IBS HYDERABAD

Academic Year: - 2023-2025

Name: Mohammed Kaif Khan

Enrollment No: 23BSPHH01C0401
Section: H
Seat No: 42
Email ID: [email protected]

FINANCIAL MANAGEMENT – 1
PROJECT - COST OF CAPITAL

HINDUSTAN MACHINE TOOLS LIMITED (HMT)

 EXECUTIVE SUMMARY

HMT Ltd is a renowned entity in the Indian manufacturing sector with a rich heritage spanning nearly
seven decades. The company operates across diverse segments, including machine tools, tractors,
watches, and engineering products, and has evolved its strategy to adapt to a dynamic market
landscape.

Examining the financial performance reveals a mixed picture. While HMT Ltd has displayed improved
profitability in recent years due to cost control and operational enhancements, the high debt burden
remains a concern. Over the past 5 years, HMT Ltd has faced both challenges and opportunities. The
company has experienced revenue fluctuations driven by changes in demand and market dynamics.
HMT's financial performance has been mixed in recent years. The company's revenue has declined
from Rs. 1,500 crore in 2018-19 to Rs. 1,100 crore in 2022-23. This decline in revenue has led to a
corresponding decline in profitability. HMT's net profit has declined from Rs. 100 crore in 2018-19 to
Rs. 50 crore in 2022-23.
HMT Ltd, despite being a prominent player historically in the Indian manufacturing sector, has faced
several challenges that have contributed to its financial difficulties over the years.

Here are some key reasons for these financial difficulties:

1.Obsolete Technology: HMT Ltd's core business in machine tools and watches was affected by the
rapid advancement of technology. The company struggled to keep up with modern manufacturing
techniques and faced competition from more technologically advanced and efficient global players.
2. Increased Competition: The Indian manufacturing landscape became increasingly competitive with
the entry of domestic and international competitors. HMT Ltd, once a market leader, had to contend
with a crowded marketplace, which often led to price wars and reduced profit margins.

3. High Debt Levels: Accumulation of significant debt, often used for expansion and working capital
requirements, strained the company's financial position. High-interest payments added to the financial
burden and reduced profitability.
4. Inefficient Management: Inefficient management practices, including poor resource allocation and
strategic planning, hindered the company's ability to navigate challenges effectively.
 Cost of capital (wacc)

● The cost of capital formula computes the weighted average cost of securing funds
from debt and equity holders.

● Knowing the cost of capital is vital for financial decision-making. It helps evaluate a
company’s capital structure components (debt, preference shares, equity) based on
their proportions.

● Calculating the weighted average cost of capital is crucial for making critical financial
decisions such as leverage, dividends, and capital structure

To determine the cost of capital, business leaders, accounting departments, andinvestors must
consider three factors: cost of debt, cost of equity, and cost ofpreference shares.
 Cost of Debt
While debt can be detrimental to a business’s success, it’s essential to its capital structure.
Cost of debt refers to the pre-tax interest rate a company pays on its debts, such as
loans, credit cards, or invoice financing. When this kind of debt is kept at a manageable
level, a company can retain more of its profits through additional tax savings.

Calculation:- The cost of debt of the chosen company is to be estimated as the ratio of
the“Financial Expenses” of a company and “Interest Bearing Debt Funds”.

● Financial Expenses :- In the P&L statement of the company as a Finance Cost.

● Interest Bearing Debt Funds :- includes all the current and non-current
financialliabilities except Trade payables.

Years 2023 2022 2021 2020 2019

Long Term Borrowings 2.41 0 0.36 2.55 1.98

Short Term Borrowings 641.72 641.61 0 0 0

Finance Costs 0.13 8.5 17.3 0.02 0.29

Average Cost of
Years 2023 2022 2021 2020 2019 Debt
Cost of Debt (PreTax) 0.020182 1.324792 4805.556 0.784314 14.64646 964.4662617

Note: Cost of Debt will be adjusted for the tax while calculating the WACC by Multiplying
[INTrate (1-Tax Rate)]

Cost of Equity
Equity is the amount of cash available to shareholders as a result of asset liquidationand
paying off outstanding debts, and it’s crucial to a company’s long-term success. Cost of
equity is the rate of return a company must pay out to equity investors. Itrepresents the
compensation that the market demands in exchange for owning anasset and bearing the
risk associated with owning it.
The cost of equity can be calculated by:-

CAPM (Capital Asset Pricing Model) method:-

The Capital Asset Pricing Model (CAPM) is a model that describes the relationship
between the expected return and risk of investing in a company's stock. It is based on the
idea of systematic risk (also known as non-diversifiable risk) that investors need to be
compensated for in the form of a risk premium. A risk premium is a rate of return greater
than the risk-free rate.

CAPM is to evaluate whether a stock is fairly valued when its risk and the time value of
money are compared to its expected return. It is widely used for pricing risky securities and
generating expected returns for assets given the risk of those assets and cost of capital.

[Cost of Equity = Risk-Free Rate of Return + Beta × (Market Rate of Return - Risk-Free Rate
of Return)]

Cost of Capital
Equity Rf + Beta(Rm - Rf) 0.132406018
Debt Int Rate (1 - Tax Rate) 0.018912816

The Company has not issued any Dividend in 12 YEARS

Cost of Preference Stocks

Preferred stock is a form of equity that firms issue in order to raise funds. Legally, itis
regarded as equity, but its characteristics are more similar to bonds.

Preferred equity owners get paid prior to common stock owners and the dividend
rates remain the same.

Note:- NO preferred stocks are provided by the company HMT Ltd.

WACC
The weighted average cost of capital (WACC) is the most common method for calculating
the cost of capital. It equally averages a company’s debt and equity from all sources.
WACC is calculated by multiplying the cost of each capital source (both equity and debt)
byits relevant weight by market value, then adding the products together to determine
the total. The formula is:

➔ WACC = (E/V x Re) + ((D/V x Rd) x (1 – T))

Here’s a breakdown of this formula’s components:

● E: Market value of firm’s equity

● D: Market value of firm’s debt
● V: Total value of capital (equity + debt)
● E/V: Percentage of capital that’s equity (Weight)
● D/V: Percentage of capital that’s debt (Weight)
● Re: Required rate of return
● Rd: Cost of debt
● T: Tax rate

Cost of
Book Value Weights Capital
Equity 1.347130376 0.132406018
Debt -0.347130376 0.018912816
WACC 0.171802956

Cost of
Market Value Weights Capital
Equity 0.533015913 0.132406018
Debt 0.466984087 0.018912816
WACC 0.079406499

CONCLUSION
HMT Ltd. is a company with a strong brand presence and a long history of operation.
However, the company has faced significant financial challenges in recent years. HMT needs
to address these challenges and capitalize on its opportunities in order to achieve
sustainable growth and profitability.