ASSIGNMENT 7 B11066 DEWAN HOUSING FINANCE LIMITED (DHFL)

A) The LTD-to-Equity Ratio, Interest-Bearing-Liabilities-to-Equity Ratio and the TD-toEquity Ratio1

DHFL (all figure in RS. Crs) Year Share capital Reserve and surplus share application money Equity (Net Worth) Debt : secured loans Unsecured loans Total Debt short term loans current liabilities and provisions 2011 104.43 1444.01 0.00 1548.44 13615.29 1234.78 14850.07 97.48 259.4 9.53 9.76 9.59 2010 85.03 788.41 0.00 873.44 8664.63 262.16 8926.79 0.00 139.1 10.22 10.38 10.22 2009 63.52 394.02 56.00 513.54 5749.51 126.87 5876.38 0.00 116.84 11.44 11.67 11.44 2008 67.52 377.55 0.00 445.07 3792.53 176.90 3969.43 0.00 66.59 8.92 9.07 8.92 2007 74.29 288.49 0.00 362.78 2887.65 327.05 3214.70 0.00 55.16 8.86 9.01 8.86

Long term debt/equity Total debt/equity Interest bearing liabilities/equity

B) Surrogate debt items There are no surrogate debt items in the capital structure of DHFL.

C) Comparison with industry average1Following companies were taken to calculate the industry average ratios1. 2. 3. 4. 5. Dewan Housing Finance Limited(DHFL) GRUH finance limited Housing Development Finance Corporation Limited LIC Housing Finance Limited GIC Housing Finance Limited

Industry average

2011 8.26 9.02 8.61

2010 8.12 8.78 8.48

2009 8.95 9.65 9.30

2008 7.86 8.69 8.36

2007 8.41 9.17 8.77

Long term debt/equity Total debt/equity Interest bearing liabilities/equity

Long term debt to equity ratio- The long term debt to equity ratio of DHFL has been constantly high as compared to industry average. DHFL has more long term debt as compared to equity, Total Debt to Equity ratio- Total Debt to Equity ratio of DHFL has been high as compared to the industry average for the last 4 years. Interest Bearing Liabilities to Equity ratio- The Interest Bearing Liability to Equity ratio for DHFL has been constantly high as compared to the industry average.

D) Reasons for high Debt to Equity ratios for Housing Finance industry Housing finance industry is a capital intensive industry which requires huge amounts of funds to carry out its business as compared to other industries. This The cost of debt is low as compared to the cost of equity so they raise more money by way of debt than equity. Debt for the industry is easily available to the industry by National Housing Board (NHB) & other banks. NHB has set a Capital Adequacy Ratio (CAR) of 12% which requires the companies to have this much amount of equity, this is done to cover the risk to depositors. It also leads to a high debt to equity ratios. The industry also has a high interest bearing liability to equity ratio as compared to other industries as most of the debt company has is interest bearing. Because of the nature of the business the industry has more long term loans as compared to other industries. The industry has less short term loans and current liabilities as compared to other industries which lead to high debt to equity ratios. The industry DFL as reflected by DHFL & GRUH Finance Limited is high which is also reflected in the high debt to equity ratio of the industry.

E) Reasons for DHFL for having a high Debt to Equity Ratios as compared to Industry DHFL has in the recent years expanded its operations geographically and segment wise also; it requires a high amount of financing which was raised by way of debt. One of the reasons could be the cost of debt as compared to the cost of equity and as DHFL is expanding more as compared to others so the company more inclined to raise money by way of debt. The DFL of the company is high as compared to one of its peer (GRUH Finance limited) which means that the company has high interest expenses which is reflected in the high debt to equity ratio of the company. The company also has high gearing as compared to GRUH Finance limited which means that the company is able to convert borrowed money into income in much better way as compared to others in industry; this could also be one of the reasons for a high debt to equity ratio. DHFL is company which is promoted by the Wadhwan family, whereas most of the companies under study are either PSUs (LIC Housing Finance, GIC Housing Finance) or large corporate organizations (HDFC,GRUH). The implication of it could be that the promoters of DHFL want to have more control over the company as compared to other companies in the industry which results in it having a high debt to equity ratio as compared to the industry.i

F) Relation to Modigliani & Miller proposition2- As the company pays taxes so we are relating only to the proposition with taxes 1. Proposition 1 - It states that Value of levered firm = value of unlevered firm + (tax)* Debt DHFL has a high debt to equity ratio so it gets shielded from the tax and has to pay low taxes as high amount of interest gets deducted from EBIT. So the cost of taxes is reduced. 2. Proposition 2- it states that Re = Ro + D/E (Ro - rd ) (1-tc) Re = cost of equity R0= unlevered cost of equity Rd= cost of debt The cost of equity is high according to the 2nd proposition as the debt to equity ratio of DHFL is high. Therefore we can say that though DHFL is trying to increase its value by having more amount of debt financing, but this increase in its debt equity ratio is also coming with an increased risk of investing in the company and a resulting increase in the cost of equity.

B11066_7.xlsx

iii

1 annual report of DHFL,GRUH finance, HDFC,LIC housing finance, GIC housing finance 2 corporate finance by RWJK