi, custom duty, and any such
amount, which does not form part of the original invoice, is to
be capitalized along with the relevant assets.
All installation cost, service charges and labour cost, trial run
cost (net of realizable value of the product), technician fee and
any other expenditure directly attributable to the installation.
Cenvat /CVD credits will be netted off from the cost of assets.
As per accounting standard we have to capitalise the assets net
of Modvat.
E&F department operational cost will be directly identified
with the projects or allocated to the projects on equitable basis.
For all this expenditure it is important to book at the stage of
initiation at SAP locations through the same capital internal
order number, which has been uniquely given to the Capex
proposal at the time of initiation of the particular asset.
Regarding Cenvat/ CVD credits netting off, special care is
required to be taken towards year ends to ensure meeting
technical requirements as per the Accounting Standards and
ensure maximum depreciation (including higher depreciation
allowed is accounted for on capitalization, as applicable &
there is no Cenvat (cash flow) loss.

Capex Numbering
The numbering scheme is as under
Entity/Division/Cost Center No./ Year/ Serial No. of
CEP raised by that RCC/ Running Serial No. of Capex of the
Division/ Plant, to be given by the Accounts department. In
case of Head Office, H.O will appear against division's name.

At the beginning of the year capital budget prepared by every cost

center (RCC) for the particular year in every business area. This
budget prepared every department and submitted to the division.
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Then division decided and finalized the budget and given to the
management committee for the final approval. Capital budget is
three type prepared by the company.
Divisional
Info tech
Employee entitlement
The whole process works in a very systematic manner where
firstly engineers working at operational level locate the
requirement of any new machinery. After identifying need at
operational level process of capital budgeting commence.
Currently whole Capex system is followed manually. The whole
organization is divided plant wise.
Plants located at Mohali 1 &2, Toansa, Dewas are handled
division wise. Division consists of head from each department and
they control API Manufacturing plants from one division. API
manufacturing acts as a coordinator between above 4 plants. They
are responsible for communicating reports generated by each plant
head that comes under API manufacturing to higher authorities.
For each Plant responsible cost center head are assigned who
looks after operational need. Different RCC’s are prepared
depending upon the functions.
These head can be divided into following categories
 Production
 Engineering
 Personnel/security
 Safety/ETP
 QA/QC
 Stores

For above different functions RCC’s head prepared their

requirement chart specifying
 RCC’s number

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  Description (whether production, engineering,
QA/QC)
 Classification (Replacement, Upgradation)
 Kind of expenditure (capital or revenue)
 Justification
 VED
 Quantity

RCC’s number is unique for each function. Description about

the function whether it falls in production, engineering,
personnel etc.

Revenue or capital expenditure can be further divided as per

RCC’s requirements:

CAPITAL EXPENDITURE
Regulation
GMP (Goods Manufacturing Practices)
EHS (Environment Health Safety)
Replacement
Capacity
Upgradation
Additional

REVENUE EXPENDITURE
Operating Expenses
Stores

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 Repairs Building
Repairs and Maintenance
Staff Welfare
VED is a management science tool, which is used by various
department depicting vitality of particular need raised at
operational level where
V stands for VITAL
E stands for ESSENTIAL
D stands for DESIRABLE

The above requirement chart prepared by RCC head then

consolidated by Divisional Finance Accounts Department and
budgets are prepared. For each plant this chart is prepared
where requirement of various functions are shown and also
respective RCC head gives justification. Finance department
review the expenditure type whether capital or revenue again
as it could be classified wrong by RCC head. Finance
department then modifies this chart into budget based on
Plant wise requirement
Kind of function

In plant wise requirement various excel files are prepared

which is as follows
Summery statement
Revenue expenditure
Capital expenditure
RCC wise
Similarly depending upon the functions various budgets is
prepared. Basically here for production and engineering
requirements send by RCC head is provided in plant wise
description chart but for others such as
Personnel/security

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 Safety/ETP
QA/QC
Stores

In above functions division wise budgets are also made for

example

QA/QC -> Division -> PDL

QA
Contract Manufacturing

Personnel/security -> Division -> Personnel/security

Division Management
Division Accounts

Separate budgets are prepared and then sanctioned by

respective head.
Now the budgets prepared by finance department is further
send to respective departmental head. Then plant heads,
followed by Vice President & onwards as per the Capex
amount, approves these capex’s.

As explained earlier Finance manager maintain the budget

information, following manufacturing locations of API are
catered at Mohali Division
MOHALI
TOANSA
DEWAS

After preparation of Budgets, BOD approves Capital

Expenditure by initiating CAPEX form by Plant head that is

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 appropriately signed by requisite authorities. In CAPEX Form
itself amount is classified into various categories
A. Replacement/Cost Reduction
B. Expansion into New Product/New Product Packs
C. Quality, Safety, Environmental
D. Expansion of Existing Products Packs
E. Replacement: Maintenance of Business
F. Others
All kinds of expenditure are classified into above head for API
Manufacturing for approval of Capital Expenditure

Accounting Route for API Manufacturing

Capital Expenditure
When top authorities approve the Capex requirement then an
internal order number is created by Plant department. After the
creation of internal order number finance department inform
respective accounts department about the same. On receipt of
the IO, indenter will create the purchase requisition that
subsequently go to purchase department. Purchase department
will float enquires and prepare comparative charts for at least 3
vendors. After selecting the vendor, purchase department will
place a purchase order (PO) on the vendor for supply of the
asset. In case, as per the terms of the PO, any advance is to be
given to vendor, the same is released by accounts department,
after passing the necessary entries in the vendor account under
respective business area (BA). The purchase department while
preparing the PO would ensure to mention complete name as
“RANBAXY LABORATORIES LIMITED, API
MANUFACTURING” and address/ location of delivery of the
asset. On receipt of the goods, the
Stores department will arrange to prepare the GRN and get the
same approved by the user department. On approval of the
GRN, the stores department will send the bill to accounts for

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 invoice verification. The accounts department will verify the
invoice with PO and release the balance payment to vendor.

Material Cost
The purchase requisition (PR) for domestic materials i.e. Solvents,
Chemicals and other Consumables required for project completion
will be raised by scientists after obtaining approval from the
respective head, the purchase requisition (PR) will be send to
purchase department for procurement of the material. Purchase
department will float enquires and prepare comparative charts for
at least 3 vendors. The purchase department will place the PO on
the vendor for supply of the materials. In case, as per the terms of
the PO, any advance is to be given to vendor, the same will be
released by accounts department after passing the necessary
entries in the vendor account under Business Area (BA). The
purchase department while preparing the PO would ensure to
mention complete name as “RANBAXY LABORATORIES
LIMITED, API MANUFACTURING” and address/ location of
delivery of the asset. On receipt of the goods, the stores
department will arrange to prepare the GRN and do the respective
head approve the same. On approval of the GRN, the stores
department will send the bill to accounts department for invoice
verification. The accounts department verifies the invoice with PO
and releases the balance payment to vendor. The cost of material
will be booked in the API MANUFACTURING cost center under
Business Area 1000.
In case of imported material on receipt of approved PR from the
API MANUFACTURING, purchase department, Mohali will send
the PR to international purchasing department (ID Purchase) at
Devika Tower, Delhi. The ID Purchase, while preparing the PO
would ensure to mention the complete as “RANBAXY
LABORATORIES LIMITED, API MANUFACTURING” and
address/ location of delivery of the asset.
On receipt of the material, the purchase department will arrange to
prepare the GRN and do the respective head approve the same. On
approval

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Of the GRN, the ID Purchase department will send the bill to
accounts department will only verify for invoice verification. The
accounts department will verify the invoice with PO .the
verification of Custom duty; Overseas fright etc. will be done by
ID accounts and will arrange to release the payment to vendor.
The cost of material will be booked in the API
MANUFACTURING cost center under Business Area 1000.
In the SAP system, a separate storage location (Storage Location
1075 plant 1030) for material required by API
MANUFACTURING should be created so that at any given point
the material purchased & consumed may be identified. Physically,
the capital assets as well as the materials purchased for API
MANUFACTURING should be stored in a separate storage
preferably within API MANUFACTURING storage location.

Revenue Expenditure
Apart from material, to carry on the API MANUFACTURING,
certain expenses will be incurred under various accounting heads.
These expenses either may be incurred directly by API
MANUFACTURING, or may be incurred by other locations. The
accounting of these expenses would be made as under:
The manpower i.e. lab technician and other supporting staff
working for the API MANUFACTURING should be identified.
All direct & indirect expenses incurred in connection with
recruitment, salaries, allowances and other benefits related the said
manpower be charged to the cost center for API
MANUFACTURING e.g. Repairs & maintenance of building,
AMC’s housekeeping, Horticulture, Books & Periodicals,
Conference & Meeting, training, traveling lab assistant, Gifts &
presents etc, should be charged to the cost center of API
MANUFACTURING.
Utilities cost such as Electricity, Water, Power, and Stream etc,
incurred for API MANUFACTURING, based upon the actual bills
received from the supplier. In case the utilities are provided by any
of the existing manufacturing facilities, the supply should be
monitored by separate meter/sub meter etc, and charges for the

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same based upon the actual units consumed should be debited to
the cost center of API MANUFACTURING.
The other supplies/facilities such as Telephone, Fax, Telex etc.,
should be directly in the name of API MANUFACTURING. In
case, any common facility is used, charges on reasonable basis
should be debited to the cost center of API MANUFACTURING,
Mohali. The supplies from common canteen should also be
charged on a reasonable basis i.e. linked to the number of
employees working in API MANUFACTURING. The charges for
Tea, coffee, snakes etc, consumed by API MANUFACTURING.
Guest would be charged on reasonable basis to the Cost Center of
API MANUFACTURING.
In case any materials/consumables are provided by any of the
manufacturing location to the API MANUFACTURING. A stock
transfer note will be raised on API MANUFACTURING.
Similarly if any services are provided by marketing facility to API
MANUFACTURING, cost there of at arms length basis will be
debited to the API MANUFACTURING.
Statutory Compliances (For Duties & Taxes):
[a] Excise:
1. The CENVAT credit shall not be available in respect
of the Inputs received from the vendors.
2. Transfer of any excisable inputs as such or
intermediate from manufacturing locations the same
should be on payment/reversal of appropriate duty, on
which CENVAT is not applicable
[b] Sales Tax:
1. The premises stand already declared for the purpose of
sales tax registration.
2. As no direct sale activity is involved from the
premises, hence no payment on account of sales taxes.
[c] Other taxes:
As applicable on the items procured for the purpose
(Octroi, etc.)

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SAP Programming Route For Approval Of Capex

SAP stands for System Application Products in Data Processing.

Before giving the route of SAP for Capex an introduction about
what actually is SAP
Ranbaxy is an ERP organization that uses the SAP software
system in their organization. Ranbaxy has adopted SAP R/3
version. System Application Product (SAP) is a product of
GERMANY that helps in data processing.
In this SAP software there are various modules, which deal with
different business activities.
Configuration of inventory under SAP system
In the SAP system various materials master codes are maintained
to identify the materials whether it is raw material, work in
progress, finished goods or semi finished goods. For this purpose a
7-digit code is maintained.

RAW MATERIAL 3******

PACKING MATERIAL 5******
WORK IN PROGRESS 8******
FINISHED GOODS 1******
STORE AND SPARES 4******

Material module under SAP consist of the following

 Organization structure
 Master data
 Procurement process
 Inventory management

Organization structure
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 Client
Company code
Business Area
Plant
Controlling area
Operating concern
Cost center

Client & Company Code

Client - Application-independent unit: Top level Physical structure
Client is a self-contained unit in SAP R/3 System with Separate
Master Records and its own set of tables
Company Code Represents an independent legal accounting unit,
wherein a Balance sheet, and P&L statement can be prepared.
Several company codes can be set up for each client, thus enabling
accounting data to be managed simultaneously for several
independent organizations.
Example: a subsidiary company, member of a corporate group
RANBAXY organization has different client and company codes
for its companies. Such as

Hdfc bank
Ranbaxy fine chemical LTD
Ranbaxy UK LTD

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Business Area
Line of Business: e.g. API Manufacturing, Pharmaceuticals.
An organizational entity that is not independent from a Legal
standpoint. Internal balance sheets and income Statements can be
created at Business Area level.
Business Area configured in RLL
 API MANUFACTURING
 API MARKETING
 FORMULATION MANUFACTURING
 FORMULATION MARKETING
 TRADING
 ALLIED BUSINESS
 PHARMA BUSINESS SUPPORT
 REASEARCH & DEVELOPMENT

Plant
A plant is an organizational unit within a company. A plant
produces goods; render services, or makes goods available for
distribution. A plant can be one of the following types of locations

Manufacturing facility e.g. MFG (Mohali)

Warehouse distribution center
Branch office

Controlling Area
This is organizational controlling unit. Transactions within
Controlling area is possible

Operating Concern

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Top-level logical unit in SAP. It is superset of all Cost Center,
Business Area and Controlling Area etc

Cost Center
Cost center is the smallest unit in Phase I. In SAP for handling
various costs, there are different types of cost centers. Examples,
Personal Cost Center, Amoxy Cost Center, Utility Cost Center.
For Financial purposes Cost Center are classified into various
heads such as administrative cost center, works cost center, Utility
/ Production cost center.

SAP Route
SAP functioning in the system begins by creating internal order.
Internal order number is created by finance department by using
SAP command is

Accounting -> Investment Management -> internal order ->

Master data -> special functions -> KO02

The above path command is KO02 that creates an internal order

for which following information need to be filled

General data, Applicant, Person Responsible, Processing group,

Estimated costs, Application data, Department, Control data,
System status, User status, Assignments, Company code, Business
area, Plant, Object class

To make certain changes in internal order the command is

Accounting -> Investment Management -> internal order ->

Budgeting -> Original Budget -> KO22

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In above command is used to verify the amount and text of
internal order.

The report created by finance department can be viewed by using

command S_ALR_8701301.

It is not mandatory to fill up certain fields in the internal order at

the time of its creation with the result that the cost over-runs are
not reflected automatically by SAP systems. For example, the
system provides that where the expenditure under any internal
order exceeds 2.5% of the budgeted amount, the same is reflected
in the reports.
After creating the internal order the finance manager will mail the
CAPEX amount sanctioned by higher authorities and also the
internal order number to respective Plant Head. Indenter will
indent the required material. Indenter is the person who at
operational level requires the material In SAP next step is creation
of Purchase Requisition that can further be prepared in 2 ways
Cost Center
CAPEX-IO

For the purpose of capitalization we have to focus on CAPEX

route. Here, after getting mail from finance department Plant Head
will authorizes the indenter to raise indent that is the indenter will
create Purchase Requisition. From the department the SAP route
comes to Purchase Department that in Mohali handles the
Purchase Requisition for Mohali and Toansa. In purchase
department three documents are prepared in order to raise final
PURCHASE ORDER that is initiate to supplier.

1 REQUEST FOR QUOTATION (RFQ) – Purchase Department

after receiving the Purchase Requisition will place order
depending upon requirements. In system, for different items
different staff person receives particular Purchase requisition that
is differentiated by unique purchasing group. For Example 505 is
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the purchasing group that handled Purchase Requisition for items
related to Electrical and instruments.
For each item Purchase Department is required to send RFQ to 3
vendors. Three is the minimum limit for every item but in case
where Purchase Requisition (PR) specify the brand of particular
need to be acquired, in that case only one RFQ need to send. For
example if PR specifies one LG T.V then only one RFQ need to
send to dealers dealing in LG commodities. For CAPEX PR starts
from 3000001987. RFQ is the 10-digit number. In SAP for
creating a RFQ ME41 is the command used by purchase
department. Then a applet window comes where information
regarding

RFQ type
Language key
RFQ date
Quotation deadline
RFQ
Organizational data
Purchase organization
Purchasing group
Default data for items
Item category
Delivery date
Plant
Material Group
Storage location.

Page 66 of 81
Balance sheet

  Dec ' 08 Dec ' 07 Dec ' 06 Dec ' 05 Dec ' 04
Sources of funds
Owner's fund
Equity share capital 210.19 186.54 186.34 186.22 185.89
Share application money 175.66 1.18 0.88 0.28 2.83
Preference share capital - - - - -
Reserves & surplus 3,330.92 2,350.68 2,162.79 2,190.80 2,320.79
Loan funds
Secured loans 162.07 365.07 224.29 353.49 133.37
Unsecured loans 3,563.30 3,137.96 2,954.31 676.31 2.49
Total 7,442.14 6,041.42 5,528.61 3,407.10 2,645.38
Uses of funds
Fixed assets
Gross block 2,386.75 2,261.48 2,133.57 1,799.32 1,402.79
Less : revaluation reserve - - - - -
Less : accumulated depreciation 930.07 791.96 699.54 599.35 525.21
Net block 1,456.68 1,469.52 1,434.03 1,199.97 877.58
Capital work-in-progress 428.77 327.42 301.88 432.84 264.16
Investments 3,618.03 3,237.55 2,679.95 762.78 679.07
Net current assets
Current assets, loans & advances 6,509.97 2,922.42 2,620.99 2,409.08 2,366.89
Less : current liabilities & provisions 4,571.31 1,915.49 1,508.24 1,397.56 1,542.33
Total net current assets 1,938.67 1,006.93 1,112.76 1,011.52 824.57
Miscellaneous expenses not written - - - - -
Total 7,442.14 6,041.42 5,528.61 3,407.10 2,645.38
Notes:
Book value of unquoted investments 3,372.60 3,106.69 2,659.94 762.77 679.07
Market value of quoted investments - 280.46 14.27 0.01 0.01
Contingent liabilities 252.85 201.00 159.40 202.40 307.95
Number of equity sharesoutstanding (Lacs) 4203.70 3730.71 3726.87 3724.42 1858.91

Page 67 of 81
Capital structure

From To Class Of Authorized Issued Paid Up Paid Up Paid Up

Year Year Share Capital Capital Shares (Nos) Face Value Capital
Equity
2008 2008 299.00 210.18 420369753 5 210.18
Share
Equity
2007 2007 299.00 186.54 373070829 5 186.54
Share
Equity
2006 2006 299.00 186.34 372686964 5 186.34
Share
Equity
2005 2005 299.00 186.22 372442190 5 186.22
Share
Equity
2004 2004 199.00 185.89 185890742 10 185.89
Share
Equity
2003 2003 199.00 185.54 185543625 10 185.54
Share
Equity
2002 2002 199.00 185.45 185452098 10 185.45
Share
Equity
2001 2001 150.00 115.90 115895478 10 115.90
Share
Equity
2000 2000 150.00 115.90 115895478 10 115.90
Share
Equity
1999 1999 150.00 115.90 115895250 10 115.90
Share
Equity
1997 1998 69.00 53.73 53726252 10 53.73
Share
Equity
1996 1997 69.00 49.41 49414717 10 49.41
Share
Equity
1995 1996 69.00 48.13 43132253 10 43.13
Share
Equity
1995 1996 69.00 48.13 5000000 3 1.25
Share
Equity
1994 1995 69.00 43.13 43132253 10 43.13
Share
Equity
1993 1994 69.00 35.33 35330269 10 35.33
Share
Equity
1992 1993 49.00 21.79 21793050 10 21.79
Share

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Recommendations and Suggestions for
the Indian Pharma Industry.

The achievements of the Indian pharmaceutical industry are

spectacular in recent times and are praise worthy, which has evolved
as model industry of the country in performance. But, in the 21st
century, the pharmaceutical value chain would depend on the ability
of pharmaceutical companies to make the technological shift
necessary to maintain and increase their competitive positions.
Also for the MNCs, India provides not just the possibility – but the
unique & tangible opportunity to make the desired ‘technological
shift’ – in process, and in location! The question before Pharma
Company CEOs the world over today is not: ‘Should my company go
to India?’ but ‘Can my company afford not to go to India’?”

STEPS REQUIRED TO BOOST THE COMPETITIVENESS OF

THE PHARMA INDUSTRY
 Extension of deduction of 150% of R&D expenses. This
would encourage more and more companies to invest in R&D.
 The government has earmarked 150 crores for R&D. This is just
not enough. It should be augmented to at least 2000 crores.
 To rationalize Drug Price Control Order (DPCO). The
objective of the price control was to ensure adequate availability
of quality medicines at affordable prices. The product patent
regime will make it obligatory for Indian companies to compete
in R&D if they want to survive. Similarly, WTO led global
trading system will result in import tariffs coming down. For
Indian companies to compete with cheap imports, they will have
to invest in cost effective technology and processes. Therefore,
it is imperative that the pharma industry has surplus for
investment. In this context, a liberalized price control regime
becomes more important.
 An academic –industrial relationship can be further
explored, on the lines of the US model, where the universities
are the sites of innovation and the industry commercializes the

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 product. The universities are permitted to own the Intellectual
Property Rights (IPR) and get a share of the profits. Academic
institutions will then become the engines of entrepreneurship.
This also requires setting up of greater number of centres of
academic excellence throughout India in different states, so that
people from across the country can avail of such education and
make their contributions without feeling the need to look
beyond India for achieving academic excellence.
 Income tax exemptions should be given on clinical trials and
contract research done outside the company and abroad.
This is because India is seen as emerging as a major centre for
outsourcing of clinical trials for the Pharmaceutical MNCs.

 The problem of spurious drugs has to be tackled.

 The procedure for procurement of licence should be made
more stringent, including extensive disclosure of detailed
personal, financial and business information and a
thorough background check. There is a strong need to
strengthen and streamline the Central and State Drug
Control Organizations. State drug controllers should take
measures like setting up of separate intelligence-cum-legal
machinery with police assistance. Faking should be made
non-bailable and cognizable offence and the prosecution
should be instituted by any police or Central Bureau of
Investigation officer not less than the rank of a sub-
inspector (instead of an inspector in the extant provision).
 Most of the cases relating to spurious drugs remain
undecided for years. Hence there is a strong need for
setting up separate courts for speedy trials of such
offences. The case should be tried by the court of the rank
of a Session Judge or above whereas the extant provision
provides for a trial by a metropolitan magistrate or a first
class judicial magistrate or above.
 Each state should set up accredited testing laboratories that
are well equipped and adequately staffed. The staff should
be trained well for drawing samples for test and

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 monitoring the quality of drugs and cosmetics moving in
the State. It is most important and essential to have
training programmes for technical staff of central and state
drug control laboratories and private testing laboratories as
it is based on the report of these testing laboratories that a
manufacturer releases his product or otherwise. Legal
action against the manufacturer is likely to be taken on the
basis of the test report given by a government analyst.
 India should exploit its know-how in herbal medicines. Since
these medicines do not come under the purview of the TRIPS
regime and the research in new chemical entities involves
millions of dollars of investment, the Indian companies should
engage in R&D in herbal medicine. The companies should try to
exploit the Indian traditional knowledge in ayurveda and herbal
cures and file as many patents for herbal medicine as they can.
For this the government should set up R&D laboratories
undertaking research exclusively in the area of herbal medicines
and support the companies in their research and patent filing.
 The government should encourage setting up of USFDA-
compliant plants by providing tax holidays for a specified
period (as given in regions like Baddi), so that the Indian
companies can exploit the opportunity arising out of patented
drugs and take up marketing of generics in the developed
countries like USA.

TRENDS AND STRATEGIES

The Indian domestic pharmaceutical industry is increasingly
becoming globally competitive to counter the weaknesses and threats.
The key trends and strategies being adopted by the local
pharmaceutical industry are:
Increased R&D Focus
Driven by the imminent change to a product patent regime at home
from 2005 the leading pharmaceutical companies in India have been
increasing their R&D budgets over the years. Indian pharmaceutical
companies are likely to double their expenditure on R&D over the
next 2 years.
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Page 72 of 81
Exports Driven Growth
Indian pharmaceutical companies are on a global beat. Currently,
exports contribute more than half the total revenues for most of the
Indian pharmaceutical majors. Exports have increased in recent years
as Indian pharmaceutical companies have made deep inroads into the
regulated generic markets of the US and Europe, in addition to
unregulated markets.
MNCs Showing Growing Interest in India
The share of MNCs in the Indian pharmaceuticals market is expected
to increase with the recognition of product patents in the country from
2005, as they will be able to freely introduce top of the line, patented
products in the domestic market. Moreover, with the new price
control order expected to be passed soon, DPCO coverage will be
substantially reduced and margins of most MNCs with strong brands
will drastically improve. The Indian Government’s decision to allow
100 per cent Foreign Direct Investment into the drugs and
pharmaceutical industry is expected to aid increased investment in
R&D infrastructure by MNCs in India.

Recommendations and Suggestions for Hdfc bank.

This paper describes a methodology for deriving the optimum capital
structure for an unlevered equity driven firm. Using a hypothetical
model for computing optimal capital structure, the idea is to
determine the optimum level of debt which Ranbaxy can for
maximisising its market value and shareholders wealth. Various
methods through which Ranbaxy can raise debt are:
Debentures
Debentures are loans that are usually secured and are said to have
either fixed or floating charges with them.
A secured debenture is one that is specifically tied to the financing of
a particular asset such as a building or a machine. Then, just like a
mortgage for a private house, the debenture holder has a legal interest
in that asset and the company cannot dispose of it unless the
debenture holder agrees. If the debenture is for land and/or buildings
it can be called a mortgage debenture.

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Debenture holders have the right to receive their interest payments
before any dividend is payable to shareholders and, most importantly,
even if a company makes a loss, it still has to pay its interest charges.
If the business fails, the debenture holders will be preferential
creditors and will be entitled to the repayment of some or all of their
money before the shareholders receive anything.
Other Loans
The term debenture is a strictly legal term but there are other forms of
loan or loan stock. A loan is for a fixed amount with a fixed
repayment schedule and may appear on a balance sheet with a
specific name telling the reader exactly what the loan is and its main
details.
Overdraft Facilities
Many companies have the need for external finance but not
necessarily on a long-term basis. A company might have small cash
flow problems from time to time but such problems don't call for the
need for a formal long-term loan. Under these circumstances, a
company will often go to its bank and arrange an overdraft. Bank
overdrafts are given on current accounts and the good point is that the
interest payable on them is calculated on a daily basis. So if the
company borrows only a small amount, it only pays a little bit of
interest.
Lines of Credit from Creditors
This source of finance really belongs under the heading of working
capital management since it refers to short term credit. By a 'line of
credit' we mean that a creditor, such as a supplier of raw materials,
will allow us to buy goods now and pay for them later. Why do we
include lines of credit as a source of finance? Well, if we manage our
creditors carefully we can use the line of credit they provide for us to
finance other parts of our business.
Grants
Grants can be an attractive aspect of a company's financing structure.
If a company has a specific issue that it wants or needs to deal with
then it could find that there are grants available from local councils
and other bodies that will help to pay for it.

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Venture Capital
Venture Capital has become a vital aspect of the source of finance
market over the last 10 to 15 years. Venture Capital can be defined as
capital contributed at an early stage in the development of a new
enterprise, which may have a significant chance of failure but also a
significant chance of providing above average returns and especially
where the provider of the capital expects to have some influence over
the direction of the enterprise. Venture Capital can be a high risk
strategy.
Factoring
Factoring allows you to raise finance based on the value of your
outstanding invoices. Factoring also gives you the opportunity to
outsource your sales ledger operations and to use more sophisticated
credit rating systems. Once you have set up a factoring arrangement
with a Factor, it works this way:
Once you make a sale, you invoice your customer and send a copy of
the invoice to the factor and most factoring arrangements require you
to factor all your sales. The factor pays you a set proportion of the
invoice value within a pre-arranged time - typically, most factors
offer you 80-85% of an invoice's value within 24 hours.
Leasing
Leasing is a contract between the leasing company, the lessor, and the
customer (the lessee). The leasing company buys and owns the asset
that the lessee requires. The customer hires the asset from the leasing
company and pays rental over a pre-determined period for the use of
the asset. There are two types of leases:
 Finance Leases
Under a finance lease the rental covers virtually all of the costs
of the asset therefore the value of the rental is equal to or greater
than 90% of the cost of the asset. The leasing company claims
writing down allowances, whilst the customer can claim both
tax relief and VAT on rentals paid.

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  Operating Leases
The lease will not run for the full life of the asset and the lessee
will not be liable for its full value. The lessor or the original
manufacturer or supplier will assume the residual risk. This type
of lease is normally only used when the asset has a probable
resale value, for instance, aircraft or vehicles.
The most common form of operating lease is known as contract hire.
Essentially, this gains the customer the use of the asset together with
added services. A very common example of an asset on contract hire
would be a fleet of vehicles.

Indian pharmaceutical scene is fast changing. Consumer expectations

are going up leading to more difficulties for pharmaceutical
marketing professionals. Change in the character profile of the
doctors with socio-economic changes have also affected many
pharmaceutical companies. Thus Ranbaxy should also concentrate on
following areas to strengthen market position:

Do Market Audit
The company should carryout an audit of all its activities. This
activity analyses different marketing activities and suggest the bench
mark for the company. This is a self supportive study as the
marketing audit gives lot of avenues in streamlining the operations
and cutting the cost. It also helps to remove unnecessary activities,
which may be redundant for tomorrow. This gives also an insight to
the future scenario.

Sales Management Audit and Preparation of New Sales Strategy

Sales Management plays a very important role in pharmaceutical
industry. Medical Representative or Area Manager is the key person
in improving the sales. Medical Representative and Manager, if are
not happy, and not properly directed can lead to chaotic conditions.

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Page 77 of 81
Training
Reorientation of the field force and manager is a must. Training plays
a very important role in motivating representatives as well as
managers. It helps them to sharpen their tools and develop
confidence. A series of refresher course should be organized in order
to update managers on the medical skills and the selling skills. The
net benefits of a training program may be summarized as under:

i. Confidence level of the medical representatives goes up. They

added lot of key customers whom they were not meeting earlier.
Increase in customer base with also regular visit to key
customers led to improvement in output.
ii. Improvement in strike rate – converting Non Prescribing
Potential Doctors to Irregular Prescribing Doctors Quicker.
This leads to improvement in the productivity.
iii. Training helps in accelerating productivity and overall growth
in the Company.
Morale of the people if kept high then anything can be achieved.
Today as per the study conducted in India, majority of the people
works at 40% of its energy level. A positive attitude with proper work
culture will not come only through lectures but there should be
adequate reward systems.

Optimization of Resources
Resources available today are becoming scarce. Therefore, for turning
around the company, optimization of resources does play a very
important role. The activities like rationalizing of tour programme,
defining the head quarters working norms, proper planning of input
plans like samples, gifts based on contribution, core doctors visit
analysis, application of ACE approach and input-output model led to
increase in profitability.

Page 78 of 81
 CONCLUSION

The successful strategy for Hdfc bank. in a post 2010 world will
include:
(a)Attain right product-mix
(b) Augment skills
(c)Use M&A options for either companies or products.
(d) Building ‘Innovation’ Engine at R&D
(e)Sustain growth momementum in USA.
(f) Attain critical mass in Europe and Latin America.
(g) Specialty products focus for “Brand” marketing.
(h) Fortifying home business – leverage India Base.
(i) Seeding the Japanese market.
(j) Networking, licensing and acquisitions.
(k) Technology, new market entry vehicles, brands/
proprietary products
(l) Global talent pool to fuel growth.

The increasing importance of biotech industry and its symbiotic

relationship to pharma will also be very relevant in Ranbaxy’s
strategy. However Ranbaxy should not close its eyes on the ever
increasing Global competition, which is a big threat for the company.
The entry of international and new domestic players would intensify
the competition significantly.
Further there is threat from other low cost countries like China and
Israel. However, on the quality front, India is better placed relative to
China. So, differentiation in the contract manufacturing side may
wane. The short-term threat for the pharma industry is the
uncertainty regarding the implementation of VAT. Though this is

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likely to have a negative impact in the short-term, the implications
over the long-term are positive for the industry.
The Indian pharmaceutical industry is at the center stage in the global
healthcare arena and Ranbaxy endeavors to be at the forefront in
delivering the India centric advantages to the advanced and
developing countries of the world.
From a small domestic company at inception, Ranbaxy has grown
formidably to be a Billion dollar institution that was envisioned by
Late Dr Parvinder Singh, Chairman and Managing Director, Ranbaxy
in early 90's.
It is with the unwavering ' dedication ' and the ' will to win ' of Team
Ranbaxy across the globe that Ranbaxy has traversed this journey so
far. The management feels that the next league is a greater challenge,
as the company has other milestones to achieve.
Whilst Ranbaxy continues to enhance the momentum of its generics
business in its key geographies, parallel to that it is also accelerating
its drug discovery program. The company is committed to provide
quality generics at affordable prices to the patients worldwide with a
view to help bring down the healthcare costs. Ranbaxy’s management
is confident that its efforts would see the Company emerge as a
leading player in the global generic space in the years to come.
As the company moves ahead towards its mission to become a
Research based International Pharmaceutical Company. The
management believes that, it is the spirit of Team Ranbaxy that would
enable Ranbaxy to reach out to Vision 2012

Page 80 of 81
 Bibliography
 WEBSITES:-
- www.ranbaxy.com
 ONLINE JOURNALS:-
- Cygnus Business Consulting & Research
Indian Pharmaceutical Industry-Oct-Dec 2008

- FICCI Report for National manufacturing

Competitiveness Council (NMCC)
 BOOKS:-
- Financial Management
(ICFAI University)
- Financial Management
(Fourth edition)
By M.Y.Khan & P.K.Jain
(Tata McGraw Hill Publishing Company Ltd.)
- Financial Management
(Sixth edition)
By Prasanna Chandra
(Tata McGraw Hill Publishing Company Ltd.)
- Financial Management
(Fourth edition)
By Ravi M Kishore

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