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Financial leverage as the balance sheet polluter b.v.raghunandan

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Financial leverage as the balance sheet polluter b.v.raghunandan

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Deals with debt as a toxic option and the virtues of equity shares rediscovered by venture capital. It also shows how hollow the benefits of financial leverage and what an outdated concept it is.

Deals with debt as a toxic option and the virtues of equity shares rediscovered by venture capital. It also shows how hollow the benefits of financial leverage and what an outdated concept it is.

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Financial leverage as the balance sheet polluter b.v.raghunandan

  1. 1. Financial Leverage: the Balance Sheet Polluter -B.V.Raghunandan Department of Commerce, Poornaprajna College, Udupi September 8, 2015
  2. 2. Leverage • Leverage: Having debt in the capital structure of a company • In 1950s and 60s, it was considered to be a magical act through comparison of leveraged company and a non-leveraged company • Effect was considered for profitable companies and non-profitable companies were ignored
  3. 3. Rationale for Acceptance • High corporate taxes caused reduced tax incidence as interest on debt was a business expense • Promoters’ Control was not diluted as debt did not carry voting rights • Equity form of finance like venture capital emerged later • The concept of risk management also emerged later
  4. 4. Reality Check • During a long gestation period of heavy industries and infrastructure projects, it becomes toxic • For the industry having a huge capital cost and huge running expenses like civil aviation, it is devastating • When unexpected risks exist, the tables will turn very quickly • Prolonged trade cycles like mining and metal industries
  5. 5. Warning • Sharia held debt to be a sin • Shakespeare maintained, "never a lender nor a borrower be” and also depicted the cruelest aspect through the character of Shylock in Merchant of Venice • Financial Management considered both equity and debt to be the components of capital structure • Never considered the repayment programme, cautions, warning signals etc as an important exercise
  6. 6. A Carefree World • Corporates did not learn the lesson leading to the development of art and science of bankruptcy • Individuals and families were encouraged to over-borrow like housing finance, consumer finance, finance for hospital bills, student loans • Questionable methods employed for recovery including foreclosure • Credit card booms • Empty houses and homeless population
  7. 7. Banks: the uninnovative bureaucrats • Since 2003, after the reverse merger of ICICI into ICICI Bank, commercial banks started development finance also • However, it was in the form of Long Term Loans rather than in the form of subscribing to equity shares • Eventually, the loans get converted into equity as a part of Strategic Corporate Debt Restructuring • Loan targets are given to bank managers forcing them to find borrowers
  8. 8. Revival of Equity Culture • A more mature and developed primary market and stock market • Reduced corporate tax rates • Emergence of venture capital and private equity fund • Contribution of HNI and Angel Investors • A Systematic Risk Management and Popularity of debt-free capital structure • Basel Norms for Banks
  9. 9. Rationale for Equity Shares • No need to pay dividend in the absence of profit • Even in the presence of profit, a growth oriented company does not declare dividend • No need to pay dividend during gestation period • Large body of investors to share the losses • Equity shares are the cheapest source of finance • Shareholder Loyalty for other projects and group companies • Huge funds can be raised through IPOs and FPOs • Share Premium as another cheap source of finance • Listed companies having access to cheaper foreign funds
  10. 10. The Fallen Empire-DLF Limited • 1946-Chaudhry Ragvendra Singh promoted • Developer of residential and other complexes in Delhi until 1957 • 1957-Delhi Development Authority banned private developers • It went out to Gurgaon in Haryana to develop a city
  11. 11. IPO Details of DLF Ltd. • 2007-IPO made • 17.5 crore shares of Rs.2 through book-building • Cut-off Price Rs.525 • Face Value of Shares: Rs.35 crore • Share Premium: Rs.9,152.5 crore • Share Price went upto Rs.1000 in 2008
  12. 12. Falling Down from Grace • Forays into Capital Intensive expansion • Hospitality Industry • Wind and other power business • Extensive Borrowings • Debt: Rs.19000 crores • Questionable Trade Practices
  13. 13. Correlation between Interest and Profit of DLF Ltd.(Figures in Rs.Crore) Year Sales Interest Profit 2007-08 14433 310 7,847 2008-09 10,035 555 4,497 2009-10 7,423 1,110 1,709 2010-11 9,560 1,706 1,638 2011-12 9,629 2,246 1,169 2012-13 7,773 2,314 663 2013-14 8,298 2,463 582
  14. 14. Alternative • FPO at the cut-off price of IPO could have brought in a huge amount of cost-free funds • It would have saved the interest • More meaningful diversification • Taking care of quality of building in Gurgaon and maintaining the customer relation
  15. 15. THANK YOU

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