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    CORPORATE FINANCE

    RELIANCE CAPITALGroup-2

    Ankit Chadha, Gaurav Vijay Shah, Mohit Dhand,

    Sandeep Aggrawal, Tamal Taru

    12/9/2009

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    Contents:

    1.Acknowledgement 1

    2.History of the Company 2

    3.Overview of the Company 2

    4.Objective of study 3

    5.Methodology 3

    6.Cost of Equity 3

    6.1.Calculation of Beta 4

    6.2.Calculation of Market Return 4

    6.3.Risk free rate of return 4

    7.Cost of Retained Earnings 5

    8.Cost of Debt 5

    8.1.Bank loans 5

    8.2.Debentures 6

    9.Cost of Preference Capital 7

    10.Weighted Average Cost of Capital 811.Problems in calculation cost of capital

    12.Findings

    13.Bibliography

    14.Appendix

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    Acknowledgement

    At the successful completion of our project, we would like to express our sincere gratitude

    to all the people without whose support this project would not have been completed.

    At the onset, we would like to thank our institute FORE School Of Management for giving

    us the opportunity to undergo this project.

    We would also like to acknowledge the constant help and encourage ment of our Corporate

    Finance-I faculty Prof. Vineet Gupta , who has given his valuable suggestions, expert

    guidance and support.

    We would also like to thank all those who have directly or indirectly helped us in the

    preparation of this report.

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    History of Reliance Capital:

    Reliance Capital Limited was incorporated in year 1986 at Ahmedabad in Gujarat as Reliance

    Capital & Finance Trust Limited. The name RCL came into effect from January 5, 1995. In

    2002, RCL shifted its registered office to Jamnagar in Gujarat before it finally moved to

    Mumbai in Maharashtra, in 2006.In 2006, Relia nce Capital Ventures Limited merged with

    RCL and with this merger the shareholder base of RCL rose from 0.15 million shareholders to

    1.3 million.RCL entered the Capital Market with a maiden public issue in 1990 and in

    subsequent years further tapped the capital market through rights issue and public issues.

    Presently the shares are listed on The Stock Exchange Mumbai and the NSE of India.

    Overview of the business:

    Reliance Capital, a constituent of S&P CNX Nifty and MSCI India, is a part of the Reliance Anil

    Dhirubhai Ambani Group and is one of India's leading, most valuable and fastest growing

    privates sector financial services companies. RCL in the initial years engaged itself in steady

    annuity yielding businesses such as leasing, bill discounting, and inter -corporate deposits.

    Later, in 1993 diversified its business in the areas of portfolio investment, lending against

    securities, custodial services, money market operations, project finance advisory services,

    and investment banking. Reliance Capital has a net worth of Rs. 7,669 crore (US$ 1.6 billion)

    and total assets of Rs. 25,606 crore (US$ 5 billion) as on September 30, 2009.

    Business mix of Reliance Capital

    Area Business

    Asset Management Mutual Fund, Portfolio Management, Offshore Fund

    Insurance Life Insurance, General Insurance

    Consumer Finance Mortgages, , Loans against shares, Vehicle & Business Loans

    Broking and

    Distribution

    Stocks Commodities and Derivatives, Wealth Management Services,

    Portfolio Management Services, Investment Banking, Foreign

    Exchange and Offshore Investment, Third Party Products

    Other Businesses Asset Reconstruction, Institutional Broking, Private Equity, Exchanges

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    Subsidiary companies forming part ofconsolidated financial statement of Reliance Capital

    Ltd

    1 Reliance Capital Asset Management Ltd.

    2 Reliance Capital Trustee Co. Ltd.

    3 Reliance General Insurance Company Ltd.

    4 Reliance Gilts Ltd.

    5 Reliance Asset Management (Mauritius) Ltd.

    6 Reliance Asset Management (Singapore) Pte. Ltd.

    7 Reliance Money Express Ltd.

    8 Medybiz Pvt. Ltd.

    9 Net Logistics Pvt. Ltd.

    10 Reliance Capital Research Pvt. Ltd.

    11 Reliance Technology Ventures Pvt. Ltd.

    12 Reliance Equity Advisors (India) Ltd.

    13 Reliance Capital Asset Management (UK) Plc.

    14 Reliance Capital Markets Pvt. Ltd.

    15 Reliance Equities International Pvt. Ltd.

    16 Reliance Home Finance Pvt. Ltd.

    17 Reliance Capital Services Pvt. Ltd.

    18 Reliance Capital (Singapore) Pte. Ltd.

    19 Reliance Consumer Finance Pvt. Ltd.

    20 Reliance Securities Ltd.

    21 Reliance Prime International Ltd.

    22 Reliance Commodities Ltd.

    23 Reliance Financial Ltd.

    24 Reliance Alternative Investments Services Pvt. Ltd.

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    Objective of study:

    To calculate the cost of capital of Reliance Capital Limited

    Methodology:

    yCost of equity is calculated by the Capital Asset Pricing Model (CAPM)

    yCost of retained earnings is calculated same as the cost of equity

    yCapital structure as on 31 st march, 2009 has been determined from information

    taken from annual report 2008-09

    yData related to share prices and market indexes is taken from various sources like

    Capitaline database, www.bseindia.com, www.moneycontrol.com,

    www.money.rediff.com

    yRisk Free rate of return has been taken from http://www.rbi.org.in/

    yDaily share prices of Reliance Capital ltd from SENSEX has been collected for the past

    95 months from 1-1-2002 to 31-03-2009

    yCost of capital has been calculated by weighted average method

    Cost of equity:

    Firms raise equity capital by issuing shares. The shareholders required rate of return

    which equates the present value of the expected dividends with the market value of the

    shares is the cost of equity.

    We have calculated the cost of equity by CAPM based approach which takes into

    consideration three parameters:

    yRisk free rate - Rf

    yMarket return - Rm

    yBeta (Measure of risk) -

    The formula is

    Re = Rf+ ( Rm - Rf)

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    We have collected the share prices of Reliance Capital ltd and BSE SENSEX from Capitalline

    database. By using MS Excel we have calculated the percentage rate of returns on daily

    basis for both of them.

    Calculation of Beta ():

    We applied regression for calculating the value of Beta by taking percentage return of

    market as the independent variable and the percentage return of security as the dependent

    variable.

    The Beta () was found to be 1.521

    Calculation of Market return:

    We have calculated the market return by calculating average daily return on SENSEX for a

    period of 95 months and then multiplied it with 250. W e have taken 250 as average numberof trading days in an year during which stock market is open for trading of shares. It comes

    out to be:

    =0.074893 * 250

    = 18.72314

    Risk free rate of return (R f):

    For calculating the risk free rate of return, we have taken three government securities of

    more than six years of different coupon rates from the website of Reserve Bank of India.

    First we calculated the average of yields for a period of 5 years for each security and then

    calculated the average of these three average yields. Hence, R fis calculated to be 7.732%

    Cost of Equity:

    Substituting the values of R f, Rm and in the formula we get;

    Particulars Value

    Cost of equity 24.6369847

    Market return 18.72314

    Risk free rate of return 7.372

    Beta 1.52099089

    Re = 7.732 + 1.521(18.72314 7.732) = 24.64%

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    Cost of retained earnings:

    Theoretically, the cost of retained earnings is calculated same as the cost of equity using the

    formula

    Re = Rf+ ( Rm - Rf)

    But the cost of external equity is more than cost of retained earnings due to the presence of

    flotation cost. These costs include fees paid to merchant bankers, underwriting commission,

    administrative cost, etc.

    Cost of retained earnings = cost of externa l equity *(1- flotation cost)

    However, due to the unavailability of data about the floatation cost, cost of retained

    earnings is considered to be equal to the cost of equity.

    And hence, cost of retained earnings, Re = 24.64 %

    Cost of debt:

    The firms raise the capital in the form of debts from debenture holders, banks, financialinstitutions, subscribers to commercial paper, etc. and pay them a fixed rate of return.

    This interest rate the company pays on all of its debt is called as the cost of debt.

    i. Bank loansThe amount of the loan which the company has borrowed has been taken from Schedule C

    of the Consolidated Balance Sheet of the Annual Report 2008 2009. The interest paid on

    this loan is got from Schedule L of the Annual Report 2008 2009. It is reported to be:

    Bank loan amount = short term + long term loans = Rs.7023.09 crores

    Long term bank loans = Rs 1855.56 crores

    Interest on bank loans = Rs 595.41

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    Out of the total term loans, Rs. 598 crore is payable within a year as found from the notes to

    the account. Other short term sources of finance were commercial papers, unsecured bank

    loans and short term loans. This cannot be considered as a part of cost of loan because it is

    of short term nature. So this should be deducted from the total loans. The interest is

    calculated for the whole amount of term loans so it should be proportionately reduced.

    We have also included working capital loans in the bank loans. Working Capital Loans have

    reduced from 1378.24 crore in 2007-08 to 1010.29 crore in 2008-09. This can be concluded

    from the fact that some part of the loan has been repaid during the year. Still company is

    using Working Capital Loan for a period more than 1 year. Company might be using roll over

    facility of bank. Therefore, we are taking this amount as a long term source of capital

    Proportion of long term in total bank loans = 26.41 %

    Interest = 595.41 * 26.41 %

    = Rs. 157.27 crore

    Cost of term loan = Long term interest * (1 t)

    Long term loan amount

    Where t = tax rate.

    The corporate tax rate is 33.99%.

    So now by substituting the values, we get

    Cost of term loan = 157.27 * (1 - 0.3399)

    1855.56

    = 5.60%

    ii. Debentures:Cost of debenture is calculated on long term debentures. In the year 2007 -08 NCD were

    884.32 which rose to 1181.90 in 2008 -09. Long term debentures issued by the company are

    repaid in year 2008-09, whereas new debentures issued are of short tenure i.e. 360 days

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    which we found out from information memorandum submitted by RCL with SEBI. So we are

    taking proportion of debentures in capital structure to be zero. Hence, the cost of

    debentures is also zero.

    So, our total cost of debt comes out to be 5.60 %

    Cost of preference capital:

    Company is having a authorized preference capital of Rs 100 crores. But there are no

    preference shares issued by the company till now, so when we are calculating our cost of

    capital we will consider the cost of preference capital to be zero.

    Hence we tabulate the results found so far:

    The total capital raised by the company is:

    Particulars Amount (in crore)

    Equity Capital 246.16

    Retained Earnings 7207.00

    Preference Capital 0.00

    Debt 1855.56

    Total 9308.72

    Particulars (In %)

    Cost of equity (Ke) 24.63

    Cost of retained earnings 24.63

    Cost of preference capital (Kp) 0

    Cost of debt (Kd) 5.60

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    Proportions of respective capital are:

    Particulars Weight

    Equity Capital 0.0264

    Retained Earnings 0.7742

    Preference Capital 0.00

    Debt 0.1993

    Weighted Average Cost of Capital (WACC):

    Company finances its project by raising capital from different sources based on factors like

    cost of capital, ease of raising capital, market condition, etc. Capital structure have different

    components i.e. Debentures, equity shares, preference shares and loans. The component

    costs are multiplied by the weights of the various sources of capital to obtain the weighted

    average cost of capital. The composite or overall cost of capital is the weighted average of

    the costs if various sources of funds, weights being the proportions of each source of funds

    in the capital structure. WACC is calculated as:

    1.Cost of the specific sources of funds is calculated.

    2.The cost of each source is multiplied by its proportion in the capital structure.

    3.The weighted component costs are added to get the firms weighted average cost of

    capital.

    WACC = Equity Proportion * Ke + Retained earnings proportion * Ke + Preference

    stock proportion* Kp +Debt proportion*Kd

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    Weighted component cost:

    Particulars Value

    Equity Capital 0.65

    Retained Earnings 19.069

    Preference Capital 0.00

    Debt 1.12

    WACC 20.84

    So, the Weighted Average Cost of Capital for Reliance Capital Limited comes out to be

    20.84 % as on 31 March 2009.

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    Problems and limitations in calculation of Cost of Capital

    yFlotation cost was not known which we required in the calculation of cost of

    retained earnings

    yLimitation of CAPM lies in the assumptions taken.

    yCoupon rates as well as terms of loans were not available.

    yNo information about working capital loans

    yInterest was given for all the loans together.

    Findings

    y Major part of the capital structure is retained earnings. This shows that company is

    using its own funds to finance its projects and do not rely much on outside debt. Thisalso reduces the chance of bankruptcy. This can also be due to ability of company to

    generate returns upto expectations of shareholders.

    yRCL has less equity as compared to debt. Company has included debt to get the tax

    benefit on interest paid which reduces the cost to company. Company might be

    using debt to increase the return to shareholders.

    yPreference stock was not there in their capital structure. Debentures issued by the

    company were short term as interest rates were high, company may not want to

    carry the burden for a long period.

    yCost of retained earnings and equity was equal.

    yLoans have smallest cost whereas cost of equity as well as retained earnings was the

    largest. From this we can conclude that cost of retained earnings is not zero and cost

    of debt is smallest. This does not implies that company should include high debt in

    its capital structure. Cost of debt increases with increase in proportion of debt in the

    capital structure as credit rating of company falls due increase in financial risk of the

    company

    yCost of capital of Reliance capital Limited is 20.84%

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    Bibliography

    1.http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/FHB100909_Full.pdf , November

    28,2009

    2.http://www.madaan.com/taxrates.htm, December 02,2009

    3.http://www.bseindia.com, November 27, 2009

    4.http://www.moneycontrol.com, November 27, 2009

    5.http://www.money.rediff.com, November 27, 2009

    6.http://www.reliancecapital.co.in/idf_areports.html , December 03, 2009

    7.http://www.reliancecapital.co.in/idf_qresults.html, December 03, 2009

    8.http://bseindia.com/downloads/ipo/200931814558Information%20Memorandum%20RCL%20NCD%20Listing2009.pdf,November 30, 2009

    9.Pandey, I. M. Financial Management: Vikas Publishing House Pvt. Ltd, 1995

    10.Srivastava Rajiv, and Misra Anil. Financial Management: Oxford University Press,

    2009

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    Appendix

    1.Calculation Of Beta

    Regression Statistics

    Multiple R 0.7091645

    R Square 0.5029143

    Adjusted R Squ 0.5026398

    Standard Error 2.5658485

    Observations 1813

    ANOVA

    df SS MS F gnificance F

    Regression 1 12062.6622 12062.66 1832.235 3.5E-277Residual 1811 11922.8603 6.583578

    Total 1812 23985.5225

    Coefficientstandard Erro t Stat P-value ower 95% pper 95%ower 95.0 pper 95.0%

    Intercept 0.0574583 0.06031914 0.952572 0.340934 -0.06084 0.175761 -0.06084 0.175761

    X Variable 1 1.5209909 0.03553334 42.80461 3.5E-277 1.4513 1.590682 1.4513 1.590682

    2.P 84 and P89 of Annual report of Reliance Capital Limited 2008-09

    3.Calculation of Risk free rate of return:

    Y

    L

    ecuritie s 2004-0 200 -0 200 -0 200 - 08 2008- 09 A era

    e

    8.0

    20 .4 .22 .8 .93 .29 .328

    . 9

    20 .39 .29 .9

    .99 . 4 .432

    .2

    20

    .4

    .23 .9 8.03 .

    .3

    a

    era

    e .3 2