CHAPTER -1

INTRODUCTION

1
1.1 Meaning of capital structure/financial leverage

The term capital structure refers to the mix of different types of securities (long-term debt,
common stock, preferred stock) issued by a company to finance its assets. The capital
structure refers to the way that a firm finances its assets through some combination of
financing sources. The first choice is internal financing which is the using of profit or retained
earnings as a source of capital for new investment. The second choice is external financing
which is the usage of new money, such as equity, debt, hybrid securities, form outside of the
firm brought in for investment. Based on different kinds of financial decisions, the capital
structures of firms could be shaped differently. A company is said to be unlevered as long as
it has no debt, while a firm with debt in its capital structure is said to be leveraged. Note that
there exist two major leverage terms: operational leverage and financial leverage. While
operational leverage is related to a company’s fixed operating costs, financial leverage is
related to fixed debt costs. Loosely speaking, operating leverage increases the business (or the
operating) risk, while financial leverage increases the financial risk. Total leverage is then
given by a firm’s use of both fixed operating costs and debt costs, implying that a firm’s total
risk equals business risk plus financial risk. In this study of capital structure and its
determinants, with leverage, it mean financial leverage, or its synonym gearing.

The capital structure involves two decisions-

 Type of securities to be issued are equity shares, preference shares and long term
borrowings( Debentures).
 Relative ratio of securities can be determined by process of capital gearing. On this
basis, the companies are divided into two-
1. Highly geared companies- Those companies whose proportion of equity
capitalization is small.
2. Low geared companies- Those companies whose equity capital dominates total
capitalization.

Financial leverage refers to a firm's use of fixed-charge securities like debentures and
preference shares (though the latter is not always included in debt) in its plan of financing the

2
asset.The amount of debt which a firm employs or proposes to employ can be expressed in
relation to total assets or total equity. Equity will include paid-up capital and reserves and
total assets will be taken at net value . Even though, both equity shares and assets can be
measured at market values, the present discussion will use only book values. Market values
are difficult to obtain, fluctuate widely and are not available for new undertakings which also
make use of the concept of financial leverage in planning their sources of finance.

1.2 Factors Determining Capital Structure

 Trading on Equity- The word “equity” denotes the ownership of the company.
Trading on equity means taking advantage of equity share capital to borrowed funds
on reasonable basis. It refers to additional profits that equity shareholders earn because
of issuance of debentures and preference shares. It is based on the thought that if the
rate of dividend on preference capital and the rate of interest on borrowed capital is
lower than the general rate of company’s earnings, equity shareholders are at
advantage which means a company should go for a judicious blend of preference
shares, equity shares as well as debentures. Trading on equity becomes more
important when expectations of shareholders are high.
 Degree of control- In a company, it is the directors who are so called elected
representatives of equity shareholders. These members have got maximum voting
rights in a concern as compared to the preference shareholders and debenture holders.
Preference shareholders have reasonably less voting rights while debenture holders
have no voting rights. If the company’s management policies are such that they want
to retain their voting rights in their hands, the capital structure consists of debenture
holders and loans rather than equity shares.
 Flexibility of financial plan- In an enterprise, the capital structure should be such that
there is both contractions as well as relaxation in plans. Debentures and loans can be
refunded back as the time requires. While equity capital cannot be refunded at any
point which provides rigidity to plans. Therefore, in order to make the capital structure
possible, the company should go for issue of debentures and other loans.

3
 Choice of investors- The company’s policy generally is to have different categories of
investors for securities. Therefore, a capital structure should give enough choice to all
kind of investors to invest. Bold and adventurous investors generally go for equity
shares and loans and debentures are generally raised keeping into mind conscious
investors.
 Capital market condition- In the lifetime of the company, the market price of the
shares has got an important influence. During the depression period, the company’s
capital structure generally consists of debentures and loans. While in period of boons
and inflation, the company’s capital should consist of share capital generally equity
shares.
 Period of financing- When company wants to raise finance for short period, it goes
for loans from banks and other institutions; while for long period it goes for issue of
shares and debentures.
 Cost of financing- In a capital structure, the company has to look to the factor of cost
when securities are raised. It is seen that debentures at the time of profit earning of
company prove to be a cheaper source of finance as compared to equity shares where
equity shareholders demand an extra share in profits.
 Stability of sales- An established business which has a growing market and high sales
turnover, the company is in position to meet fixed commitments. Interest on
debentures has to be paid regardless of profit. Therefore, when sales are high, thereby
the profits are high and company is in better position to meet such fixed commitments
like interest on debentures and dividends on preference shares. If company is having
unstable sales, then the company is not in position to meet fixed obligations. So,
equity capital proves to be safe in such cases.
 Sizes of a company- Small size business firms capital structure generally consists of
loans from banks and retained profits. While on the other hand, big companies having
goodwill, stability and an established profit can easily go for issuance of shares and
debentures as well as loans and borrowings from financial institutions. The bigger the
size, the wider is total capitalization.

4
 CHAPTER-2
LITERATURE REVIEW

2.1 Literature review

5
The discussion of the literature on capital structure first considers definitions and the general
theory of capital structure. This is followed by a review of the empirical literature on the
determinants of capital structure choice.

2.2.1 Theory on capital structure

Capital structure is defined as the specific mix of debt and equity a firm uses to finance its
operations. Four important theories are used to explain the capital structure decisions. These
are based on asymmetric information, tax benefits associated with debt use, bankruptcy cost
and agency cost. The first is rooted in the pecking order framework, while the other three are
described in terms of the static trade-off choice. These theories are discussed in turn.

The concept of optimal capital structure is expressed by Myers (1984) and Myers and Majluf
(1984) based on the notion of asymmetric information. The existence of information
asymmetries between the firm and likely finance providers causes the relative costs of finance
to vary among different sources of finance. For example, an internal source of finance where
the funds provider is the firm will have more information about the firm than new equity
holders, thus these new equity holders will expect a higher rate of return on their investments.
This means it will cost the firm more to issue fresh equity shares than to use internal funds.
Similarly, this argument could be provided between internal finance and new debt-holders.
The conclusion drawn from the asymmetric information theories is that there is a certain
pecking order or hierarchy of firm preferences with respect to the financing of their
investments .This “pecking order” theory suggests that firms will initially rely on internally
generated funds, i.e., undistributed earnings, where there is no existence of information
asymmetry; they will then turn to debt if additional funds are needed, and finally they will
issue equity to cover any remaining capital requirements. The order of preferences reflects the
relative costs of various financing options. Clearly, firms would prefer internal sources to
costly external finance .Thus, according to the pecking order hypothesis, firms that are
profitable and therefore generate high earnings are expected to use less debt capital than those
that do not generate high earnings.

6
Capital structure of the firm can also be explained in terms of the tax benefits associated with
the use of debt. It observe that tax policy has an important effect on the capital structure
decisions of firms. Corporate taxes allow firms to deduct interest on debt in computing
taxable profits. This suggests that tax advantages derived from debt would lead firms to be
completely financed through debt.

This benefit is created, as the interest payments associated with debt are tax deductible, while
payments associated with equity, such as dividends, are not tax deductible. Therefore, this tax
effect encourages debt use by the firm, as more debt increases the after tax proceeds to the
owners .It is important to note that while there is corporate tax advantage resulting from the
deductibility of interest payment on debt; investors receive these interest payments as income.
The interest income received by the investors is also taxable on their personal account, and
the personal income tax effect is negative. As the supply of debt from all corporations
expands, investors with higher and higher tax brackets have to be enticed to hold corporate
debt and to receive more of their income in the form of interest rather than capital gains.
Interest rates rise as more and more debt is issued, so corporations face rising costs of debt
relative to their costs of equity. The tax benefits arising from the issue of more corporate debt
may be offset by a high tax on interest income. It is the trade-off that ultimately determines
the net effect of taxes on debt usage .

Bankruptcy costs are the costs incurred when the perceived probability that the firm will
default on financing is greater than zero. The potential costs of bankruptcy may be both direct
and indirect. Examples of direct bankruptcy costs are the legal and administrative costs in the
bankruptcy process. Bankruptcy costs must be trivial or nonexistent if one assumes that
capital market prices are competitively determined by rational investors. Examples of indirect
bankruptcy costs are the loss in profits incurred by the firm as a result of the unwillingness of
stakeholders to do business with them. Customer dependency on a firm’s goods and services
and the high probability of bankruptcy affect the solvency of firms (Titman, 1984). If a
business is perceived to be close to bankruptcy, customers may be less willing to buy its
goods and services because of the risk that the firm may not be able to meet its warranty
obligations. Also, employees might be less inclined to work for the business or suppliers less
likely to extend trade credit.

7
These behaviors by the stakeholders effectively reduce the value of the firm. Therefore, firms
that have high distress cost would have incentives to decrease outside financing so as to lower
these costs. Bankruptcy costs increase with debt, thus reducing the value of the firm.
According to Miltunharris, raviv(1990) it is optimal for a firm to be financed by debt in order to
benefit from the tax deductibility of debt. The value of the firm can be increased by the use of
debt since interest payments can be deducted from taxable corporate income. But increasing
debt results in an increased probability of bankruptcy. Hence, the optimal capital structure
represents a level of leverage that balances bankruptcy costs and benefits of debt finance.

The greater the probability of bankruptcy a firm faces as the result of increases in the cost of
debt, the less debt they use in the issuance of new capital The use of debt in the capital
structure of the firm also leads to agency costs. Agency costs arise as a result of the
relationships between shareholders and managers, and those between debt-holders and
shareholders .The relationships can be characterized as principal-agent relationships. While
the firm’s management is the agent, both the debt-holders and the shareholders are the
principals. The agent may choose not to maximize the principals’ wealth. The conflict
between shareholders and managers arises because managers hold less than 100% of the
residual claim Consequently, they do not capture the entire gain from their profit-enhancing
activities but they do bear the entire cost of these activities. Separation of ownership and
control may result in managers exerting insufficient work, indulging in perquisites, and
choosing inputs and outputs that suit their own preferences. Managers may invest in projects
that reduce the value of the firm but enhance their control over its resources. For example,
although it may be optimal for the investors to liquidate the firm, managers may choose to
continue operations to enhance their position. Managers have an incentive to continue a firm’s
current operations even if shareholders prefer liquidation.

On the other hand, the conflict between debt-holders (creditors) and shareholders is due to
moral hazard. Agency theory suggests that information asymmetry and moral hazard will be
greater for smaller firms . Conflicts between shareholders and creditors may arise because
they have different claims on the firm.

8
Equity contracts do not require firms to pay fixed returns to investors but offer a residual
claim on a firm’s cash flow. However, debt contracts typically offer holders a fixed claim
over a borrowing firm’s cash flow. When a firm finances a project through debt, the creditors
charge an interest rate that they believe is adequate compensation for the risk they bear.
Because their claim is fixed, creditors are concerned about the extent to which firms invest in
excessively risky projects. For example, after raising funds from debt-holders, the firm may
shift investment from a lower-risk to a higher-risk project.

The conflict between debt-holders and equity-holders arises because debt contract gives
equity-holders an incentive to invest sub optimally. More specifically, in the event of an
investment yielding large returns, equity-holders receive the majority of the benefits.
However, in the case of the investment failing, because of limited liability, debt-holders bear
the majority of the consequences. In other words, if the project is successful, the creditors will
be paid a fixed amount and the firm’s shareholders will benefit from its improved
profitability. If the project fails, the firm will default on its debt, and shareholders will invoke
their limited liability status. In addition to the asset substitution problem between shareholders
and creditors, shareholders may choose not to invest in profitable projects (under invest) if
they believe they would have to share the returns with creditors.

The agency costs of debt can be resolved by the entire structure of the financial claim. The
agency problems associated with information asymmetry, managerial (stockholder) risk
incentives and forgone growth opportunities can be resolved by means of the maturity
structure and call provision of the debt. For example, shortening the maturity structure of the
debt and the ability to call the bond before the expiration date can help reduce the agency
costs of underinvestment and risk-shifting. Both features of the corporate debt serve as
identical purposes in solving agency problems.

9
 CHAPTER-3
OBJECTIVE OF STUDY
& SCOPE OF STUDY

3.1 Objective of the study.

10
Prime Objective:

The basic objective of the study is to analyze the effectiveness of the capital structure of
company through various financial ratios.

Sub Objectives:

 To know the financial position of the company through capital structure.

 To study the operating leverage and financial leverage so as to know the fixed cost of
NHPC ltd.

 To know the solvency of the business and the capacity to give interest to the long term
loan lenders (debenture holders) and dividend to the shareholders.

 To study the leverage ratios of the NHPC Ltd.

11
 CHAPTER-4

COMPANY PROFILE

12
4.1 ABOUT THE INDUSTRY

The electricity sector in India supplies the world's 5th largest energy consumer, accounting for
4.0% of global energy consumption by more than 17% of global population. The Energy
policy of India is predominantly controlled by the Government of India's, Ministry of Power,
Ministry of Coal and Ministry of New Renewable Energy and administered locally by Public
Sector Undertakings (PSUs).

About 65.34% of the electricity consumed in India is generated by thermal power plants,
21.53% by hydroelectric power plants, 2.70% by nuclear power plants and 10.42% by
Renewable Energy Sources. More than 50% of India's commercial energy demand is met
through the country's vast coal reserves. The country has also invested heavily in recent years
in renewable energy utilization, especially wind energy. In 2010, India's installed wind
generated electric capacity was 13,064 MW. Additionally, India has committed massive
amount of funds for the construction of various nuclear reactors which would generate at least
30,000 MW. In July 2009, India unveiled a $19 billion plan to produce 20,000 MW of solar
power by 2022

Hydro Power

India was one of the pioneering countries in establishing hydro-electric power plants. The
power plants at Darjeeling and Shimsha (Shivanasamudra) were established in 1898 and 1902
respectively and are among the first in Asia.

The installed capacity as of 30-06-2011 is approximately 37,367.4 MW which is 21.53% of

total Electricity Generation in India. The public sector has a predominant share of 97% in this
sector. India was the 7th largest producer of hydroelectric power in 2008 after Norway: 114
TWh and 3.5 % the world total in 2008. The potential for hydroelectric power in India is one
of the greatest in the world. Source: (http://en.wikipedia.org/wiki/Hydroelectric_power_in_India)

13
4.2 Company Profile

NHPC Limited (Formerly known as National Hydroelectric Power Corporation Ltd.), A

Govt. of India Enterprise, was incorporated in the year 1975 with an authorized capital of Rs.
2000 million and with an objective to plan, promote and organize an integrated and efficient
development of hydroelectric power in all aspects. Later on NHPC expanded its objects to
include development of power in all its aspects through conventional and non-conventional
sources in India and abroad.

At present, NHPC is a Mini Ratna Category-I Enterprise of the Govt. of India with
an authorized share capital of Rs. 1,50,000 Million . With an investment base of over Rs. 3,
87,180 Million Approx., NHPC is among the TOP TEN companies in the country in terms of
investment.

Initially, on incorporation, NHPC took over the execution of Salal Stage-I, Bairasiul and
Loktak Hydro-electric Projects from Central Hydroelectric Project Construction and Control
Board. Since then, it has executed 14 projects with an installed capacity of 5295 MW on
ownership basis including projects taken up in joint venture. NHPC has also executed
5 projects with an installed capacity of 89.35 MW on turnkey basis. Two of these projects
have been commissioned in neighboring countries i.e. Nepal and Bhutan.During the financial
year 2010-2011, NHPC Power Stations achieved the highest ever generation of 18604 MU.
Source: (http://nhpcindia.com/hindi/scripts/HAboutUs_TheCompany.aspx)

14
Figure 1.1 : GENERATION source:-(http://nhpcindia.com/hindi/scripts/HAboutUs_TheCompany.aspx)
During the period 2010-2011, NHPC had a sales turnover of 4046.59 crore with a Net Profit
of 2166.67 crore.
Presently NHPC is engaged in the construction of 10 projects aggregating to a total installed
capacity of 4502 MW. NHPC has added 1970 MW during the 10th Plan period and planned
to add 2230 MW during 11th Plan period. 12 projects of 9651 MW are awaiting
clearances/Govt. approval for their implementation. Detailed Projects reports are being
prepared for 7 projects of 2485 MW.

Since its inception in 1975, NHPC has grown to become one of the largest organizations in
the field of hydro power development in the country. With its present capabilities, NHPC can
undertake all activities from concept to commissioning of Hydroelectric Projects

4.2.1 MARKET VALUE

At present, NHPC is a schedule 'A' Enterprise of the Govt. of India with an authorized share
capital of Rs. 1,50,000 Million . With an investment base of over Rs. 2, 20,000 million
Approx. In 2009-2010 NHPC made a profit after tax of Rs2090 crores. An increase of 94%
than the previous year profit of 1050 crores. NHPC is among the top ten companies in India in
terms of investment. Department of Public Enterprise, Govt. of India recently conferred
prestigious Miniratna status to NHPC.

Initially, on incorporation, NHPC took over the execution of Salal Stage-I, Bairasiul and
Loktak Hydro-electric Projects from Central Hydroelectric Projects Control Board. Since
then, it has executed 14 projects with an installed capacity of 5295 MW on ownership basis
including projects taken up in joint venture. NHPC has also executed 5 projects with an
installed capacity of 89.35 MW on turnkey basis. Two of these projects have been
commissioned in neighboring countries i.e. Nepal and Bhutan at a capacity of 14.1 &60 MW.

15
NET SALES V/S VALUE ADDED

source:- (http://nhpcindia.com/English/Scripts/Financia_Graphical_Presentation.aspx)

1.2.2 ON-GOING WORK

Presently NHPC is engaged in the construction of 10 projects aggregating to a total installed

capacity of 4502 MW. NHPC has planned to add 5322 MW during 11th Plan period. 12
projects of 9651 MW are awaiting clearances/Govt. approval for their implementation.
Detailed Projects report or Feasibility Report is being prepared for 7 projects of 5755 MW.

Since its inception in 1975, NHPC has grown to become one of the largest organizations in
the field of hydro power development in the country. With its present capabilities, NHPC can
undertake all activities from concept to commissioning of hydroelectric projects.

(I) Hydro Power Stations

Total - 5295 MW

16
S.no. Power Plant State Commissioned Capacity (MW) year of commission
1 Bairasiul Himachal Pradesh 180 1981
2 Loktak Manipur 105 1983
3 Salal-I Jammu & Kashmir 345 1987
4 Tanakpur Uttarakhand 120 1992
5 Chamera-I Himachal Pradesh 540 1994
6 Salal-II Jammu & Kashmir 345 1996
7 Uri-I Jammu & Kashmir 480 1997
8 Rangit Sikkim 60 1999
9 Chamera-II Himachal Pradesh 300 2004
10 Indira Sagar Madhya Pradesh 1000 2005
11 Dhauliganga-I Uttarakhand 280 2005
12 DulHasti Jammu & Kashmir 390 2007
13 Omkareshwar Madhya Pradesh 520 2007
14 Teesta-V Sikkim 510 2008
15 Sewa-II Jammu & Kashmir 120 2010
Source: (http://nhpcindia.com/hindi/scripts/Hsite_map.aspx)

(II) Hydro Power Stations Under construction

Total - 4502 MW

S.no. Power Plant State Total Capacity (MW) Completion Schedule

1 Kishenganga Jammu & Kashmir 330 2016
2 Teesta Low Dam-III West Bengal 1320 2011
3 Parbati-II Himachal Pradesh 800 2013
4 Subansiri (Lower) Assam 2000 2012
5 Chamera-III Himachal Pradesh 231 2010
6 Teesta Low Dam-IV West Bengal 160 2011

17
7 Parbati-III Himachal Pradesh 520 2010
8 Nimmo-Bazgo Jammu & Kashmir 45 2010
9 Chutak Jammu & Kashmir 44 2011
10 Uri-II Jammu & Kashmir 240 2011
Source: (http://nhpcindia.com/hindi/scripts/Hsite_map.aspx)

(iii) Hydro Power Stations constructed on Deposit/Turnkey Basis

Total - 89.3 MW

Total Capacity Year of

S.no. Power Plant Country/State
(MW) Commissioning
1 Devighat Nepal 14.1 1984
2 Kurichu Bhutan 60 2002
Andaman and Nicobar
3 Kalpong 5.25 2001
Islands
4 Sippi Arunachal Pradesh 4 2007
5 Kambang Arunachal Pradesh 6 2008
Source: (http://nhpcindia.com/hindi/scripts/Hsite_map.aspx)

SWOT ANALYSIS OF NHPC

STRENGTH OF NHPC:

18
  The company has kept with itself sufficient liquid funds to meet any kind of cash
requirement.
 Efficient working capacity of plants.
 Efficient and timely completion of projects.
 A minimum risk factor.
 Best-integrated project management systems.
 Company with an excellent record and high profits.
 An early starter-more than 30 years experience in power sector.
 Excellent growth prospects with significant additions, modifications
and replacements.
 Employee-friendly personnel policies.
.
WEAKNESSES OF NHPC:

 Some of the Plant have become old and need investment in Renovation
&Modernization.
 High cost of Nhpc plants.
 Depleting raw materials.

OPPURTUNITIES:

 Demand and supply gap.

 Upcoming hydro and nuclear sector.
 Huge opportunity in consultancy services.

THREATS:

19
 Initially NHPC was enjoying monopoly in the industry as there were hardly any
players in their competition, but now many players like Jindal hydro power Limited
(JHPL) and SJVN are entering the market and have great potential to perform.
 Huge capital requirement for expansion, diversification, horizontal and vertical
integration of R&M.

20
 Chapter 5-

RESEARCH

METHODOLOGY

21
5.1 Research design:

The descriptive form of research method is adopted for study. The major purpose of descriptive
research is description of state of affairs of the institution as it exists at present. The nature and
characteristics of the financial statements of NHPC ltd. have been described in this study.

5.2 Nature of data:

The data required for the study has been collected from secondary source .The relevant information
were taken from annual reports, journals, brochures, magazines and websites.

5.3. Methods of data collection:

This study is based on the annual report of NHPC ltd. Hence the information related to, leverage, short
term and long term solvency were very much required for attaining the objectives of the present study.

5.4 Sample size:

Study is based on Annual reports of 5 consecutive years starting from 2006-07to 2010-11 of NHPC
LTD.

5.5 Tools of study.

The study will follow the following steps:

To have a meaningful analysis and interpretation of various data collected, the following tools were
used for this study.

 PBIT-EPS analysis- It examines how different capital structures affect earnings

available to shareholders (Earning Per share). It is the analysis of the effect of
financing alternatives on earnings per share. To design the capital structure of the firm
in such a way so as to minimize the cost of capital. EBIT-EPS analysis is a method to
study the effect of leverage under alternative methods of financing.

22
 Operating leverage analysis-: Use of fixed operating costs rather than variable costs.
If most costs are fixed (i.e., they do not decline when demand falls) then the firm has
high DOL (degree of operating leverage). Arise from the firm’s fixed operating cost
such as salaries depreciation, insurance, property taxes .

 Financial leverage analysis- The substitution of fixed-charge financing for variable-

cost (dividend) equity financing. Arise from the firm’s fixed financing cost such as
interest on debt.

 Study of capital structure and its determinants-It allow to explore how the
following factors influence the mix of debt and equity a firm uses to finance its
operations.
 Growth in Net Profits and Sales.
 Firm risk
 Size of business

23
 Chapter 6-
DATA ANALYSIS & INTREPRETATION

24
6.1 PBIT-EPS ANALYSIS

It examines how different capital structures affect earnings available to shareholders (Earning
Per share). It is the analysis of the effect of financing alternatives on earnings per share. To
design the capital structure of the firm in such a way so as to minimize the cost of capital.
EBIT-EPS analysis is a method to study the effect of leverage under alternative methods of
financing.

CALCULATION OF EBIT:-

Sales : xxxxx
(-)V.C: xxx
=Contribution: xxxxx
(-)F.C: xxxx
=EBIT {Earnings before Interest and Taxes}

CACULATION OF EPS:-

EBIT: xxxxx
(-)INTERSET: xxx
=EBT: xxxxx
(-)TAX: xx
=Earning for ESH: xxxxx
(÷) No. of E.S: xxx

= EPS (EARNING PER SHARE)

25
 RELATIONSHIP BETWEEN PBIT AND EPS:-
EPS= (PBIT-I)-t/n

6.1.1 PBIT-EPS ANALYSIS FROM 2006-2010: (in crores)

PBIT-EPS PBIT-EPS PBIT-EPS PBIT-EPS PBIT-EPS

ANALYSIS 2006: ANALYSIS 2007: ANALYSIS 2008: ANALYSIS 2009: ANALYSIS 2010:

EPS = (PBIT-I)-t/n EPS = (PBIT-I)-t/n EPS = (PBIT-I)-t/n EPS = (PBIT-I)-t/n EPS = (PBIT-I)-t/n

=(1185.14-372.98)(1- =(1319.49-231.75)- =(1758.19-611.54)- = (1683.52-505.18)- = (2859.16-457.08)-

69.41)/1230.08 162.94/1230.08 142.56/1230.08 103.12/1230.08 311.58/1230.08

= 0.603 = 0.75 = 0.816 = 0.87 = 1.70

PROFIT BEFORE INTEREST AND TAX (PBIT)

Financial Year PBIT

2005-06 1185.14
2006-07 1319.49
2007-08 1758.19
2008-09 1683.52
2009-10 2859.16

26
Interpretation-

PBIT shows constant growth in first three years but it decrease in 2008-09 ,but it jumped to
almost double in 2010.This is mainly due to many of the plants were not being used to their
full capacity and now they are.

EARNINGS PER SHARE (EPS)

Financial Year Earnings per share (EPS)

2005-06 0.603
2006-07 0.75
2007-08 0.816
2008-09 0.87
2009-10 1.7

Table 4.1 Earnings per Share

EARNINGS PER SHARE (EPS)

EPS
1.8
1.6
1.4
Earning per Share

1.2
1
EPS
0.8
0.6
0.4
0.2
0
2005-06 2006-07 2007-08 2008-09 2009-10
Financial year

Fig 4.1 Earnings per share (EPS)

27
Interpretation

Earnings per share have shown a constant growth for initial three years followed by a huge
jump of almost double. This is majorly due to commencing of the new projects which were
under construction and also many of the plants were not being used to their full capacity and
now they are.

6.2LEVERAGE ANALYSIS:-

1. DEGREE OF OPERATING LEVERAGE (DOL)

2. DEGREE OF FINANCIAL LEVERAGE (DFL)

3. DEGREE OF TOTAL LEVERAGE (DTL)

DEGREE OF OPERATING LEVERAGE:-

Operating Leverage: Use of fixed operating costs rather than variable costs.If most costs are
fixed (i.e., they do not decline when demand falls) then the firm has high DOL (degree of
operating leverage). Arise from the firm’s fixed operating cost such as salaries depreciation,
insurance, property taxes .

The percentage in operating income (EBIT) associated with a given percentage in sales.

∆ EBIT ∆ EBIT
Percentage change ∈NOI EBIT EBIT
DOL= = =
Percentage chang∈sales ∆ SALES ∆Q
SALES Q

28
 DEGREE OF FINANCIAL LEVERAGE :-

The substitution of fixed-charge financing for variable-cost (dividend) equity financing. Arise
from the firm’s fixed financing cost such as interest on debt.
The percentage change in earning available to common stockholders associated with a given
percentage in EBIT.

∆ EPS
EPS EBIT
DFL= =
∆ EBIT EBIT −∫ ¿ ¿
EBIT

DEGREE OF TOTAL LEVERAGE (DTL) :-

The percentage change in EPS that results from a given percentage change in sales.
DTL = DOL X DFL

6.2.1 DEGREE OF OPERATING LEVERAGE (DOL):-

DOL 2006: DOL 2007: DOL 2008: DOL 2009: DOL 2010:

GROSS PROFIT GROSS PROFIT GROSS PROFIT GROSS PROFIT GROSS PROFIT
DOL= DOL= DOL= DOL= DOL=
EBIT EBIT EBIT EBIT EBIT

=1185.14/742.75 =1319.49/1431.16 =1758.19/1505.10 =1683.52/1075.22 =2859.16/2090.50

=1.595 =0.92 =1.16 =1.566 =1.367

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DEGREE OF OPERATING LEVERAGE

Financial
year Degree of operating leverage (DOL)
2005-06 1.595
2006-07 0.92
2007-08 1.16
2008-09 1.566
2009-10 1.367

Table 4.2: Degree of operating leverage

Degree of Operating Leverage

1.8
1.6
1.595 1.566
1.4
1.367
1.2
1.159999999999 DOL
1 99
0.8 0.92
0.6
0.4
0.2
0
2005-06 2006-07 2007-08 2008-09 2009-10

Fig 4.2 Degree of operating leverage

INTERPRETATION

The DOL is an index number which measures the effect of a change in sales on operating
income, or EBIT. It shows that company is giving fewer amounts and bears less depreciation
charge which is good for company.

30
 6.2.2: DEGREE OF FINANCIAL LEVERAGE (DFL):

DFL 2006: DFL 2007: DFL 2008: DFL 2009: DFL 2010:

PBIT PBIT PBIT PBIT PBIT

DFL= DFL= DFL= DFL= DFL=
PBT PBT PBT PBT PBT

= 1185.14/812.16 =1319.49/1087.74 =1758.19/1146.65 =1683.52/1178.34 =2859.16/2402.08

=1.46 =1.21 =1.53 =1.43 =1.19

DEGREE OF FINANCIAL LEVERAGE

Financial year Degree of Financial leverage(DFL)

2005-06 1.46
2006-07 1.21
2007-08 1.53
2008-09 1.43
2009-10 1.19

Table 4.3DEGREE OF FINANCIAL LEVERAGE

31
 Degree of Financial leverage
1.8
1.6
1.4
1.2
1 DFL

0.8
0.6
0.4
0.2
0
2005-06 2006-07 2007-08 2008-09 2009-10

Fig 4.3 DEGREE OF FINANCIAL LEVERAGE

INTERPRETATION

It is visible that the DFL is decreasing as the graph comes down it mean company is paying
less interest so it is good for company or company is improving its position by increasing its
sales without increasing the expenses or increase in expense is of lower proportion.

6.2.3: DEGREE OF TOTAL LEVERAGE (DTL) :-

DTL 2006 DTL 2007 DTL 2008 DTL 2009 DTL 20010
DTL=DOL X DFL DTL = DOL X DFL DTL = DOL X DFL DTL = DOL X DFL DTL = DOL X DFL
=1.595 X 1.46 =0.92 X 1.21 =1.16 X 1.53 =1.560 X 1.43 =1.367 X 1.19
=2.32 =1.113 =1.77 =2.23 =1.62

32
DEGREE OF TOTAL LEVERAGE

Financial Year Degree of total leverage(DTL)

2005-06 2.32
2006-07 1.113
2007-08 1.77
2008-09 2.23
2009-10 1.62

Table 4.4 Degree of total leverage

DTL
2.5

1.5 DTL

0.5

0
2005-06 2006-07 2007-08 2008-09 2009-10

Fig 4.4 Degree of total leverage

INTERPRETATION

The percentage change in EPS that results from a given percentage change in sales.It is visible
that the DTL is decreasing as the graph comes down it means that sales is decreasing.

6.3:Leverage ratios

Capital Structure Ratio

Capital Structure Ratio = long term debt / (shareholders equity + long term debt)

33
Capital Structure Ratio (2010) = LOAN FUNDS/(SHAREHOLDERS FUNDS + LOAN
FUNDS)

=13868.22/ (23273.19+13868.22)

= 37%

Capital Structure Ratio (2009) = LOAN FUNDS/(SHAREHOLDERS FUNDS + LOAN

FUNDS)

=12234.03/ (17980.62+12234.03)

= 40.5%

Capital to Non-Current Assets Ratio

Capital to Non-Current Assets Ratio = owners equity / non-current assets

Capital to Non-Current Assets Ratio (2010) = SHARE HOLDER FUNDS/FIXED ASSETS

= 23273.19/30419.95

=0.76

Capital to Non-Current Assets Ratio (2009) = SHARE HOLDER FUNDS/FIXED ASSETS

=17980.62/28142.43

=0.64

Financial Leverage Ratio

Financial Leverage Ratio = total debt / shareholders equity.

Financial Leverage Ratio (2010) = total debt / shareholders equity.

=13868.22/23273.19

34
 = 0.60

Financial Leverage Ratio (2009) = total debt / shareholders equity.

= 12234.03/ 17980.62

= 0.68

Debt to Assets

Debt to Assets = total debt / total assets

Debt to Assets (2010) = total debt / total assets

Debt to Assets = 13868.22/ 43135.79

= 0.32

Debt to Assets (2009) = total debt / total assets

= 12234.03/35355.3

= 0.346

Debt Ratio

Debt Ratio = liabilities / assets

Debt Ratio (2010) = liabilities / assets

=19862.6/43135.79 = 0.46

Debt Ratio (2009) = liabilities / assets

= 17377.01/35355.3 = 0.49

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Short Term Debt to Liabilities

Operating Leverage

Operating Leverage (2010) = percent change in EBIT / percent change in sales.

= 13.26/ 60.36 = 21.96 %

LEVERAGE RATIOS AND INTERPRETATION

Ratio 2010 2009 Interpretation

Capital structure ratio 37% 40.5% A capital structure ratio over
50% indicates that a company
may be near their borrowing
limit.
Capital to Non-current assets Ratio 0.76 0.64 A higher capital to non-current
assets ratio indicates that it is
easier to meet the business' debt
and creditor commitments.
Financial Leverage ratio 0.60 0.68 The financial leverage
ratio indicates the extent to
which the business relies on debt
financing.
Debt to Assets Ratio 0.32 0.346 A debt to assets ratio over 65%
indicates excessive debt.
Debt Ratio 0.46 0.49 A high debt ratio is unfavorable
because it indicates that the
company is already
overburdened with debt.
Operating Leverage 21.96% A high operating leverage ratio,
with a highly elastic product
demand, will cause sharp
earnings fluctuations.

Table 4.5: Leverage ratios and interpretation

36
6.4: DETERMINANTS OF CAPITAL STRUCTURE.

1. Growth in Net Profits and Sales.

NET PROFITS

Net Profits
2500
2000
Profits (in Crores)

1500
1000
Profits
500
0
01 02 03 04 05 06 07 08 09 10
-20 -20 -20 -20 -20 -20 -20 -20 -20 -20
00 01 02 03 04 05 06 07 08 09
20 20 20 20 20 20 20 20 20 20
FINANCIAL YEAR

Fig 4.5 Net profits.

SALES OF ENERGY

Sales
4000

3000
SALES (In Crores.)

2000 Sales

1000

0
01 02 03 04 05 06 07 08 09 10
-20 -20 -20 -20 -20 -20 -20 -20 -20 -20
00 01 02 03 04 05 06 07 08 09
20 20 20 20 20 20 20 20 20 20

Fig 4.6 Sales of energy.

Both, sales and Net profits has shown a positive growth in past 10 years but the major
changes can observed in the past 2-3 years where both the sales and net profits have shown a

37
tremendous growth this mainly due to completion and operation of the new sites of the
company.

These figure are expected to grow to even a better height as there are many projects which are
in pipe line and will be functioning in next few years which would reduce the expenses of the
company and will bring a steep increase in the net profits.

2) Firm risk:

 ¨Dependence on State Electricity Board-

The majority of NHPC’s revenues are derived from sales of power to the state electricity
entities, as per the directives of the Government of India & so any delays in collection of
payments would have an impact on the earnings of the company.

 ¨Regulated business environment-

NHPC operates in a highly regulated environment with directives from the government & the
CERC. Furthermore, any changes to the CERC’s tariff regulations may adversely affect the
cash flow & results of operations.

 ¨Development of projects may be subject to unexpected complexities & delays-

There are a number of uncertainties inherent in the development & construction of any
hydroelectric project, including geological, hydrological & climatic conditions. The
uncertainties may result in cost overruns of the projects & may also hamper the company’s
cash inflow.

3) TAX:

Deferred tax liability of the company is Rs.1,291.6 Million.

Total tax paid on March 2010 is -4,528.3 Million.

Tax rate (%) OF March 2010 is16.4.

38
Pre-tax profit for March 10 is 17,362.4 Million.

4)SIZE OF THE BUSINESS:

NHPC is a Mini Ratna company.

Its size can be determined from the following figures.

Total asset value of the company: Rs.39,153.15Crores

Net worth of NHPC: Rs.23,273.19Crores

Thus it is clear from the figure and further reference can be taken from the annexure which
shows the size of business of NHPC LTD.

39
 CHAPTER 7-

FINDINGS AND SUGGESTION

40
7.1: FINDINGS

OPERATING LEVERAGE

The operating leverage in the study period except in the year 2006-2007 is more than previous
year but in year 2009-10 it again decreased the DOL is an index number which measures the
effect of a change in sales on operating income, or EBIT. It shows that company is giving less
amount and bear less depreciation charge it is good for company.

FINANCIAL LEVERAGE

The above table and diagram shows that the borrowing of the firm started to increase from the
year 2007-08 and gradually the expenses of the company increased in the form of Interest on
Debt. This is a good sign for the company as it can increase the EPS of equity holder.

NHPC is a highly levered firm with a good mixture of both debt and equity in its capital. This
study has empirically examines the relationship between capital structure and value of the
firm. The estimation method uses fixed firm panel data. The study provides new insights on
the way in which the capital structure measured by total debt-to-assets ratio. We predict and
show that capital structure have direct effect on the value of firm. That is, at higher debt the
value of firm is high, and reducing their debt leads to reduction in the value of firm as the
Earning per share start to reduce. This is due to the complex interaction of market conditions,
agency costs, and bankruptcy costs. We find that size and tangibility have a positive and
growth, risk and ownership have a negative influence on capital structure.

 Intangible assets of the company increased.

 Net current assets of the company increased.

 Study of capital structure and its determinants.

41
 The analysis was made with the help of the secondary data collected from the company.

•All the limitations of PBIT-EPS analysis, operating leverage analysis and financial leverage
analysis and interpret are applicable to this study.

7.2 CONCLUSION:-

On studying the financial performance of NHPC Ltd. for a period of five years from 2005-06
to 2009-10, the study reveals that the financial performance is better. NHPC Ltd has been able
to maintain optimal cost positioning. Despite the increase in competition, the company has
been able to maintain and grow its market share to make strong margins in market,
contributing to the strong financial position of the company. The company was able to meet
its entire requirements for capital expenditures and higher level of working capital
commitment with higher volume of operations and from its operating cash flows.

The profits of the company will increase at a good rate in the near future once there projects
in pipe line get commenced. Further the profits are expected to double in next 5 years.

42
SUGGESTION

Initially NHPC was enjoying monopoly in the industry as there were hardly any players in
their competition, but now many players like Jindal hydro power Limited (JHPL) and SJVN
are entering the market and have great potential to perform. Therefore the company should
now start to worry about the competition which was not there earlier.

 In all the years the debt equity is more, when compared with borrowings. Hence the
company is maintaining its debt position.
 In all the years the equity is more when compared with borrowings. Hence the company is
maintaining its debt position.
 Earnings per share of the company is Increasing this is majorly due to commencing of the
new projects which were under construction and so plants were used to their full capacity
 Degree of financial leverage is decreasing so company should increase its sales without
increasing the expenses or increase in expense is of lower proportion.

43
Bibliography
BOOKS

 PANDEY I M (2006), Financial Management, Vikas Publishing House Pvt. Ltd., New
Delhi pg.125-140
 KHAN MY, JAIN P K (2007), 3rd edition Financial Markets, McGraw Hill pg. 75-86.
 R.P RUSTAGI (2008) 5TH EDITION, Fundamental of Financial Management,
Galgotia Pvt.Ltd pg.89-93

RESEARCH REPORT

• Myers and Majluf (Spring, 2001),The journal of economic

perspective,StewartC.Mayers ,Vol. 15, No. 2. pp. 81-102.

• Titman; Roberto Wessel,(Mar., 1988), The Journal of Finance, Wiley-Blackwell ,Vol. 43,
No.1. pp. 1-19

• Miltun Harris, RavivVol (June 1990),capital structure and informational role of debt ,Wiley-
Blackwell, ,ix no.2 pp. 2-23.

REPORTS

 Song Han-Suck(INFRA) ,January 2005,Capital Structure Determinants An Empirical

Study of Swedish Companies ,cesis-wileyPaper no.25
 Annual Reports Of NHPC LTD (2006-2007).
 Annual Reports Of NHPC LTD (2007-2008).
 Annual Reports Of NHPC LTD (2008-2009).
 Annual Reports Of NHPC LTD (2009-2010).
 Indira group report April 30,2010The Journal of Finance Vol.10 pp. 67-75.

44
WEBSITES

http://nhpcindia.com/English/Scripts/Financial.aspx?Vid=59 7 June 2012

http://nhpcindia.com/English/Scripts/Financial_PreviousYears.aspx 12 Aug 2012

http://nhpcindia.com/English/Scripts/Financia_Graphical_Presentation.aspx 19 Aug 2012

http://www.iimahd.ernet.in/publications/data/2002-03-01IMPandey.pdf 20 Aug 2012

http://www.nseindia.com/content/corporate/eq_NHPC_base.pdf 23 Sep 2012

http://www.infra.kth.se/cesis/documents/WP25.pdf

http://www.jstor.org/discover/10.2307/2328319?
uid=3738256&uid=2129&uid=2&uid=70&uid=4&sid=21101303840561

http://www.indiratrade.com/reports/institutional/nhpc.pdf

http://ecsocman.hse.ru/data/957/126/1231/titman_wessel_-_determinants_of_cs_1988.pdf

45
ANNEXURES

46
Annexure 1

BALANCE SHEET AS AT 31ST MARCH, 2010

47
Annexure 2

Profit & Loss Account for the year Ended 31st March 2010

48
Annexure 1

BALANCE SHEET AS AT 31ST MARCH, 2010

49