SERI Valuation

Valuation & Forecast of SREI Infrastructure Finance Ltd
TABLE OF CONTENTS
Page No.
Executive Summary 03
PART ONE
Introduction 08
Introduction to the Project
Introduction to NBFC’s
Introduction to SREI Infrastructure Finance Ltd
PART TWO
Analysis 33
Economy Analysis
Industry Analysis
Company Analysis
SWOT Analysis
Ratio Analysis
PART THREE
Valuation 141
Firm valuation: DCF Approach
Asset Based Method
Income based Approach
Equity valuation: DDM Approach
Relative methods
1
Economic Value Added (EVA)

Market Value Added (MVA)
PART FOUR
Forecasting 174
Forecasting of Profit & Loss A/C
Forecasting of Balance Sheet.
PART FIVE
Conclusion 186
Annexure 187
Bibliography 202
2
EXECUTIVE SUMMARY
Non Banking Financial Companies (NBFCs) have come a long way from the
era of concentrate regional operations, lesser credibility and poor risk
management practices to highly sophisticated operations, pan-India presence and
most importantly an alternate choice of financial intermediation (not an alternate
choice of banking as NBFCs still operate with lots of limiting factors, which
make them non-comparable to banks).
It is true that the difference between commercial banks and NBFCs is getting
increasingly blurred as NBFCs are today present in almost all the segments of
financial sector save cheque issuance and clearing facility. NBFCs are now
recognized as complementary to the banking system capable of absorbing shocks
and spreading risks at times of financial distress. The Reserve Bank of India
(RBI) also recognizes them as an integral part of the financial system and is
trying to improve the credibility of the entire sector.
Today, NBFCs are present in the competing fields of vehicle financing, hire
purchase, lease, personal loans, working capital loans, consumer loans, housing
loans, loans against shares, investments, distribution of financial products, etc.
More often than not, NBFCs are present where the risk is higher (and hence the
returns), reach is required (strong last-mile network), recovery has to be the
focus area, loan-ticket size is small, appraisal & disbursement has to be speedy
and flexibility in terms of loan size and tenor is required.
3
The key differentiating factor working in favour of NBFCs is ‘service’. Today, a
borrower is looking for more convenience, quick appraisal & decision-making,
higher amount of loan-to value and longer tenor. Though banks are not behind on
the service aspect, they are largely limited to urban centers. When it comes to
semi-urban and rural centers, particularly where the banking culture still not
fully developed, NBFCs enjoy an edge over banks. However, even in the urban
areas, NBFCs have created niches for themselves, which are often neglected by
banks e.g. non-salaried individuals, traders, transporters, stock brokers, etc, and
all these categories are growing at a rapid pace.
New opportunities like home equity, credit cards, personal finance, etc, are
expected to take NBFCs to a new level. Growth in all these segments is
sustainable at a higher rate than before given the low penetration and changing
demography in the country. Secondly, 100% cover for public deposits would
ensure higher credibility to the sector. Thirdly, capital had always been a limiting
factor for the sector. In a booming economy and the capital market, we expect
that these companies are now in a better position to raise capital at competitive
rates to fuel their future growth plans. Fourthly, better risk management and
regulatory practices, NBFCs enjoy a higher credibility today. Last but not the
least, due to an established reach and network,
NBFCs could be the favorites of the foreign financial giants to make an inroad in
the country. The RBI has proposed to open the domestic market for foreign banks
after FY2009 and some of the foreign banks would not hesitate to shake hands
with NBFCs to hit the ground running.
SREI is one of India’s largest private sector infrastructure and

construction equipment financial institutions. The company began its operations
in 1989. It is headquartered in Kolkata, and has a pan-India presence with a
4
network of 37 offices. It also has an international footprint, with operations in
the Russian Federation and Germany.
SREI operates in the infrastructure financing segments of infrastructure

equipment, infrastructure projects and renewable energy. It is the market leader
in the segment, managing an asset base of Rs 33931 mn (USD 762.48 mn) as on
31 st March 2006.
SREI is a widely held company, listed on the Kolkata, Mumbai, National and
London Stock Exchanges with a market share capitalization of Rs 5624 mn as on
22 nd May 2006. During the year, SREI raised RS 1530 mn (USD 35 mn) through
the GDR programme with its securities being listed on the London Stock
Exchange, becoming the first NBFC to do so.
The project report basically aims at the valuation and forecast of SREI
Infrastructure Finance Ltd. The project starts with the introduction to the project,
NBFC sector and the company. It proceeds with the detailed analysis of the
firm,i.e the SWOT analysis and ratio analysis. Ratio analysis undertakes the
calculation and finding the trend of the company in respect of ratios related to
liquidity, leverage, market and profit for the last five years. The next step in the
project is valuation. A business valuation determines the estimated market value
of a business entity. A valuation estimates the complex economic benefits that
arise from combining a group of physical assets with a group of intangible assets
of the business as a going concern. The valuation, which is part art and part
science, estimates the price that hypothetical informed buyers and sellers would
negotiate at arms length for an entire business or a partial equity interest. The
value of the firm for the last five years has been calculated and compared by
using the Discounted Cash Flow method. In this method the cash flows for the
respective years are calculated and then discounted by the cost of capital. Income
5
Based Methods, i.e. the Net Income Approach and the Net Operating Income
Approach are also used to find the value of the company. The next step in
valuation is finding the intrinsic value of equity for the year 2006 and 2007 using
the Dividend Discount Model. The Net Asset per share is also calculated to
estimate the worth of net assets per equity share. Relative methods like P/E ratio,
PEG ratio, Price to cash flows and many others are used to estimate the value of
equity as at 31/03/2007. After valuation the Balance Sheet and the Profit and
Loss account has been forecasted using ratios, total income and growth rate.
6
PART 1
7
INTRODUCTION
8
INTRODUCTION TO THE PROJECT
OBJECTIVES BEHIND THE PROJECT
Primary objective :
⇒ Compute the value of SREI INFRASTRUCTURE FINANCE LTD.
⇒ Compute the intrinsic value of SREI INFRASTRUCTURE
FINANCE LTD.
Secondary objective :
⇒ To do the financial statement analysis
⇒ To do the fundamental analysis for the determination of intrinsic
worth of the firm
• To do the Economic analysis
• To do the Industry analysis
• To do the Company analysis
9
INTRODUCTION TO NBFCs
The financial system comprises of financial institutions, financial instruments

and financial markets that provide an effective payment and credit system and
thereby facilitate channelising of funds from savers to the investors of the
economy. In India considerable growth has taken place in the Non-banking
financial sector in last two decades. Over a period of time they are successful in
rendering a wide range of services. Initially intended to cater to the needs of
savers and investors, NBFCs later on developed into institutions that can provide
services similar to banks. A non-banking financial company (NBFC) is a
company registered under the Companies Act, 1956 and is engaged in the
business of loans and advances, acquisition of
shares/stock/bonds/debentures/securities issued by government or local authority
or other securities of like marketable nature, leasing, hire-purchase, insurance
business, chit business, but does not include any institution whose principal
business is that of agriculture activity, industrial activity,
sale/purchase/construction of immovable property.
A non-banking institution which is a company and which has its principal

business of receiving deposits under any scheme or arrangement or any other
manner, or lending in any manner is also a non-banking financial company
(residuary non-banking company).
10
According to Reserve Bank (Amendment act, 1997) “A Non Banking Finance

Company (NBFC)”means-
⇒ a financial institution which is a company;

⇒ a non banking institution which is a company and which has as its
principal business the receiving of deposits under any scheme or
arrangement or in other manner a lending in any manner;
⇒ Such other non banking institution or class of such institutions as
the bank may with the previous approval of the central government
specify.
The definition excludes financial institutions which carry on agricultural

operations as their principle business. NBFCs consists mainly of finance
companies which carry on functions like hire purchase finance, housing finance,
investment, loan, equipment leasing or mutual benefit financial operations, but
do not include insurance companies or stock exchange or stock broking
companies.
NBFCs are doing functions akin to that of banks, however there are a few
differences:
• (i) a NBFC cannot accept demand deposits (demand deposits are funds
deposited at a depository institution that are payable on demand --
immediately or within a very short period -- like your current or savings
accounts.)
• (ii) it is not a part of the payment and settlement system and as such
cannot issue cheques to its customers; and
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• (iii) deposit insurance facility of DICGC is not available for NBFC

depositors unlike in case of banks.
To encourage the NBFCs that are run on sound business principles, on July 24,
1996 NBFCs were divided into two classes:
⇒ Equipment leasing and hire purchase companies (finance

companies), and
⇒ Loan and investment companies.
In India several factors have contributed to the growth of NBFCs. They provide
tailor made services to their clients. Comprehensive regulation of the banking
system and absence or relatively lower degree of regulation over NBFCs has
been some of the main reasons for the growth momentum of the latter. It has been
revealed by some research studies that economic development and growth of
NBFCs are positively related. In this regard the World Development Report has
observed that in the developing counties banks hold a major share of financial
assets than they do in the industrially developed countries. As the demand for
financial services grow, countries need to encourage the development NBFCs and
securities market in order to broaden the range of services and stimulate
competition and efficiency. In India the last decade has witnessed a phenomenal
increase in the number of NBFCs. The number of such companies stood at 7063
in 1981, at 15358 in 1985 and it increased to 24009 by 1990 and to 55995 in
1995. The main reasons for deposits with NBFCs are greater customer orientation
and higher rate of interest offered by them as compared to banks. With such a
dramatic growth in the numbers of NBFCs it was thought necessary to have a
regulatory framework for NBFCs. Slowly the RBI came out with set of
guidelines for NBFCs.
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The salient features of this guideline are given below.

⇒ The acceptance of deposits has been prohibited for the NBFCs having
net owned fund less than Rs.25 lakhs.
⇒ The extent of public deposit raising is linked to credit rating and for
equipment leasing and hire purchase companies it can be raised to a
higher tune.
⇒ Interest rate and rate of brokerage is also defined under the new
system.
⇒ Income recognition norms for equipment leasing and Hire purchase
finance companies were liberalized for NPA from overdue for six
months to twelve months.
⇒ Capital adequacy raised 10% by 31/3/98 and 12% by 31/3/99.
⇒ Grant of loan by NBFCs against the security of its own shares is
prohibited.
⇒ The liquid assets are required to be maintained @ 12.5% and 15% of
public deposits from 1/4/98 and 1/4/99 respectively.
Modifications also came to these norms over a period of time. The provisioning
norms for hire purchase and lease companies were changed. Accordingly, credit
was to be given to the underlying assets provided as security. The risk weight for
investment in bonds of all PSBs and FD/CD/ bonds of PFI is reduced to 20%. By
monetary and credit policy for 1999-2000 the RBI has raised the minimum net
owned funds limit for new NBFCs to Rs. 2 crores which are incorporated on or
after 20/4/99. According to the guideline issued on 8/4/99 the company is to be
classified as NBFCs if its financial assets account for more than 50% of its total
assets i.e. net of intangible assets and the income from financial assets should be
more than 50% of the total income.6 By June 1999 RBI had removed the ceiling
on bank credit to all registered NBFCs which are engaged in the principle
13
business of equipment leasing, hire purchase, loan and investment activities.
From above brief summary regarding steps taken by RBI for managing NBFC it
is apparent that RBI assigns the priority for proper management of NBFCs
keeping in view the investor’s protection. In the light of the above regulatory
frame work one should like to examine various parameters of different groups of
NBFCs.
The NBFCs that are registered with RBI are:
• (i) equipment leasing company;

• (ii) hire-purchase company;
• (iii) loan company;
• (iv) investment company.
With effect from December 6, 2006 the above NBFCs registered with RBI have
been reclassified as
• Asset Finance Company (AFC)

• Investment Company (IC)
• Loan Company (LC)
AFC would be defined as any company which is a financial institution carrying

on as its principal business the financing of physical assets supporting productive
/ economic activity, such as automobiles, tractors, lathe machines, generator sets,
earth moving and material handling equipments, moving on own power and
general purpose industrial machines.
Principal business for this purpose is defined as aggregate of financing

real/physical assets supporting economic activity and income arising therefrom is
not less than 60% of its total assets and total income respectively.
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The above type of companies may be further classified into those accepting
deposits or those not accepting deposits.
Besides the above class of NBFCs the Residuary Non-Banking Companies are
also registered as NBFC with the Bank.
The NBFCs accepting public deposits should furnish to RBI:
• Audited balance sheet of each financial year and an audited profit and loss
account in respect of that year as passed in the general meeting together
with a copy of the report of the Board of Directors and a copy of the
report and the notes on accounts furnished by its Auditors;
• Statutory Annual Return on deposits - NBS 1;
• Certificate from the Auditors that the company is in a position to repay the
deposits as and when the claims arise;
• Quarterly Return on liquid assets;
• Half-yearly Return on prudential norms;
• Half-yearly ALM Returns by companies having public deposits of Rs 20
crore and above or with assets of Rs 100 crore and above irrespective of
the size of deposits ;
• Monthly return on exposure to capital market by companies having public
deposits of Rs 50 crore and above; and
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• A copy of the Credit Rating obtained once a year along with one of the
Half-yearly Returns on prudential norms as at (v) above.
Today, NBFCs are present in the competing fields of vehicle financing,

hire purchase, lease, personal loans, working capital loans, consumer loans,
housing loans, loans against shares, investments, distribution of financial
products, etc. More often than not, NBFCs are present where the risk is higher
(and hence the returns), reach is required (strong last-mile network), recovery
has to be the focus area, loan-ticket size is small, appraisal & disbursement has
to be speedy and flexibility in terms of loan size and tenor is required. The key
differentiating factor working in favour of NBFCs is ‘service’. Today, a borrower
is looking for more convenience, quick appraisal & decision-making, higher
amount of loan-to value and longer tenor. Though banks are not behind on the
service aspect, they are largely limited to urban centers. When it comes to semi-
urban and rural centers, particularly where the banking culture still not fully
developed, NBFCs enjoy an edge over banks. However, even in the urban areas,
NBFCs have created niches for themselves, which are often neglected by banks
e.g. non-salaried individuals, traders, transporters, stock brokers, etc, and all
these categories are growing at a rapid pace.
New opportunities like home equity, credit cards, personal finance, etc, are
16
least, due to an established reach and network,
INTRODUCTION TO THE COMPANY
SREI is one of India’s largest private sector infrastructure financial

institutions. The company began its operations in 1989. It is headquartered in
Kolkata, and has a pan-India presence with a network of 37 offices. It also has an
international footprint, with operations in the Russian Federation and Germany.
SREI operates in the infrastructure financing segments of infrastructure

equipment, infrastructure projects and renewable energy. It is the market leader
in the segment, managing an asset base of Rs 33931 mn (USD 762.48 mn) as on
31 st March 2006.
SREI is a widely held company, listed on the Kolkata, Mumbai, National

and London Stock Exchanges with a market share capitalization of Rs 5624 mn
as on 22 nd the may 2006. During the year, SREI raised RS 1530 mn (USD 35 mn)
through the GDR programme with its securities being listed on the London Stock
Exchange, becoming the first NBFC to do so.
CORE VALUES
⇒ Customer partnership
⇒ Respect for people
⇒ Stakeholder value enhancement
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⇒ Integrity
⇒ Passion for excellence
⇒ Professional entrepreneurship
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OPERATIONAL OVERVIEW
1. INFRASTRUCTURE EQUIPMENT FINANCE
CORE ACTIVITIES
Financing construction equipment like heavy and light excavators, loaders,
earth moving equipment, dumpers, tippers, cranes among others.
HIGHLIGHTS 2005-06
 Contributed Rs 23030 mn to business.
 Securitised assets to increase availability of finances to fund new
projects.
 Non-performing assets as a proportion of total assets declined from
1.43% in 2004-05 to 0.92% in 2005-06.
 Increased market share to 30% in 2005-06.
With the government increasing its focus on implementing new

infrastructure projects and improving the existing ones, the requirement for
quality equipment has increased. These equipments enable the delivery of
projects in internationally comparable timeframes.
SREI realized the potential of the sector and capitalized on the first mover
advantage. As a result the Company has achieved a pre-eminent position in the
industry and is the leader in the segment. SREI’s disbursement grew from Rs
16099.70 mn in 2004-05, representing a growth of 54%.
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2. INFRASTRUCTURE PROJECT FINANCE
CORE ACTIVITIES
Projects financed by the Company include bridges, approach bridges,
bypasses and roads, independent power projects, captive power projects and
small-to-medium sized power projects and equipment in the power sector,
port equipment, private berths and container handling jetties in the port
sector.
HIGHLIGHTS 2005-06
 Non-performing assets as a proportion of total assets remained same at
0.05% in 2005-06.
 Forayed into new sector- civil aviation, financing projects worth Rs
1080 mn.
Since the early nineties, India has been experiencing a consistently high GDP
growth rate. This has been achieved through the first generation of economic
reforms in 1991. However the rapid economic growth has put the existing
infrastructure under tremendous pressure. Specifically, the country has not
deployed enough funds for building the necessary power plants, transmission
lines, distribution networks, roads, ports, airports, water and sanitation
infrastructure since Independence.
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3. RENEWABLE ENERGY EQUIPMENT FINANCE – SREU
CORE ACTIVITIES
SREI Renewable Energy Unit (SREU) finances only eco-friendly green
energy systems of various sizes and specifications on easy and affordable
lease/hire-purchase terms to suit the varied needs of customers, both for
domestic and commercial use. The financing period is normally between one
to five years and funding is sourced by the company primarily from domestic
and international financial institutions.
HIGHLIGHTS 2005-06
 Tie-ups with leading vendors.
 Increasing awareness and extending reach by building relationship
with reputed NGOs/Co-operatives/Self Help Groups.
Being a responsible corporate citizen, we set up SREU in may 1999 with the
objective of promoting the use of renewable sources of energy and in doing so
became the first private sector company in the country to finance renewable
energy products.
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EXCITING SERVICE PORTFOLIO
As a part of its strategy to deliver superior value to all stakeholders, SREI

has expanded its services, forayed into allied business to offer holistic solutions
to cater to customer needs. These activities are primarily in the domains of
venture capital funding, capital markets, insurance broking, foreign exchange,
asset disposal, equipment rentals and deposits.
SREI Subsidiaries :-
SREI Venture Capital Limited:

This is a SEBI registered venture capital fund operating four schemes that
focus on high growth sectors of the economy.
Schemes Target Size Target Sector

Medium and Small Rs 1000 mn Road, Power, Port & Urban
Infrastructure Fund (MASIF) (USD 22mn) Infrastructure Projects.
India Global Competitive Rs 10000 mn Globally competitive
Fund (IGCF) (USD 220 mn) companies.
Prithvi Infrastructure Fund Rs 5000 mn Infrastructure & Realty Sector.
(USD 110 mn)
Infrastructure Project Rs 100 mn Infrastructure Sector.
Development Fund (USD 2.2 mn)
22
SREI Capital Markets Limited:
SREI Capital Markets Limited is a SEBI registered Category I merchant

banker. It offers services from infrastructure advisory, investment banking,
infrastructure project conceptualization, development, implementation and
management to financial structuring, resource mobilization and capital issues. It
also offers financial advisory services as well as services in the domain of
privatization to government enterprises and departments.
SREI Insurance Services Limited:
This is a unique, all encompassing insurance services and brokerage

company. Registered with the Insurance Regulatory Development Authority
(IRDA), it is a composite broker offering services in the domains of Life
Insurance, General Insurance and Reinsurance, as well as risk management
advisory services. The company provides consultancy and risk management
services for insurance/reinsurance and undertakes other related activities. The
primary objective with which the Company has been established is to educate the
customer about the equipment and to provide holistic insurance solutions under
one roof. It also helps negotiate for better rates with insurance companies.
SREI Forex Limited:
SREI Forex capitalizes on India’s fast growing foreign trade and increased
business and leisure travel undertaken by Indians. The company is a full fledged
money changer. It deals in 44 currencies and travellers cheques besides having a
tie up with Western Union to facilitate money transfer.
23
Global Investment Trust Limited:
Global Investment Trust Limited (GITL) is a wholly owned subsidiary of

SREI Infrastructure Finance Limited. The Company has been set up with the
objective functioning as trustees for various funds and to offer related services. It
currently acts as trustee company for few capital and private equity funds being
managed by SREI Venture Capital Limited.
SREI Joint Ventures:-
Bengal SREI Infrastructure Development Limited:
Bengal SREI Infrastructure Development Limited is a joint venture

company floated by West Bengal Industrial Development Corporation Limited
and SREI Capital Markets Limited with a view to create, expand and modernize
infrastructure facilities in West Bengal and other states of India. It offers
services in the domains of project advisory, policy advisory and industrial
capability building. It is actively involved in projects relating to roads, industrial
and agricultural infrastructure.
IIS International Infrastructure Services GmbH:
IIS International Infrastructure Services GmbH (IIS) has been

incorporated in Bonn, Germany. The business of IIS is leasing of infrastructure
equipment and rendering advisory services, apart from acting as a holding
company for SREI’s investment in other countries.
24
SREI Associate:-
Quipo Infrastructure Equipment Limited:
QIEL has been sponsored by SREI and supported by the Construction

Industry Development Council (the apex industrial body formed by the Planning
Commission and the Ministry of Surface Transport, Govt. of India). The company
provides high value, multi-purpose, specialized and general-purpose
infrastructure equipment on rental. In addition, it also provides auxiliary value
added services such as trained operators to run and service the equipment and on
site repairs and maintenance with a high uptime of the equipment to the
contractor. This enables the contractor to focus on his core competence-
construction and project management, and allows him to access such
infrastructure equipment without blocking his limited capital resources.
Quipo- equipment bank:
Quipo was set up to cater to the needs of construction companies and

contractors, who cannot afford high technology equipment due to capital
constraints. Quipo acts as an equipment repository renting out equipment based
on need, creating a level playing field in the process. Additionally, it ensures
uniformity and productive deployment of idle equipment thus effectively
conserving scarce capital resources.
Quipo- oil and gas:
First Indian company to provide comprehensive equipment and services

solutions with specialized services for drilling.
25
Quipo- telecom:
First Indian company providing passive infrastructure sharing for mobile

telecom companies.
Henry Butcher International Valuers & Auctioneers Pvt. Ltd .
This is a 50:50 Joint venture between Quipo and GoIndustry Henry

Butcher. GoIndustry group is one of the largest asset management companies in
the world, providing industrial equipment disposal and consultancy services.
Through this joint venture we provide services for auctions asset disposal and
valuation services- a first time offering for the Indian markets. This format for
disposal of assets has been adopted to optimize their realizable value.
NAC Infrastructure Equipment Limited
SREI is a joint sponsor of NAC Infrastructure Equipment Limited

alongwith the National Academy of Construction, IIEL, L&T Finance Ltd. and
Nagarjuna Construction Company Ltd. The Company operates on the similar
lines of quipo. It acts as an equipment bank and focuses on the high-growth
South Indian market, which includes the states of Andhra Pradesh, Karnataka,
Tamil Nadu and Kerala.
26
FINANCIAL OVERVIEW
The Company has reported excellent results for the financial year ended 2005-
06. During the year the Company's disbursement went up by 54% per cent to
reach a level of Rs 24807.60 mn. This has been achieved on the back of the huge
investments lined up for enhancing and expanding the country's infrastructure.
Along with the increase in disbursements, there has been an equally robust
growth in our assets managed. The assets under management have increased from
Rs 20921.10 mn to Rs 33930.60 mn. SREI continues to operate in a market
requiring first-hand knowledge and expertise. This has aided the Company to
maintain its leadership position in financing of infrastructure equipment. The
Company has been focusing on lending to SME (small and medium enterprises)
customers. The Company has been able to maintain low levels of NPAs through:
⇒ robust appraisal system de-risking the Company from possible defaults
⇒ strong collection and repossession capabilities
⇒ prudent selection of assets
PROFIT AND LOSS STATEMENT OVERVIEW:
Financial income and expenditure:

The total income increased from Rs 1299.30
mn in 2004-05 to Rs 2272.50 mn in 2005-06. The income is derived from the
core activities of infrastructure equipment financing, infrastructure project
finance and renewable energy equipment finance. With rising interest rates the
Company's cost of interest increased from Rs 558.30 mn to Rs 1067.30 mn.
Income from other sources comprised of write back of provision for diminution
in value of long term investments, dividend on trade investments and others. The
write back of provision was to the extent of Rs 0.50 mn, dividend amounted to Rs
0.60 mn, while others accounted for Rs 3.60 mn.The administrative and other
27
expenses increased by almost 36 per cent. Personnel expenses increased by 48

per cent as the Company has been steadily increasing its business, it is essential
to have adequate number of people to steer operations. The other expenses
increased by 29 percent. The profit before tax has recorded a growth of over 71
percent, rising from Rs 398.00 mn in the last financial year to Rs 682.00 mn at
present. The profit after tax increased by 71.10 per cent from Rs 283.00 mn to Rs
484.20 mn in 2005-06.
BALANCE SHEET OVERVIEW
SOURCES OF FUNDS :
During the year the Company raised Rs 1530 mn
through the GDR route and in the process became the first Indian NBFI to be
listed on the London Stock Exchange. Post issue of GDRs, the Company's equity
share capital stands at Rs 1090.9 mn, comprising of 109.09 mn shares of face
value Rs 10 each. The Company leverages its resources in the most productive
manner and deploys excess funds to generate and increase business. Reserves and
surplus increased by 173 per cent from Rs 1104.80 mn to Rs. 3014.30 mn. This
was largely on account of the premium received through the issuance of GDR. As
per the RBI guidelines, the Company increased its provision for special reserves
from Rs. 264.70 mn to Rs. 362.70 mn. The term loans increased by 253 per cent.
The company accessed Rs 4256.50 mn from domestic financial institutions and
banks and Rs 1951.80 mn from foreign financial institutions. Working Capital
increased by 13.93 per cent. During the year under review, six banks - HDFC
Bank, Yes Bank, Kotak Mahindra Bank, Indian Overseas Bank, Corporation Bank
and Bank of Rajasthan - joined the consortium lending to the Company,
enhancing the total strength of consortium bankers to 33, the largest
suchconsortium among NBFCs in India. The Company raised Rs 1300 mn by way
of debentures to meet the increased demand for funds. The Company has
28
been focusing on reducing its reliance on public deposits. As a result, it accounts

for only 0.86 per cent of the total funds at the Company's disposal. The public
deposits went up marginally from Rs 144.70 mn to Rs 144.90 mn. During the
year the Company redeemed commercial papers amounting to Rs 300 mn,
bringing down the total from Rs 450 mn to Rs 150 mn. The total amount
securitised by the Company increased from Rs 8447.5 mn to Rs 11381.9 mn
providing it access to greater funds.
APPLICATION OF FUNDS:
The Company's base of financial assets increased from Rs 10452.5 mn in

2004-05 to Rs 16848.2 mn in 2005-06, recording a growth of 61 per cent. The
project finance division of the Company has recorded impressive growth. This
can be attributed to the hectic activity being witnessed in the country and SREI's
understanding of the sector. The Company leverages its strong relations with the
small and medium enterprises and customises its disbursals. This has led to the
divisionrecording a growth of 26 per cent. During the year the fixed asset base
grew by 1157 percent from Rs 178 mn to Rs 2237.50 mn. This was largely a
result of the innovative practice of beginning operating leases in this year. Under
this mechanism, the ownership of the asset financed rests with SREI, and
therefore the company avails of the depreciation benefit. It also results in a
quantum increase in the fixed assets base. During the year, assets financed under
the operating lease mechanism amounted to Rs 2114.00 mn. The provisioning for
assets increased by 34 per cent, from Rs 22.20 mn in 2004-05 to Rs 29.80 mn,
even as our asset base grew by 1157 per cent.
29
OPERATIONAL OVERVIEW
Disbursements
Total disbursements of the Company grew from Rs 16099.7 mn in 2004-05

to Rs 24807.6 mn in 2005-06, recording a remarkable growth of 54 per cent.
Treasury operations
SREI sourced its funds from numerous financial institutions including

banks, domestic institutions, foreign financial institutions and multilateral
agencies. SREI's dynamic treasury team helped mobilise resources from
the domestic and international markets to meet its extensive funding
requirements. Active management of cash surpluses, stiff negotiations for
obtaining funds at lower interest rates and hedging exposure to prevailing
market risks aided access to greater resources.
Capital adequacy ratio
The capital adequacy of the Company was 19.75 percent as on 31st March
2006, which is well above the minimum level of 12 per cent prescribed by the
ReserveBank of India.
The Company has complied with all the norms prescribed by the Reserve
Bank of India including the newly introduced Anti money laundering and Know
your customer (KYC) guidelines and all the mandatory accounting standards
issued by The Institute of Chartered Accountants of India. It has adopted a sound
and forward looking accounting policy of providing for non performing assets in
30
terms of the guidelines laid down by the Foreign Financial Institutions, which are
more stringent than the guidelines of the Reserve Bank of India.
Interest rates
SREI's average rate of interest increased from 6.23 percent in 2004-05 to

7.97 per cent in 2005-06 through competent cash management, raising additional
resources by issuance of GDRs, MIBOR linked bonds/debentures and the use of
longer tenure foreign loans (7-10 years) and redemption of commercial papers.
Credit rating
SREI's credit ratings have been consistently improving. Improved credit

ratings are important as it allows SREI to raise resources at competitive rates.
The lenders, to ensure that their funds are safe, attach significant weight to it.
Non performing assets
The Company's NPAs stood at 1.43 per cent of total assets in 2004-05 and
further decreased to 0.92 per cent in 2005-06 which was amongst the lowest in
the industry. On a net basis, the Company's NPA is nil.
SREI carries out a due diligence before any loan is disbursed to assure
itself of the quality and safety of the asset and is complemented by a
conservative treatment of non performing assets on the Company's books. NPA
provision norms followed by SREI conform to thestandards set by Indian
regulatory authorities, foreign lending institutions and credit rating agency
parameters.
31
32
PART 2
33
ANALYSIS
34
ECONOMIC ANALYSIS
Overview of recent macroeconomic developments:
The year 2006-07 marks the fourth consecutive year of vibrant economic growth,
thus producing an average growth of 8.5 per cent. But the major issues are still
the same, infrastructure development and slow growth in agricultural sector. The
Eleventh Five-Year Plan is likely to aim at rising growth scenario in two-digit
figure over the five year period between 2007-08 and 2011-12. Despite several
bottlenecks, steady improvements in the domestic saving and investment rates
would possibly sustain the high growth expectation. In the coming years, the
outlook for the Indian economy remains bullish. The CSO’s advance estimates of
a 9.2 per cent real GDP growth for 2006-07 as well as the expectations of
continuing this high growth during 2007-08, seem realistic
The economy appears to be heated up as inflationary pressures are on the rise

which may require for policy changes on the economy’s expansionary plans.
While agricultural sector is expected to show only minor improvement, good
industrial performance including improvement in core infrastructure industries,
and a vibrant services sector continuing to lead the economy’s growth momentum
backed by a booming information technology industry, justifies the expectations
for high growth for the current year(2006-2007) as well as the next year(2007-
2008). The supply-side has been impressive; the demand-side is too exuberant
raising concerns of heating up. Money supply expansion has been considerably
higher till date (30th march 2007) during the current year with each of its
components displaying accelerated increases. The growth in bank credit, too, has
been at a high pace. These monetary developments in recent years have resulted
in high liquidity in the economy.
35
And coupled with supply-side constraints in some essential commodities as also

pressures from global commodity prices, the demand pressures have led to a rise
in average inflation to 5.2-5.4 per cent in 2006-07 so far as against 4.4 per cent a
year ago. The central bank has adopted instruments like increases in the reverse
repo rate and cash reserve ratio in order to curtail liquidity while the government
has initiated several measures like changes in the customs duty structure and
restrictions on trade in commodities markets to deal with the influence of
demand pressures as well as that of supply shortages. In the latest Union Budget
for 2007-08, the past trends for macro-level reforms has been replaced with
concerns regarding the structural changes in the economy; on the taxation side,
substantial concessions have been made both in direct and indirect taxes for
small and medium enterprises (SMEs), even as measures have been proposed to
reduce indirect tax burdens on commodities for fighting inflation. On the
expenditure front, substantial increases in government spending on social sector
areas, particularly health and education, as well as agriculture and physical
infrastructures have been announced. In the external sector, the REER (real
effective exchange rate) shows an appreciation of nearly 7-8 percentage points
while the nominal value of the rupee has moved up close to the base level of
2004-05. This has implications for the economy’s export competitiveness,
particularly at a time when export growth is slowing, but it also has positive
effects on the imports of capital goods in which the economy is facing a shortage
of installed capacities.
Inflation analysis:
The annual inflation as measured by movements in the wholesale price

index (WPI) on a point-to-point basis has risen by 6.1 per cent in the month
ending February 24, 2007 contrasts with the rise of 4.2 per cent in the
corresponding period of the previous year However, the inflation rate after
36
reaching a peak of 6.7 per cent in the first week of February 2007 slipped in the
subsequent next three week period to register the above 6.1 per cent rate. This
respite in the upward movements during the month is mainly brought about by
falling prices of wheat, pulses, substantial lowering of prices of vegetables and
sugar and, to some extent, the decline in prices of petrol and diesel. The annual
increases in different consumer price indices (CPIs) – all for January 2007 – have
ranged between 6.7 per cent and 9.5 per cent compared with the range of 4.4 per
cent to 5.0 per cent increases in the previous year. Specifically, in the current
year, the CPI for agricultural labourers has shown a faster rate of increase than
the rate of inflation of other CPIs.
The inflation rates on an average basis, too, have been depicting obvious
increases 5.3 per cent during April-February 2006-07 as against 4.5 per cent
during April-February 2005-06 in WPI, though less than the 6.7 per cent recorded
in the corresponding period of 2004-05. A similar, though at a higher level, trend
has also been witnessed in the movements of all CPIs
Sources of Inflationary Pressures
A number of commodities and commodity groups have faced price

pressure during the current year so far. The ‘primary articles’ index has shown a
11.1 per cent rise over the past 12-month period as against a 5.7 percent rise in
the preceding 12-month period. ‘Manufactured Products’, another major group
has experienced a higher rate of price rises of 6.2 per cent during the current year
as against 2.1 per cent last year. On the other hand, the third major group, ‘fuel,
power, light and lubricants’ has shown a considerably lower price rise of 1.4 per
cent this year as against 8.6 per cent in the previous 12- month period because of
reduction in the prices of petrol and diesel.
37
Supply shortages of a large number of primary articles have been reflected

in their sharp price increases: cereals (8.3 per cent in the last one year as against
5.2 per cent a year earlier), pulses (16.8 per cent against 28.7 per cent), fruits
(13.7 per cent against a decline of 3.8 per cent last year), milk (7.9 per cent as
against 1.9 per cent ), condiments and spices (30.8 per cent against 2.4 per cent)
and other food articles (12.0 per cent against 18.1 per cent). Oilseeds have faced
acute supply shortages due to hampered kharif output and hence their price index
has risen sharply by 23.5 per cent as against a large fall of 9.1 per cent in the
preceding 12-month period.
Fiscal Year Price Movements
During the current fiscal so far (April 2006 to February 2007), the prices
of “all commodities” have risen by 5.9 per cent as against a comparatively lower
increase of 3.9 per cent last year. Prices of ‘primary articles’ have accelerated to
register an increase of 10.7 per cent and contributed about 40 per cent to the
overall price level rise as compared to an increase of 5.0 per cent and a 28 per
cent contribution during the last fiscal year. The prices of ‘manufactured
products’ have risen by 6.2 per cent during the review period as against a
nominal rise of 1.7 per cent last year. The group’s contribution works out to be
58 per cent as against 25 per cent last year. The third major group ‘ fuel, power,
light and lubricants’, however, has recorded a lower increase of 0.9 per cent
during the fiscal year so far as against a larger rise of 8.4 per cent during the
corresponding period last year mainly due to stable international oil prices.
Among ‘primary articles’, pulses, vegetables, fruits, condiments and spices,
oilseeds and minerals have registered double-digit inflation during the review
period. Among ‘manufactured products’ the prices of grain mill products, edible
oils, iron and steel, and nonferrous metals have recorded double-digit increases.
The sub-group, sugar, khandasari and gur is the lone sub-group to record a
38
decline within in the major group ‘manufactured products’. This group has
recorded a double digit fall of 10.5 per cent due to a fall in sugar prices which
can be attributed to substantial increase in sugar cane production and their
crushing for higher sugar production.
Consumer Price Indices
The inflation this year arising from shortages of essential commodities has
also been reflected in consumer prices. The CPI for industrial workers (CPI-IW)
has risen by 6.7 per cent year-on-year in January 2007 as against a rise of 4.4 per
cent in January 2006 or on an average basis, the increase has been 6.7 per cent
during the first 10 months of the current fiscal year as compared to 4.0 per cent
during the corresponding period last year. A similar, but at a higher level,
increase has occurred in CPI for non-manual employees. However, among the
CPIs, the highest rise has occurred in CPI for agricultural labourers an annual
rise of 9.5 per cent in January 2007 as against 4.7 per cent last year or on an
average basis, the current fiscal year rise has been 7.5 per cent in contrast to a
rise to just 3.6 per cent last year. The prices of food index, a major group in
agriculture labour index has recorded a double-digit inflation rate of 11.2 per
cent during the current fiscal so far as against a lower growth of 5.8 per cent last
year.
Global Inflation Rate
A worrisome aspect of the world inflation scene is that India is

experiencing a relatively high inflation rate (CPI-IW) at 6.7 per cent during the
current year among the comparable groups of countries like China (2.2 per cent),
South Korea (2.1 per cent), Thailand (2.3 per cent) and Malaysia (3.2 per cent).
39
However, among Asian countries, Pakistan and Indonesia have recorded

higher inflation rates of 6.6 per cent and 6.3 per cent, respectively, in the review
period. Inflation has been stable in the advanced economies. Inflation in the euro
area remained below the European Central Banks’ 2 per cent ceiling as fuel
prices declined. Consumer prices in euro area have risen by 1.9 per cent from a
year earlier. Oil prices in these areas have recorded a 24 per cent drop from July
level which pushed down the prices of transport fuel by 0.22 per cent in February
from a year earlier.
Money and Banking Analysis
During the financial year 2006-07, the monetary and banking variables
have begun to further speed up, essentially as a result of taxation and other year-
end considerations. During the past one month ending March 2, 2007, all
components of M3, except demand deposits, have shown higher rates of
expansion than in the comparable month of the previous year. M3, except demand
deposits, have shown higher rates of expansion than in the comparable month of
the previous year. M3 expansion of Rs 77,837 crore (or by 2.5 per cent) during
the latest month has been indeed high as compared with the expansion of Rs
55,780 crore (1.8 per cent) during the corresponding month of the previous year.
Continued expansion in bank credit and rise in foreign exchange assets, have
contributed to the accelerated monetary expansion. The largest increase in
monetary expansion has occurred under time deposits: an increase of Rs 53,718
crore (2.4 per cent) as against Rs 30,764 crore (1.4 per cent) in the corresponding
period of the previous year . Currency expansion too has been of a higher order
this year: Rs 11,170 crore (2.4 per cent) as against Rs 8,107 crore (1.7 per cent).
Higher tempo of financial activities supported by increased capital market
activities as well as industrial activities have resulted in higher levels of currency
expansion during the recent period as well as during the current fiscal
40
year so far. An expansion of Rs 458,241 crore in M3 (16.8 per cent) during April-
March 2, 2007 as against an increase of Rs 277,448 crore (11.9 per cent) during
the comparable period of the previous year is indeed noteworthy. While currency
with the public has shown a higher rise [Rs 70,954 crore (17.2 per cent) against
Rs 58,195 crore (16.4 per cent) last year], the largest increase has occurred under
time deposits: Rs 357,223 crore or 18.8 per cent as against Rs 175,736 crore or
10.6 per cent. Demand deposits have grown at a considerably slower rate of 7.9
percent (Rs 31,869 crore) in contrast to the expansion of 13.9 per cent (Rs 44,768
crore) in the previous year.
Banking Operations
The higher tempo of banking activities in the recent period is reflected in

the data on scheduled commercial banks. All variables show an accelerated
growth in the latest month as compared with the growth in the month a year ago.
While banks’ deposit growth has been faster almost continuously since the
beginning of the current financial year, higher investments and bank credit,
particularly non-food credit expansion, are a recent phenomenon. Banks’
investments in government securities have expanded phenomenally Rs 44,414
crore during the latest month period in contrast to an absolute fall of Rs 7,727
crore in the corresponding month of the previous year.
Hike in Lending Rates
State Bank of India, the country’s largest bank, has raised its prime
lending rate (PLR) for the second time in less than three months, but at the same
time has decided to spare existing home and educational loan borrowers from the
hike. SBI has raised its PLR by 75 basis points to 12.25 per cent with effect from
41
February 20 and also announced that it will be offering the highest interest rate
of 9.5 per cent among commercial banks for deposits with maturity of 4 years to
less than 5 years. Centurion Bank of Punjab has increased its prime lending rate
(PLR) by 100 basis points to 14.50 per cent per annum from March 1, 2007.
ICICI Bank, the country’s second largest bank, has hiked its lending rates for
fresh loans to individuals by 50 basis points, following a 50 basis point increase
in CRR by the RBI. So we may expect the banks to announce increase in interest
rates on loans to corporates, which would definitely a negative news for the
bonds as well as the equity markets. The bond prices would crash down, and
higher interest rates would hurt the corporate profit margins.
External sector analysis
With the base effect coming into play, export growth in Jan-07 remained
in the single-digit range for the second consecutive month up 5.5% (US$9.6bn).
It is expected this trend would continue for the next few months given that export
growth during the period Jan06-Aug06 averaged was closed to 30% YoY. On the
import front, due to lower oil prices, it is expected a moderate import growth and
hence a narrowing in the trade deficit. The full-year estimates of exports
touching US$120.7bn (20%) and imports up US$177bn (26.2%) resulting in the
customs trade deficit widening to US$56.3bn in FY07 as compared with
US$39.8bn in FY06. Composition of trade comes out with a two-month lag.
Export growth in the current fiscal has been led by engineering goods and
petroleum products. As regards imports, besides oil, over 70% of the rise in non-
oil imports is due to capital goods, industrial raw materials – all of which support
the investment story.
The current account deficit of the county has stood at $ 3 billion for the
third quarter ended December 31, 2006, according to statistics put out by the
42
Reserve Bank of India compared with $ 4.7 billion in the corresponding period in
the previous fiscal. For the nine-month period covering (April-December 2006),
the current account deficit has stood at about $12 billion, at the same level as in
the previous corresponding period.
The foreign exchange reserves of India have surged by $1.789 billion to

touch $197.746 billion in the week ended March 23, 2007. The reserves have
increased by over $3.3 billion in two consecutive weeks. During the week ended
March 16, the reserves had touched $1.547 billion to $ 195.957 billion.
According to the RBI's Weekly Statistical Supplement, foreign currency assets
increased by $1.789 billion to $190.392 billion.
The country's external debt stock has shot up by $6.19 billion in the
quarter ended December 2006 to $142.66 billion on the back of a sharp increase
in commercial borrowings by corporate sector and also due to rise in non-
resident India (NRI) deposits. While long-term debt outstanding for the quarter
ended December 2006 increased by $6.80 billion to $132.64 billion, short-term
debt declined by $610 million to $10.02 billion at end-December 2006.
The rupee-dollar exchange rate touched a high of Rs 42.90 on April 4 but

dipped to Rs 43.15 on April 5. The six-month forward premia closed at 5.41 per
cent (annualized) on April 05, 2007 vis-à-vis 4.40 per cent on March 30, 2007.
Industrial growth analysis
Industrial growth rose 10.9% in Jan 2007 – lower than the November and
December data, but higher than the consensus expectations and the 8.5% growth
seen in the same period last year. This is positive and bodes well for the govt’s
9.2% GDP estimate for FY07.
43
Growth on a sectoral basis was led by manufacturing up 11.6%, electricity

and mining up 8.5% and 6.0%; (2) Continued buoyancy across the use-based
classification – led largely by basic goods (11.6%), intermediate goods (12.7%)
and consumer goods – especially non-durables; (3) However, capital goods
production came in at 8.6%, which can be attributed partially to the base effect
(27% in Jan06).
Interest Rate Implications
On the back of the strong IIP data coupled with the fact that we expect
inflation to remain in the 5.5-6.5% range until March/April, we expect policy
rates to rise by 25bps in April. While concerns on overheating in sectors remains,
we do not anticipate policy rates to rise much further as significantly higher rates
could result in more dollar inflows and thus make currency management difficult.
Infrastructure sector analysis
Railway
Indian Railways has witnessed a 9.12 per cent growth in freight loading
during April 2005-February 2006 to 655.35 million tonnes (mt) from 600.58 mt.
It has also registered a 14.89 per cent increase in freight earnings touching Rs
37,589.03 crore from Rs 32,716.59 crore during the period. Passenger earnings
have risen by 13.61 per cent to Rs 15,371.93 crore from Rs 13,530.19 crore. The
integral coach factory and rail coach factory has produced 1,110 and 1,164
coaches, respectively, during the period, exceeding the target by 26 and 4
coaches each. The rail wheel factory has produced 1,22,339 wheels and 52,537
axles during the same period compared to the target of 1,18,126 wheels and
52,528 axles.
44
Shipping
The union shipping ministry is considering an action plan for the next five
years to increase the draught in the major ports in the country up to 18 m to
handle larger vessels. In this context, the ministry has prepared an action plan to
increase the draught in major ports such as Kolkata from the present 7 to 9 m,
Haldia Dock Complex from 8.5 to 9 m, Visakhapatnam from 17 to 18 m, Ennore
from 13.5 to 16.5 m, Chennai from 17 to 17.5 m, Tuticorin from 10.7 to 14.7 m,
Kochi from 12.5 to 14.5 m, New Mangalore from 14 to 17 m, Goa from 13.3 to
14.3 m, Mumbai from 9.1 to 14 m, JNPT from 12.5 to 14 m and Kandla from 11.7
to 14.5 m. The ministry is also planning to set up a deep-sea port off the coast of
West Bengal . The new port will be like that of Shanghai Port far away from the
coast with a draught of 20 m to cater to vessels with a capacity of more than 1.5
lakh TEUS.
In 2006-07, the 12 major ports have handled a total of 463.84 million

tonnes (mt) of traffic, up by an estimated 9.51 per cent over 423.56 mt handled in
2005-06, according to tentative figures released by the Indian Ports Association.
However, there has been a marginal shortfall of 0.4 per cent from the target of
465.7 mt. Visakhapatnam port is the largest cargo-handling port with a total
traffic throughput of 56.38 mt, followed by Kolkata port (including Haldia) 55.05
mt and Chennai 53.4 mt. In terms of growth, Mumbai port has topped the list
with an 18.5 per cent growth at 52.36 mt (44.19 mt in 2005-06), followed by
Jawaharlal Nehru port 18.45 per cent at 44.81 mt (37.83 mt), Ennore 16.86 per
cent at 10.71 mt (9.17 mt) and Paradip 16.33 per cent at 38.51 mt (33.10 mt).
Kolkata Dock System (excluding Haldia) has also posted 16.56 per cent growth
at 12.59 mt (10.80 mt). But traffic throughput at Haldia remained virtually
stagnant at 42.45 mt (42.33 mt), or a mere 0.28 per cent rise. Together with
Haldia, Kolkata port has, thus, posted a meager growth of 3.59 per cent. Other
ports that posted double digit growth during the year are Kandla, 15.41 per
45
cent at 52.98 mt (45.90 mt), followed by Chennai 13.05 per cent at 53.41 mt
(47.24 mt) and Kochi 10.28 per cent 15.31 mt (13.88 mt). New Mangalore port
has reported a negative growth of 6.99 per cent at 32.04 mt (34.45 mt).
Visakhapatnam port, the largest cargo-handling port, has registered the lowest
growth of 1.05 per cent, followed by Tuticorin at 5.03 per cent to 18 mt (17.13
mt) and Mormugao by 8.06 per cent to 34.24 mt (31.68 mt).
Cement
The government has made cement imports duty-free and is also

contemplating a removal of the dual excise duty structure on cement announced
in the recent budget. The government has abolished, with immediate effect, the
countervailing duty of 16 per cent and additional customs duty of 4 per cent on
Portland cement, widely used in construction. This follows a full customs duty
exemption on Portland cement in January 2007. The domestic cement companies
have been asked by the government to suggest proposals to reduce prices.
Cement prices have risen from an average of Rs 165 (per 50 kg bag) in January
2006 to Rs 209 in February 2007 and subsequently to Rs 220.The government
has also clarified that the countervailing duty exemption on cement import would
be Rs 350 per tonne in the case of cement of declared retail sale price not
exceeding Rs 190 per 50 kg bag. For higher priced cement, the excise duty would
be Rs 600 per tonne. Since the budget, differences have arisen between
government and domestic manufacturers.
46
Bond markets analysis
Bond markets were relatively less impacted by the global financial turmoil
with the benchmark ten-year yield closing marginally higher at 7.94% from
7.93%.Though budget estimates were in line with the FRBM targets and
measures to ease inflationary pressures continued, the RBI announced a series of
measures earlier this month to absorb excess liquidity to contain inflation.
Measures include: (1) Capping the amount of money they will absorb through
revere repos to Rs30bn on a daily basis which possibly was done to discourage
banks to fulfill their SLR requirements by borrowing G Secs in repo; and (2)
Modifying the market stabilisation scheme (MSS scheme) – which would now
use a mix of T-Bills and dated securities to and T-bills under the (MSS).
Implication: These measures are likely to divert short-term liquidity to the

inter-bank money market thus bringing down the overnight call money rate. The
reverse-repo window being limited to Rs30bn could see increased demand for
bonds in the short tenors upto 1 year and in excess liquidity conditions could
result in a steepening of the curve. Moreover, greater shifting of sterilisation
money to MSS would mean that the government pays the cost for MSS while
reverse repo window cost is borne by RBI.
Note : for the actual data refer to the key indicators table in annexure – 1
(source latest economic and political weekly)
47
ANALYSIS OF MACRO ECONOMIC INDICATORS (as per the latest

economic survey 2006-2007)
India's real GDP has attained an average growth rate of 8.1% between
2003- 2006 as compared to that of 4.6% in the three years preceding this period.
It is believed that this above 8% growth achieved in the last three years is
cyclical in nature and does not reflect a long-term structural growth.
It is expected the Indian economy's growth to fall by 50-100bps in FY07E

and FY08E compared to the last three year's average growth of 8.1% led by
rising inflation and interest rates, soaring crude oil prices and a likely slowdown
in the domestic capital markets.
Table 1
Years 2003 2004 2005 2006 2007
Real GDP 3.8 8.5 7.5 9 9.2
growth in
%
Figure – A
Real GDP growth rate %
10
Real GDP Growth
8
6
rate%
4
2
0
2004 2005 2006 2007 2008E
years real GDP
48
TABLE 2
Nominal GDP$bn
2004 2005 2006 2007 2008E
603 695 805 913 1073
Figure - B
Nominal GDP(US $billion)
1200
1000 Indian
Nominal GDP(US$billion)
800
600
400
200
0
2004 2005 2006 2007 2008E
nominal
years GDP
economy records an average growth of 8.1% between 2003-07
India's real GDP has attained an average growth rate of 8.1% between
2003-2006 as compared to that of 4.6% in the two years preceding this period.
The stupendous increase in the growth figures is primarily due to a robust
performance from the non-farm sector, which has grown at an average 9.1% in
the period 2003-06 as compared to the growth of 6.2% between 2001-03. Not
only has the services sector contribution to GDP gradually increased to 60.7% in
2006 from 56.8% in 2001, the growth rate has also increased from an average
6.6% between 2001-03 period to 9.7% growth in the last three years. The
industrial sector has also shown a steady growth - albeit at a lower rate than the
services sector - recording an average growth of 7.2% in the last three years as
49
compared to that of 5.2% between 2001-03. Agricultural growth in the last three
years has however been erratic reflecting the sector's continued dependence on
monsoon. Although the average agriculture sector growth at 4.9% in the last
three years has been above the trend growth rate of 4% and significantly higher
than the negative growth rate of 0.2% between 2001-03, the higher growth
mainly emanated from a strong 10% growth in FY04 and a 3.9% trend growth in
FY07.This helped to average out the dismal performance of the agriculture sector
in FY06 when it grew by a mere 0.7%
It is believed that this above 8% growth achieved in the last three years is
cyclical in nature and does not reflect a long-term structural growth. An
environment of excess global liquidity during 2003, given the ultra loose
monetary policy in major developed countries, has helped fuel a robust yet
unsustainable growth in most of the emerging market countries in the last three
years. In India, a credit boom - led by a fall in the domestic real interest rates
since end-2003 and a soaring capital market - reflecting the increase in the global
risk appetite of investors have helped to sustain the robust growth momentum in
the last three years. However, currently real interest rates are on the rise both
globally and domestically to curb inflationary pressures. Given the likelihood of
a slowdown in the capital markets owing to drying up of global liquidity
exacerbated by rising international oil prices on the face of mounting geo-
political risks, India's growth is most likely to slow down by 50-100bps in
FY07E and FY08E than the last three year's average growth of 8.1%. RBI's
projection of 7.5-8% growth for FY07 is on the optimistic side and there would
be some slippage in the growth numbers as the lagged effect of rising interest
rates on credit growth would start to manifest itself, especially in the second half
of FY07E. it is expect GDP growth to be in the range of 7-7.5% in FY07

depending on the performance of the South-West monsoon.
50
Services sector - fuelling India's growth engine
India has relied on a services-led growth model to reach a higher growth

trajectory unlike its Chinese counterpart, which relies heavily on a
manufacturing-led growth strategy. As a result the services sector contribution to
GDP has kept on steadily increasing from an average 51% between FY93-FY03
to 60.7% in FY06.The stupendous performance of the services sector leading to
an average growth of 9.1% in the last three years has acted as the main catalyst
behind India's rising GDP in this period. Lead indicators of services sector
performance for 2006 suggest continued buoyancy. Going forward, it is expected
the services sector growth momentum to be maintained but at lower levels
compared to the double-digit growth recorded in the last two years. It is
expected that the services sector would grow at 9% in FY07E.
Table 4
Services
Growth% 2004 2005 2006 2007 2008E
8.5 9.6 9.8 11.2 10.9
Services Growth%
Figure D
12
Services growth%
10
8
6
4
2
0
2004 2005 2006 2007 2008E
Years Services Sector
51
MONETARY INDICATORS
In a widely expected move, the RBI increased both the Reverse-Repo and
the Repo rate by 25bps in the latest Monetary Policy Review, taking the key short
term interest rates to 6% & 7% respectively.
It is not expected that RBI will hike interest rates any more in this
calendar year although it would definitely continue to maintain its hawkish
stance on interest rates and keep a close vigil on global macroeconomic
conditions.
As against the RBI's projection of 7.5-8% real GDP growth in FY07E, it is

expected to have slightly lower growth at 7-7.5% mainly due to an expected
slowdown in economic conditions in the latter half of the current fiscal.
RBI raises the Reverse-Repo rate by 25bps taking it to 6.25%
In a widely expected move, the Reserve Bank of India increased the

Reverse-Repo rate by 25bps in the 2007(3 rd Quarter) Monetary Policy Review,
taking the key short-term interest rate to 6.25%. It increased the Repo rate by
25bps, taking it to 7.25% - thereby maintaining 100bps spread between the two
rates. Bank Rate and Cash Reserve Ratio have been kept unchanged.
The 2007 interest rate hike is the seventh rate hike since Oct'04 when the
RBI first embarked on a monetary tightening cycle.However it would definitely
continue to maintain its hawkish stance on interest rates and keep a close vigil on
global macroeconomic conditions..The RBI has retained both its GDP growth
projection and inflation forecast for FY07E at 7.5-8.0 % and 5.0-5.5%
52
respectively. Although economic conditions are robust at this moment, we expect

the economy to slow down in the second half of FY07E leading to a lower GDP
growth estimate of 7-7.5% in FY07E.
53
MACROTREND
Very low real interest rates helped to create the present credit boom
It is believed that the fall in the real interest rates (10-Yr G-Sec – WPI
Inflation) from a high of 6.5% in Feb'02 to abnormally low levels in FY03 and
FY04 has helped to trigger the current credit cycle which has been sustained for
almost two years now. The US had cut down its key short-term interest rate - the
Fed-Fund rate - to as low as 1% in 2003 and this led to the building up of global
excess liquidity which manifested itself in the form of low real interest rates in
most parts of the world and India was no exception. In a series of rate cuts, the
Reverse-Repo rate was brought down from 6.5% in Feb'02 to 4.5% in Sept'04.
Since then the RBI has however embarked on a monetary tightening cycle in an
effort to rein in inflationary pressures by increasing nominal interest rates and
rationalizing the real interest rates.
The current credit cycle is nearing its end
The current credit cycle was an offshoot of rising consumer demand

fuelled by abnormally low real interest rates. It started from June'04 and has
almost lasted for two years. However the lagged effect of interest rate hikes (in
India it takes 15 months for a monetary policy to have effect on the economy)
which started since Oct'04 is expected to weigh down on the credit growth in the
latter half of the current fiscal, slowing it down from last year's 30% growth to
25% levels in FY07E.
54
Mismatch between the deposits and credit growth
The current credit cycle, which is nearing its end, is characterized by a

huge divergence in growth between aggregate deposits and bank credit. While the
bank credit has grown at an average 30% in the last two years, aggregate deposits
have grown at a much lower rate of 16-17%. Such a huge divergence in growth
rates is unsustainable and carries the risk of triggering inflation. As a result the
RBI has been increasing interest rates aggressively to narrow the gap between the
two growth rates. It should be borne in mind that monetary policy works with a
lag and it takes at least 15 months before the effect of a rate hike starts kicking
in. Therefore, the monetary tightening cycle, which the RBI embarked on since
Oct'04, will start taking effect now, helping to bring down the divergence
between the credit and deposits growth rate.
Table 5
Bank credit 2004 2005 2006 2007 2008E

15.3 30.9 30 23 20
Figure E
Bank Credit Growth(%)
35
30
25
Bank Credit 20
Growth (%) 15
10
5
0
Bank 2004 2006 2008E
credit
Years credit growth
55
Table 6
Deposit growth 2004 2005 2006 2007 2008E

17.5 13 17 15 15
Figure F
Deposit Growth(%)
20 17.5 17
Deposit Growth(%)
15 15
15 13
10
0
2004 2005 2006 2007 2008E
Years
deposit growth
Widening gap between the C/D & I/D ratio
The high credit growth in the last two years have been sustained by the
commercial banks liquidating their investments in G-sec's (as it is unprofitable to
stay invested in the bond markets in a rising interest rate scenario) and using the
resources to fund the credit growth. As a result, the Credit-Deposit ratio has
increased from an average of 55% in 2004 to 71% currently and the Investment-
Deposit ratio has steadily fallen from an average of 46% to 35% currently thus
widening the gap between the two ratios considerably.
56
Inflation
It is believed that inflation is purely a monetary phenomenon and is not

caused by either "demand side factors" or "supply side factors" - the most
common example being oil price shock. They are of the view that inflation is
caused when money supply or credit grows in excess of the nominal GDP growth.
The effect of money is non neutral and when injected in the economy affects
specific areas first setting in a motion of relative price changes, which causes
distortion in the structures of production and ultimately leads to a general rise in
price level. The WPI and CPI indices used to measure inflation are based on the
faulty assumption of neutrality of money i.e. the effect of newly injected money
would affect all prices in a neutral way. General goods price rises, which are
captured through price Indexes such as WPI & CPI are only one of the many
symptoms of inflation - they cannot explain either the true cause or depict the
correct level of inflation.
Table 7
Years 2003 2004 2005 2006 2007
Inflation 3.4 5.4 6.5 4.5 5.3
WPI in %
Figure G
Inflation WPI chart
7
6.5
6
Inflation WPI in %
5.4 5.3
5
4.5
4
3 3.4
2
1
0
2003 2004 2005 2006 2007
2003-07
WPI
High money supply and bank credit growth main threat to inflation
57
The real fear of inflation stems from the fact that broad Money Supply
(M3) and Bank Credit are growing at a faster rate than nominal GDP. This has no
doubt created inflation which has flowed into asset prices, commodity prices,
equities and goods and services. Just because the inflation has not shown up in
narrowly defined price indexes such as WPI does not mean that inflation is not a
concern. RBI seems to have recognized this risk and has openly shown
discomfort about the way asset prices and credit growth have been soaring up.
Money supply presently growing at 18.8% against RBI's target of 15% for
FY07E
Broad money supply (M3) and bank credit growth are currently growing at
18.8% and 31% respectively - much higher than RBI's target of 15% and 22% for
FY07E.Therefore some more tightening may be warranted to bring down the
money supply and bank credit growth. However we can expect to see more rate
hikes in Jan'07 Monetary Policy Review if the bank credit and money supply
continues to grow at a fast pace.
Fed about to pause rate hikes but BOJ and ECB to continue
It is expected the US Federal Reserve to increase the target Fed-Funds rate

by another 25bps on 8th Aug'06 taking the key short-term interest rate to 5.5%.
From this stage onwards there is an uncertainty whether the Fed would prefer to
raise rates further or not. The decision would depend on the Fed's outlook on
core inflation, which is presently at 3% - much above the Fed's comfort zone of
2%. However the BOJ and ECB are expected to tighten interest
58
rates further although these rate hikes are expected in the later part of the year.
With the US almost nearing the end of the interest rate tightening cycle, while
the other countries are still raising rates, the interest differential advantage is
likely to shift away from the US to the countries those who still have some more
tightening left.
Indian interest rates likely to take a cue from US interest rates
It is expected RBI to increase interest rates any more in this calendar year.
With the target Fed-Fund rate likely to end at 5.5%, a 50bps interest differential
will be maintained between the Indian and the US interest rates. If the Fed
increases interest rates beyond 5.5%, this might lead RBI to raise rates some
more in Jan'07 to maintain a favourable interest differential apart from domestic
considerations for raising interest rates. We expect the uncertainty relating to the
US interest rate hikes to come to an end by August'06 - or maximum by Sept'06
after which a clearer picture will emerge about the domestic interest rates. It is
expected the 10-Yr G-Sec to come below 8% by next month once the uncertainty
relating to the interest rate hikes come to an end with the only caveat that oil
prices do not shoot up any further due to geo-political risks.
Table 8
Interest Rate PLR year end
2004 2005 2006 2007 2008E
10 10.3 10 10.5 10
Figure H
59
Interest Rate-PLR year end
years 2008E
2006
2004
9.7 9.8 9.9 10 10.1 10.2 10.3 10.4 10.5 10.6

Interest Rate -PLR year end PLR
FISCAL INDICATORS
India's public finance is expected to deteriorate in the coming months due

to the effect of increasing interest rates, reduction in the import duties of
transport fuel from 10% to 7.5% on 16th June'06 and finally the government's
decision to put on hold all divestment decisions and proposals until further
notice.
It is expected the fiscal deficit to have a slippage of Rs.120bn in FY07E

thus pushing it up to 4.1% of GDP - same as last year's headline fiscal deficit.
60
EXTERNAL SECTOR INDICATORS
The trends are bullish on INR and expect the INR to be around Rs.
42.5/US$ by Mar'07- end primarily led by a weak dollar. However certain factors
such as continued rise in international oil prices, a reversal of capital flows and
political risks may pose to be major threats to our projections.
In the worst-case scenario it is expected INR to depreciate to Rs. 45/US$ by

April '07 end.
Table 10
RS/US$ 2004 2005 2006 2007 2008E
45.9 45 44.3 44.9 43.2
Figure J
Rs/US$ annual avg.

Rs.US$ annual avg.
47
45.9
46 45 44.9
45 44.3
44 43.2 Rs/US$
43
42
41
2004 2005 2006 2007 2008E
years
61
Reasons in favour of INR appreciation:
1) Relative weakness of the USD:
INR bullishness is mainly in anticipation of a sharp depreciation in the USD

by the end of this year. Despite the burgeoning CAD (US$822.8bn, 6.8% of
GDP) and Budget Deficit (3.6% of GDP) in the US, the USD has continued to
remain bullish so far mainly due to Fed's repeated interest rate hikes and further
interest rate hike expectations, which tilted the interest differential advantage in
favour of the US. Now with the interest rate tightening cycle coming to an end,
the situation is expected to reverse leading to a sharp depreciation of the USD
and a concomitant rise in the other currencies including INR. The downside risks
to our view on Dollar bearishness lies in the possibility of the Fed continuing its
monetary tightening cycle much higher than the expected 5.5% levels. If the core
inflation refuses to come down from the current levels of 3% in the US, the Fed
may continue with hiking rates and the Fed-Fund rate may even go up to 6%. In
such a scenario, the USD will continue to remain strong on expectations of rising
rates and the INR will weaken in such a scenario.
2) RBI may opt for INR appreciation as a monetary tightening strategy:
At the current moment the RBI is faced with the problem of rising
inflationary pressures. RBI has been hiking interest rates to fight inflation.
However INR has been depreciating in the last few months leading to a further
easening of the liquidity conditions, which might exacerbate the current
inflationary pressures. India imports 70% of its oil requirements and given a
significant share of petroleum crude & products in the total imports (31%), a
significant Rupee depreciation can worsen the domestic inflation situation. It has
been empirically seen that a 1 percentage point appreciation in India's trade
62
weighted exchange rate leads to the same long-run impact of a 18-20bp increase
in interest rates.
Moreover the shifts in exchange rate have an effect on the inflationary

conditions in just two months whereas the impact of an interest rate hike works
with a lag of 15 months in India. Therefore, given the scenario of high crude oil
prices and rising inflationary pressures the RBI may opt for using the exchange
rate route to tighten liquidity and control inflation rather than using the interest
rate route.
Reasons against INR appreciation:
Concerns about widening CAD
India's Current Account Deficit (CAD) has widened in the last year to
US$10.6bn (1.3% of GDP) from US$5.4bn (0.8% of GDP). This was mainly due
to a deteriorating Trade Deficit, which touched US$51.5bn (6.5% of GDP) in
FY06 as compared to US$36.6bn (5.3% of GDP) in FY05 led by a higher oil and
non-oil imports growth. Most of the Trade Deficit was financed by a strongly
growing invisibles which stood at US$40.9bn (5.1% of GDP) in FY06 compared
to last year's US$31.2bn (4.5% of GDP) thus containing the CAD at a lower level
of 1.3% of GDP.
Oil prices remain a major threat for the widening Trade Deficit
Apart from a higher non-oil imports growth due to a fast growing domestic
economy, the main reason for the deteriorating Trade Deficit has been high
international crude oil prices. WTI oil prices are currently hovering around
US$74/bbl amidst intense geo-political risks leading to supply shortages from oil
63
exporting countries. If the oil prices remain at these levels or worsen in the
remaining part of FY07E, it would lead to a further widening of the Trade Deficit
and CAD even after assuming a buoyant invisibles trend. Given the likelihood of
a global slowdown by the end of 2006 driven by hardening of interest rates, it is
expected oil prices to come down from its current high level and average around
US$70/bbl in FY07E. In such a scenario, the Trade Deficit will not deteriorate
substantially in FY07 and remain under manageable limits. It is expected Trade
Deficit to be around US$60bn in FY07 (6.9% of GDP). However if the political
tension in the Middle-East heightens leading to a war at some stage, oil prices
may skyrocket, which would substantially worsen the Trade Deficit.
CAD may widen substantially if invisibles flow slows down
Given a manageable Trade Deficit and an expected buoyant trend in invisibles,

the Current Account Deficit is expected to be slightly higher than last year at
US$15bn (1.7% of GDP). It is believed that the flows in the capital account will
be sufficient to finance the CAD without dipping into the forex reserves though
the capital flows will slow down compared to last year leading to less accretion
to forex reserves. However if the invisibles flow slows down considerably
triggered by a fall in the repatriation of remittances and software services as a
result of rising interest rates in other parts of the world and an impending global
slowdown, this will widen the CAD even further leading to a depreciating
pressure on the INR.
64
Net accretion to forex reserves likely to slow down in FY07E
India's forex reserves are currently in a very comfortable position. The forex
reserves stood at US$162.7bn as on 14th July - enough to cover 11 months of
imports. We expect overall BOP to be in the surplus in FY07E. However net
accretion to forex reserves will slow down in FY07E compared to the last two
years due to the combined effects of a rising CAD and a falling Capital Account
Surplus. In the worst case scenario of massive capital outflows and a widening
CAD, leading to an overall negative BOP, the forex reserves position is more
than sufficient to take care of the adverse situation. However if the overall BOP
goes to a negative zone, the INR will take a severe beating. Although this
possibility cannot be ruled out, we believe this is a low probability outcome.
Table 12
Forex reserves 2004 2005 2006 2007 2008E
106.1 135.1 145.1 161.6 177.5
Figure L
Forex reserves (excl.gold) US $bn
200
150
100
50
0
2004 2005 2006 2007 2008E FOREX
65
66
Performance of Equity Market till third quarter (2006-2007)
Primary Market
Resources raised through the public issues segment picked-up during the
quarter ended December 2006 vis-à-vis the previous quarter. Cumulative
resources raised through public issues during April-December 2006 increased by
33.0 per cent to Rs. 25,365 crore, even as the number of issues came down from
88 to 78 . The average size of public issues increased from Rs.217 crore during
April-December 2005 to Rs.325 crore during April-December 2006. Except one
issue, all public issues during April-December 2006 were in the form of equity.
Out of 78 issues during April-December 2006, 41 issues were initial public
offerings (IPOs), accounting for 78.7 per cent of resource mobilisation.
Mobilisation of resources through private placement increased by 55.5 per

cent to Rs.71,038 crore during April-September 2006 over the corresponding
period of the previous year . Resources mobilised by private sector entities
increased by 67.0 per cent, while those by public sector entities increased by 43.8
per cent during April-September 2006. Financial intermediaries (both from
public sector and private sector) accounted for the bulk (70.2 per cent) of the
total resource mobilisation from private placement market during April-
September 2006 (61.1 per cent during April-September 2005).
The resources raised through Euro issues - American Depository Receipts

(ADRs) and Global Depository Receipts (GDRs) - by Indian corporates during
April-December 2006 at Rs.8,841 crore were almost the same as in the
corresponding period of previous year.
During April-December 2006, net mobilisation of resources by mutual

funds increased substantially by 190 per cent to Rs.79,708 crore over the
corresponding period of 2005. Bulk of the net mobilisation of funds was under
67
income/debt-oriented schemes (73.0 per cent of total), while growth/ equity-

oriented schemes accounted for 25.8 per cent of the net mobilisation of funds.
Interpretation : This shows the buoyancy in the primary markets, the amount of
funds mobilized has been increasing over the years. It is indeed a positive factor
for financial services firms like Religare Securities as managing IPO investments
is one of their key services offered to the clients. Further it also provides an
opportunity to list itself as other brokerage firms have already done in the recent
past.
Secondary Market
The domestic stock markets remained buoyant and recorded further gains
during the third quarter of 2006-07. Continued buying by FIIs on the back of
strong domestic fundamentals, robust corporate results, upward trend in the
international equity markets and decline in global crude oil prices provided
support to domestic stock markets. Domestic stock markets declined during May-
June, 2006 in consonance with global trends increased risk aversion over
concerns of slowdown in global growth, increase in global inflation, higher
international interest rates and meltdown in base metal prices. The BSE Sensex
reached 8929 as on June 14, 2006, a decline of 29.2 per cent over the then all-
time high of 12612 reached on May 10, 2006. Stock markets recovered these
losses in the following months, reflecting fresh buying by FIIs, recovery in base
metal prices and decline in international crude oil prices amidst continuing
robust macroeconomic fundamentals. The BSE Sensex reached a new high of
13972 on December 7, 2006. The markets witnessed some correction in the next
few days, inter alia, due to profit taking at higher levels, deceleration in
industrial activity for October 2006, announcement of CRR hike and the decision
of the Bank of Thailand (BoT) to impose unremunerated reserve requirement
68
(URR) on short-term capital flows. The markets, however, recovered in the next
few days. The BSE Sensex closed at all-time high of 14218 on January 18, 2007.
The Sensex was 14041 on January 23, 2007, 24.5 per cent above its end-March
2006 level. Profits after tax of corporates exhibited further improvement in the
second quarter of 2006-07. Ratio of profits after tax to sales also improved to
11.0 per cent during the quarter ended September 2006 from 10.6 per cent in the
preceding quarter and 8.5 per cent a year ago and . FIIs turned net sellers in
Indian stock markets in December 2006 after making large purchases during
August-November 2006. According to the Securities and Exchange Board of
India (SEBI), FIIs made net purchases of Rs.18,176 crore (US $ 3.9 billion)
during 2006-07 (up to January 22, 2007) as compared with net purchases of
Rs.33,461 crore (US $ 7.5 billion) during the corresponding period of the
previous year.
Major indices and sectors have shown mixed trends during 2006-07 so far
. On a point-to-point basis (up to January 22, 2007), BSE 500, BSE Mid-cap and
BSE Small-cap increased by 20.7 per cent, 13.8 per cent and 14.8 per cent,
respectively. Amongst major sectors, bank stocks recorded gains of 42.0 per cent
over end-March 2006, followed by oil and gas (34.7 per cent), IT stocks (32.8 per
cent), consumer durables (20.2 per cent), capital goods (15.1 per cent), auto (6.2
per cent), public sector undertakings (1.9 per cent), metals (1.3 per cent) and
healthcare (1.0 per cent). However, fast The price-earnings (P/E) ratio for the 30
scrips included in the BSE Sensex increased from 20.9 at end-March 2006 to
22.8 at end-December 2006. The market capitalisation of the BSE increased by
19.9 per cent between end-March 2006 and end-December 2006. Volatility during
April-December 2006 was lower than that in the same period a year ago.
Total turnover (BSE and NSE) in the cash segment during April-December
2006 at Rs.21,23,724 crore was 30.8 per cent higher than that in the
corresponding period of 2005 Total turnover (BSE and NSE) in the derivative
69
segment increased by 72.0 per cent during April-December 2006 to Rs.53,49,595
crore.
Interpretation: The liquidity in the secondary markets are also very encouraging
for Indian capital markets. Foreign investors as well as domestic investors are
showing improved interest to trade in the markets. The valuations are also
looking to be fair at present with some signs of minor corrections. As long as
potential is there is book profit in the market, investors would remain interested.
Surging volumes and new peaks achieved by Indian benchmark indices are
anything but great news for brokerage services firms, as it provides with
tremendous potential to attract new investors and increase revenues.
70
71
72
EFFECT OF THE BUDGET ON THE NBFCs
The number of applications received by RBI for grant of certificate of

registration (CoR) as NBFCs till end-March 2006 was 38,244, out of which,
13,141 applications (net of cancellation), including 423 applications (net of
cancellation) of public deposit accepting companies (NBFCs-D), were authorised
to accept/hold public deposits. At end-June 2006, the total number of NBFCs
registered with RBI was 13,014 (net of cancellation). (Table 3.11). 3.78 With the
exit of many NBFCs from the public deposits taking usiness, the number of
NBFCs-D has steadly declined. As at end June 2006, NBFCs-D were 428. The
number of Residuary Non-Banking Financial Companies (RNBFCs) remained
unchanged at 3 at end-March 2006. During 2005-06, assets and public deposits of
NBFCs increased by Rs. 2,394 crore and Rs.2,316 crore, respectively. Net owned
funds of NBFCs increased by Rs.562 crore during 2005-06, despite a decline in
the number of reporting NBFCs. Deposits of reporting NBFCs at end-March 2006
were marginally lower at 1.1 per cent of aggregate deposits of SCBs compared
to 1.2 per cent at end-March 2005. Total assets/liabilities of NBFCs (excluding
RNBFCs) at end-March 2006 wereRs.35,561 crore, down marginally by 1.2 per
cent from Rs.36,003 crore at end-March 2005. Such assets/liabilities had
increased by 9.9 per cent during 2004-05. There were major changes in the
composition of assets and liabilities as well in 2005-06. On the liability side,
paid-up capital as well as public deposits of these companies declined by 11.7
per cent and 32.1 per cent, respectively, during 2005- 06. On the asset side, Bill
Discount business in 2005-06 registered a substantial decline of 90.4 per cent
compared to an increase of 7.8 per cent during 2004-05; their SLR investment
declined by 41.3 per cent during 2005-06 compared to an increase of 31.0 per
cent during 2004-05 and decline of loans and advances was 27.8 per cent
compared to an increase of 3.1 per cent in the previous year. In 2005-06, a
significant decline in feebased income (61.2 per cent) and only a marginal
increase in fund-based income (5.3 per cent) resulted in stagnancy of the overall
73
income of NBFCs (marginal decline of 0.1 per cent) compared to an increase in

overall income of 5.8 per cent in 2004-05. Concomitantly, expenditure registered
an increase of 13.0 per cent in 2005-06 mainly because of an increase of 31.6 per
cent in operating expenses. Net profit after tax of NBFCs in 2005-06 was only
Rs. 152 crore compared to Rs.572 crore in 2004-05, representing a decline of
73.4 per cent compared to an increase of 7.7 per cent in 2004-05. Gross NPAs as
a proportion of gross advances as well as net NPAs as a proportion of net
advances of reporting NBFCs (excluding RNBFCs, Mutual Benefit Companies
(MBCs) and Miscellaneous Non-Banking Companies (MNBCs)) at end-March
2006 declined sharply to 2.4 per cent and 0.4 per cent, respectively, compared
with 8.2 per cent and 2.4 per cent, respectively at end-March 2005. The number
of NBFCs (excluding RNBFCs, MBCs and MNBCs) with less than the minimum
regulatory CRAR of 12.0 per cent declined from 64 at end-March 2005 to19 at
end-March 2006. The number of NBFCs with CRAR more than 30 per cent also
declined from 280 at end-March 2005 to 252 at end-March 2006.
74
Competitive forces theory – MICHAEL E. PORTER
Strategy analysis is an important starting point for the analysis of financial

statements. Strategy analysis allows the analyst to probe the economics of the
firm at a qualitative level so that the subsequent accounting and financial
analysis is grounded in business reality. Strategy analysis also allows the
identification of the firm’s profit drivers and key risks. This, in turn, enables the
analyst to assess the sustainability of the firm’s current performance and make
realistic forecasts of future performance. A firm’s value is determined by its
ability to earn a return on its capital in excess of the cost of capital. While a
firm’s cost of capital is determined by the capital markets, its profit potential is
determined by its own strategic choices:
(1) the choice of an industry or a set of industries in which the firm operates
(industry choice),
(2) the manner in which the firm intends to compete with other firms in its
chosen industry or industries (competitive positioning), and
(3) the way in which the firm expects to create and exploit synergies across the
range of businesses in which it operates (corporate strategy). Strategy analysis,
therefore, involves industry analysis, competitive strategy analysis, and corporate
strategy analysis.
75
INDUSTRY ANALYSIS
In analyzing a firm’s profit potential, an analyst has to first assess the

profit potential of each of the industries in which the firm is competing, because
the profitability of various industries differs systematically and predictably over
time. For example, the ratio of earnings before interest and taxes to the book
value of assets for all U.S. companies between 1981 and 1997 was 8.8 percent.
However, the average returns varied widely across specific industries: for the
bakery products industry, the profitability ratio was 43 percentage points greater
than the population average, and 23 percentage points less than the population
average for the silver ore mining industry.
There is a vast body of research in industrial organization on the influence

of industry structure on profitability. Relying on this research, strategy literature
suggests that the average profitability of an industry is influenced by the “five
forces” shown in Figure below. According to this framework, the intensity of
competition determines the potential for creating abnormal profits by the firms in
an industry. Whether or not the potential profits are kept by the industry is
determined by the relative bargaining power of the
76
77
Competitive Force 1: Rivalry Among Existing Firms
In most industries, the average level of profitability is primarily

influenced by the nature of rivalry among existing firms in the industry. In some
industries, firms compete aggressively, pushing prices close to (and sometimes
below) the marginal cost. In other industries, firms do not compete aggressively
on price. Instead, they find ways to coordinate their pricing, or compete on non
price dimensions, such as innovation or brand image. Several factors determine
the intensity of competition between existing players in an industry
INDUSTRY GROWTH RATE
If an industry is growing very rapidly, incumbent firms need not grab

market share from each other to grow. In contrast, in stagnant industries, the only
way existing firms can grow is by taking share away from the other players. In
this situation, one can expect price wars among firms in the industry.
CONCENTRATION AND BALANCE OF COMPETITORS
The number of firms in an industry and their relative sizes determine the
degree of concentration in an industry. The degree of concentration influences
the extent to which firms in an industry can coordinate their pricing and other
competitive moves. For example, if there is one dominant firm in an industry
(such as IBM in the mainframe computer industry in the 1970s), it can set and
enforce the rules of competition. Similarly, if there are only two or three equal-
sized players (such as Coke and Pepsi in the U.S. soft-drink industry), they can
implicitly cooperate with each other to avoid destructive price competition. If an
industry is fragmented, price competition is likely to be severe.
78
DEGREE OF DIFFERENTIATION AND SWITCHING COSTS.
The extent to which firms in an industry can avoid head-on competition

depends on the extent to which they can differentiate their products and services.
If the products in an industry are very similar, customers are ready to switch
from one competitor to another purely on the basis of price. Switching costs also
determine customers’ propensity to move from one product to another. When
switching costs are low, there is a greater incentive for firms in an industry to
engage in price competition.
SCALE/LEARNING ECONOMIES AND THE RATIO OF FIXED TO

VARIABLE COSTS.
If there is a steep learning curve or there are other types of scale

economies in an industry, size becomes an important factor for firms in the
industry. In such situations, there are incentives to engage in aggressive
competition for market share. Similarly, if the ratio of fixed to variable costs is
high, firms have an incentive to reduce prices to utilize installed capacity. The
airline industry, where price wars are quite common, is an example of this type of
situation.
EXCESS CAPACITY AND EXIT BARRIERS.
If capacity in an industry is larger than customer demand, there is a strong

incentive for firms to cut prices to fill capacity. The problem of excess capacity
is likely to be exacerbated if there are significant barriers for firms to exit the
industry. Exit barriers are high when the assets are specialized, or if there are
regulations which make exit costly.
79
Competitive Force 2: Threat of New Entrants
The potential for earning abnormal profits will attract new entrants to an
industry. The very threat of new firms entering an industry potentially constrains
the pricing of existing firms within it. Therefore, the ease with which new firms
can enter an industry is a key determinant of its profitability. Several factors
determine the height of barriers to entry in an industry:
ECONOMIES OF SCALE
When there are large economies of scale, new entrants face the choice of
having either to invest in a large capacity which might not be utilized right away,
or to enter with less than the optimum capacity. Either way, new entrants will at
least initially suffer from a cost disadvantage in competing with existing firms.
Economies of scale might arise from large investments in research and
development (the pharmaceutical or jet engine industries), in brand advertising
(soft-drink industry), or in physical plant and equipment (telecommunications
industry).
FIRST MOVER ADVANTAGE.
Early entrants in an industry may deter future entrants if there are first
mover advantages. For example, first movers might be able to set industry
standards, or enter into exclusive arrangements with suppliers of cheap raw
materials. They may also acquire scarce government licenses to operate in
regulated industries. Finally, if there are learning economies, early firms will
have an absolute cost advantage over new entrants. First mover advantages are
also likely to be large when there are significant switching costs for customers
once they start using existing products. For example, switching costs faced by
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the users of Microsoft’s DOS operating system make it difficult for software
companies to market a new operating system.
ACCESS TO CHANNELS OF DISTRIBUTION AND RELATIONSHIPS.
Limited capacity in the existing distribution channels and high costs of

developing new channels can act as powerful barriers to entry. For example, a
new entrant into the domestic auto industry in the U.S. is likely to face
formidable barriers because of the difficulty of developing a dealer network.
Similarly, new consumer goods manufacturers find it difficult to obtain
supermarket shelf space for their products. Existing relationships between firms
and customers in an industry also make it difficult for new firms to enter an
industry. Industry examples of this include auditing, investment banking, and
advertising.
LEGAL BARRIERS
There are many industries in which legal barriers, such as patents and
copyrights in research-intensive industries, limit entry. Similarly, licensing
regulations limit entry into taxi services, medical services, broadcasting, and
telecommunications industries.
Competitive Force 3: Threat of Substitute Products
The third dimension of competition in an industry is the threat of

substitute products or services. Relevant substitutes are not necessarily those that
have the same form as the existing products, but those that perform the same
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function. For example, airlines and car rental services might be substitutes for
each other when it comes to travel over short distances. Similarly, plastic bottles
and metal cans substitute for each other as packaging in the beverage industry. In
some cases, threat of substitution comes not from customers’ switching to
another product but from utilizing technologies that allow them to do without, or
use less of, the existing products. For example, energy-conserving technologies
allow customers to reduce their consumption of electricity and fossil fuels. The
threat of substitutes depends on the relative price and performance of the
competing products or services, and on customers’ willingness to substitute.
Customers’ perception of whether two products are substitutes depends to some
extent on whether they perform the same function for a similar price. If two
products perform an identical function, then it would be difficult for them to
differ from each other in price. However, customers’ willingness to switch is
often the critical factor in making this competitive dynamic work. For example,
even when tap water and bottled water serve the same function, many customers
may be unwilling to substitute the former for the latter, enabling bottlers to
charge a price premium. Similarly, designer label clothing commands a price
premium even if it is not superior in terms of basic functionality, because
customers place a value on the image offered by designer labels.
RELATIVE BARGAINING POWER IN INPUT AND OUTPUT MARKETS
While the degree of competition in an industry determines whether or not

there is Potential to earn abnormal profits, the actual profits are influenced by
the industry’s bargaining power with its suppliers and customers. On the input
side, firms enter into transactions with suppliers of labor, raw materials and
components, and finances. On the output side, firms either sell directly to the
final customers, or enter into contracts with intermediaries in the distribution
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chain. In all these transactions, the relative economic power of the two sides is
important to the overall profitability of the industry firms.
Competitive Force 4: Bargaining Power of Buyers
Two factors determine the power of buyers: price sensitivity and relative
bargaining power. Price sensitivity determines the extent to which buyers care to
bargain on price; relative bargaining power determines the extent to which they
will succeed in forcing the price down.
PRICE SENSITIVITY.
Buyers are more price sensitive when the product is undifferentiated and
there are few switching costs. The sensitivity of buyers to price also depends on
the importance of the product to their own cost structure. When the product
represents a large fraction of the buyers’ cost (for example, the packaging
material for soft-drink producers), the buyer is likely to expend the resources
necessary to shop for a lower cost alternative. In contrast, if the product is a
small fraction of the buyers’ cost (for example, windshield wipers for automobile
manufacturers), it may not pay to expend resources to search for lower-cost
alternatives. Further, the importance of the product to the buyers’ product quality
also determines whether or not price becomes the most important determinant of
the buying decision.
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RELATIVE BARGAINING POWER
Even if buyers are price sensitive, they may not be able to achieve low
prices unless they have a strong bargaining position. Relative bargaining power
in a transaction depends, ultimately, on the cost to each party of not doing
business with the other party. The buyers’ bargaining power is determined by the
number of buyers relative to the number of suppliers, volume of purchases by a
single buyer, number of alternative products available to the buyer, buyers’ costs
of switching from one product to another, and the threat of backward integration
by the buyers. For example, in the automobile industry, car manufacturers have
considerable power over component manufacturers because auto companies are
large buyers, with several alternative suppliers to choose from, and switching
costs are relatively low. In contrast, in the personal computer industry, computer
makers have low bargaining power relative to the operating system software
producers because of high switching costs.
Competitive Force 5: Bargaining Power of Suppliers
The analysis of the relative power of suppliers is a mirror image of the

analysis of the buyer’s power in an industry. Suppliers are powerful when there
are only a few companies and there are few substitutes available to their
customers. For example, in the soft- drink industry, Coke and Pepsi are very
powerful relative to the bottlers. In contrast, metal can suppliers to the soft drink
industry are not very powerful because of intense competition among can
producers and the threat of substitution of cans by plastic bottles.
Suppliers also have a lot of power over buyers when the suppliers’ product or
service is critical to buyers’ business. For example, airline pilots have a strong
bargaining power in the airline industry. Suppliers also tend to be powerful when
they pose a credible threat of forward integration. For example, IBM is powerful
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relative to mainframe computer leasing companies because of IBM ’s unique

position as a mainframe supplier, and its own presence in the computer leasing
business.
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COMPETITIVE STRATEGY ANALYSIS
The profitability of a firm is influenced not only by its industry structure

but also by the strategic choices it makes in positioning itself in the industry.
While there are many ways to characterize a firm’s business strategy, as Figure 2-
2 shows, there are two generic competitive strategies:
(1) cost leadership and
(2) differentiation.
Both these strategies can potentially allow a firm to build a sustainable

competitive advantage.
Strategies for Creating Competitive Advantage
Strategy researchers have traditionally viewed cost leadership and

differentiation as mutually exclusive strategies. Firms that straddle the two
strategies are considered to be “stuck in the middle” and are expected to earn low
profitability. These firms run the risk of not being able to attract price conscious
customers because their costs are too high; they are also unable to provide
adequate differentiation to attract premium price customers.
SOURCES OF COMPETITIVE ADVANTAGE
Cost leadership enables a firm to supply the same product or service

offered by its competitors at a lower cost. Differentiation strategy involves
providing a product or service that is distinct in some important respect valued
by the customer. For example, in retailing
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Competitive Strategy 1: Cost Leadership
Cost leadership is often the clearest way to achieve competitive advantage.

In industries where the basic product or service is a commodity, cost leadership
might be the only way to achieve superior performance. There are many ways to
achieve cost leadership, including economies of scale and scope, economies of
learning, efficient production, simpler product design, lower input costs, and
efficient organizational processes. If a firm can achieve cost leadership, then it
will be able to earn above-average profitability by merely charging the same
price as its rivals. Conversely, a cost leader can force its competitors to cut prices
and accept lower returns, or to exit the industry. Firms that achieve cost
leadership focus on tight cost controls. They make investments in efficient scale
plants, focus on product designs that reduce manufacturing costs, minimize
overhead costs, make little investment in risky research and development, and
avoid serving marginal customers. They have organizational structures and
control systems that focus on cost control.
Competitive Strategy 2: Differentiation
A firm following the differentiation strategy seeks to be unique in its

industry along some dimension that is highly valued by customers. For
differentiation to be successful, the firm has to accomplish three things. First, it
needs to identify one or more attributes of a product or service that customers
value. Second, it has to position itself to meet the chosen customer need in a
unique manner. Finally, the firm has to achieve differentiation at a cost that is
lower than the price the customer is willing to pay for the differentiated product
or service. Drivers of differentiation include providing superior intrinsic value
via product quality, product variety, bundled services, or delivery timing.
Differentiation can also be achieved by investing in signals of value, such as
brand image, product appearance, or reputation. Differentiated strategies require
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investments in research and development, engineering skills, and marketing

capabilities. The organizational structures and control systems in firms with
differentiation strategies need to foster creativity and innovation. While
successful firms choose between cost leadership and differentiation, they cannot
completely ignore the dimension on which they are not primarily competing.
Firms that target differentiation still need to focus on costs, so that the
differentiation can be achieved at an acceptable cost. Similarly, cost leaders
cannot compete unless they achieve at least a minimum level on key dimensions
on which competitors might differentiate, such as quality and service.
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INDUSTRY ANALYSIS OF NBFCs
Non Banking Financial Companies (NBFCs) have come a long way from
the era of concentrated regional operations, lesser credibility and poor risk
management practices to highly sophisticated operations, pan-India presence and
most importantly an alternate choice of financial intermediation (not an alternate
choice of banking as NBFCs still operate with lots of limiting factors, which
make them non-comparable to banks). It is true that the difference between
commercial banks and NBFCs is getting increasingly blurred as NBFCs are today
present in almost all the segments of financial sector save cheque issuance and
clearing facility. NBFCs are now recognized as complementary to the banking
system capable of absorbing shocks and spreading risks at times of financial
distress. The Reserve Bank of India (RBI) also recognises them as an integral
part of the financial system and is trying to improve the credibility of the entire
sector. Today, NBFCs are present in the competing fields of vehicle financing,
hire purchase, lease, personal loans, working capital loans, consumer loans,
housing loans, loans against shares, investments, distribution of financial
products, etc. More often than not, NBFCs are present where the risk is higher
(and hence the returns), reach is required (strong last-mile network), recovery
has to be the focus area, loan-ticket size is small, appraisal & disbursement has
to be speedy and flexibility in terms of loan size and tenor is required. The key
differentiating factor working in favour of NBFCs is ‘service’. Today, a borrower
is looking for more convenience, quick appraisal & decision-making, higher
amount of loan-tovalue and longer tenor. Though banks are not behind on the
service aspect, they are largely limited to urban centres. When it comes to semi-
urban and rural centres, particularly where the banking culture still not fully
developed, NBFCs enjoy an edge over banks. However, even in the urban areas,
NBFCs have created niches for themselves, which are often neglected by banks
e.g. non-salaried individuals, traders, transporters, stock brokers, etc, and all
these categories are growing at a rapid pace.
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New opportunities like home equity, credit cards, personal finance, etc, is
least, due to an established reach and network, NBFCs could be the favourites of
the foreign financial giants to make an inroad in the country. The RBI has
proposed to open the domestic market for foreign banks after FY2009 and some
of the foreign banks would not hesitate to shake hands with NBFCs to hit the
ground running. We believe that the sector is today at an inflection point and is
likely to take a big leap in terms of growth and profitability going forward.
The companies covered for the comparison are:

⇒ Shriram Transport Finance(STF)
⇒ Shriram City Union Finance(SCUF)
⇒ Cholamandalam Investment(CIFL)
⇒ Sundaram Finance (SFL)
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Profile
NBFCs’ operations can largely be categorised into equipment leasing, hire

purchase, investments and loans. There are 13,261 NBFCs, of which 507 were
public deposit accepting companies. Though the number of registered NBFCs is
pretty high, there are only 16 companies with an asset size of above Rs.5.00bn
and collectively they held nearly 4/5th of total assets of all NBFCs. However, the
size of NBFCs is very small compared to the banking industry. In June 2004,
NBFCs’ size was merely 5.7% of gross banking credit, which further deteriorated
to 4.5% in June 2005. There are two reasons for such decline- one, the banking
credit growth has been extremely good in FY05 i.e. at nearly 32.2% compared to
4.3% growth in NBFCs’ case. Secondly, the number of NBFCs (deposit taking)
is consistently declining over a period of time. It declined from 875 in FY03 to
777 in FY04 and further to 573 in FY05. Nonetheless, we expect the growth in
larger NBFCs’ asset to be in the range of 25-30% over next two years.
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Regional presence
NBFCs have typically grown in the southern part of the country. Most of
the NBFCs have started their journey as chit-funds and then largely catering to
the growing needs of individuals, forayed into much-better organized non-
banking operations. Though there are no concrete reasons why NBFCs are more
deep-rooted in south India, we understand that it is largely because of
demographic patterns.
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Though the number of NBFCs in north India is also high, average deposit
is far lower compared to south India. Other parts of the country do not have
significant presence of NBFCs and are also on declining trend.
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Asset & liability mix
NBFCs have made a transient shift in their liability composition. Once

largely dependent on the public deposits, now borrowing in the form of non-
convertible debentures, bank borrowings, commercial papers, etc, are the largest
form of liabilities. On the asset side, leasing, hire purchase and loans & advances
constitute the larger pie of nearly 85%. This includes auto loans, hire-purchase,
leased assets, personal finance, housing loans, loans against shares, consumer
durable loans, etc. Investments also add another 12% of total asset size as some
of the large NBFCs are purely engaged in the business of investments. The
diversified nature of asset mix gives stability to the NBFCs, which is important
for the stable and consistent growth of the sector.
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Financial performance
NBFCs, despite their numbers declining, have done well in the recent past.
The surge in retail credit, particularly in vehicle and home financing, has helped
the sector most. Besides, the gap between the cost of funds between banks and
NBFCs are also on the decline. The important point in the picture is the growth
in net owned funds of the NBFCs despite decline in number of operational
NBFCs indicates growing trend in financial health of the sector.
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The general decline in the interest rates has also helped NBFCs to a large
extent. In FY03, there were merely 23% companies which were having public
deposits (which is typically the costliest outside liability) at a cost more than
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10%. The same increased to over 70% in FY05. But it is more important to note
here that the gap between the cost of funds between banks and NBFCs have
declined from 5.5% to a more sustainable level of 4%. So, while the yield on
assets declined, spread has risen over the last two years.
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Despite rising competition from banks and within NBFCs itself, return on assets
in the category have been on a rising trend and is now stabilizing around 1.6%.
This is primarily due to better yield on assets, higher recovery and limited
overhead costs structure of NBFCs.
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In terms of asset quality, like banks, NBFCs also have seen commendable
improvement in their asset quality, both in terms of gross and net non-performing
assets (NPA). In last five years, gross NPA has declined secularly from 11.5% to
7.0%. In the same period net NPA also improved from 5.6% to 3.4%.
Retail Finance
Retail finance is one of the major thrust areas for financial intermediaries due
to the following reasons:
⇒ Low penetration and high growth opportunity
⇒ Change in demography and lifestyle
⇒ Higher disposable income and higher affordability
⇒ Better margins and profitability
⇒ Low loan-ticket size
⇒ Lower delinquencies
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Retail finance has grown up in size from Rs.272bn in FY99 to Rs.1,213bn in
FY04 and is expected to touch Rs.2,792bn by FY09 i.e. a CAGR of 18% over
next five years. Banks have become very much active in the retail space and their
share also has gone up from less than 40% in FY99 to over 65% in FY04. As per
a Cris Infac study it is slated to go up to 75% by FY09. Housing finance
constitutes the largest pie of retail finance with a total market share of over 65%.
The growth in housing finance is further expected to be in the range of 25-30%
over next couple of years given that the penetration level is still low and is
catching up fast. Secondly, the loan ticket size is also on rise.
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Though housing finance today constitutes nearly 40% of total housing cost, it is
still merely 3% of GDP, which is much lower than the global average of nearly
8%.
Similarly, increase in borrowing capacity due to various reasons like decline in
interest rate, longer tenure and increase in income levels have led to the spurt in
retail finance.
Auto finance
Banks are slowly capturing the larger pie of the auto finance market;
however, this has not deterred the NBFC players too. Low loan ticket size,
fabulous growth and rising finance penetration besides lucrative margins are
some of the reasons why all sorts of financial intermediaries are fiercely
competing for larger market share.
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COMPARATIVE ANALYSIS
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105
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COMPANY ANALYSIS
SREI INFRASTRUCTURE FINANCE LTD:
SREI started its activities in 1989 with the objective to be an active participant in
nation building. SREI has 2 principal businesses : infrastructure asset creation and wealth
management services. SREI offers on the one hand equipment finance, project finance,
renewable energy finance and financial services to the infrastructure sector. On the other
hand it offers services of funds mobilisation through government securities, fixed
depositsand bonds. SREI is fully supported by IFC, International Finance Corporation,
and by FMO (the Netherlands) and DEG (Germany). The company has established a
reputation for providing long-term funds. SREI is today one of India's leading non-
banking financial institutions, which prudently selected India's infrastructure as its
principal growth area. The institution provides focused services to a large number of
customers-individuals and corporate. SREI provides mainly leasing and hire purchase
finance of heavy equipment for contractors in the infrastructure sector. SREI, although
not exclusively operating in the SME sector, has a large SME component in its clientele.
The assets financed are excavators, tipper trucks, tractors, mixers and other equipment,
predominantly for the construction industry, which has been identified by the World Bank
as a priority market for India . Most of the contractors are family owned businesses.
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The board of directors of SREI INFRASTRUCTURE FINANCE LTD are:

.
NAME PREVIOUS EXPERIENCE
M.S.Verma, Chairman • Chairman & MD, State Bank of India

• Chairman, TRAI
Salil K. Gupta, Chief Mentor • Chairman, West Bengal Industrial Development

Corp.
• President, Institute of Chartered Accountants of
India
Hemant Kanoria, Vice Chairman & • President, Calcutta Chamber of Commerce

Managing Director • Chairman, CII (ER) Infrastructure
B. Swaminathan, Nominee Director, • Director (Finance) Coal India Ltd.

IREDA • Joint Secretary, Ministry of Finance, GoI
R. Sankaran, Director • Partner, Arthur Andersen
V. H. Pandya, Director • Senior Executive Director, SEBI

• Director, GIC Asset Management and Reliance
Capital
S. Rajagopal, Director • CMD, Bank of India & Indian Bank
Sunil Kanoria, Director • Chairman & Managing Director, Quipo

Infrastructure Equipment Ltd.
S. Chatterjee, Whole time Director • Executive Director, UTI Bank
P. K. Pandey, Executive Director • Chartered Accountant, having vast experience in

power sector
K. K. Mohanty, Executive Director • Engineer, having vast experience in financial

sector
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SWOT ANALYSIS
Strengths(S):
⇒ SREI INFRASTRUCTURE FINANCE LTD.is the first NBFI to get listed
in the LONDON STOCK EXCHANGE.
⇒ It is the first NBFI to raise funds through the GDR route
⇒ It initiated the first auction of interest rate for equipment, called, PAISON
KI NILAMI.
⇒ SREI devised a unique concept of equipment bank, which provides
equipment on rent.
⇒ Low financing cost and high asset quality.
⇒ It holds 30% of the infrastructure equipment financing market share.
⇒ Improvement of credit rating from AA to AAA.
⇒ Strong management & organization structure.
⇒ Effective recovery management.
Weaknesses(W):
⇒ Pressure on margins.
⇒ Low market price per share.
Opportunities(O):
⇒ RBI has allowed NBFCs to borrow through external commercial
borrowings (ECB).
⇒ Recent JV with BNP Paribas
⇒ Infrastructure thrust by government.
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⇒ Geographical expansion into Russia.

⇒ Facilities from IFC, Washington under Global Environment Facility and
IREDA.
Threats (T):
⇒ Threats from competitors, like, GE, ICICI, and MAGMA being the biggest
competitor.
⇒ Refinance.
⇒ Probability of loss in remarketing of assets.
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FINANCIAL STATEMENT ANALYSIS
Financial statement analysis or Ratio analysis is “The technique of the

calculation of a number of accounting ratio from the data or figures found in the
financial statements, the comparison of the accounting ratio with those of the
previous years or with those of another concerns engaged in similar, trade or with
the standard ratio and interpretation of the comparison”.
The ratio analysis is useful in the following manner:-
1. Ratio analysis simplifies the understanding of the financial statement.

2. Financial statement contains a large number of financial figures. The study of
these figures will not provide proper idea about their significance; hence it is
necessary to establish relationship between figures to understand them better.
3. It helps to determine the financial soundness of business; a management
accountant can ascertain the financial position of undertaking with accounting
ratio. He can evaluate the liquidity, solvency, profitability etc.
4. Forecasting, planning, communication, control are the main activities of the
management. They can be better performed through ratio analysis comparison of
past performance with present of one concern with that of other etc. it even helps
in areas where improvement in performance is lacking.
CLASSIFICATION OF RATIOS
The accounting ratios can be classified as follows :-

• Liquidity Ratios
• Asset Management Ratios
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• Financial Leverage Ratios

• Profitability Ratios
Liquidity Ratio :
These ratios indicate the short term solvency position of the
concern. This is weather the concern will be able to meet its short-term liability.
Out of its short term assets, it also indicates the working capital position of the
concern. These ratios when they are compared with the turnover. They also
indicate weather there is any over-trading or under-trading.
1. These ratios help the trader (owner), banker, short term lenders, to know
weather the concern to capacity to repay the loans.
2. These ratios help the management and share holder with long-term creditors.
The long term creditors will know weather concern has to capacity to pay
their interest, the management will know the financial position.
The Liquidity Ratios most commonly used are as follows:

1. Current Ratio or Working Capital Ratio
2. Quick Ratio, Liquid Ratio, Liquidity Ratio or Acid Test Ratio
3. Absolute Liquid Raito or Cash Position Ratio or Cash Ratio
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Current Ratio or Working Capital Ratio:

Current ratio is the ratio which expresses the relationship between current
assets and current liabilities. It helps in ascertaining the short term solvency
ratio, and measures the availability of working capital.
Current Assets Includes: Cash-in-hand, Cash-at-bank, B/R, Sundry

Debtors, Stock (inventory), Marketable Securities (short term investment), Pre-
paid expenses, advance granted to staff and income receivable.
Current liabilities include: those liabilities which will have to be repaid in

1 year time like ,B/P, Sundry creditors, bank o/d, cash credit, short term loans,
o/s expenses, incomes received in advance, provision for income tax, unclaimed
proposed dividends and any position of long term loan following due for payment
in current year from current assets.
Current Ratio is calculated as follows:

Current Assets
Current Liabilities
2002 2003 2004 2005 2006

3.50 4.072 8.78 7.96 55.53
Interpretation:
The current ratios in the 5yrs show a rising trend. Moreover in the
first few years the ratio is ideal.i.e. sufficient current assets are available to meet
the current liabilities. But in the year 2006, the ratio is too high, meaning more
than required assets are maintained against the liabilities, compared to , which
results in blocking of resources in working capital.
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QUICK RATIO:
This ratio compares the assets that are quickly converted into cash to
current liabilities. The Quick Ratio measures the ability to meet current
obligations based on the most liquid assets. Liquid assets include cash,
marketable securities, and accounts receivable. Quick Liabilities are: includes all
current liabilities except bank o/d and cash credit.
Quick Ratio is calculated as follows:

Quick Assets
Quick Liabilities
2002 2003 2004 2005 2006

0.055 0.140755 0.506303 0.357424 4.338049
Interpretation:
The ratio states how much assets are available to meet the current
liabilities of the firm, without selling off the inventories. The above figures
shows fluctuations, in the first four years, the liquid assets are insufficient to
meet the liabilities, but in the year 2006, the assets are four times the liabilities,
which again indicates, idle asset.i.e.too much resources blocked in the working
capital. The company should invest or utilize the funds in some other streams.
CASH RATIO:
Absolute liquid assets and quick liabilities are taken for calculating this
ratio. This ratio is used to know the cash position of the company. Absolute
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Liquid assets include Cash in hand, cash at bank, Realizable Marketable
Securities. Quick Liabilities includes all current liabilities except bank o/d and
cash credit.
Cash ratio is calculated as follows:

Absolute Liquid Assets
Quick Liabilities
2002 2003 2004 2005 2006

0.038 0.088 0.410 0.270 4.280
Interpretation:
The company maintains steady cash all through the first four years,
but in the year 2006 the amount of cash in proportion to the current liabilities is
too high, meaning funds stuck in the form of cash. This represents inefficiency
and un-utilisation of resources.
FINANCIAL LEVERAGE RATIOS:
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This ratio measures the financial position of the owners. The long term
solvency of the concern and guides the management in proper administration.
These ratios are helpful for long term creditors, share holders and management. It
is an important indicator of the relationship of owner’s equity and borrowed
funds.
The commonly used Financial Leverage Ratios are:
1. Debt-to-equity Ratio or External and Internal Ratio.

2. Net Worth Ratio or Proprietary Ratio
3. Solvency Ratio
4. Fixed Asset to Net Worth Ratio
5. Current Asset to Net Worth Ratio
6. Current Liabilities to Net Worth Ratio
7. Capital Gearing Ratio
8. Times Interest earned
DEBT-to-EQUITY RATIO:
This expresses the relationship between debt and equity. This ratio
indicates the extent to which debt is covered by shareholder’s fund. The debt-to-
equity ratio tells how the firm finances its operations with debt relative to the
book value of its shareholders’ equity. It reflects the real position of the equity
holders and the lenders and indicates the company’s policies on the mix of both
the funds Debt refers to refers to long term liability. Equity refers to Proprietary
fund (owners fund) i.e. capital accumulated reserves and profitless issues and
fictitious assets.
Debt-to- Equity Ratio is calculated as follows:

Long Term Debt
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Shareholders Fund
2002 2003 2004 2005 2006

5.400 5.370 5.580 6.011 4.127
Interpretation:
The debt equity ratio states the amount of debt which the firm uses
for every rupee of shareholder’s fund. The figure above shows an increasing
trend indicating financial weakness of the company. The firm is highly leveraged,
but a sudden fall in the year 2006 indicates an improvement.i.e. further
borrowing will be easier compared to the earlier years.
NET WORTH RATIO:

This ratio expresses the relationship between net worth and total assets.
Net worth means total assets minus total liabilities or share holders fund. Total
assets refer to all realizable assets; they include all tangible assets and patents,
copyrights, trademark. But they do not include goodwill because it cannot be
realised until the concern is sold or liquidated.
Net worth Ratio is calculated as follows:

Net worth (shareholders fund)
Total Realizable Assets
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2002 2003 2004 2005 2006

0.1031 0.0913 0.0787 0.01312 0.1815
Interpretation:
The ratio indicates how much assets does the firm maintains
compared to its shareholders fund. The ratios are considerably good. Along the 5
years the firm maintains a considerable proportion of the assets. This states a
stronger financial position of the concern.
SOLVENCY RATIO:
This ratio is calculated with the help of total assets and total liabilities. It
is an important indicator of the financial position.
Solveny Ratio is calculated as follows:

Total Assets
Total Liabilities
2002 2003 2004 2005 2006

1.119 1.128 1.44 1.33 1.22
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Interpretation:
SREI maintains a stable solvency ratio throughout the 5 years. This
indicates a strong financial position of the concern as the company, maintains
adequate assets to meet its liabilities.
FIXED ASSET TO NET WORTH RATIO:

This ratio expresses the relationship between fixed assets and net worth.
This ratio states what proportion of the shareholders funds are invested in the
assets. If the ratio is more it indicates it means majority of share holders’ funds
are sunk in fixed assets and the concern has to manage its working capital from
borrowed funds. Fixed assets refer to assets like land and building, machinery,
furniture, vehicles etc. which are used permanently or for a longer period of time.
Fixed assets mean net fixed assets i.e. fixed assets minus depreciation. Net worth
refers to share holders’ funds.
The ratio is calculated as follows:

Net Value of Fixed Assets
Net Worth
2002 2003 2004 2005 2006

0.105 0.111 0.113 0.109 0.545
Interpretation:
The company maintains a considerable ratio along the first few
years, indicating optimum utilisation of shareholders fund. But in the year 2006
the ratio is too high indicating excess funds sunk in the fixed assets and the firm
has to go in for borrowed funds to fund its working capital. This is the reason
that the debt euity ratio is too high in this year.
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CURRENT ASSET TO NET WORTH RATIO:

This ratio tries to establish the relationship between the current assets and net
worth. This ratio suggests the position of share holders fund divided in acquiring the
current assets.
This ratio is calculated as follows:
Current Assets
Net Worth
2002 2003 2004 2005 2006

8.520 8.056 7.170 7.670 16.910
Interpretation:
The ratios above show a fluctuating trend. At the beginning the a
large portion of the funds were used in the assets, though it reduced in the next
few years, in the year 2006,the ratio represents a large proportion of shareholders
funds blocked in current assets. This shows inadequate utilisation of resources
and, funds blocked unnecessarily.
CURRENT LIABILITIES TO NET WORTH RATIO:

This suggests the position of current liability and owners fund in the
enterprise. It compares the current liabilities with the networth of the company.

Current Liabilities
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Net Worth
2002 2003 2004 2005 2006

2.430 1.970 0.810 0.960 0.304
Interpretation:
The above ratios show a decreasing trend, i.e. sufficient cover for
current liabilities is reducing year by year. But there is a sharp reduction in the
year 2006 which indicates that the firm does not have sufficient coverage for its
current liabilities.
CAPITAL GEARING RATIO:

It expresses the relationship between fixed interest and dividend, bearing
securities to equity share holders’ fund. Equity capital in this context means
capital and all accumulated reserves less loses and fictitious assets.
Fixed interest bearing securities: -refers to long term loan carrying fixed rate of
interest e.g.: debentures, long term fixed deposit.
Fixed dividend bearing shares: - refers to long term preference share capital,
which is entitled to a fixed rate of dividend.
This ratio is the measure of capital investment of equity share holder, if the fixed
interest and fixed dividend bearing securities are more than equity share holders
fund, company is said to be highly geared. On the other hand if the equity share
holders fund is more than fixed interest and dividend bearing securities then the
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company is said to be low geared. The degree of capital gearing adopted will
determine the future prospect of raising finance
Capital Gearing Ratio is calculated as follows:

Fixed Interest and Fixed Dividend Bearing shares
Equity Share Capital
2002 2003 2004 2005 2006

0.173 0.107 0.617 1.777 1.513
Interpretation:
Capital gearing ratio states the use of debt so as to maximize the
earnings of the ordinary shareholders. Thus in case of this co. the gearing ratio
increases till 2005 and then falls. This is because of the increase in the equity
share capital in the year 2006.
TIMES INTEREST EARNED:

Times Interest Earned is the number of times the company’s earnings
(before interest and taxes) covers the interest expense. It represents the margin of
safety in making fixed interest payments. A high ratio is desirable from both
creditors and management.
Times Interest Earned is calculated as follows:
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Earning Before Interest & Taxes
Interest Expense
2002 2003 2004 2005 2006

1.28 1.34 1.52 1.87 1.72
Interpretation:
The figures show a considerable and steady increase, i.e. the
company maintains a desirable shield against the interest expense. This gives a
good impression to both the creditors and the investors.
PROFITABILITY RATIOS:
Profitability ratios measure the profitability of a concern. They reveal the
total effect of a concern. They reveal the total effect of business transaction, the
profit earning capacity, successful achievement of the concern in earning profits
are the main source of finance for its existence. Profit is the yard stick to
measure efficiency of the owners, investors, creditors etc. they indicate the safety
of the funds and a source of extra benefits to the employees, for the government,
as they are the basis for tax collection. Even customers are benefited as they can
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demand price reduction. They are the index of the economic progress of the
country.
The Profitability Ratios commonly used are:

1. Gross Profit Ratio
2. Net Profit Ratio
3. Operating Profit Ratio
4. Return on Investment
5. Return on Equity
6. Return on Asset
GROSS PROFIT RATIO:

Gross profit ratio measures the relationship of gross profit to net sales and
is generally expressed in percentage. This ratio is an important measure of
profitability ratio. It is useful to compare the gross profit margin across similar
business. In this context total income is considered to be the sales. Total income
is taken as sales in this context.
Gross Profit Ratio is calculated as follows:
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Gross Profit x 100
Sales
2002 2003 2004 2005 2006

15.940 18.910 25.770 31.540 34.170
Interpretation:
The gross profit margin over the five years rises considerably,
indicating the progress of the business. It also indicates that the rate in increase
of cost of sales is less than the rate of increase in sales, hence increased
efficiency.
NET PROFIT RATIO:

This ratio indicates the net margin earned in sales. Net profit means final
balance of operating and non operating income after meeting all expenses. It is a
widely used measure of performance. In this context total income is considered
as sales. Total income is taken as sales in this context.

Net Profit x 100
Net Sales
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2002 2003 2004 2005 2006

11.400 12.280 17.670 21.780 21.300
Interpretation:
The net profit margin over the five years shows an increasing trend.
This indicates improved performance of the company. Moreover this ratio is of
vital importance when the performance of the company is being compared with
similar companies in the industry.
OPERATING PROFIT RATIO:

It establishes the relationship between cost of goods sold and other
operating expenses to net sales. Operating cost refers to all expenses incurred for
operating a business. It comprises of cost of goods sold, factory expenses, office
and administrative expenses. Total income is considered as total sales.

Operating Profit x 100
Net Sales
2002 2003 2004 2005 2006

84.530 83.740 80.190 74.510 81.140
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Interpretation:
The above figures show that operating profit margin reduced in the
year 2005, but again rose in the year 2006. this represents the increase in the
operating cost, and changes in managerial efficieny.
RETURN ON INVESTMENT:
It is the only measures that indicate the earnings of the business on capital
employed. It is useful for inter firm comparison. It helps to measure the
efficiency of 2 or more departments with in the same organization. It helps to
assess the relative profitability of different product. It helps to find out whether
alternative use of funds is justifiable. It also helps in profit planning.

Earning Before Interest & Taxes x 100
Capital Employed
2002 2003 2004 2005 2006

9.560 9.830 8.710 7.340 7.610
Interpretation:
This ratio measures the efficiency as how much the company earns
compared to the total capital employed. If we see the trend of this ratio in context
of SREI, the ration decreases till 2005 and in the next year the ratio increases.
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RETURN ON EQUITY:
This ratio shows the profit attributable to the amount invested by the
owners of the business. It indicates the potential investors into the business what
they might hope to receive as a return. The stockholders equity includes share
capital, share premium, distributable and non distributable reserves.

Profit Margin x Asset Turnover x Financial Leverage
Profit After Tax x Sales x Assets

Sales Assets Stockholders Equity
= PAT
Shareholders equity
2002 2003 2004 2005 2006

0.239 0.273 0.382 0.529 0.444
Interpretation:
A stable increase in this ratio for the past four years indicate
increased profit left for ordinary shareholders. In the next year the ratio
decreased irrespective of increase in the profit due to increase in the equity share
capital. The company thus is still efficient in providing adequate returns to the
equity shareholders.
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RETURN ON ASSETS:
Return on Assets measures the net income returned on each dollar of
assets. This ratio measures overall profitability from our investment in assets.

Profit After Taxes
Total Assets
2002 2003 2004 2005 2006

0.011 0.012 0.018 0.020 0.021
Interpretation:
Funds contributed by the equity shareholders and other lenders are
used in the purchase of assets. Thus the company must provide adequate return
on the respective assets. The efficiency in doing this is represented in the above
chart, where the return on assets continuously increases.
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MARKET VALUE RATIOS:

One final group of ratios that warrants some attention is Market Value
Ratios. These ratios attempt to measure the economic status of the organization
within the marketplace. Investors use these ratios to evaluate and monitor the
progress of their investments.
The commonly used Market Value Ratios are:

1. Earning Per Share
2. Dividend Per Share
3. Price Earning Ratio
4. Dividend Yield
5. Dividend Coverage
6. Dividend Payout Ratio
7. Book Value Per Share
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EARNING PER SHARE:

Whatever income remains in the business after all prior claims, other than
owners claims, have been paid , will belong to the ordinary shareholders who can
then make a decision as to how much of this income they wish to remove from
business in the form of a dividend, and how much they wish to retain in the
business. The shareholders are particularly interested in knowing how much have
been earned during the financial year on each of the shares held by them. For this
reason earning per share is calculated. Growth in earnings is often monitored
with Earnings per Share (EPS). The EPS expresses the earnings of a company on
a "per share" basis.
The ratio is calculated as under:

Earnings after Interest and Tax – Preferential Dividend
Number of Equity Shares
2002 2003 2004 2005 2006

2.39 2.73 3.82 5.29 4.44
Interpretation:
The above table shows the efficiency of the firm, i.e.SREI in
providing adequate return per share through increase in profits after tax. The year
2006 experiences a downfall irrespective of increase in the profit is due to the
issue of new equity shares.
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DIVIDEND PER SHARE:

This ratio calculates the dividend paid to each shareholder. It is the ratio
of total dividend attributable to the shareholders to the number of shares
outstanding.

Total Dividend
No.of.Shares Outstanding
2002 2003 2004 2005 2006

1.201 1 1.501 1.501 2.046
Interpretation:
The above figure states the amount of return the equity holders get.
This ratio shows a considerable trend, which leads to increase in the dividend per
share. The increasing trend leads to confidence in the equity shareholders.
DIVIDEND YIELD:
The dividend yield ratio indicates the return that investors are obtaining
on their investment in the form of dividends. For investors interested in a source
of income, the dividend yield is important since it gives the investor an
indication of how much dividends are paid by the company.

Dividend per share
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Market Price per share
2002 2003 2004 2005 2006

0.151 0.121 0.111 0.033 0.029
DIVIDEND COVERAGE RATIO:

This ratio measures the extent of earnings that are being paid out in the
form of dividend. It indicates how many times the dividend paid are covered by
earnings.

Earning Per Share
Dividend Per Share
2002 2003 2004 2005 2006

1.992 2.730 2.547 3.527 2.176
Interpretation:
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The table above shows an increase in the payment of dividend to
equity shareholders out of the earning per share. The increase in the earnings per
year leads to increase in the payment of dividend compared to the earnings,
giving confidence to the equity shareholders. a low dividend coverage refers to
the company in ploughing back of profits for further expansion and research.
DIVIDEND PAYOUT RATIO:

This ratio looks at the dividend payment in relation to net income. It states
what portion of the net income is distributed as dividend.

Dividend Per Share
Earning Per Share
2002 2003 2004 2005 2006

50.209 36.630 39.267 28.355 45.946
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BOOK VALUE PER SHARE:

Book Value per Share expresses the total net assets of a business on a per
share basis. This allows us to compare the book values of a business to the stock
price and gauge differences in valuations. Net Assets available to shareholders
can be calculated as Total Equity less Preferred Equity.
Book Value per Share is calculated as follows:

Net Assets Available to Equity shareholders
Outstanding Common Shares
2002 2003 2004 2005 2006

2.39 2.73 3.82 5.29 4.44
Interpretation:
The book value per share shows an increase in each year, which
gives a good impression of SREI. Again the same reason for the decrease in book
value per share in the year 2006, .i.e. issue of new shares in this year.
PRICE EARNING RATIO:

The relationship of the price of the stock in relation to EPS is expressed as
the Price to Earnings Ratio or P / E Ratio. Investors often refer to the P / E Ratio
as a rough indicator of value for a company. A high P / E Ratio would imply that
investors are very optimistic (bullish) about the future of the company since the
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price (which reflects market value) is selling for well above current earnings. A
low P / E Ratio would imply that investors view the company's future as poor and
thus, the price the company sells for is relatively low when compared to its
earnings.
The P / E Ratio is calculated as follows:

Market Price Per Share
Earning Per Share
2002 2003 2004 2005 2006

3.322 3.021 3.548 8.683 15.585
Interpretation:
The increase in the earning each year, hence the increase in market
price per share leads to an increasing trend each year. This ratio is of vital
importance and can be used in the valuation of the equity which has been taken
up later in the project.
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CASH FLOW ANALYSIS
Ratio analysis focuses on analyzing a firm’s income statement (net profit margin
analysis) or its balance sheet (asset turnover and financial leverage). The analyst
can get further insights into the firm’s operating, investing, and financing
policies by examining its cash flows. Cash flow analysis also provides an
indication of the quality of the information in the firm’s income statement and
balance sheet. In Reported cash flow statement, firms classify their cash flows
into three categories: cash flow from operations, cash flow related to
investments, and cash flow related to financing activities. Cash flow from
operations is the cash generated by the firm from the sale of goods and services
after paying for the cost of inputs and operations. Cash flow related to
investment activities shows the cash paid for capital expenditures; interoperate
investments, acquisitions, and cash received from the sales of long-term assets.
Cash flow related to financing activities shows the cash raised from (or paid to)
the firm’s stockholders and debt holders. Firms use two cash flow statement
formats: the direct format and the indirect format. The key difference between
the two formats is the way they report cash flow from operating activities. In the
direct cash flow format, which is used by only a small number of firms in
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practice, operating cash receipts and disbursements are reported directly. In the
indirect format, firms derive their operating cash flows by making adjustments to
net income. Because the indirect format links the cash flow statement with the
firm’s income statement and balance sheet, many analysts and managers find this
format more useful. SEBI requires Indian companies to maintain the cash flow in
indirect format several factors affect a firm’s ability to generate positive cash
flow from operations. Healthy firms that are in a steady state should generate
more cash from their customers than they spend on operating expenses. In
contrast, growing firms, especially those investing cash in research and
development, advertising and marketing, or building an organization to sustain
future growth, may experience negative operating cash flow. Firms’ working
capital management also affects whether they generate positive cash flow from
operations. Firms in the growing stage typically invest some cash flow in
operating working capital items like accounts receivable, inventories, and
accounts payable. Net investments in working capital are a function of firms’
credit policies (accounts receivable), payment policies (payables, prepaid
expenses, and accrued liabilities), and expected growth in sales (inventories).
Thus, in interpreting firms’ cash flow from operations after working capital, it is
important to keep in mind their growth strategy, industry characteristics, and
credit policies. The cash flow analysis model next focuses on cash flows related
to long-term investments. These investments take the form of capital
expenditures; interoperate investments, and mergers and acquisitions. Any
positive operating cash flow after making operating working capital investments
allows the firm to pursue long-term growth opportunities. If the firm’s operating
cash flows after working capital investments are not sufficient to finance its
long-term investments, it has to rely on external financing to fund its growth.
Such firms have less flexibility to pursue long-term investments than those that
can fund their growth internally. There are both costs and benefits from being
able to fund growth internally. The cost is that managers can use the internally
generated free cash flow to fund unprofitable investments; such wasteful capital
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expenditures are less likely if managers are forced to rely on external capital
suppliers. Reliance on external capital markets may make it difficult for
managers to undertake long-term risky investments if it is not easy to
communicate to the capital market the benefits from such investments. Any
excess cash flow after these long-term investments is free cash flow that is
available for both debt holders and equity holders. Payments to debt holders
include interest payments and principal payments. Firms with negative free cash
flow have to borrow additional funds to meet their interest and debt repayment
obligations, or cut some of their investments in working capital or long-term
investments, or issue additional equity. This situation is clearly financially risky
for the firm. Cash flow after payments to debt holders is free cash flow available
to equity holders. Payments to equity holders consist of dividend payments and
stock repurchases. If firms pay dividends despite negative free cash flow to
equity holders, they are borrowing money to pay dividends. While this may be
feasible in the short term, it is not prudent for a firm to pay dividends to equity
holders unless it has a positive free cash flow on a sustained basis. On the other
hand, firms that have a large free cash flow after debt payments run the risk of
wasting that money on unproductive investments to pursue growth for its own
sake. An analyst, therefore, should carefully examine the investment plans of
such firms. The analyst should focus on a number of cash flow measures:
(1) cash flow from operations before investment in working capital and interest
payments, to examine whether or not the firm is able to generate a cash surplus
from its operations,
(2) cash flow from operations after investment in working capital, to assess how
the firm’s working capital is being managed and whether or not it has the
flexibility to invest in long-term assets for future growth,
(3) free cash flow available to debt and equity holders, to assess a firm’s ability
to meet its interest and principal payments, and
(4) free cash flow available to equity holders, to assess the firm’s financial
ability to sustain its dividend policy and to identify potential agency problems
from excess free cash flow.
139
These measures have to be evaluated in the context of the company’s business,

its growth strategy, and its financial policies. Further, changes in these measures
from year to year provide valuable information on the stability of the cash flow
dynamics of the firm.
PART 3
140
VALUATION
141
What is Valuation?
A business valuation determines the estimated market value of a business
entity. A valuation estimates the complex economic benefits that arise from
combining a group of physical assets with a group of intangible assets of the
business as a going concern. The valuation, which is part art and part science,
estimates the price that hypothetical informed buyers and sellers would negotiate
at arms length for an entire business or a partial equity interest.
Reasons for valuation:
⇒ To establish a price for a transaction

⇒ Business planning
⇒ Attract capital
⇒ Aid in estate and gift planning
⇒ Meet governmental requirements
⇒ Buying or selling a full or partial interest in a business
⇒ A business merger or acquisition
⇒ Admission or retirement of a partner in a business
⇒ Property division in a divorce, when marital property
includes an interest in a business
⇒ Payment of estate or inheritance taxes involving an interest
in a business
⇒ Estate planning
⇒ Preparing personal financial statements including an
interest in a business
142
⇒ Employee Stock Ownership Plans (ESOPS) require
valuation of employer securities upon their acquisition by
an ESOP, and at least annually thereafter, under the
Employee Retirement Income Security Act of 1974 (ERISA)

and the Internal Revenue Code
⇒ Dispute resolution in cases where damages must be

determined for lost value of a business, such as breach of
contract, patent infringement, franchise disputes, antitrust
suits, eminent domain, lender liability, and dissenting
stockholder suits.
143
FIRM VALUATION
Discounted Cash Flow Approach
In simple terms, discounted cash flow tries to work out the value of a
company today, based on projections of how much money it's going to make in
the future. DCF analysis says that a company is worth all of the cash that it could
make available to investors in the future. It is described as “discounted” cash
flow because cash in the future is worth less than cash today.
As an investor, you have a lot to gain from mastering DCF analysis. DCF
analysis requires you to think through the factors that affect a company, such as
future sales growth and profit margins. It also makes you consider the discount
rate, which depends on a risk-free interest rate, the company's costs of capital
and the risk its stock faces. All of this will give you an appreciation for what
drives share value, and that means you can put a more realistic price tag on the
company's stock.
Basis for Discounted Cash flow Valuation:

This approach has its foundation in the present value rule, where the value
of any asset is the present value of expected future cash flows that the asset
generates.
144
The cash flows will vary from asset to asset -- dividends for stocks, coupons
(interest) and the face value for bonds and after-tax cash flows for a real project.
The discount rate will be a function of the riskiness of the estimated cash flows,
with higher rates for riskier assets and lower rates for safer projects. You can in
fact think of discounted cash flow valuation on a continuum. At one end of the
spectrum, you have the default-free zero coupon bond, with a guaranteed cash
flow in the future. Discounting this cash flow at the riskless rate should yield the
value of the bond. A little further up the spectrum are corporate bonds where the
cash flows take the form of coupons and there is default risk. These bonds can be
valued by discounting the expected cash flows at an interest rate that reflects the
default risk. Moving up the risk ladder, we get to equities, where there are
expected cash flows with substantial uncertainty around the expectation. The
value here should be the present value of the expected cash flows at a discount
rate that reflects the uncertainty.
145
INPUTS TO THE MODEL
CASH FLOW:
The Cash Flow to the firm is the sum of the cash flows to all claim
holders in the firm, including stockholders bondholders and preferred stock
holders. To estimate how much cash a firm can afford to return to its
stockholders, we begin with the net income –– the accounting measure of the
stockholders’ earnings during the period –– and convert it to a cash flow by
subtracting out a firm’s reinvestment needs. First, any capital expenditures,
defined broadly to include acquisitions, are subtracted from the net income, since
they represent cash outflows. Depreciation and amortization, on the other hand,
are added back in because they are non-cash charges. The difference between
capital expenditures and depreciation is referred to as net capital expenditures
and is usually a function of the growth characteristics of the firm. High-growth
firms tend to have high net capital expenditures relative to earnings, whereas
low-growth firms may have low and sometimes even negative, net capital
expenditures. Second, increases in working capital drain a firm’s cash flows,
while decreases in working capital increase the cash flows available to equity
investors. Firms that are growing fast, in industries with high working capital
requirements (retailing, for instance), typically have large increases in working
capital. In case of SREI we find that the working capital increases over the years.
Thus we can define the cash flows left over after these changes as the free cash
flow to the (FCFF).
146
Free Cash Flow to the Firm =

Net Operating Profit After Tax
Add: Depreciation
Less: Gross Capital Expenditures
Less: Change in Net Working Capital
Estimating WACC
After calculating the cash flows, the net present value of these is to be
found out, through a discount rate called WACC, i.e. weighted average cost of
capital. The WACC is calculated as follows:
WACC = Wd*Kd (1-t) + We*Ke
Where,
Wd= weight of debt
Kd= cost of debt
t= tax rate
We= weight of equity
Ke= cost of equity
Cost of debt :
147
The first step in calculating the cost of debt is the finding the estimated rate
of return required by the debtholders. It is the after tax cost of debt that is used
to calculate the weighted average cost of capital, and it is the interest rate on
debt,Kd, less tax saving that result because interest is deductible. Thus cost of
debt is calculated as
= Kd(1-t)
Cost of equity:
The next step in calculation of WACC is the cost of equity. It is the arte of
return which the stockholders expect to earn on equivalent risk investments.
Three methods are typically used in finding the cost of equity:

- Capital Asset Pricing Model (CAPM)
- Discounted Cash flow Model
- Bond Yield Plus Risk Premium approach
Cost of equity,Ke, in this context is used as follows:

Dividend per Share +g
Market Value per Share
STABLE GROWTH:
There are three paths to discounted cash flow valuation -- the first is to
value just the equity stake in the business, the second is to value the entire firm,
which includes, besides equity, the other claimholders in the firm (bondholders,
148
preferred stockholders, etc.) and the third is to value the firm in pieces,
beginning with its operations and adding the effects on value of debt and other
non-equity claims. While all three approaches discount expected cashflows, the
relevant cashflows and discount rates are different under each. The value of
equity is obtained by discounting expected cashflows to equity, i.e., the residual
cashflows after meeting all expenses, reinvestment needs, tax obligations and net
debt payments (interest, principal payments and new debt issuance), at the cost of
equity, i.e., the rate of return required by equity investors in the firm.
The dividend discount model is a specialized case of equity valuation,

where the value of the equity is the present value of expected future dividends.
The value of the firm is obtained by discounting expected cashflows to the firm,
i.e., the residual cashflows after meeting all operating expenses, reinvestment
needs and taxes, but prior to any payments to either debt or equity holders, at the
weighted average cost of capital, which is the cost of the different components of
financing used by the firm, weighted by their market value proportions.
Interpretation:
The estimation of the value of the firm using the above formula is
shown in the table below. The first step being the calculation of free cash flows,
which increases each year due to change in working capital, capital expenditures,
debt and equity share capital. The value of the firm is calculated by discounting
the future free cash flow with the cost of capital. The value of the firm increases
each year and thus shows an rising trend. This advantage is taken use of in the
year 2007 when SREI went for a 50-50 JV with BNP Paribas. The trend in the
149
value of the firm for the past five years and the coming five years has been
shown in the table and the graph below:
YEAR 2003 2004 2005 2006 2007 2008 2009 2010 2011
VALUE 701.487 802.750 967.207 1772.992 1933.686 2065.427 2354.467 2678.859 3041.816
3500.000
3000.000
VALUE OF FIRM
2500.000
2000.000
Series1
1500.000
1000.000
500.000
0.000
10
03
04
05
06
07
08
09
11
20
20
20
20
20
20
20
20
20
YEAR
150
INCOME BASED APPROACH
Net Income Approach :
According to the Net Income Approach, the capital structure decision is

relevant to the valuation of the firm. In other words a change in the financial
leverage will lead to a corresponding change in the overall cost of capital as well
as the total value of the firm. This approach is based on three assumptions, i.e.
first there are no taxes, second that the cost of debt is less than the equity
capitalization rate or the cost of equity, third the use of debt does not change the
risk perception of the investors.
The implication of the three assumptions underlying the NI approach is
that as the degree of leverage increases, the proportion of cheaper source of
funds, i.e., debt in the capital structure increases. As a result, the weighted
average cost of capital tends to decline leading to an increase in the total value of
the firm. Thus the cost of debt and cost of equity being constant, the increased
value of debt, will magnify the shareholder’s earning and therefore the market
value of the ordinary shares. The value of the firm under Net Income approach is
calculated as follows:
EBIT
Ke
Where,
EBIT refers to earning before interest & tax
Ke refers the cost of equity which is calculated as follows:
DPS + g
MPS
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DPS refers to the dividend per share
MPS refers to the market price per share
G is the growth in the dividends per share
Interpretation:
The estimation of net asset per share is shown in the table given
below and the trend over the past five years is shown in the chart below. The
trend shows a gradual increase in the year 2003, 2004 and 2005, but a sudden
increase in the year 2006. It is expected that the value of the firm will increase in
the next year.
NET INCOME APPROACH
YEAR 2003 2004 2005 2006 2007 2008 2009 2010 2011
VALUE 615.96 685.35 787.42 1471.43 1702.39 2163.78 2718.18 3347.89 4024.12
OF
FIRM
4500
4000
VALUE OF THE FIRM
3500
3000
2500
VALUE OF THE FIRM
2000
1500
1000
500
0
2002
2003
2007
2008
2009
2004
2005
2006
2010
2011
YEAR
152
Net Operating income Approach :
Another income based method to valuation is the Net Operating income

Approach. The essence of this approach is that the capital decisions are
irrelevant. Any change in the leverage will not change the total value of the firm.
And the market price of the shares as well as the overall cost of capital is
independent of the degree of leverage.
The Net Operating income Approach is calculated as below:

S+V
Ko
Where,
S refers to the equity
V refers to the debentures
Ko refers to the working average cost of capital.
Interpretation:
The calculation of net operating income approach is shown in the
table and the trend over the past five years has been shown in the chart. The
value of the firm shows an increasing trend for the past five years. This indicates
the increase in efficiency of the firm in regards to operating cost. Reduction in
cost of sales or operating cost leads to increase in the profit and hence increase in
the value of the firm.
153
NET OPERATING INCOME APPROACH
YEAR 2003 2004 2005 2006 2007 2008 2009 2010 2011
VALUE 434.1 708.7 1364. 2477.76 1812.7 2065.8 2389.11 2589.6 2453.04
4 2 9 3 7 9
OF FIRM
3000
2500
VALUE OF THE FIRM
2000
1500 VALUE OF THE FIRM
1000
500
0
2002
2003
2007
2008
2009
2004
2005
2006
2010
2011
YEAR
154
ASSET BASED METHOD
Asset Based approach focuses in determining the value of the net assets
from the perspective of equity share valuation. What should be the basis of
valuation is the central issue of this approach. It should be determined whether
the assets should be valued at book, market , replacement or liquidation vale.
More often than not they are valued at boo value ,that is, original acquisition cost
minus accumulated depreciation , as assets are normally acquired with the intent
to be used in the business and not for resale. Thus the value of the asset is based
on the going concern concept. Apart from tangible assets, such as goodwill,
patent, trademark, brands, and others, super profit method should be used.
The net asset value can be calculated as follows:

Net asset = Total Assets- Total Liabilities
The value of net asset is also known as net worth or equity/ordinary

shareholder’s fund.net asset per share can be obtained, dividing the net asset by
the number of equity shares issued and outstanding. Thus
Net Asset Per Share = Net Asset

No.of equity shares issued and outstanding
The value of the net asset is contingent upon the measure of value adopted
for the purpose of valuation of the assets. In case of book value the value of asset
and liabilities are taken at their book values.
155
In the market value measure, asset shown in the balance sheet are revealed at
their current market prices. The net asset valuation is in tune with the going
concern concept of accounting. In contrast, liquidation value measure is guided
by the realizable value available on winding up the company. Liquidation value

is the net asset value per share available to the equity shareholders. Thus
Net Asset per share =
Liquidation value of asset- liquidation exp.-total external liabilities

No. of equity shares issued and outstanding
The calculation of the net asset per share has been shown in the excel
sheet below. And the trend of the net asset per share is shown in the chart. Net
asset per share for the year has also been forecasted. It is estimated that the net
asset per share will increase compared to the value in 2006, which indicated a
reduction compared to 2005.
YEAR 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
NET ASSET 13.87 14.8 16.8 20.069 18.09 21.69 24.35 27.33 30.71 34.56
PER SHARE
156
40
Value ot net assets per share
35
30
25
Value ot net assets per
20
share
15
10
5
0
2002
2003
2005
2007
2009
2011
2004
2006
2008
2010
Year
157
EQUITY VALUATION
DIVIDEND DISCOUNT MODEL (DDM ):
The Dividend Discount Model is the most commonly used method for a
firm’s equity valuation. Financial theory states that the value of a stock is the
worth of all the future cash flows expected to be generated by the firm
discounted by the appropriate risk adjusted rate. We can use dividends as a
measure of the cash flows returned to the shareholder. Thus DDM is used to
value the equity of SREI INFRASTRUCTURE FINANCE Ltd.
INPUTS TO THE MODEL:
Various inputs are required to value equity in this model. These are as
follows:
⇒ DPS = Dividend to be received in a n year.
⇒ Ke = The expected rate of return for the investment
.
The required rate of return can be estimated using the following formula:
Ke = DPS + g
MPS
Where,
DPS refers to the dividend per share
158
MPS refers to the market per share
g is the growth rate in the dividends
STABLE MODEL :
This model is used when the concerned firm experiences long term stable
growth. The growth rate referred here is generally equal to the gross domestic
product (GDP). It is observed that SREI INFRASTRUCTURE FINANCE Ltd’s
growth in the year 2006 has been stable and almost equal to the GDP.
Under the stable growth model the value of equity is calculated as under:
DPS
Ks-g
Where ,
Wd is the weight of the debt.
Kd is the cost of debt
t refers to tax rate
We refers to the weight of equity and,
Ke refers to the cost of equity
THE TWO-STAGE MODEL :
The two-stage growth model attempts to cross the chasm from theory to
reality. The two-stage growth model assumes that the company will experience a
period of high- growth followed by a decline to a stable growth period. The
159
model is based upon two stages of growth, an extraordinary growth phase that
lasts n years and a stable growth phase that lasts forever afterwards.This is
assumed in regards to SREI INFRASTRUCTURE FINANCE Ltd, because as we
have seen in the economic analysis, the co. is at present in the maturity stage,
and after this stage the business experiences a gradual growth rate. The value of
equity under this model is calculated as follows:
Value of the Stock =

PV of Dividends during extraordinary phase + PV of terminal price
t=n
∑ DPS + Pn
t=1 Ks,hg-g Ks,st- gn
where,
Pn = DPS(1)
Ks-g
DPS refers to the dividend in the year t.
Ke,refers to the cost of equity(hg: high growth
Period,st: stable growth period).
Pn refers to the terminal value at the year n.
g is the extraordinary growth for the first n yrs.
gn refers to the steady growth forever after year n.
gn = (1-payout ratio)* return on equity
DPS(1) = DPS(1+gn)
Interpretation:
The calculation of the value of equity as on 31/03/2006 using the
stable growth model. There has been a high growth in the year 2006 compared to
160
2005, thus it is assumed that the next five years will experience a high growth
rate of 17.33%. Hence the value of equity as on 31/03/2007 is calculated by
using the two-stage growth model. The market price per share as on the 31/03/06
is Rs. 69.196. Using the stable growth model the intrinsic value of equity comes
to Rs.198.06. This indicates that the value of equity of SREI is highly

undervalued. The intrinsic value of the share as for the next year, i.e. 2007 is
estimated to be Rs.134.051.
161
RELATIVE VALUATION
In contrast to the various discounted cash flow techniques that attempt to

estimate a specific value for a stock based on its estimated growth rates and its
discount rate, the relative valuation techniques implicitly contend that it is
possible to determine the value of an economic entity (i.e., the market, an
industry, or a company) by comparing it to similar entities on the basis of several
relative ratios that compare its stock price to relevant variables that affect a
stock’s value, such as earnings, cash flow, book value, and sales.
Therefore, in this section, we discuss the following relative valuation ratios:

(1) price/earnings (P/E),
(2) price/cash flow (P/CF),
(3) price/book value (P/BV), and
(4) price/sales (P/S).
We begin with the P/E ratio, also referred to as the earnings multiplier model,
because it is the most popular relative valuation ratio.
P/E Ratio:
The P/E ratio also known as the P/E multiple is the method most widely used
by fianace managers, investment analysts and equity shareholders to arrive at the
market price of the equity share. The application of this method primarily
requires the determination of earnings per share (EPS).
162
The EPS is calculated as follows:
EPS= Net Income Available to Equity Shareholders

No. of Equity Shares Outstanding
Market Value per share (MPS) is also required for the computation of the P/E
ratio. Thus the P/E ratio is calculated as under:
P/E multiple = Market Value per share

Earning per share
Portfolio managers and analysts sometimes compare PE ratios to the

expected growth rate to identify undervalued and overvalued stocks. In the
simplest form of this approach, firms with PE ratios less than their expected
growth rate are viewed as undervalued. In its more general form, the ratio of PE
ratio to growth is used as a measure of relative value, with a lower value believed
to indicate that a firm is under valued. For many analysts, especially those
tracking firms in high-growth sectors, these approaches offer the promise of a
way of controlling for differences in growth across firms, while preserving the
inherent simplicity of a multiple.
If the value ofSREI Infrastructure Finance Ltd is found out on the basis of
P/E ratio then the probable value of the stock that should be there on 31/3/07
should be 4.44*20.50 = Rs 91.02, here 4.44 is trailing 12 months earnings of
SREI Infrastructure Finance Ltd (from 1.4.1005-31.3.2006) and 20.50 is expected
P/E ratio .
163
PEG Ratio
The PEG ratio is defined to be the price earnings ratio divided by the
expected growth rate in earnings per share. This ratio is more useful for growth
investors who invest in fast growing companies. The PEG ratio compares a
stock’s price/earnings (”P/E”) ratio to its expected EPS growth rate. If the PEG
ratio is equal to one, it means that the market is pricing the stock to fully reflect
the stock’s EPS growth. This is “normal” in theory because, in a rational and
efficient market, the P/E is supposed to reflect a stock’s future earnings growth.
If the PEG ratio is greater than one, it indicates that the stock is possibly
overvalued or that the market expects future EPS growth to be greater than what
is currently in the Street consensus number. Growth stocks typically have a PEG
ratio greater than one because investors are willing to pay more for a stock that is
expected to grow rapidly (otherwise known as “growth at any price”). It could
also be that the earnings forecasts have been lowered while the stock price
remains relatively stable for other reasons.
If the PEG ratio is less than one, it is a sign of a possibly undervalued

stock or that the market does not expect the company to achieve the earnings
growth that is reflected in the estimates. Value stocks usually have a PEG ratio
less than one because the stock’s earnings expectations have risen and the market
has not yet recognized the growth potential. On the other hand, it could also
indicate that earnings expectations have fallen faster than the Street could issue
new forecasts.
164
: PEG ratio = P/E Ratio
Estimated Growth Rate
Price to Cash Flows
Price over cash flow is calculated by dividing the price of a company’s

share by cash flow per share. When a company files their cash flow statement,
they are documenting how much money went into or out of the business during a
given time period. This ratio explains how much investors must pay for $1 in
cash earnings per share. Since you are a shareholder in the company, you want
management to increase retained earnings by holding onto profits from revenue
once they receive them. A company that spends excessively often fails to return
maximum value to the shareholders.
Companies use cash to distribute dividends, pay off their debts, buyback
shares at a discount, and to reinvest back into the core businesses. When all else
fails, I like to invest in companies that holds lots of cash.
If we estimate the value of the share of SREI Infrastructure Finance Ltd

using Price to cash flows as on 31/3/2007, the cash flow estimated for the year is
Rs. 2158.825, and the average price to cash flows for the last three years is .030
so if the company would end this year with same Price/cash flows as the average
of last three years value of one share as on 31/3/07 = 2158.825* .030= Rs.
64.765
Price / book value ratio.
165
The Price-to-book ratio, or P/B ratio, is a financial ratio used to compare a
company's book value to its current market price. Book value is an accounting
term denoting the portion of the company held by the shareholders; in other
words, the company's total assets less its total liabilities. The calculation can be
performed in two ways but the result should be the same each way. In the first
way, the company's market capitalization can be divided by the company's total
book value from its balance sheet. The second way, using per-share values, is to
divide the company's current share price by the book value per share (i.e. its
book value divided by the number of outstanding shares).
As with most ratios, be aware this varies a fair amount by industry.
Industries that require higher infrastructure capital (for each dollar of profit) will
usually trade at P/B much lower than the P/B of (e.g.) consulting firms. P/B
ratios are commonly used for comparison of banks, because most assets and
liabilities of banks are constantly valued at market values. P/B ratios do not,
however, directly provide any information on the ability of the firm to generate
profits or cash for shareholders
This ratio also gives some idea of whether an investor is paying too
much for what would be left if the company went bankrupt immediately. For
companies in distress the book value is usually calculated without the intangible
assets that would have no resale value In such cases P/B should also be
calculated on a 'diluted' basis, because stock options may well vest on sale of the
company or change of control or firing of management
Applying this ratio for valuing SREI as on 31/03/07 , according to
the estimates company would be ending this year with a book value of around
21.68 times and average P/BV per share of last 3 years is around 9.26 so if the
company would end this year with same P/BV as the average of last three years
value of one share as on 31/3/07 = 9.26* 21.68= Rs 200.75
Other relative methods used are:

⇒ Price to net earnings multiple
166
⇒ Price to Pre-tax Earnings multiple
⇒ Price to Operating Profit
March March March March March

2002 2003 2004 2005 2006
3.322 3.021 3.548 8.683 15.585
P/E Ratio
PEG - - - - 13.85
Ratio
Price to .620 .564 .663 1.62 1.429
Net
Earnings
Price to .475 .385 .472 1.15 1.01
Pre-Tax
Earnings
Price to - 0.010 0.015 0.042 0.035
cash flow
Price to 3.32 3.02 3.54 8.68 15.58
book
value
167
ECONOMIC VALUE ADDED (EVA)
The traditional discounted cash flow model provides for a rich and
thorough analysis of all the different ways in which a firm can increase value;
but it can become complex, as the number of inputs increases. It is also very
difficult to tie management compensation systems to a discounted cash flow
model, since many of the inputs need to be estimated and can be manipulated to
yield the results management wants. If we assume that markets are efficient, we
can replace the unobservable value from the discounted cash flow model with the
observed market price and reward or punish managers based upon the
performance of the stock. Thus, a firm whose stock price has gone up is viewed
as having created value, whereas one whose stock price has fallen has destroyed
value. Compensation systems based upon the stock price, including stock grants
and warrants have become a standard component of most management
compensation package. While market prices have the advantage of being up to
date and observable, they are also noisy. Even if markets are efficient, stock
prices tend to fluctuate around the true value and markets sometimes do make
mistakes. Thus, a firm may see its stock price go up and its top management
rewarded, even as it destroys value. Conversely, the managers of a firm may be
penalized as its stock price drops, even though the managers may have taken
actions that increase firm value. The other problem with stock prices as the basis
for compensation is that they are available only for the entire firm. Thus, stock
prices cannot be used to analyze the managers of individual divisions of a firm or
for their relative performance. In the last decade, while firms have become more
focused on value creation, they have remained suspicious of financial markets.
While they might understand the notion of discounted cash flow value, they are
unwilling to tie compensation to a value that is based upon dozens of estimates.
In this environment, new mechanisms for measuring value that are simple to
168
estimate and use, do not depend too heavily on market movements and do not
require a lot of estimation, find a ready market.
Economic Value Added
The economic value added (EVA) is a measure of the rupee surplus value
created by an investment or a portfolio of investments. It is computed as the
product of the "excess return" made on an investment or investments and the
capital invested in that investment or investments.
Economic Value Added = (Return on Capital Invested – Cost of

Capital) (Capital Invested) = after tax operating income – (Cost of Capital)
(Capital Invested)
= NOPAT – Total Capital* WACC
Calculating EVA
The definition of EVA outlines three basic inputs we need for its computation –
• the return on capital earned on investments,
• the cost of capital for those investments and,
• the capital invested in them.
How much capital is invested in existing assets? One obvious answer is to

use the market value of the firm, but market value includes capital invested not
just in assets in place but in expected future growth1. Since we want to evaluate
the quality of assets in place, we need a measure of the market value of just these
assets. Given the difficulty of estimating market value of assets in place, it is not
surprising that we turn to the book value of capital as a proxy for the market
value of capital invested in assets in place. The book value, however, is a number
169
that reflects not just the accounting choices made in the current period, but also
accounting decisions made over time on how to depreciate assets, value
inventory and deal with acquisitions. At the minimum, the three adjustments we
made to capital invested in the discounted cashflow valuation – converting
operating leases into debt, capitalizing R&D expenses and eliminating the effect
of one-time or cosmetic charges – have to be made when computing EVA as well.
The older the firm, the more extensive the adjustments that have to be made to
book value of capital to get to a reasonable estimate of the market value of
capital invested in assets in place. Since this requires that we know and take into
account every accounting decision over time, there are cases where the book
value of capital is too flawed to be fixable. Here, it is best to estimate the capital
invested from the ground up, starting with the assets owned by the firm,
estimating the market value of these assets and cumulating this market value. To
evaluate the return on this invested capital, we need an estimate of the after-tax
operating income earned by a firm on these investments. Again, the accounting
measure of operating income has to be adjusted for operating leases, R&D
expenses and one-time charges to compute the return on capital.
The third and final component needed to estimate the economic value
added is the cost of capital. In keeping with our arguments both in the investment
analysis and the discounted cash flow valuation sections, the cost of capital
should be estimated based upon the market values of debt and equity in the firm,
rather than book values. There is no contradiction between using book value for
purposes of estimating capital invested and using market value for estimating
cost of capital, since a firm has to earn more than its market value cost of capital
to generate value. From a practical standpoint, using the book value cost of
capital will tend to understate cost of capital for most firms and will understate it
more for more highly levered firms than for lightly levered firms. Understating
the cost of capital will lead to overstating the economic value added. From the
table and chart below it is seen that the economic value added by SREI reduces
170
considerably and increases in the last year drastically. This is due to increase in
the inputs of EVA.
The Economic Value added by SREI is calculated as below:
YEAR 2003 2004 2005 2006 2007 2008 2009 2010 2011
EVA 6.54 9.9 12.15 18.1 38.57 57.9 80.18 107.92 144.086
ECONOMIC VALUE ADDED:
160.000
140.000
120.000
100.000
EVA
80.000 EVA
60.000
40.000
20.000
0.000
2003 2004 2005 2006 2007 2008 2009 2010 2011
YEAR
171
MARKET VALUE ADDED (MVA):
The MVA approach measures the change in the market value of the firm’s
equity vis-à-vis equity investment (consisting of equity share capital and retained
profits). It is the difference between the current market value of a firm and the
capital contributed by investors. If MVA is positive, the firm has added value. If
it is negative the firm has destroyed value. In short a MVA is the total of all
capital that is held against the company which also includes the market value of
debt and equity. Therefore
MVA = Market Value of firm’s equity- Equity capital invested/funds
Though the concept of MVA can also be adapted to measure value from the
perspective of providers of all invested funds (i.e. including preference share
capital and debt). Therefore,
MVA=
[Total Market Value of Firm’s Securities – ( Equity Shareholders Fund +
Preference Share Capital + Debentures)]
=69.106* 109.09 - [ 109.09 + 301.43 + 165]
= Rs. 6973.07 cr.
172
PART 4
173
FORECASTING
174
FORECASTING
Most financial statement analysis tasks are undertaken with a forward-

looking decision in mind—and much of the time; it is useful to summarize the
view developed in the analysis with an explicit forecast. Managers need forecasts
for planning and to provide performance targets; analysts need forecasts to help
communicate their views of the firm’s prospects to investors; bankers and debt
market participants need forecasts to assess the likelihood of loan repayment.
Moreover, there are a variety of contexts (including but not limited to security
analysis) where the forecast is usefully summarized in the form of an estimate of
the firm’s value—an estimate that, after all, can be viewed as the best attempt to
reflect in a single summary statistic the manager’s or analyst’s view of the firm’s
prospects. Prospective analysis includes two tasks—forecasting and valuation—
that together represent approaches to explicitly summarizing the analyst’s
forward-looking views.
Business Analysis and Valuation Tools
The upshot is that a forecast can be no better than the business strategy
analysis, accounting analysis, and financial analysis underlying it. However,
there are certain techniques and knowledge that can help a manager or analyst to
structure the best possible forecast, conditional on what has been learned in the
previous steps. Below, a summarized approach to structuring the forecast, some
information useful in getting started, and some detailed steps used to forecast
earnings, balance sheet data, and cash flows is presented .
175
THE TECHNIQUES OF FORECASTING
The Overall Structure of the Forecast:
The best way to forecast future performance is to do it comprehensively—

producing not only earnings forecast, but a forecast of cash flows and the balance
sheet as well. A comprehensive approach is useful, even in cases where one
might be interested primarily in a single facet of performance, because it guards
against unrealistic implicit assumptions. For example, if an analyst forecasts
growth in sales and earnings for several years without explicit consideration of
the required increases in working capital and plant assets and the associated
financing, the forecast might possibly imbed unreasonable assumptions about
asset turnover, leverage, or equity capital infusions. A comprehensive approach
involves many forecasts, but in most cases they are all linked to the behavior of a
few key “drivers.” The drivers vary according to the type of business involved,
but for businesses outside the financial services sector, the sales forecast is
nearly always one of the key drivers; profit margin is another. When asset
turnover is expected to remain stable—as is often realistic—working capital
accounts and investment in plant should track the growth in sales closely. Most
major expenses also track sales, subject to expected shifts in profit margins. By
linking forecasts of such amounts to the sales forecast, one can avoid internal
inconsistencies and unrealistic implicit assumptions. In some contexts, the
manager or analyst is interested ultimately in a forecast of cash flows, not
earnings per share. Nevertheless, even forecasts of cash flows tend to be
grounded in practice on forecasts of accounting numbers, including sales and
earnings. Of course, it would be possible in principle to move directly to
forecasts of cash flows—inflows from customers, outflows to suppliers and
laborers, and so forth—and in some businesses, this is a convenient way to
proceed. In most cases, however, the growth prospects and profitability of the
firm are more readily framed in terms of accrual-based sales and operating
176
earnings. These amounts can then be converted to cash flow measures by

adjusting for the effects of non cash expenses and expenditures for working
capital and plant.
Getting Started: Points of Departure
Every forecast has, at least implicitly, an initial “benchmark” or point of

departure— some notion of how a particular amount, such as sales or earnings,
would be expected to behave in the absence of detailed information. By the time
one has completed a business strategy analysis, an accounting analysis, and a
detailed financial analysis, the resulting forecast might differ significantly from
the original point of departure. Nevertheless, simply for purposes of having a
starting point that can help anchor the detailed analysis, it is useful to know how
certain key financial Statistics behave “on average.”
In the case of some key statistics, such as earnings, a point of departure or

benchmark based only on prior behavior of the number is more powerful than one
might expect. Research demonstrates that some such benchmarks for earnings are
not much less accurate than the forecasts of professional security analysts, who
have access to a rich information set. Thus, the benchmark is often not only a
good starting point, but also close to the amount forecast after detailed analysis.
Large departures from the benchmark could be justified only in cases where the
firm’s situation is demonstrably unusual. Reasonable points of departure for
forecasts of key accounting numbers can be based on the evidence summarized
below. Such evidence may also be useful for checking the reasonableness of a
completed forecast.
177
THE BEHAVIOR OF EARNINGS .
Earnings have shown, on an average to follow a process that can be

approximated by a “random walk” or “random walk with drift”; thus, the prior
year’s earnings is a good starting point in considering future earnings potential.
Even a simple random walk forecast—one that predicts next year’s earnings will
be equal to last year’s earnings—is surprisingly useful. One study documents that
professional analysts’ year-ahead forecasts are only 22 percent more accurate (on
average) than a simple random walk forecast. Thus, a final earnings forecast will
usually not differ dramatically from a random walk benchmark. The implication
of the evidence is that, in beginning to contemplate future earnings possibilities,
a useful number to start with is last year’s earnings; the average level of earnings
over several prior years is not. Long-term trends in earnings tend to be sustained
on average, and so they are also worthy of consideration. If quarterly data are
also considered, then some consideration should usually be given to any
departures from the long-run trend that occurred in the most recent quarter. For
most firms, these most recent changes tend to be partially repeated in subsequent
quarters. The total earnings trend of SREI can be shown as below.
250.000
200.000
150.000
Series1
100.000
50.000
0.000
1 2 3 4 5
year
178
THE BEHAVIOR OF RETURNS ON EQUITY
Given that prior earnings serves as a useful benchmark for future earnings, one
might expect the same to be true of rates of return on investment, like ROE. That,
however, is not the case, for two reasons. First, even though the average firm
tends to sustain the current earnings level, this is not true of firms with unusual
levels of ROE. Firms with abnormally high (low) ROE tend to experience
earnings declines (increases).Second, firms with higher ROEs tend to expand
their investment bases more quickly than others, which causes the denominator
of the ROE to increase. Of course, if firms could earn returns on the new
investments that match the returns on the old ones, then the level of ROE would
be maintained. However, firms have difficulty in pulling that off. Firms with
higher ROEs tend to find that, as time goes by, their earnings growth does not
keep pace with growth in their investment base, and ROE ultimately falls. The
resulting behavior of ROE and other measures of return on investment is
characterized as “mean-reverting”: firms with above-average or below-average
rates of return tend to revert over time to a “normal” level within no more than
ten years.
THE BEHAVIOR OF COMPONENTS OF ROE
The behavior of rates of return on equity can be analyzed further by looking at

the behavior of its key components.
179
Operating asset turnover tends to be rather stable, in part because it is so much a
function of the technology of the industry. Net financial leverage also tends to be
stable, simply because management policies on capital structure aren’t often
changed.
0.600
0.500
0.400
ROE
0.300 Series1
0.200
0.100
0.000
1 2 3 4 5
year
NOPAT
Margin and spread stand out as the most variable component of ROE if the forces
of competition drive abnormal ROE s toward more normal levels, the change is
most likely to arrive in the form of changes in profit margins and the spread. The
change in spread is itself driven by changes in NOPAT margin, since the cost of
borrowing is likely to remain stable if leverage remains stable. To summarize,
profit margins, like ROE s, tend to be driven by competition to “normal” levels
over time. However, what constitutes normal varies widely according to the
technology employed within an industry and the corporate strategy pursued by
the firm—both of which influence turnover and leverage.
In a fully competitive equilibrium, profit margins should remain high for firms
that must operate with a low turnover, and vice versa. The implication of the
above discussion of rates of return and margins is that a reasonable point of
180
departure for a forecast of such a statistic should consider more than just the
most recent observation. One should also consider whether that rate or margin is
above or below a normal level. If so, then absent detailed information to the
contrary, one would expect some movement over time to that norm. Of course,
this central tendency might be overcome in some cases—for example, where the
firm has erected barriers to competition that can protect margins, even for
extended periods. The lesson from the evidence, however, is that such cases are
unusual. In contrast to rates of return and margins, it is reasonable to assume that
asset turnover, financial leverage, and net interest rate remain constant over time.
Unless there is an explicit change in technology or financial policy being
contemplated for future periods, a reasonable point of departure for assumptions
for these variables is the current period level. As one proceed below with the
steps involved in producing a detailed forecast, the reader will note that the
above knowledge of the behavior of accounting numbers to some extent is used.
However, it is important to keep in mind that knowledge of average behavior will
not fit all firms well. The art of financial statements analysis requires not only
knowing what the “normal” patterns are but also expertise in identifying those
firms that will not follow the norm.
60.000
50.000
40.000
NOPAT
30.000 Series1
20.000
10.000
0.000
1 2 3 4 5
year
181
ELEMENTS OF THE DETAILED FORECAST
Here summarized steps that could be followed in producing a comprehensive

forecast is presented ,The discussion assumes that the firm being analyzed is
among the vast majority for which the forecast would reasonably be anchored by
a sales forecast of penetration can be achieved.
The Forecast of Earnings/Total income/Sales:

Since earnings is the main concern for SREI, the
forecasting starts from estimating the earnings, i.e., total income. This is a non
banking financial institution and earns through lending for equipment, assets, etc.
in the past five years we see an increasing trend in the total income, and in the
last year, there is a big leap in the income. Thus total income has been taken as
the basis for further forecasting of the various items in different statements. The
next step is to forecast sales or the total income. The total income has been
forecasted on the basis of the average growth rate of the past five years.
The Forecast of Balance Sheet Accounts
Since various balance sheet accounts may be driven by different factors,

they are usually best forecasted individually. However, several asset accounts,
including operating working Capital accounts and operating long-term assets are
driven over the long run by sales activity. Thus, these accounts can be forecast as
fractions of sales, allowing for any expected changes in the efficiency of asset
utilization. Here sales refers to the total income. Among the assets, fixed assets,
current assets and loans and advances are taken on the basis of sales. Interest
accrued is forecasted on the basis of investment, and investment is forecasted on
182
the basis of average growth rate. The rest are estimated to grow on the basis of
average growth rate.
The next step is the forecasting of the liability side items of the balance
sheet. Equity share capital in the past years is constant, excepting the year 2006.
Thus it is assumed to be constant the next forecasted years.
Reserves provisions and deferred tax is forecasted on the average growth rate.
Current liabilities are forecasted on the basis of sales/total income. Total debt is
taken as the balancing figure.
The ratios used are:

⇒ Fixed assets turnover ratio
⇒ Current asset turnover ratio.
⇒ Inventories turnover ratio
⇒ Sales/ total income to current liabilities.
FORECAST OF PROFIT and LOSS ACCOUNT:
The total income is forecasted on the basis of average growth rate over the
past five years. Administration and other expenses are forecasted on the basis of
the total income, as these expenses depend on the total income. Depreciation
depends on the fixed assets. Thus the depreciation is forecasted on the basis of
the average growth of the percentage of depreciation to the gross fixed assets.
Debtors are assumed to be constant and bad debt depends on the debtors. The bad
debts are forecasted on the basis of average growth rate. Finance charges,
interest, provisions, and miscellaneous expenditure are taken on the basis of
average growth rate. The forecasted profit and loss account shows a considerable
increase in the profit, i.e., profit after tax. Dividends are taken on the basis of
183
equity, and the forecasted dividends show an increase each year, with an increase
in the earning per share, dividend per share, and decrease in the payout ratio.
184
PART 5
185
CONCLUSION
The findings during the project can be summarized as follows:
⇒ The free cash flows in every year increases considerably.

⇒ The value of the firm since last five years increases and so does in the next five
years, which would enable the company to go in for any mergers or acquisition or
joint venture, which it is aminig for
⇒ The market value of the share as at 31/03/06 is Rs.69.196, but the intrinsic value
of the share is estimated to around Rs.198.05. this indicates that the value of the
share is undervalued.
⇒ Estimating the growth rate as 17.33%, the value of equity in the next year is
estimated as Rs 134.051.
⇒ Market value added by SREI INFRASTRUCTURE FINANCE LTD is
Rs.6973.06 crore.
⇒ The forecasted financial statements, i.e. the Profit & Loss A/c and the Balance
Sheet shows the company’s future prospects are good and that the company will
experience growth in the coming years.
186
ANNEXURE
1. Ratio Analysis.
2. Calculation of Working Average Cost of Capital.
3. Discounted Cash flow(DCF) Valuation of the Firm
4. Income Based Approach
5. Net Asset Based Approach
6. Equity Valuation
7. Economiv Value Added
8. Projected Profit & Loss A/C
9. Projected Balance Sheet
10. P/L A/C for the past five years
11. Balance Sheet for the past five years
12. Cash Flow Statement for the past five years.
187
RATIO ANALYSIS
LIQUIDITY RATIOS
Mar-02 Mar-03 Mar-04 Mar-05 Mar-06
Current ratio 3.500 4.072 8.780 7.960 55.530
Quick ratio/ Acid test ratio 0.043 0.048 0.061 0.764 1.475
Cash Ratio 0.038 0.088 0.410 0.270 4.280
FINANCIAL LEVERAGE
RATIOS
Debt-to-Equity Ratio 5.400 5.370 5.580 6.011 4.127
Net Worth Ratio 0.103 0.091 0.079 0.013 0.182
Solvency Ratio 1.119 1.128 1.44 1.33 1.22
Fixed Asset to Net Worth Ratio 0.105 0.111 0.113 0.109 0.545
Current Asset to Net Worth Ratio 8.520 8.056 7.170 7.670 16.910
Current Liabilities to Net Worth Ratio 2.430 1.970 0.810 0.960 0.304
Capital Gearing Ratio 0.173 0.107 0.617 1.777 1.513
Times Interest Earned 1.28 1.34 1.52 1.87 1.72
PROFITABILITY RATIOS
Gross Profit Ratio(%) 15.940 18.910 25.770 31.540 34.170
Net Profit Ratio(%) 11.400 12.280 17.670 21.780 21.300
Operating Profit Ratio (%) 84.530 83.740 80.190 74.510 81.140
Return on Equity 0.239 0.273 0.382 0.529 0.444
Return on Investment(%) 9.560 9.830 8.710 7.340 7.610
Return on Assets 0.011 0.012 0.018 0.020 0.021
equity multiplier 21.986 22.048 21.442 26.139 20.740
MARKET VALUE RATIOS

Earning Per Share 2.39 2.73 3.82 5.29 4.44
Dividend Per Share 1.200 1.000 1.500 1.500 2.040
Market Price Per Share 7.939 8.247 13.555 45.932 69.196
Dividend Pay out Ratio 50.209 36.630 39.267 28.355 45.946
Price-Earning Ratio 3.322 3.021 3.548 8.683 15.585
Dividend Yield 0.151 0.121 0.111 0.033 0.029
Dividend Coverage 1.992 2.730 2.547 3.527 2.176
Book value per share 2.39 2.73 3.82 5.29 4.44
Payout ratio 3.32 3.02 3.54 8.68 15.58
188
CALCULATION OF WORKING AVERAGE COST OF CAPITAL
Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
109.09 109.09 109.09 109.09
Equity Share Capital 53.450 53.450 53.450 53.450 109.090 0 0 0 0 109.090
101.96 126.00 156.48 175.30
debentures 9.240 5.740 33.000 95.000 165.000 6 6 4 6 165.022
148.45 235.09 265.57 284.39
TOTAL CAPITAL 62.690 59.190 86.450 0 274.090 211.056 6 4 6 274.112
Int.on.debt 60.01 62.08 54.9 45.84 94.57 110.04 128.04 148.99 173.37 201.73
Kd(%) 14.000 14.000 14.000 14.000 14.000 14.000 14.000 14.000 14.000 14.000
Wd 0.147 0.097 0.382 0.640 0.602 0.483 0.536 0.589 0.616 0.602
Kd(1-t) 9.100 9.100 9.100 9.100 9.100 9.100 9.100 9.100 9.100 9.100
Wd*Kd(1-t) 1.341 0.882 3.474 5.824 5.478 4.396 4.877 5.362 5.609 5.478
NO.of.Equity Shares 53.450 53.450 53.450 53.450 10.900 10.900 10.900 10.900 10.900 10.900
Total Dividend 6.400 5.330 8.000 8.000 22.300 25.510 29.180 33.390 38.195 43.695
Dividend Per share 1.197 0.997 1.497 1.497 2.046 2.340 2.677 3.063 3.504 4.009
Market Value per 203.52 349.03 598.59
share 7.939 8.247 13.555 45.932 69.196 118.670 0 7 8 1026.595
DPS/MPS 0.151 0.121 0.110 0.033 0.030 0.020 0.013 0.009 0.006 0.004
Ke(%) 14.121 14.110 14.033 14.030 14.020 14.013 14.009 14.006 14.004
We 0.853 0.903 0.618 0.360 0.398 0.517 0.464 0.411 0.384 0.398
We*Ke 12.752 8.724 5.052 5.584 7.246 6.502 5.754 5.372 5.573
WACC(%) 13.634 12.198 10.876 11.062 11.643 11.380 11.116 10.982 11.052
189
EMPTY
190
NI APPROACH
(EBIT/Ke)
EBIT 76.74 83.98 83.60 85.64 162.77 198.21 246.24 302.15 367.67 444.75
Ko(%) - 13.63 12.20 10.88 11.06 11.64 11.38 11.12 10.98 11.05
VALUE OF THE 1471.4 1702.3 2163.7 2718.1 3347.8

FIRM 615.96 685.36 787.42 3 9 9 8 9 4024.12
NOI
APPROACH
(S+V/Ko)
S+V 62.69 59.19 86.45 148.45 274.09 211.06 235.10 265.57 284.40 274.11
Ko - 13.63 12.20 10.88 11.06 11.64 11.38 11.12 10.98 11.05
VALUE OF THE 1364.9 2477.7 1812.7 2065.8 2589.6

FIRM 434.14 708.72 3 6 3 7 2389.11 9 2480.18
191
NET ASSET BASED APPROACH

Fixed Assets after

depreciation 13.09 14.87 16.32 17.80 223.75 345.97 342.65 338.95 334.95 330.75
Current Assets:-
1044.8 1035.9 1697.3 1796.4 1901.3 2021.3 2129.9
Inventory 8 8 977.16 1198.32 3 5 6 9 1 2254.29
Debtors 4.07 4.07 3.27 4.14 1.69 1.69 1.69 1.69 1.69 1.69
Cash & Bank 11.59 23.46 48.49 43.66 142.42 302.52 493.39 710.75 987.11 1301.81
other receivebles 1.06 9.58 8.08 8.58 0.00 0.00 0.00 0.00 0.00 0.00
1061.6 1073.0 1037.0 1254.7 1841.4 2100.6 2396.4 2733.8
Total current assets 0 9 0 0 4 6 4 3 3118.71 3557.79
1074.6 1087.9 1053.3 1272.5 2065.1 2446.6 2739.0 3072.7 3453.6

A 9 6 2 0 9 3 9 8 6 3888.54
Current Liabilties & Provisons

Current Liabilties 303.57 263.65 118.19 157.74 33.22 13.58 5.55 2.27 0.93 0.38
Provisions 29.54 33.52 37.06 42.09 58.23 67.08 77.27 89.01 102.53 118.10
Preference Share Dividend - - - - - - - - - -
B 333.11 297.17 155.25 199.83 91.45 80.66 82.82 91.28 103.45 118.48
Net Assets Available For The 1072.6 1973.7 2365.9 2656.2 2981.5 3350.2
Equity Shares 741.58 790.79 898.07 7 4 7 7 0 1 3770.06
A-B
NO.of.Equity Shares 53.45 53.45 53.45 53.45 109.09 109.09 109.09 109.09 109.09 109.09
2002.0 2003.0 2004.0 2005.0 2006.0 2007.0 2008.0 2009.0 2010.0
0 0 0 0 0 0 0 0 0 2011.00
Value ot net assets per
share 13.87 14.79 16.80 20.07 18.09 21.69 24.35 27.33 30.71 34.56
192
EQUITY VALUATION
STABLE GROWTH MODEL
2006
DPS 2.04
Ke 14.03%
growth(g) 13%
Ks-g 1.03%
Value of the Equity 198.0582524
TWO STAGE GROWTH MODEL
Ke 14.03%
g(%) 17.33%
Ke to the Discounting DPS

DPS*(1+g) power n by Ke
DPS 2.040
2.10470
DPS(1) 2.4 1.1403 9
2.98153
DPS(2) 3.876 1.3 8
4.22402
DPS(3) 6.26 1.482 2
7.01775
DPS(4) 11.86 1.69 1
13.7343
DPS(5) 26.37 1.92 8
A 30.0624
Value the Stable Growth Period
DPS
DPS(1+g) 15.51984
Ke 14.03%
g 8%
Ks-g 6.03%
value 257.3772
Present Value of the Dividends (B) 134.051
Value of Equity=A+B 164.113
193
ECONOMIC VALUE ADDED
NOPAT(A) 12.800 14.610 20.440 28.300 48.420 63.147 84.654 109.696 139.155 174.049
Total
capital 62.690 59.190 86.450 148.450 274.090 211.056 235.096 265.574 284.400 271.110
WACC(%) - 13.630 12.198 10.876 11.062 11.643 11.380 11.116 10.982 11.052
8.06759 10.545 16.14542 30.3198 24.5732 26.7539 29.5212 31.23280

TC*WACC(B) 7 2 2 4 5 2 1 8 29.96308
2003 2004 2005 2006 2007 2008 2009 2010 2011
EVA 6.542 9.895 12.155 18.100 38.574 57.900 80.175 107.922 144.086
194
FORECASTED P/L A/C
Total income 268.541 317.335 374.995 443.132 523.649

less: Administartion & other expenses 38.885 42.307 46.030 50.081 54.488
less: Finance Charges 11.835 11.519 11.212 10.912 10.621
less: Interest 110.04 128.04 148.99 173.37 201.73
less: Depreciation 12.638 10.2 8.234 6.646 5.36
less: Bad debt 1.533 1.073 0.751 0.526 0.368
less: Provisions 4.192 4.553 4.945 5.371 5.834
less: Misc exp 1.249 1.444 1.670 1.931 2.232
180.373 199.137 221.832 248.837 280.633
Profit before tax 88.169 118.199 153.163 194.295 243.016
less: Tax 25.022 33.544 43.467 55.140 68.967
Net Profit 63.147 84.654 109.696 139.155 174.049
Dividends 25.510 29.180 33.390 38.195 43.695

Earning Per Share 0.579 0.776 1.006 1.276 1.595
Dividend Per Share 0.234 0.267 0.306 0.350 0.401
Payout Ratio 0.404 0.345 0.304 0.274 0.251
195
FORECASTED BALANCE SHEET
Equity Share Capital 109.09 109.09 109.09 109.09 109.09

Reserves 434.06 625.05 900.07 1296.09 1866.38
Total Debt 1991.47 2144.129 2270.533 2352.061 2357.009
Current Liabilities 13.58 5.55 2.27 0.928 0.38
Provisions 67.07514 77.26385 89.00023 102.5194 118.0921
Deferred Tax 79.78896 96.22549 116.0479 139.9538 168.7843
Total 2695.064 3057.308 3487.011 4000.642 4619.735
Total assets 358.612 352.85 347.179 341.6 336.11

less: depreciation 12.638 10.2 8.234 6.646 5.36
Net Fixed Assets 345.974 342.65 338.945 334.954 330.75
Capital WIP 0 0 0 0 0
Investment 144.86 201.99 281.67 392.76 547.66
Inventories 1796.45 1901.36 2021.39 2129.91 2254.29
Debtors 1.69 1.69 1.69 1.69 1.69
C&B balance 302.55 493.389 710.746 987.113 1301.807
Other Receivables 0 0 0 0 0
Total Current Assets 2100.69 2396.439 2733.826 3118.713 3557.787
Interest Accrued but not due 4.83 6.95 9.98 14.34 20.6
Loans & Advances 89.71 95.69 102.07 108.89 116.15
Misc Expenditure 8.9996 13.5894 20.51999 30.98518 46.78762
Total 2695.064 3057.308 3487.011 4000.642 4619.735
196
PROFIT & LOSS A/C

Total income 112.240 118.910 115.700 129.930 227.250
Interst & Financial Charges 76.99 77.08 62.96 55.83 106.73
Operating& Administrative Charges 17.36 19.34 22.92 33.12 42.87
PBDT 17.890 22.490 29.820 40.980 77.650
Depreciation 1.16 1.09 1.12 1.18 9.45
Profit Before Tax 16.730 21.400 28.700 39.800 68.200
Tax 3.93 6.79 8.26 11.5 19.78
Net Profit 12.800 14.610 20.440 28.300 48.420
197
BALANCE SHEET
Equity Share Capital 53.45 53.45 53.45 53.45 109.09

Preference share capital 0 0 0 0 0
TOTAL CAPITAL 53.45 53.45 53.45 53.45 109.09
Reserves 71.22 79.82 91.23 110.48 301.43
NET WORTH 124.67 133.27 144.68 163.93 410.52
Mezzanine Capital 52.66 77.88 79.7 81.01 79.65
Secured Loans 604.38 570.44 601.44 799.18 1328.08
Unsecured Loans 33.67 67.97 126.73 105.34 286.65
TOTAL DEBT 690.71 716.29 807.87 985.53 1694.38
Current Liabilities 303.57 263.65 118.19 157.74 33.22
Provisions 29.54 33.52 37.06 42.09 58.23
Deferred Tax 26.65 31.76 38.25 47.82 66.16
TOTAL 1175.14 1178.49 1146.05 1397.11 2262.51
Fixed Asset 14.25 15.96 17.44 18.98 233.20

Depreciation 1.16 1.09 1.12 1.18 9.45
NET FIXED ASSETS 13.09 14.87 16.32 17.80 223.75
INVESTMENT 30.59 23.61 23.51 49.5 103.89
Inventories 1044.88 1035.98 977.16 1198.32 1697.33
Debtors 4.07 4.07 3.27 4.14 1.69
C&B balance 11.59 23.46 48.49 43.66 142.42
Other Receivables 1.06 9.58 8.08 8.58 0
Total Current Assets 1061.6 1073.09 1037 1254.7 1841.44
Interest Accrued but not
due 0.31 0.49 0.85 2.26 3.37
Loans & Advances 64.44 63.58 65.83 71.5 84.1
Misc Expenditure 5.11 2.85 2.11 1.35 5.96
TOTAL 1163.21 1164.71 1130.42 1380.49 2048.21
198
Year End Mar 06 Mar 05 Mar 04 Mar 03 Mar 02
Cash Flow Summary

Cash and Cash Equivalents at Begining of the year 43.66 48.49 23.46 11.58 8.54
Net Cash from Operating Activities -543.74 -143.94 -55.83 -14.28 -145.33
Net Cash Used In Investing Activities -269.68 -28.21 -2.89 6.97 -12.32
Net Cash Used In Financing Activities 912.18 167.32 83.75 19.19 160.69
Net Inc/(Dec) In Cash And Cash 98.76 -4.83 25.03 11.88 3.04
Cash And Cash Equivalents At End Of The Year 142.42 43.66 48.49 23.46 11.58
Cash Flow From Operating Activities 200603 200503 200403 200303 200203
Net Profit Before tax & Extraordinary Items 68.20 39.80 28.70 21.40 16.73
Adjustment For
Depreciation 9.45 1.18 1.12 1.09 1.16
Interest(Net) 106.73 55.83 62.96 75.07 73.42
Dividend Received -0.06 -0.02 -0.01 -0.51 -0.64
P/L on Sales Of Assets 0.00 0.01 0.00 -0.08 0.00
P/L on Sales Of Invests 0.00 0.00 0.00 0.00 0.00
Prov. & W/O(NET) 1.03 0.55 0.56 0.67 0.67
P/L In Forex 0.00 0.00 0.00 0.00 0.00
Fin. Lease & Rental Chrgs 0.00 0.00 0.00 0.00 0.00
Others 0.00 0.00 0.00 0.00 0.00
117.15 57.55 64.63 76.24 74.61
Op. Profit Before Working Capital Changes 185.35 97.35 93.33 97.64 91.34
Adjustment For
Trade & 0th Recievables -7.75 -5.69 -1.30 -10.19 2.66
Inventories 0.00 0.00 0.00 0.00 0.00
Trade Payables 29.08 42.20 -32.12 -37.54 129.06
Loan & Advances -639.57 -221.32 -52.59 12.69 -293.00
Investments 0.00 0.00 0.00 0.00 0.00
Net Stock On Hire 0.00 0.00 0.00 0.00 0.00
Leased Assets Net Of Sale 0.00 0.00 0.00 0.00 0.00
Trade Bills(s) Purchased 0.00 0.00 0.00 0.00 0.00
Change In Borrowing 0.00 0.00 0.00 0.00 0.00
Change In Deposits 0.00 0.00 0.00 0.00 0.00
Others 0.00 0.00 0.00 0.00 0.00
-618.24 -184.81 -86.01 -35.04 -161.28
Cash Generated From/(Used In) Operations -432.89 -87.46 7.32 62.60 -69.94
Interest Paid(Net) -104.01 -54.09 -61.01 -75.70 -73.73
Direct Taxes Paid 0.00 0.00 0.00 0.00 0.00
Advance Tax Paid -6.84 -2.39 -2.14 -1.18 -1.66
Others 0.00 0.00 0.00 0.00 0.00
-110.85 -56.48 -63.15 -76.88 -75.39
199
Cash Flow Before Extraordinary Items -543.74 -143.94 -55.83 -14.28 -145.33
Extraordinary Items
Excess Depreciation W/b 0.00 0.00 0.00 0.00 0.00
Premium On Lease Of Land 0.00 0.00 0.00 0.00 0.00
Payment Towards VRS 0.00 0.00 0.00 0.00 0.00
Prior Year's Taxation 0.00 0.00 0.00 0.00 0.00
Gain On Forex Exch. Tran 0.00 0.00 0.00 0.00 0.00
Others 0.00 0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00 0.00
Net Cash Flow From Operating Activities -543.74 -143.94 -55.83 -14.28 -145.33
Cash Flow From Investing Activities 200603 200503 200403 200303 200203
Investment In Assets :
Purchased Of Fixed Assets -215.42 -2.24 -3.00 -1.74 -2.33
Sale Of Fixed Assets 0.02 0.00 0.00 0.29 0.00
Capital WIP 0.00 0.00 0.00 0.00 0.00
Capital Subsidy Recd 0.00 0.00 0.00 0.00 0.00
Financial/Capital Investment:
Purchase Of Investments -54.34 -25.99 0.00 0.00 -12.20
Sale Of Investments 0.00 0.00 0.10 6.97 0.00
Investment Income 0.00 0.00 0.00 0.00 0.00
Interest Received 0.00 0.00 0.00 0.94 1.57
Dividend Received 0.06 0.02 0.01 0.51 0.64
Invest. In Subsidiaries 0.00 0.00 0.00 0.00 0.00
Loan to Subsidiaries 0.00 0.00 0.00 0.00 0.00
Investment In Group Cos 0.00 0.00 0.00 0.00 0.00
Issue Of Sh.On Acqu. Of Cos 0.00 0.00 0.00 0.00 0.00
Canc. Of Invest. In Cos Acq 0.00 0.00 0.00 0.00 0.00
Acquisition Of Companies 0.00 0.00 0.00 0.00 0.00
Inter Corporate Deposits 0.00 0.00 0.00 0.00 0.00
Others 0.00 0.00 0.00 0.00 0.00
Net Cash Used In Investing Activities -269.68 -28.21 -2.89 6.97 -12.32
Cash Flow From Financing Activities 200603 200503 200403 200303 200203
Proceeds:
Proceeds from Iss. Of SnCap Incl Sh Prem 222.99 0.00 0.00 0.00 0.00
Proceed from Issue Of Deb 0.00 0.00 0.00 0.00 0.00
Proceed from 0th. L Term Borr 708.85 176.35 89.76 0.37 166.08
Proceed from Bank Borr 0.00 0.00 0.00 0.00 0.00
Proceed from Sh Term Borr 0.00 0.00 0.00 0.00 0.00
Proceed from Deposits 0.00 0.00 0.00 0.00 0.00
Share Application Money 0.00 0.00 0.00 0.00 0.00
Cash/Cap. Investment Subsidy 0.00 0.00 0.00 0.00 0.00
Loan From A Corporate Body 0.00 0.00 0.00 0.00 0.00
200
Payments:
Share Application Money Refund 0.00 0.00 0.00 0.00 0.00
On Redem Of Deben 0.00 0.00 0.00 0.00 0.00
Of 0th L Term Borr 0.00 0.00 0.00 0.00 0.00
Of Sh Term Borr 0.00 0.00 0.00 0.00 0.00
Of Fin. Lease Liabi 0.00 0.00 0.00 0.00 0.00
Dividend Paid -11.72 -8.00 -5.33 -6.40 -7.04
Shelter Assistance Reserve 0.00 0.00 0.00 0.00 0.00
Others -7.94 -1.03 -0.68 25.22 1.65
Net Cash Used in Financing Activities 912.18 167.32 83.75 19.19 160.69
201
BIBLIOGRAPHY
The books referred for the project work are:

⇒ Brigham Eugene F. & Ethardt Michael C.- Corporate Finance – Thomson
Publishers- 11th Edition
⇒ Brealey, Myers, Marcus- Fundamentals of Corporate Finance- McGraw Hill
Publishers – 3rd Edition
⇒ Brown Reilly – Investment Analysis and Portfolio Management – 7th Edition
⇒ CFA- Analysis of Equity Investments: Valuation
⇒ Damodaran Aswath - Investment valuation – Tata McGraw Hill - 2nd Edition
⇒ Economic Survey- Monetary and Banking Developments- Chapter 3
⇒ Khan M.Y & Jain P.K- Financial management – Tata Mc.GrawHill Publishers
– 3rd Edition
⇒ Pandey I. M- Financial Management- Vikas Publishing House – 10th Edition
⇒ Copeland Tom, Koller Tim, Murrin Jack- Valuation measuring and managing
the value of companies – McKinsey & Company Inc.- 3rd Edition
The sites referred are:

⇒ www.fool.com
⇒ www.google.com
⇒ www.investopedia.com
⇒ www.moneycontrol.com
⇒ www.nseindia.com
⇒ www.rbi.com
⇒ www.srei.com
⇒ www.wikipedia.com
⇒ www.yahoofinance.com
202
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SERI Valuation

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Valuation & Forecast of SREI Infrastructure Finance Ltd

Economic Value Added (EVA)

SREI is one of India’s largest private sector infrastructure and

SREI operates in the infrastructure financing segments of infrastructure

INTRODUCTION TO THE PROJECT

OBJECTIVES BEHIND THE PROJECT

The financial system comprises of financial institutions, financial instruments

A non-banking institution which is a company and which has its principal

According to Reserve Bank (Amendment act, 1997) “A Non Banking Finance

⇒ a financial institution which is a company;

The definition excludes financial institutions which carry on agricultural

• (iii) deposit insurance facility of DICGC is not available for NBFC

⇒ Equipment leasing and hire purchase companies (finance

The salient features of this guideline are given below.

The NBFCs that are registered with RBI are:

• (i) equipment leasing company;

• Asset Finance Company (AFC)

AFC would be defined as any company which is a financial institution carrying

Principal business for this purpose is defined as aggregate of financing

The NBFCs accepting public deposits should furnish to RBI:

account in respect of that year as passed in the general meeting together

report and the notes on accounts furnished by its Auditors;

• Statutory Annual Return on deposits - NBS 1;

deposits as and when the claims arise;

• Quarterly Return on liquid assets;

• Half-yearly Return on prudential norms;

• Half-yearly ALM Returns by companies having public deposits of Rs 20

the size of deposits ;

• Monthly return on exposure to capital market by companies having public

deposits of Rs 50 crore and above; and

Half-yearly Returns on prudential norms as at (v) above.

Today, NBFCs are present in the competing fields of vehicle financing,

INTRODUCTION TO THE COMPANY

SREI is one of India’s largest private sector infrastructure financial

SREI operates in the infrastructure financing segments of infrastructure

SREI is a widely held company, listed on the Kolkata, Mumbai, National

1. INFRASTRUCTURE EQUIPMENT FINANCE

With the government increasing its focus on implementing new

2. INFRASTRUCTURE PROJECT FINANCE

3. RENEWABLE ENERGY EQUIPMENT FINANCE – SREU

EXCITING SERVICE PORTFOLIO

As a part of its strategy to deliver superior value to all stakeholders, SREI

SREI Venture Capital Limited:

Schemes Target Size Target Sector

SREI Capital Markets Limited is a SEBI registered Category I merchant

SREI Insurance Services Limited:

This is a unique, all encompassing insurance services and brokerage

SREI Forex Limited:

Global Investment Trust Limited (GITL) is a wholly owned subsidiary of

SREI Joint Ventures:-

Bengal SREI Infrastructure Development Limited:

Bengal SREI Infrastructure Development Limited is a joint venture

IIS International Infrastructure Services GmbH:

IIS International Infrastructure Services GmbH (IIS) has been

Quipo Infrastructure Equipment Limited:

QIEL has been sponsored by SREI and supported by the Construction

Quipo- equipment bank:

Quipo was set up to cater to the needs of construction companies and

Quipo- oil and gas:

First Indian company to provide comprehensive equipment and services

First Indian company providing passive infrastructure sharing for mobile

Henry Butcher International Valuers & Auctioneers Pvt. Ltd .

This is a 50:50 Joint venture between Quipo and GoIndustry Henry