Capital Structure & Financial Leverage Analysis of Software Industry : Group No. 6: Anuj Surana Gautam Malhotra Karan malhotra Kush Shrimali Nidhi Mittal Soumik Mitra

Group No. 6:

Anuj Surana

Gautam Malhotra

Karan malhotra

Kush Shrimali

Nidhi Mittal

Soumik Mitra

OBJECTIVES OF THE STUDY: To study as to why the Capital Structure of Software Companies is different from other Industries. To study the reasons as to why software companies are not using component of Debt Capital to financially leverage their Earnings.

To study as to why the Capital Structure of Software Companies is different from other Industries.

To study the reasons as to why software companies are not using component of Debt Capital to financially leverage their Earnings.

Capital Structure: Capital Structure is the mixture of sources of funds a firm uses. Sources of Funds : Debt Preferred stock Common Stock A firm with a lot of debt in its Capital Structure is said to be highly levered.

Capital Structure is the mixture of sources of funds a firm uses.

Sources of Funds :

Debt

Preferred stock

Common Stock

A firm with a lot of debt in its Capital Structure is said to be highly levered.

Comparison: Company Name Equity Share Capital Retained Earnings Debt capital (S.L. + U.L) Debt-Equity Ratio Infosys Technologies Pvt. Ltd. 2860 132040 0 0 Satyam Computer Services Pvt. Ltd. 1359 72217 236 0.04 Tech Mahindra Ltd. 1214 11070 950 0.08 WIPRO Ltd. 3503 112604 38224 0.33 HCL Technologies Ltd. 1350 30800 253 0.01

Financial Leverage: Financial leverage occurs whenever a firm finances with interest-bearing debt. It occurs due to the Fixed Interest Charge. To ascertain whether management is able to earn more on the debt funds than the funds cost. If a firm does not have any interest-bearing debt financing, then it does not have any financial risk and cannot realize financial leverage.

Financial leverage occurs whenever a firm finances with interest-bearing debt.

It occurs due to the Fixed Interest Charge.

To ascertain whether management is able to earn more on the debt funds than the funds cost.

If a firm does not have any interest-bearing debt financing, then it does not have any financial risk and cannot realize financial leverage.

Comparison: Particulars Infosys Satyam Tech Mahindra WIPRO HCL EBIT 4417 2222 7658 32596 10090 (-) INT (0) (6) (283) (1168) (249) PBT 4417 2216 7375 31428 9841 DFL 1 1.003 1.038 1.037 1.025

Company Quick Assets Current Liabilities Quick Ratio (2007-08) Quick Ratio (2006-07) Quick Ratio (2005-06) Infosys 1,23,260 37,310 3.30 4.5 2.96 Satyam 74,511 14,467 5.15 5.76 6.18 Tech Mahindra 14,880 6,342 2.35 2.25 2.18 WIPRO 120,581 33,616 3.58 3.15 2.89 HCL 28,581 18,218 1.57 1.89 1.46

How Much Cash Does Your Company Need? HBR Article by Richard Passov. He proposes that Traditional Capital Structure model should account for complications faced by companies in Knowledge Based Industries. Knowledge-Intensive Companies experience relatively high volatility of their intangible assets. Reasons for High Volatility: Assets are company specific & require considerable investment to exploit, Intangible assets cannot be hedged.

HBR Article by Richard Passov.

He proposes that Traditional Capital Structure model should account for complications faced by companies in Knowledge Based Industries.

Knowledge-Intensive Companies experience relatively high volatility of their intangible assets.

Reasons for High Volatility:

Assets are company specific & require considerable investment to exploit,

Intangible assets cannot be hedged.

How Much Cash Does Your Company Need? These Intangible assets cannot be easily valued and are more vulnerable to financial distress than firms with preponderance of tangible assets. To ensure against this Risk, Knowledge Intensive Firms need to maintain large positive Cash Balances. Also, only by investing in their intangible assets can knowledge-based industries hope to preserve the value of these assets. In a nutshell, the business risk of these firms is really HIGH.

These Intangible assets cannot be easily valued and are more vulnerable to financial distress than firms with preponderance of tangible assets.

To ensure against this Risk, Knowledge Intensive Firms need to maintain large positive Cash Balances.

Also, only by investing in their intangible assets can knowledge-based industries hope to preserve the value of these assets.

In a nutshell, the business risk of these firms is really HIGH.

REASONS FOR NOT USING LONG-TERM FUNDS: Software Firms don’t require much Long-Term Funds once they have initiated their operations. Their Business Risk is high. Thus, to reduce their overall risk, they like to minimize their Financial Risk. Internal Accruals & Internal Cash Flows funds their Operations. They want to ensure High Liquidity as it enables them to make rapid shifts.

Software Firms don’t require much Long-Term Funds once they have initiated their operations.

Their Business Risk is high. Thus, to reduce their overall risk, they like to minimize their Financial Risk.

Internal Accruals & Internal Cash Flows funds their Operations.

They want to ensure High Liquidity as it enables them to make rapid shifts.

Observations from the Study: Software Firms maintain more of Cash Balances as their require short term funds. These Firms are not directly impacted by changes in Monetary Policy. To reduce their overall risk, they maintain huge cash balances. Capital Structure depends on the Nature of Industry. Service industry normally does not leverage their earnings financially. It cannot be taken as a rule of thumb, as many organizations have raised External Long-Term funds.

Software Firms maintain more of Cash Balances as their require short term funds.

These Firms are not directly impacted by changes in Monetary Policy.

To reduce their overall risk, they maintain huge cash balances.

Capital Structure depends on the Nature of Industry.

Service industry normally does not leverage their earnings financially.

It cannot be taken as a rule of thumb, as many organizations have raised External Long-Term funds.

Exception: Bidding of Axon Two major bidders: Infosys & HCL Technologies Pvt. Ltd. Difference in Structure of Financing. Infosys: Bid Amount: £ 407 million To be raised through: Cash Reserves. HCL Bid Amount: £ 441 million To be raised through: £400-million loan commitment from Standard Chartered @ 6.5%.

Bidding of Axon

Two major bidders: Infosys & HCL Technologies Pvt. Ltd.

Difference in Structure of Financing.

Infosys:

Bid Amount: £ 407 million

To be raised through: Cash Reserves.

HCL

Bid Amount: £ 441 million

To be raised through: £400-million loan commitment from Standard Chartered @ 6.5%.

Hidden Benefit(HCL): Infosys would lose 10 % interest that it would have earned, had the Cash been with the Bank. HCL would be paying 6.5 % interest to Standard Chartered to raise the amount. Thus, HCL had a 3.5 % advantage over Infosys. The term of the loan was 2.5 years. Hence, it had a total advantage of 8.75 % over Infosys. This allowed HCL to raise their Bid Amount to £ 441 million, 8.3 % higher than Infosys. HCL’s current Debt- Equity Ratio is 0.65:1

Infosys would lose 10 % interest that it would have earned, had the Cash been with the Bank.

HCL would be paying 6.5 % interest to Standard Chartered to raise the amount.

Thus, HCL had a 3.5 % advantage over Infosys. The term of the loan was 2.5 years. Hence, it had a total advantage of 8.75 % over Infosys.

This allowed HCL to raise their Bid Amount to £ 441 million, 8.3 % higher than Infosys.

HCL’s current Debt- Equity Ratio is 0.65:1