THE INDIAN INSTITUTE OF PLANNING & MANAGEMENT

NEW DELHI

THESIS

Determinants of Capital Structure in Automobile Sector of India - Case of Tata Motors

Submitted by: Shweta Kacker FW/-9-11 FF3

ABSTRACT
The term capital structure refers to the percentage of capital (money) at work in a business by type. Broadly speaking, there are two forms of capital: equity capital and debt capital. Each has its own benefits and drawbacks and a substantial part of wise corporate stewardship and management is attempting to find the perfect capital structure in terms of risk / reward payoff for shareholders. Automobile industry is a symbol of technical marvel by human kind. Being one of the fastest growing sectors in the world its dynamic growth phases are explained by nature of competition, product life cycle and consumer demand. Today, the global automobile industry is concerned with consumer demands for styling, safety, and comfort; and with labor relations and manufacturing efficiency. The industry is at the crossroads with global mergers and relocation of production centers to emerging developing economies. Due to its deep forward and backward linkages with several key segments of the economy, the automobile industry is having a strong multiplier effect on the growth of a country and hence is capable of being the driver of economic growth. It plays a major catalytic role in developing transport sector in one hand and help industrial sector on the other to grow faster and thereby generate a significant employment opportunities. Also as many countries are opening the land border for trade and developing international road links, the contribution of automobile sector in increasing exports and imports will be significantly high. As automobile industry is becoming more and more standardized, the level of competition is increasing and production base of most of auto-giant companies are being shifted from the developed countries to developing countries to take the advantage of low cost of production.

1. INTRODUCTION

Indian Automotive Sector: The automobile sector is a key player in the global and Indian economy. The global motor vehicle industry (four-wheelers) contributes 5 per cent directly to the total manufacturing employment, 12.9 per cent to the total manufacturing production value and 8.3 per cent to the total industrial investment. It also contributes US$560 billion to the public revenue of different countries, in terms of taxes on fuel, circulation, sales and registration. The annual turnover of the global auto industry is around US$5.09 trillion, which is equivalent to the sixth largest economy in the world. In addition, the auto industry is linked with several other sectors in the economy and hence its indirect contribution is much higher than this. All over the world it has been treated as a leading economic sector because of its extensive economic linkages. Indias manufacture of 7.9 million vehicles, including 1.3 million passenger cars, amounted to 2.4 per cent and 7 per cent, respectively, of global production in number. The auto-components manufacturing sector is another key player in the Indian automotive industry. Exports from India in this sector rose from US$1.0 billion in 2009-10 to US$1.8 billion in 2010-11, contributing 1 per cent to the world trade in auto components in current USD. In India, the automobile industry provides direct employment to about 5 lakh persons. It contributes 4.7 per cent to Indias GDP and 19 per cent to Indias indirect tax revenue. Till early 1980s, there were very few players in the Indian auto sector, which was suffering from low volumes of production, obsolete and substandard technologies. With de-licensing in the 1980s and opening up of this sector to FDI in 1993, the sector has grown rapidly due to the entry of global players. A rapidly growing middle class, rising per capita incomes and relatively easier availability of finance have been driving the vehicle demand in India, which in turn, has prompted the government to invest at unprecedented levels in roads infrastructure, including projects such as Golden Quadrilateral and North-East-SouthWest Corridor with feeder roads. The Reserve Bank of Indias (RBI) Annual Policy Statement documents an annual growth of 37.9 per cent in credit flow to vehicles industry in 2009. Given that passenger car penetration rate is just about 8.5 vehicles per

thousand, which is among the lowest in the world, there is a huge potential demand for automobiles in the country. Policy Environment and Evolution of Indian Auto Industry: The policy framework of Indias automobile industry and its impact on its growth While the ties between bureaucrats and the managers of state-owned enterprises played a positive role especially since the late 1980s, ties between politicians and industrialists and between politicians and labour leaders have impeded the growth. The first phase of 1940s and 1950s was characterized by socialist ideology and vested interests, resulting in protection to the domestic auto industry and entry barriers for foreign firms. There was a good relationship between politicians and industrialists in this phase, but bureaucrats played little role. Development of ancillaries segment as recommended by the L.K. Jha Committee report in 1960 was a major event that took place towards the end of this phase. During the second phase of rules, regulations and politics, many political developments and economic problems affected the auto industry, especially passenger cars segment, in the 1960s and 1970s. The third phase starting in the early 1980s was characterized by delicensing, liberalization and opening up of FDI in the auto sector. These policies resulted in the establishment of new LCV manufacturers (for example, Swaraj Mazda, DCM Toyota) and passenger car manufacturers.7 All these developments led to structural changes in the Indian auto industry. Pingle argues that state intervention and ownership need not imply poor results and performance, as demonstrated by Maruti Udyog Limited (MUL). Further, the non contractual relations between bureaucrats and MUL dictated most of the policies in the 1980s, which were biased towards passenger cars and MUL in particular. However, DCosta (2002) argues that MULs success is not particularly attributable to the support from bureaucrats. Rather, any firm that is as good as MUL in terms of scale economies, first-comer advantage, affordability, product novelty, consumer choice, financing schemes and extensive servicing networks would have performed as well, even in the absence of bureaucratic support. DCosta has other criticisms about Pingle (2000). The major shortcoming of Pingles study is that it ignores the issues related to sector specific technologies and regional differences across the country.

Productivity: The performance of the Indian auto industry with respect to the productivity growth Partial and total factor productivity of the Indian automobile industry have been calculated for the period from 1990-91 to 2010-11, using the Divisia-Tornquist index for the estimation of the total factor productivity growth. The author finds that the domestic auto industry has registered a negative and insignificant productivity growth during the last one and a half decade. Among the partial factor productivity indices only labour productivity has seen a significant improvement, while the productivity of other three inputs (capital, energy and materials) havent shown any significant improvement. Labour productivity has increased mainly due to the increase in the capital intensity, which has grown at a rate of 0.14 per cent per annum from 1990-91 to 2010-11. Organized Auto Sector in India: While the Original Equipment Manufacturers (OEMs) are at the top of the auto supply chain, it should be noted that there are a few OEMs in India which supply some components to other OEMs in India or abroad. Most of the Indian OEMs are members of the Society of Indian Automobile Manufacturers (SIAM), while most of the Tier-1 auto component manufacturers are members of the Automobile Component Manufacturers Association (ACMA). All of them are in the organized sector and supply directly to the OEMs in India and abroad or to Tier-1 players abroad. Tier-2 and Tier-3 auto-component manufacturers are relatively smaller players. Though some of the Tier-2 players are in the organized sector, most of them are in the unorganized sector. Tier-3 manufacturers include all auto-component suppliers in the unorganized sector, including some Own Account Manufacturing Enterprises (OAMEs) that operate with one working owner and his family members, wherein manufacturing involves use of a single machine such as the lathe. Auto-component manufacturers cater not only to the OEMs, but also to the aftersales market. In the recent years, there has been a rapid transformation in the character of the automotive aftermarket, as a fast maturing organized, skill-intensive and knowledge driven activity. Hence, the auto industry in India possesses a very diverse and complex structure, in terms of scale, nature of operation, market structure, etc.

Unorganized Auto Sector in India: The unorganized sector consists of enterprises that are not registered under certain sections of the Factories Act.20 In this section, data on the unorganized manufacturing sector from the National Sample Survey Organization (NSSO) is used. The unorganized auto sector in India has grown in terms of number of enterprises, employment, output, capital, capital intensity and labour productivity. However, capital productivity has fallen considerably. Very similar trends are observed in OAME, NDME and DME21 in rural and urban areas. However, it is evident that the growth of this sector has been quite low in the rural areas than in the urban areas.

Automobiles - Domestic Performance: The production and domestic sales of the automobiles in India have been growing strongly. While production increased from 4.8 million units in 2003-08 to 8.5 million units in 2010-11 (a CAGR of over 15 per cent), domestic sales during the same period have gone up from 4.6 million to 7.9 million units (CAGR 14.2 per cent).

A positive trend in the domestic market is that the growth has not been driven by one or two segments, but is consistent across all key segments. Two wheelers, which constitute the majority of the industry volume, have been growing at a rate of 14.3 per cent, three wheelers at a rate of 14 per cent and passenger vehicles at a rate of 11.3 per cent. Commercial vehicles have been growing at a higher rate of nearly 23.5 per cent, although from a lower base. Since nearly all macro-economic indicators GDP, infrastructure, population demographics, interest rates, etc. are showing a favorable trend, the domestic market for automobiles in India is expected to continue on its growth trajectory. Commercial Vehicles: The commercial vehicle production in India increased from 156,706 in 2008 to 350,033 in 2011.

This segment can be divided into three categories heavy commercial vehicles (HCVs), medium commercial vehicles (MDVs or MCVs) and light commercial vehicles (LCVs). Medium and heavy commercial vehicles formed about 62 per cent of the total domestic sales of CVs in 2004. These segments have also been driving growth, having grown at a CAGR of nearly 24.7 per cent over the past five years. The key trends facilitating growth in this sector are the development of ports and highways, increase in construction

activities and agricultural output. With better roads and highway corridors linking major cities, the demand for larger, multi-axle trucks is increasing in India. Passenger Vehicles:

Passenger vehicles consist of passenger cars and utility vehicles. This segment has been growing at a CAGR of 11.3 per cent for the past four years. A key trend in this segment is that with rising income levels and availability of better financing options, customers are increasingly aspiring for higher-end models. There has been a gradual shift from entry-level models to higher-end models in each segment. For example, in passenger cars, till recently, the Maruti 800 used to define the entry level car, and had a predominant market share. Over the last 3-4 years, higher-end models such as Hyundai Santro, Maruti Wagon R, Alto and Tata Indica have overtaken the Maruti 800. Another development has been the blurring of the dividing line between utility vehicles and passenger cars, with models like Mahindra & Mahindras Scorpio attracting customers from both segments. Upper end sports utility vehicles (SUVs) attract potential luxury car buyers by offering the same level of comfort in the interiors, coupled with on-road performance capability.

Exports of automobiles from India are booming: While the domestic sales of automobiles have been increasing at a significant rate, exports have taken a quantum leap in recent years. The exports of automobiles from India have been growing at a CAGR of 39 per cent for the past four years.

Exports growth has been spearheaded by the passenger vehicle segment, which has grown at a rate of 57.4 per cent. As a result, the share of passenger vehicles in overall vehicle exports has increased firm 18 per cent in 2001-02 to 26 per cent in 2010-11. Europe is the biggest importer of cars from the country while predominantly African nations import buses and trucks. The Association of South East Asian Nations (ASEAN) region is the prime destination for Indian two wheelers.

Competitive Advantages: India has several competitive advantages in the automobile sector, which have been analyzed using the following framework. Availability of skilled manpower with engineering and design capabilities India has a growing workforce that is Englishspeaking, highly skilled and trained in designing and machining skills required by the automotive and engineering industries. In a combined assessment of manpower availability and capabilities, India ranks much ahead of other competing economies.

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Many Indian and global players are leveraging this advantage by increasingly outsourcing activities like design and R&D to their Indian arms. The Society of Indian Automobile manufacturers (SIAM) estimates that automotive vehicle manufacturers are expected to invest US$ 5.7 billion in the Indian market from 2005 to 2010. Of this, about US$ 2.3 billion will be on research and development and the rest probably on capex. Some examples of investment in areas leveraging the engineering and design capabilities of India include: MICO, the Indian operation of Bosch and a key player in fuel injection equipment, ignition systems and electricals, has invested in the MICO Application Centre (MAC) for R&D. It has emerged as a key global R&D competency centre catering to the entire Bosch Group. It is the first of its kind in India and the Bosch Groups first outside Europe. GM set up a technical centre at Bangalore that became fully operational in September 2003. The centre focuses on both R&D and engineering, and takes up high-value work to complement current research programs, as well as new exploratory research projects.

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Competitive industry, with global players:

The Indian automobile industry is highly competitive with a large number of players in each industry segment. Most of the global majors are present in the passenger vehicle and two wheeler segments. In the components industry too, global players such as Visteon, Delphi and Bosch are well established, competing with domestic players. The presence of global competition has led to an overall increase in capabilities of the Indian auto sector. Increase in competition has led to a pressure on margins, and players have become increasingly cost efficient. Quality levels have gone up, and there is an increasing focus on compliance to TPM, TQM and Six Sigma processes. This has led to an increased confidence among domestic players, who are now focusing on opportunities abroad. Key players in the components sector like Bharat Forge and Sundaram Fasteners have become key global suppliers in their categories. Large market with significant potential for growth in demand: India offers a huge growth opportunity for the automobile sector the domestic market is large and has the potential to grow further in the future due to positive demographic trends and the current low penetration levels.

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Government Regulations and Support: The Government of India (GoI) has identified the automotive sector as a key focus area for improving Indias global competitiveness and achieving high economic growth. The Government formulated the Auto Policy for India with a vision to establish a globally competitive industry in India and to double its contribution to the economy by 2010. It intends to promote Research & Development in automotive industry by strengthening the efforts of industry in this direction by providing suitable fiscal and financial incentives. Some of the policy initiatives include: Automatic approval for foreign equity investment upto 100 per cent of manufacture of automobiles and component is permitted. The customs duty on inputs and raw materials has been reduced from 20 per cent to 15 per cent. The peak rate of customs duty on parts and components of batteryoperated vehicles have been reduced from 20 per cent to 10 per cent. These new regulations would strengthen Indias commitment to globalization. Apart from this, custom duty has been reduced from 105 per cent to 100 per cent on second hand cars and motorcycles. National Automotive Fuel Policy has been announced, which envisages a phased program for introducing Euro emission and fuel regulations by 2010. Tractors of engine capacity more than 1800 cc for semi-trailers will now attract excise duty at the rate of 16 per cent. Excise duty is being reduced on tyres, tubes and flaps from 24 per cent to 16 per cent. Customs duty on lead is 5 per cent. A package of fiscal incentives including benefits of double taxation treaty is now available. These government policies reflect the priority government accords to the automobile sector. A liberalized overall policy regime, with specific incentives, provides a very conducive environment for investments and exports in the sector.

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The outlook for Indias automotive sector appears bright: The outlook for Indias automotive sector is highly promising. In view of current growth trends and prospect of continuous economic growth of over 5 per cent, all segments of the auto industry are likely to see continued growth. Large infrastructure development projects underway in India combined with favorable government policies will also drive automotive growth in the next few years. Easy availability of finance and moderate cost of financing facilitated by double income families will drive sales in the next few years. India is also emerging as an outsourcing hub for global majors. Companies like GM, Ford, Toyota and Hyundai are implementing their expansion plans in the current year. While Ford and Toyota continue to leverage India as a source of components, Hyundai and Suzuki have identified India as a global source for specific small car models. At the same time, Indian players are likely to increasingly venture overseas, both for organic growth as well as acquisitions. The automotive sector in India is poised to become significant, both in the domestic market as well as globally. Determinants of market share of automobile industry: Costs: sales ratio has a significant positive impact on market share. This could be attributable to the fact that firms that manufacture high-value items are likely to have a higher market share, since their sales, in value terms, could be higher than others. Emolument share has a negative effect on market share, showing that labour cost constraints can distort a firms competitiveness. Export: sales ratio has a significant positive effect on market share, implying that export-oriented firms are more competitive, perhaps because of their versatility and other merits that are required for catering to international markets. Power/fuel cost share has a significant negative effect on market share, implying that efficient technologies may go a long way in improving the firms competitiveness. Imported material expenses share in total material expenses has a negative significant impact on market share, indicating that import of auto-components 14

from abroad does not guarantee competitiveness of the firms, unless it is an item that is unavailable in Indian industry Borrowings share in total investments and interests share in total costs have negative significant effect on market-share, which means that too much dependence on credit may adversely affect a firms competitiveness. This also calls for improvements in credit system and its cost in India. Inventory cost share significantly distorts competitiveness, and hence, firms following lean manufacturing are more likely to be competitive than others. Share of imported know-how expenses in overall is competitiveness-enhancing, and hence, firms could aggressively go for importing know-how that is required for various aspects of production, so as to be more competitive. Advertising costs as a share of total costs, has a significant negative effect on market share, implying that unless the structural factors such as price and quality are good, mere propaganda by advertising may in fact turn harmful for market share.

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2. COMPANY PROFILE
Tata Motors Limited: Tata Motors Ltd is a multinational corporation headquartered in Mumbai, India. Part of the Tata Group, it was formerly known as TELCO (TATA Engineering and Locomotive Company). Tata Motors has consolidated revenue of USD 16 billion after the acquisition of British automotive brands Jaguar and Land Rover in 2008. It is India's largest company in the automobile and commercial vehicle sector with upwards of 70% cumulative Market share in the Domestic Commercial vehicle segment, and had a 0.81% share of the world market in 2007 according to OICA data. The OICA ranked it as the 19th largest automaker, based on figures for 2007. and the second largest manufacturer of commercial vehicles in the world. The company is the worlds fourth largest truck manufacturer, and the worlds second largest bus manufacturer. In India Tata ranks as the leader in every commercial vehicle segment, and is in the top 3 makers of passenger cars. Tata Motors is also the designer and manufacturer of the iconic Tata Nano, which at INR 100,000 or approximately USD 2300, is the cheapest production car in the world. Established in 1945, when the company began manufacturing locomotives, the company manufactured its first commercial vehicle in 1954 in collaboration with Daimler-Benz AG, which ended in 1969. Tata Motors is a dual-listed company traded on both the Bombay Stock Exchange, as well as on the New York Stock Exchange. Tata Motors in 2005, was ranked among the top 10 corporations in India with an annual revenue exceeding INR 320 billion. In 2004 Tata Motors bought Daewoo's truck manufacturing unit, now known as Tata Daewoo Commercial Vehicle, in South Korea. It also acquired Hispano Carrocera SA, 16

now a fully-owned subsidiary. In March 2008, it acquired the Jaguar Land Rover (JLR) business from the Ford Motor Company, which also includes the Daimler and Lanchester brands. and the purchase was completed on 2 June 2008. Tata Motors has auto manufacturing and assembly plants in Jamshedpur, Pantnagar, Lucknow, Ahmedabad and Pune in India, as well as in Argentina, South Africa and Thailand. History: Tata Motors is a part of the Tata Group manages its share-holding through Tata Sons. The company was established in 1935 as a locomotive manufacturing unit and later expanded its operations to commercial vehicle sector in 1954 after forming a joint venture with Daimler-Benz AG of Germany. Despite the success of its commercial vehicles, Tata realized his company had to diversify and he began to look at other products. Based on consumer demand, he decided that building a small car would be the most practical new venture. So in 1998 it launched Tata Indica, India's first fully indigenous passenger car. Designed to be inexpensive and simple to build and maintain, the Indica became a hit in the Indian market. It was also exported to Europe, especially the UK and Italy. In 2004 it acquired Tata Daewoo Commercial Vehicle, and in late 2005 it acquired 21% of Aragonese Hispano Carrocera giving it controlling rights of the company. It has formed a joint venture with Marcopolo of Brazil, and introduced lowfloor buses in the Indian Market. Recently, it has acquired British Jaguar Land Rover (JLR), which includes the Daimler and Lanchester brand names. Expansion: The SECOND generation Tata Indica's excellent fuel economy, powerful engine and aggressive marketing strategy made it one of the best selling cars in the history of the Indian automobile industry. After years of dominating the commercial vehicle market in India, Tata Motors entered the passenger vehicle market in 1991 by launching the Tata Sierra, a multi utility vehicle.

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After the launch of three more vehicles, Tata Estate (1992, a stationwagon design based on the earlier 'TataMobile' (1989), a light commercial vehicle), Tata Sumo (LCV, 1994) and Tata Safari (1998, India's first sports utility vehicle). Tata launched the Indica in 1998, the first fully indigenous passenger car of India. Though the car was initially panned by auto-analysts, the car's excellent fuel economy, powerful engine and aggressive marketing strategy made it one of the best selling cars in the history of the Indian automobile industry. A newer version of the car, named Indica V2, was a major improvement over the previous version and quickly became a mass-favourite. Tata Motors also successfully exported large quantities of the car to South Africa.The success of Indica in many ways marked the rise of Tata Motors. Vehicle: Tata Daewoo Comercial Vehicle: With the success of Tata Indica, Tata Motors aimed to increase its presence worldwide. In 2004, it acquired the Daewoo Commercial Vehicle Company of South Korea. The reasons behind the acquisition were:

Company's global plans to reduce domestic exposure. The domestic commercial vehicle market is highly cyclical in nature and prone to fluctuations in the domestic economy. Tata Motors has a high domestic exposure of ~94% in the MHCV segment and ~84% in the light commercial vehicle (LCV) segment. Since the domestic commercial vehicle sales of the company are at the mercy of the structural economic factors, it is increasingly looking at the international markets. The company plans to diversify into various markets across the world in both MHCV as well as LCV segments.

To expand the product portfolio Tata Motors recently introduced the 25MT GVW Tata Novus from Daewoos (South Korea) (TDCV) platform. Tata plans to leverage on the strong presence of TDCV in the heavy-tonnage range and introduce products in India at an appropriate time. This was mainly to cater to the international market and also to cater to the domestic market where a major

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improvement in the Road infrastructure was done through the National Highway Development Project.

Hispano Carrocera: In 2005, sensing an opportunity in the fully-built bus segment, Tata Motors acquired a 21% controlling stake in Hispano Carrocera SA, the leading European bus and coach cabin maker. In 2009, the company picked up the remaining 79% stake in Hispano Carrocera SA for an undisclosed sum, making it a fully-owned subsidiary. Jaguar Cars and Land Rover: After the acquisition of the British Jaguar Land Rover (JLR) business, which also includes the Daimler, Lanchester and Rover brands, Tata Motors became a major player in the international automobile market. On 27 March 2008, Tata Motors reached an agreement with Ford to purchase their Jaguar Land Rover operations for US$2 billion. The sale was completed on 2 June 2008. In addition to the brands, Tata Motors has also gained access to two design centres and two plants in UK. The key acquisition would be of the intellectual property rights related to the technologies.

Joint ventures: Tata Motors has formed a 51:49 joint venture in bus body building with Marco polo of Brazil. This joint venture is to manufacture and assemble fully-built buses and coaches targeted at developing mass rapid transportation systems. The joint venture will absorb technology and expertise in chassis and aggregates from Tata Motors, and Marcopolo will provide know-how in processes and systems for bodybuilding and bus body design. Tata and Marcopolo have launched a low-floor city bus which is widely used by Delhi, 19

Mumbai,Lucknow and Banglore transport corporations. Tata Motors also formed a joint venture with Fiat and gained access to Fiats diesel engine technology. Tata Motors sells Fiat cars in India and is looking to extend its relationship with Fiat and Iveco to other segments. Tata has also formed several JV's with many small companies in various countries around the world. Important developments: Tata Nano: In January 2008, Tata Motors launched Tata Nano, the least expensive production car in the world at about Rs. 1,00,000 (US $2,500). The city car was unveiled during the Auto Expo 2008 exhibition in Pragati Maidan, New Delhi. Tata has faced controversy over developing the Nano as some environmentalists are concerned that the launch of such a low-priced car could lead to mass motorization in India with adverse effects on pollution and global warming. Tata has set up a factory in Sanand, Gujarat and the first Nanos are to roll out summer 2009. Tata Nano Europa has been developed for sale in developed economies and is to hit markets in 2010 while the normal Nano should hit markets in South Africa, Kenya and countries in Asia and Africa by late 2009. A battery version is also planned. Tata has also been approached by a province in France named Moselle to setup Tata Nano manufacturing plant. Now, TATA Motors have launched in auto expo the latest TATA NANO VERSION 2012.

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Tata Ace: Tata Ace, India's first indigenously developed sub-one ton mini truck was launched in May 2005. The mini-truck was a huge success in India with auto-analysts claiming that Ace had changed the dynamics of the light commercial vehicle (LCV) market in the country by creating a new market segment termed the small commercial vehicle (SCV) segment. Ace rapidly emerged as the first choice for transporters and single truck owners for city and rural transport. By October 2005, LCV sales of Tata Motors had grown by 36.6 percent to 28,537 units due to the rising demand for Ace. The Ace was built with a load body produced by Autoline Industries. By 20011, Autoline was producing 600 load bodies per day for Tata Motors. Ace is still one of the number maker for TML, TML sold the 2,000,000th Ace in August 2008, within 4 years since its introduction. Tata Ace has also been exported to several European, South American and African countries. Electric-versions of Tata Ace are sold through Chrysler's Global Electric Motorcars division.

Compressed air car: Motor Development International of France has developed the world's first prototype of a compressed air car, named OneCAT. In 2007, MDI owner Guy Negre was reported to have "the backing of Tata". It has airtanks that can be filled in 4 hours by plugging the car into a standard electrical plug. In 2008 MDI planned to also design a gas station compressor, which would fill the tanks in 3 minutes. There are no gasoline costs 21

and no fossil fuel emissions from the vehicle when run in town, but "the compressed air driving the pistons can be boosted by a fuel burner". OneCAT is a five seat vehicle with a 200-litre (7.1 cu ft) trunk. With full tanks it is said to run at 100 km/h (62 mph) for 90 kilometres (56 mi) range in urban cycle. There are severe physical arguments pleading against those figures. In December 2009 Tata's vice president of engineering systems confirmed that the limited range and low engine temperatures were causing difficulties. Electric vehicles: Tata Motors unveiled the electric versions of passenger car Tata Indica and commercial vehicle Tata Ace. Both run on lithium batteries. The company has indicated that the electric Indica would be launched locally in India in about 2010, without disclosing the price. The vehicle would be launched in Norway in 2009. Tata Motors' UK subsidiary, Tata Motors European Technical Centre, has bought a 50.3% holding in electric vehicle technology firm Miljbil Grenland / Innovasjon of Norway for US$1.93 M, which specializes in the development of innovative solutions for electric vehicles, and plans to launch the electric Indica hatchback in Europe next year. Operations: Tata in India: Tata Motors Limited is Indias largest automobile company, with revenues of Rs 35,651.48 crore (US$ 7.59 billion) in 2007-08. It is the leader in commercial vehicles in each segment, and among the top three in passenger vehicles with winning products in the compact, midsize car and utility vehicle segments. Tata Motors presence indeed cuts across the length and breadth of India. Over 4 million Tata vehicles ply on Indian roads, since the first rolled out in 1954. The companys manufacturing base in India is spread across Jamshedpur (Jharkhand),

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Pune (Maharashtra), Lucknow (Uttar Pradesh), Pantnagar (Uttarakhand) and Dharwad (Karnataka). Following a strategic alliance with Fiat in 2005, it has set up an industrial joint venture with Fiat Group Automobiles at Ranjangaon (Maharashtra) to produce both Fiat and Tata cars and Fiat powertrains. The company is establishing a new plant at Sanand (Gujarat). The companys dealership, sales, services and spare parts network comprises over 3500 touch points; Tata Motors also distributes and markets Fiat branded cars in India. Tatas Global Operations: Tata Motors has been aggressively acquiring foreign brands to increase its global presence. Tata Motors has operations in the UK, South Korea, Thailand and Spain. Among them is Jaguar Land Rover, a business comprising the two iconic British brands that was acquired in 2008. Tata Motors has also acquired from Ford the rights of Rover. In 2004, it acquired the Daewoo Commercial Vehicles Company, South Koreas second largest truck maker. The rechristened Tata Daewoo Commercial Vehicles Company has launched several new products in the Korean market, while also exporting these products to several international markets. Today two-thirds of heavy commercial vehicle exports out of South Korea are from Tata Daewoo. In 2005, Tata Motors acquired a 21% stake in Hispano Carrocera, a reputed Spanish bus and coach manufacturer, giving it controlling rights of the company. Hispanos presence is being expanded in other markets. On Tata's journey to make an international foot print, it continued its expansion through the introduction of new products into the market range of buses (Starbus & Globus) as well as trucks (Novus). These models were jointly developed with its subsidiaries Tata Daewoo and Hispano Carrocera. In May, 2009 Tata unveiled the Tata World Truck range jointly developed with Tata Daewoo They will debut in South Korea, South Africa, the SAARC countries and the Middle-East by the end of 2009 In 2006, it formed a joint venture with the Brazilbased Marcopolo, a global leader in bodybuilding for buses and coaches to manufacture fully-built buses and coaches for India and select international markets. Tata Motors has 23

expanded its production and assembly operations to several other countries including South Korea, Thailand, South Africa and Argentina and is planning to set up plants in Turkey, Indonesia and Eastern Europe. Tata also franchisee/joint venture assembly operations in Kenya, Bangladesh, Ukraine, Russia and Senegal. Tata has dealerships in 26 countries across 4 continents. Though Tata is present in many counties it has only managed to create a large consumer base in the Indian Subcontinent namely India, Bangladesh, Bhutan, Sri Lanka and Nepal and has a growing consumer base in Italy, Spain and South Africa Key Ratios about Tata Motors:

Key data:

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Shareholding Pattern:

Investment Highlights: Results Updates (Q3 FY11): The bottom-line of the company for the quarter stood at Rs.4001.40mn from Rs. (2632.60)mn of same period of last year. Total revenue for the third quarter stood at Rs.89799.00 mn from Rs.47586.20 which is 88.7% increased than that of a year ago period. EPS for the quarter stood at Rs.7.36 per equity share of Rs.10.00 each. Face value has been changed for this quarter. Expenditure of the company increased 60% YoY to Rs.78748.20mn from Rs.49072.10mn of same period of last year. Interest expenses for the quarter stood at Rs.2861.40mn. OPM & NPM for the quarter stood at 12% and 4% respectively.

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Quarterly Results-Standalone(Rs in mn) As at Net Sales Net Profit Basic EPS Equity Capital Dec(2010) 89799 4001.4 7.36 5439.6 Dec(2009) 47586.2 -2632.6 -5.12 5140.5 % Change 88.7

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Introduction of new products and strong continued growth in the existing portfolio, along with government stimulus, a benign liquidity environment and overall economic recovery, has driven domestic demand revival during the current year. The sales volume for the quarter (including exports) stood at 165,413 vehicles. This is a growth of 67.5% over sales of 98,760 vehicles in Q3 2009-10, which witnessed steep decline in volumes impacted by the financial crisis. In the domestic market, Commercial Vehicles sales increased by 88.8% to 93,520 units leading to a market share of 64.3%. With a growth of 121.6% in Q3 2010-11 over sales in Q3 2009-10, the Medium and Heavy Commercial Vehicle segment witnessed a year on- year growth for the second quarter in a row in the current fiscal year. Light Commercial Vehicles, led by the continued strong performance of the Ace and its variants and on the low base of previous year, witnessed significant growth of 70.5% over Q3 2009-10. While investment in infrastructure projects, continuing stimulus support and smooth implementation of the change in emission norms would influence the magnitude of growth in the coming quarters, the company has planned several new product launches to defend and improve its market position. Passenger Vehicles, including Fiat and Jaguar and Land Rover vehicles distributed in

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India, grew by 46% in the domestic market to 61,593 units. The market share for Tata passenger vehicles for the period stood at 11.8%. The company launched the new Indigo Manza during the quarter which saw the Indigo range sales grow by 63.5% over Q3 2009-10, substantially higher than the 35% growth of the Entry Mid-size Sedan market. The company has also ramped up the production rate of the Nano at the plant in Uttarakhand, and has till December 31, 2010 delivered 17,537 units of Nano. Along with Fiat, the company has a joint market share of 13.1% in the industry. Tata Motors January sales at 65,478 nos.: Tata Motors total sales (including exports) of Tata commercial and passenger vehicles in January 2011 were 65,478 vehicles, a growth of 77% over 36,931 vehicles sold in January 2010. The companys domestic sales of Tata commercial and passenger vehicles for January 2011 were 62,202 nos., a 74 % growth over 35,704 nos. sold in January last year. Cumulative sales (including exports) for the company for the fiscal at 498,108 nos., recorded a growth of 24 % over 400,284 nos. sold last year. o Commercial Vehicles: The Companys sales of commercial vehicles in January 2011 in the domestic market were 35,957 nos., the second highest ever and a 107% growth compared to 17,373 vehicles sold in January last year. LCV sales were 20,255 nos., the highest ever and a growth of 75% over January last year. M&HCV sales stood at 15,702 nos., a growth of 170% over January last year. Cumulative sales of commercial vehicles in the domestic market for the fiscal are 291,125 nos., a growth of 37% over last year. Cumulative LCV sales are 174,276 nos., a growth of 45% over last year, while M&HCV sales stood at 116,849 nos., a growth of 26% over last year. o Passenger Vehicles: The passenger vehicles business reported a total sale and distribution off take of 28,547 nos. (26,245 Tata + 2,302 Fiat) in the domestic market in January 2010, the highest ever and a 43% increase compared to 19,911 nos. (18,331 Tata + 1,580 Fiat) in January last year. Sales of Tata cars, at 22,707 nos. are the highest ever and a growth of 47% over January 2009. Sales of the Tata Nano were 4,001 nos. The Indica

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range sales were 11,448 nos., the highest this fiscal though flat over January last year. The Indigo range recorded sales of 7,258 nos., the highest ever since the Indigos launch in 2002 and a growth of 83% over January last year. The Sumo/Safari range accounted for sales of 3,538 nos., the highest this fiscal and a growth of 21% over January last year. Jaguar Land Rover sales continued their upward trend since launch in June with their highest sales in January. Cumulative sales and distribution off take of passenger vehicles in the domestic market for the fiscal are 200,573 nos. (180,184 Tata + 20,389 Fiat), against 162,425 nos. (157,439 Tata + 4,986 Fiat) last year, a growth of 23%. Cumulative sales of the Nano are 21,535 nos. Cumulative sales of the Indica range at 91,295 nos., reported a growth of 6%. Cumulative sales of the Indigo family are 41,724 nos., higher by 3%, coming into the positive territory for the first time this fiscal based on the growing acceptance of the newly launched Indigo Manza. Cumulative sales of the Sumo/Safari range are 25,630 nos., lower by 17%. Tata Nano wins the Indian Car of the Year (ICOTY) Award: The Tata Nano has won the prestigious Indian Car of the Year (ICOTY) award. In its fifth year running and modeled along the lines of the American, European and Japanese Car of the Year, the ICOTY award and Indian Motorcycle of the Year (IMOTY) award have been instituted by leading automotive magazines in India, in association with JK Tyre, to bring the auto industry in India at par internationally in recognizing their efforts. Tata Motors launches the Sumo Grande MK II: Tata Motors announced the launch of Grande MK II, an upgraded version of its premium Sumo offering in the domestic market. The Grande MK II seeks to deliver added value to customers through substantial changes in the exteriors and interiors combined with improvements in drivability, ride and handling and comfort. The exteriors have been accentuated by a new chrome lined grill, side 29

rub rails with chrome inserts and indicators on ORVMs. The interiors have been refreshed to give the vehicle a completely new, contemporary look with a two tone theme complemented by a new faux wood centre console and new fabric upholstery. Future Product launches showcased at Auto-Expo: PRIMA 1125 PRIMA 3128 PRIMA 3138 PRIMA 4038 PRIMA 4938 PRIMA 7548 MAGIC IRIS LPT 1613 CNG STARBUS HYBRID XENON CNG TATA ARIA INDICA VISTA EV TATA VENTURE INDICA SPORTS (concept) TATA PR1MA (concept) SUMO GRANDE MK-II TATA SAFARI(2012)

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Peer Group Comparison:

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Structure

Target shareholders capital

Cash Share exchange

Cash in exchange for their shares A specified number of the bidders shares for each target share.

Cash

underwritten

share Bidders shares, then self them to a merchant bank for cash A loan stock debenture in exchange for their shares.

offer (vendor placing). Loan stock Convertible preferred shares loan

or Loan stock or preferred shares convertible into ordinary shares at a predetermined conversion rate over a specified period.

Deferred payment

Part of consideration after a specified period, subject to performance criteria.

A companys financial strategy has many strands. Maintaining, reasonable gearing ratio is one of them. Ensuring adequacy of lines of credit from banks is another. Taking advantage of any tax provisions to reduce the cost of capital is also relevant. Finally, timing of security issues to exploit favorable market conditions is an important consideration. The exchange ratio, ER determines how the overall added value at any PER will be shared between B and T shareholders. When the bidder expects no synergy, it cannot afford a higher ER than a simple ratio of the targets to the bidders share price, in order to prevent loss of value from the acquisition. This means that no bid premium is paid to the target. The bidder can justify a bid premium only if the acquisition produces some

32

synergy, and if this synergy is credibly translated into a higher PER than the average of the pre bid PERs.

Financing a cash offer Internal operating cash flow A pre-bid rights issue A cash underwritten offer, e.g. vendor placing or vendor rights A pre-bid loan stock issue. Bank credit.

Use of a pre-bid loan stock issue or bank credit gives rise to a leveraged bid or leverage buyout (LBO). The bidders internal operating cash flow is perhaps the cheapest and easiest source, since it avoids both the transaction cost of raising finance and the delay in doing so. However, except for relatively small acquisition targets, a bidder is unlikely to have enough internal cash flow. A conventional rights issue is often made by firms with a well defined acquisition program. The cash underwritten offer is somewhat similar to a rights issue , but it may be more flexible in that the underwriting fails, the bidder is not left with a surplus of cash.

Leveraged cash financing One of the most important considerations in this form of financing is the ability of the bidder to service the debt obligations. That is, periodic interest payments and capital repayment. The bidder may relay on two alternative source of cash flows for this purpose. Operating cash flows. Cash proceeds from sales of the targets assets.

A careful forecast of the future operating cash flows from the target under the bidders management must be made to assess the debt -servicing capacity.

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The high gearing that results from this method of financing may be of concern to the bidder. There have been numerous cases of highly leveraged acquisitions causing the decline and downfall of acquirers. One attraction of leverage is that the related interest payment is tax deductible, thus enhancing future EPS. This compares well with a share offer or a cash offer financed by a rights issue. Financing with loan stock This differs from the leveraged cash offer in that the loan stock is the consideration for the bid and is offered to the target shareholders. They swap their shares in the target for the loan stocks of the bidder. as noted earlier, such a loan stock may be construed as a qualifying corporate bond, with a certain tax disadvantage compared to a share offer. To the target shareholders, a loan stock minimizes the problem of information asymmetry, since as in a cash offer, they are assured of a definitive sum on redemption of the stock. for some target shareholders, accepting loan stock may mean an unwanted shift of their portfolio weighting against equity. Further, acceptance of loan stock means loss of control over their company. Financing with Convertibles Use of convertibles in acquisition financing is less common than that of straight loan stock. Convertibles may be preferred stock (CPS) or loan stock (CLS). They represent a bundle of two underlying security the straight preferred or loan stock, and an option on the shares f the company. Target shareholders can, therefore, roll over their capital gains and avoid immediate CGT. Deferred consideration financing Both bidders and target shareholders face valuation risk in negotiating a price and the payment currency in a takeover. One way of mitigating this risk is to make the consideration payable to the vendors contingent upon the future performance of the target under their own management. In such companies, In an earn out, consideration to the vendor is made up of the following: An immediate payment in cash or shares of the acquirer

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A deferred payment contingent upon the target turned subsidiary achieving certain predetermined performance levels .

Earn-outs are not free of problems. The culture shock of transformation from owning and managing an independent company to running a subsidiary under the control of a larger firm may be quite traumatic. For the buyer, an earn out is a way of retaining the vendors talents. However, the vendor may lack motivation or tray to maximize short term profits to the detriment of the long-term interests of the buyer.

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3. RESEARCH METHODOLOGY
I will use quantitative research approach in this study as it requires more of the quantitative discussions. Data Collection:-I will use both primary as well as secondary sources to collect the data as follows, Primary Research:-Direct contact to officials employed in Tata Motors and other companies in Automobile and conducts the interviews through primary research tool (Questionnaire). Secondary Research: - Journals of finance, literature, news articles, books etc.

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4. LITERATURE REVIEW
Evaluating a Company's Capital Structure: For stock investors that favor companies with good fundamentals, a "strong" balance sheet is an important consideration for investing in a company's stock. The strength of a company' balance sheet can be evaluated by three broad categories of investment-quality measurements: working capital adequacy, asset performance and capital structure. In this article, we'll look at evaluating balance sheet strength based on the composition of a company's capital structure. A company's capitalization (not to be confused with market capitalization) describes the composition of a company's permanent or long-term capital, which consists of a combination of debt and equity. A healthy proportion of equity capital, as opposed to debt capital, in a company's capital structure is an indication of financial fitness. Clarifying Capital Structure Related Terminology: The equity part of the debt-equity relationship is the easiest to define. In a company's capital structure, equity consists of a company's common and preferred stock plus retained earnings, which are summed up in the shareholders' equity account on a balance sheet. This invested capital and debt, generally of the long-term variety, comprises a company's capitalization, i.e. a permanent type of funding to support a company's growth and related assets. A discussion of debt is less straightforward. Investment literature often equates a company's debt with its liabilities. Investors should understand that there is a difference between operational and debt liabilities - it is the latter that forms the debt component of a company's capitalization - but that's not the end of the debt story. Among financial analysts and investment research services, there is no universal agreement as to what constitutes a debt liability. For many analysts, the debt component in a company's capitalization is simply a balance sheet's long-term debt. This definition is too simplistic. Investors should stick to a stricter interpretation of debt where the debt 37

component of a company's capitalization should consist of the following: short-term borrowings (notes payable), the current portion of long-term debt, long-term debt, twothirds (rule of thumb) of the principal amount of operating leases and redeemable preferred stock. Using a comprehensive total debt figure is a prudent analytical tool for stock investors. Is there an optimal debt-equity relationship? In financial terms, debt is a good example of the proverbial two-edged sword. Astute use of leverage (debt) increases the amount of financial resources available to a company for growth and expansion. The assumption is that management can earn more on borrowed funds than it pays in interest expense and fees on these funds. However, as successful as this formula may seem, it does require that a company maintain a solid record of complying with its various borrowing commitments. A company considered too highly leveraged (too much debt versus equity) may find its freedom of action restricted by its creditors and/or may have its profitability hurt as a result of paying high interest costs. Of course, the worst-case scenario would be having trouble meeting operating and debt liabilities during periods of adverse economic conditions. Lastly, a company in a highly competitive business, if hobbled by high debt, may find its competitors taking advantage of its problems to grab more market share. Unfortunately, there is no magic proportion of debt that a company can take on. The debt-equity relationship varies according to industries involved, a company's line of business and its stage of development. However, because investors are better off putting their money into companies with strong balance sheets, common sense tells us that these companies should have, generally speaking, lower debt and higher equity levels. Capital Ratios and Indicators: In general, analysts use three different ratios to assess the financial strength of a company's capitalization structure. The first two, the so-called debt and debt/equity ratios, are popular measurements; however, it's the capitalization ratio that delivers the key insights to evaluating a company's capital position. The debt ratio compares total 38

liabilities to total assets. Obviously, more of the former means less equity and, therefore, indicates a more leveraged position. The problem with this measurement is that it is too broad in scope, which, as a consequence, gives equal weight to operational and debt liabilities. The same criticism can be applied to the debt/equity ratio, which compares total liabilities to total shareholders' equity. Current and non-current operational liabilities, particularly the latter, represent obligations that will be with the company forever. Also, unlike debt, there are no fixed payments of principal or interest attached to operational liabilities. The capitalization ratio (total debt/total capitalization) compares the debt component of a company's capital structure (the sum of obligations categorized as debt + total shareholders' equity) to the equity component. Expressed as a percentage, a low number is indicative of a healthy equity cushion, which is always more desirable than a high percentage of debt. Additional Evaluative Debt-Equity Considerations: Companies in an aggressive acquisition mode can rack up a large amount of purchased goodwill in their balance sheets. Investors need to be alert to the impact of intangibles on the equity component of a company's capitalization. A material amount of intangible assets need to be considered carefully for its potential negative effect as a deduction (or impairment) of equity, which, as a consequence, will adversely affect the capitalization ratio. Funded debt is the technical term applied to the portion of a company's long-term debt that is made up of bonds and other similar long-term, fixed-maturity types of borrowings. No matter how problematic a company's financial condition may be, the holders of these obligations cannot demand payment as long the company pays the interest on its funded debt. In contrast, bank debt is usually subject to acceleration clauses and/or covenants that allow the lender to call its loan. From the investor's perspective, the greater the percentage of funded debt to total debt disclosed in the debt note in the notes to financial statements, the better. Funded debt gives a company more wiggle room.

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Lastly, credit ratings are formal risk evaluations by credit-rating agencies - Moody's, Standard & Poor's, Duff & Phelps and Fitch of a company's ability to repay principal and interest on debt obligations, principally bonds and commercial paper. Here again, this information should appear in the footnotes. Obviously, investors should be glad to see high-quality rankings on the debt of companies they are considering as investment opportunities and be wary of the reverse.

Seeking the Optimal Capital Structure: Many middle class individuals believe that the goal in life is to be debt-free. When you reach the upper echelons of finance, however, that idea is almost anathema. Many of the most successful companies in the world base their capital structure on one simple consideration: the cost of capital. If you can borrow money at 7% for 30 years in a world of 3% inflation and reinvest it in core operations at 15%, you would be wise to consider at least 40% to 50% in debt capital in your overall capital structure. Of course, how much debt you take on comes down to how secure the revenues your business generates are - if you sell an indispensable product that people simply must have, the debt will be much lower risk than if you operate a theme park in a tourist town at the height of a boom market. Again, this is where managerial talent, experience, and wisdom come into play. The great managers have a knack for consistently lowering their weighted average cost of capital by increasing productivity, seeking out higher return products, and more. To truly understand the idea of capital structure, you need to take a few moments to read Return on Equity: The DuPont Model to understand how the capital structure represents one of the three components in determining the rate of return a company will earn on the money its owners have invested in it. Whether you own a doughnut shop or are considering investing in publicly traded stocks, it's knowledge you simply must have.

Examining the results above we can see that there seems to have been a change in the debt pattern amongst the auto companies. Just as Lev and many others presented in the there is a change taking place in the way that we see and evaluate the corporate world and its value drivers. Maybe the search for security has made the banks and the market

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extending the wrong companies credit; if there is a correlation between the value of the underlying assets and the loan capacity of a corporation then companies who cannot securitize their assets will be worse off in a recession. The auto company has up until now been assessed as once whole entity which gives it a lower leverage compared to the traditional company; but this would also make it better positioned and less volatile in recession. Unfortunately the lack of further data to conclude the regression analysis and finalize this study the data just shows us that we can identify but not explain a change. This article did not have the aim to further increase or change the amount of information provided to the creditors; what we can see is that suddenly corporations without any real assets have a proportionally large amount of debt in their capital structure. The reason for this is almost without a doubt that their market value on equity has deteriorated; but what is interesting is that the trend related to the traditional companies has changed. This can indicate that the loans given to the conceptual companies prior to the deterioration of the market value of equity were proportionally larger than in the past. Further tells us that the there has been a market driven change in how we assess corporate without any substantial securities; if this change was driven by increased liquidity or a fundamental assessment change in the market is for future research to tell. To conclude; there been a change in capital structure where the proportion of debt and in long term debt over the last ten years has increased amongst conceptual companies; it is though far away from being in the same proportions as for the auto companies. Growth opportunities: For companies with growth opportunities, the use of debt is limited as in the case of bankruptcy, the value of growth opportunities will be close to zero. This show that firms should use equity to finance their growth because such financing reduces agency costs between shareholders and managers, whereas firms with less growth prospects should use debt because it has a disciplinary role. This shows that firms with growth opportunities may invest sub-optimally, and therefore creditors will be more reluctant to lend for long horizons. This problem can be solved by short-term financing or by convertible bonds. From a pecking order theory perspective, growth firms with strong financing needs will issue securities less subject to informational asymmetries, i.e. short-term debt. If these

41

firms have very close relationships with banks, there will be less informational asymmetry problems, and they will be able to have access to long term debt financing as well. A common proxy for growth opportunities is the market value to book value of total assets. IT companies with growth opportunities should exhibit a greater market-to-book than firms with less growth opportunities, but it is suggest that this is not necessarily the case. This will typically occur when assets whose values have increased over time have been fully depreciated, as well as when assets with high value are not accounted for in the balance sheet. They find a negative relationship between growth opportunities and leverage. They suggest that this may be due to firms issuing equity when stock prices are high. As mentioned by them, large stock price increases are usually associated with improved growth opportunities, leading to a lower debt ratio.

Size: Auto companies tend to be more diversified, and hence their cash flows are less volatile. Size may then be inversely related to the probability of bankruptcy. They suggest that large firms have easier access to the markets and can borrow at better conditions. For small firms, the conflicts between creditors and shareholders are more severe because the managers of such firms tend to be large shareholders and are better able to switch from one investment project to another. However, this problem may be mitigated with the use of short term debt, convertible bonds, as well as long term bank financing. Most empirical studies report indeed a positive sign for the relationship between size and leverage. Less conclusive results are reported by other authors. For India, however, they find that a negative relationship exists. They confirm the finding of them for company and argue that the negative relationship is not due to asymmetrical information, but rather to the characteristics of the bankruptcy law and the system which offer better protection to creditors than is the case in other countries. Profitability:

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One of the main theoretical controversies concerns the relationship between leverage and profitability of the firm. According to the pecking order theory, firms prefer using internal sources of financing first, then debt and finally external equity obtained by stock issues. All things being equal, the more profitable the firms are, the more internal financing they will have, and therefore we should expect a negative relationship between leverage and profitability. This relationship is one of the most systematic findings in the empirical literature In a trade-off theory framework, an opposite conclusion is expected. When firms are profitable, they should prefer debt to benefit from the tax shield. In addition, if past profitability is a good proxy for future profitability, profitable firms can borrow more as the likelihood of paying back the loans is greater. Dynamic theoretical models based on the existence of a target debt-to-equity ratio show (1) that there are adjustment costs to raise the debt-to-equity ratio towards the target and (2) that debt can easily be reimbursed with excess cash provided by internal sources. This leads firms to have a pecking order behavior in the short term, despite the fact that they aim at increasing their debt-to-equity ratio. Collaterals: Tangible assets are likely to have an impact on the borrowing decisions of a firm because they are less subject to informational asymmetries and usually they have a greater value than intangible assets in case of bankruptcy. Additionally, the moral hazard risks are reduced when the firm offers tangible assets as collateral, because this constitutes a positive signal to the creditors who can request the selling of these assets in the case of default. As such, tangible assets constitute good collateral for loans. According to them, a firm can increase the value of equity by issuing collateralized debt when the current creditors do not have such guarantee. Hence, firms have an incentive to do so, and one would expect a positive relation between the importance of tangible assets and the degree of leverage. Based on the agency problems between managers and shareholders, they suggest that firms with more tangible assets should take more debt. This is due to the behavior of managers who refuse to liquidate the firm even when the liquidation value is higher than the value of the firm as a going concern. Indeed, by increasing the leverage, the probability of default will increase which is to the benefit of the shareholders. In an

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agency theory framework, debt can have another disciplinary role: by increasing the debt level, the free cash flow will decrease. As opposed to the former, this disciplinary role of debt should mainly occur in firms with few tangible assets, because in such a case it is very difficult to monitor the excessive expenses of managers. From a pecking order theory perspective, firms with few tangible assets are more sensitive to informational asymmetries. These firms will thus issue debt rather than equity when they need external financing, leading to an expected negative relation between the importance of intangible assets and leverage. Most empirical studies conclude to a positive relation between collaterals and the level of debt. Inconclusive results are reported for instance by them.

Operating Risk: Many authors have included a measure of risk as an explanatory variable of the debt level. Leverage increases the volatility of the net profit. Firms that have high operating risk can lower the volatility of the net profit by reducing the level of debt. By so doing, bankruptcy risk will decrease, and the probability of fully benefiting from the tax shield will increase. A negative relation between operating risk and leverage is also expected from a pecking order theory perspective: firms with high volatility of results try to accumulate cash during good years, to avoid under investment issues in the future. Taxes: The impact of taxation on leverage is twofold. On the one hand, companies have an incentive to take debt because they can benefit from the tax shield. On the other hand, since revenues from debt are taxed more heavily than revenues from equity, firms also have an incentive to use equity rather than debt. As suggested by them, the financial structure decisions are irrelevant given that bankruptcy costs can be neglected in equilibrium. They show that if non-debt tax shields exist, then firms are likely not to use fully debt tax shields. In other words, firms with large non-debt tax shields have a lower incentive to use debt from a tax shield point of view, and thus may use less debt. 44

Empirically, this substitution effect is difficult to measure as finding an accurate proxy for the tax reduction that excludes the effect of economic depreciation and expenses is tedious. According to them, the tax shield accounts on average to 4.3% of the firm value when both corporate and personal taxes are considered.

A capital structure is the mix of a company's financing which is used to fund its day-today operations. This source of funds can originate from equity, debt and hybrid securities. The equity will come in the form of common and preferred stocks. The debt is broken out into long-term and short-term debts. Lastly hybrid securities are a group of securities that are a combination of debt and equity. When analyzing a company it is important to note their mix of debt and equity, because it gives a firm picture of the financial health of the company. If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of these imperfections, by relaxing assumptions made in the M&M model. Trade-off theory: Trade-off theory allows the bankruptcy cost to exist. It states that there is an advantage to financing with debt (namely, the tax benefit of debts) and that there is a cost of financing with debt (the bankruptcy costs of debt). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. Empirically, this theory may explain differences in D/E ratios between industries, but it doesn't explain differences within the same industry. Pecking order theory: Pecking Order theory tries to capture the costs of asymmetric information. It states that companies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means of last resort. Hence: internal financing is used first; when that is

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depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required (equity would mean issuing shares which meant 'bringing external ownership' into the company. Thus, the form of debt a firm chooses can act as a signal of its need for external finance. The pecking order theory is popularized by Myers (1984) when he argues that equity is a less preferred means to raise capital because when managers (who are assumed to know better about true condition of the firm than investors) issue new equity, investors believe that managers think that the firm is overvalued and managers are taking advantage of this over-valuation. As a result, investors will place a lower value to the new equity issuance. Agency Costs: There are three types of agency costs which can help explain the relevance of capital structure.

Asset substitution effect: As D/E increases, management has an increased incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders.

Underinvestment problem: If debt is risky (e.g., in a growth company), the gain from the project will accrue to debt holders rather than shareholders. Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value.

Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management.

Other:

The neutral mutation hypothesisfirms fall into various habits of financing, which do not impact on value.

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Market timing hypothesiscapital structure is the outcome of the historical cumulative timing of the market by managers. Accelerated investment effecteven in absence of agency costs, levered firms use to invest faster because of the existence of default risk.

Following Modigliani and Miller's pioneering work on capital structure, we are left with the question, "Is there such a thing as an optimal capital structure for a company? In other words, is there a best way to finance the company: an optimal debt/equity ratio?" According to the trade-off theory, the answer is yes - in fact, you might even say that there is an optimal range. There is a specific debt/equity ratio that will minimize a company's cost of capital. (This is also the point at which the value of the company will be maximized.) However, because the cost of capital curve is fairly shallow (like the bottom of a bowl), you can deviate from this optimal debt/equity ratio without appreciably increasing the cost of capital This creates a range in the bottom portion of the curve where the cost of capital is essentially the same throughout the range. There is a danger of getting outside of this range however. The cost of capital will increase rapidly once you get outside the range, as shown by the blue Average Cost of Capital line in the graph below. The Trade-off View of the Cost of Capital

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A company's overall cost of capital is a weighted average of the cost of debt and the cost of equity. For example, if a company's debt/equity ratio is 30/70 and the after-tax cost of debt is 4% and the cost of equity is 10.5%, the company's overall cost of capital is 0.30 * 4% plus 0.70 * 10.5%, or 8.55%. Let's take a company from its inception: 1. When a company is new, it will likely be financed entirely with equity, so its average cost of capital is the same as its cost of equity (10% in the graph above for a 0/100 debt/equity ratio). 2. As the company grows, it establishes a track record and attracts the confidence of lenders. As the company increases its use of debt, the company's debt/equity ratio increases and the average cost of capital decreases. In essence, the company is substituting the cheaper debt for the more expensive equity, thereby decreasing its overall cost. (It might be useful to think of the company borrowing money, then using that borrowed money to buy back some of its common stock. The debt goes 48

up, the equity goes down, and the company's average cost of capital decreases because the company has substituted the cheaper debt for the more expensive equity.) 3. Eventually, as the company's debt/equity ratio increases, the cost of debt and the cost of equity will increase. Lenders will become more concerned about the risk of the loan and will increase the interest rate on its loans. Common shareholders will become more concerned about default on the loans (and, in bankruptcy, losing all of their investment) and will insist on receiving a higher rate of return to compensate them for the higher risk. Since both the cost of debt and equity increases, the average cost of capital will also increase. 4. This results in a minimum point on the cost of capital curve. However, the curve (for most industries) is relatively shallow. This means that the financial manager has considerable flexibility in choosing a debt/equity ratio. He or she wants to move to the shallow portion of the curve and, once there, remain there. However, there is a range of debt/equity ratios that will allow the company to stay in this shallow portion of the curve. Just remember that there is a danger in getting outside of this range.

If you move too far to the left-hand side of the curve, you are paying too much to raise money - you would be better off borrowing money (at a relatively low aftertax interest rate) and buying back some of the more expensive equity. (The cost of financing with debt is always considerably lower than financing with equity.)

If you move too far to the right-hand side of the curve, you are paying too much to raise money - lenders and stockholders perceive your company as being too risky. You should either pay down the debt or issue new equity in the next round of financing in order to reduce the risk and to move back into the shallow portion of the curve.

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Pecking Order Theory: There is a competing theory to the trade-off view. It is based more on observations of how managers take short-cuts rather than a repudiation of the trade-off view. The pecking order theory says that companies tend to finance investments with internal funds when possible and also issue debt whenever possible. Since internal funds (profits that are retained in the company) are a form of equity and have a very high cost, managers are obviously not always following the recommendations of the trade-off view. The pecking order theory says that companies finance investments by raising funds in this order: (1) internal funds (retained earnings), (2) debt, and (3) sale of new common stock (the most expensive form of financing). Much of this may have to do with convenience - the pecking order corresponds to the easiest and most convenient ways to raise money.

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5. FINDINGS AND ANALYSIS

Moving Average for 2001/02 to 2005/06

Company Tata Motors Hyundai Maruti Udyog Toyota Hindustan Motors Skoda Mahindra & Mahindra

Return (2006-07) -0.11 0.23 -0.3 -0.16 0.14 -0.22 -0.47

Debt-Equity 1.39 0.16 0.05 0.31 0.83 0.92 0.27

Dividend Payout 0.66 0.17 0.15 0.16 0.29 0.4 0.32

Retention Ratio 0.14 0.83 0.85 0.84 0.71 0.6 0.68

Moving Average for 2003/04 to 2006/07

Company Tata Motors Hyundai Maruti Udyog Toyota Hindustan Motors Skoda Mahindra & Mahindra

Return (2007-08) 0.81 1.58 0.62 0.06 2.18 0.8 1.56

Debt-Equity 1.44 0.13 0.05 0.27 0.78 0.94 0.19

Dividend Payout 0.41 0.2 0.18 0.13 0.3 0.43 0.43

Retention Ratio 0.39 0.8 0.82 0.87 0.7 0.57 0.57

Moving Average for 2003/04 to 2007/08

Company Tata Motors Hyundai Maruti Udyog

Return (2008-09) 0.37 0.2 0.09

Debt-Equity 1.39 0.13 0.06

Dividend Payout 0.49 0.21 0.2

Retention Ratio 0.51 0.79 0.8 51

Toyota Hindustan Motors Skoda Mahindra & Mahindra

-0.24 0.11 0.32 0.09

0.22 0.73 0.94 0.15

0.12 0.24 0.41 0.49

0.88 0.76 0.59 0.51

Moving Average for 2004/05 to 2008/09

Company Tata Motors Hyundai Maruti Udyog Toyota Hindustan Motors Skoda Mahindra & Mahindra

Return (2009-10) 1.14 1.79 1.55 0.91 0.67 0.87 0.63

Debt-Equity 1.32 0.14 0.08 0.17 0.65 0.9 0.14

Dividend Payout 0.46 0.22 0.23 0.22 0.21 0.46 0.56

Retention Ratio 0.54 0.78 0.77 0.78 0.79 0.54 0.44

Moving Average for 2005/06 to 2009/10 Company Tata Motors Hyundai Maruti Udyog Toyota Hindustan Motors Skoda Mahindra & Mahindra Return (2010-11) -0.06 0.0087 -0.1 0.02 0.01 0.03 -0.22 Debt-Equity 1.12 0.12 0.11 0.12 0.6 0.79 0.14 Dividend Payout 0.36 0.22 0.25 0.24 0.22 0.44 0.59 Retention Ratio 0.64 0.78 0.75 0.76 0.78 0.56 0.41

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ANNUAL

AVERAGE

GROWTH

OF

PRODUCTION

OF

AUTOMOBILES
Sector/Period Cars Jeeps All 4 Wheelers MCVs and HCVs LCVs All CVs Total 1985-86 to 1991-92 12.63 5.57 11.10 5.39 7.33 6.03 8.56 1991-92 to 1995-96 15.17 14.40 14.84 11.32 19.33 13.93 14.31

PERFORMANCE OF AUTOMOBILE INDUSTRY

The performance of automobile firms operating under partially de-controlled and liberalised regimes has been compared in terms of price-costmargins, growth and exports. Most of the studies linking Liberalisation to performance have analysed the impact of trade Liberalisation on productivity and efficiency of firms. Evidence on the relationship between trade Liberalisation and firm-level productivity improvements vary across countries and industries [Tybout, 1992].

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Price-Cost Margins: Competition seeking to maximise profits could be a preferred objective of all firms in the short-run. During the initial period under study, which was characterised by extensive regulations and unfulfilled demand, the price-cost margins of firms would have been quite high. However, introduction of products involving technological upgradation by new firms, could lead to lower profits for older firms. As a result, during the first period, the average profits earned by all firms in this industry could be low. With Liberalisation and change in the macro environment, profit margins can be expected to have gone up. This is because most of the firms in all the segments of this industry would have already been established and new firms would not yet have garnered a large market share. Growth: Following Marris [1964], it could be argued that a shift to a higher growth and profit frontier usually takes place with a change in the economic environment in which the firms operate. During the post1985 period, firms in this industry concentrated primarily on creating capacity and obtaining a large market share. With the intense competition that has come to characterise the industry since the 1991 policy changes, firms would have attempted to shift to a higher growth-profit frontier. Exports: Growth through geographical diversification would have been a preferred strategy by firms, either due to insufficient domestic demand or to fulfill the export obligations that the Government has imposed from time to time. During the first period, increased production was basically aimed at catering to the requirements of unfulfilled demand. As a result, barring a few firms, which had been exporting their vehicles for a long time, achieving a high domestic market share was the preferred objective of most of the firms. However, with a more open economic environment and introduction of new technological sophisticated vehicles by both the Indian as well as the multinational firms, there may have been some orientation towards external markets. Further, a fall in the value of Indian rupee would have made Indian vehicles cheaper internationally and could

54

possibly have stimulated exports. The study, therefore, postulates an increased role for exports in the post Liberalisation period in contrast to the second half of eighties.

INDIAN AUTOMOBILE SECTOR - A BOOMING MARKET

De-licensing in 1991 has put the Indian automobile industry on a new growth track, attracting foreign auto giants to set up their production facilities in the country to take advantage of various benefits it offers. This took the Indian automobile production from 5.3 Million Units in 2001-02 to 10.8 Million Units in 2007-08. The other reasons attracting global auto manufacturers to India are the countrys large middle class population, growing earning power, strong technological capability and availability of trained manpower at competitive prices. In 2006-07, the Indian automotive industry provided direct employment to more than 300,000 people,1 exported auto component worth around US$ 2.87 Billion, and contributed 5% to the GDP. Due to this large contribution of the industry in the national economy, the Indian government lifted the requirement of forging joint ventures for foreign companies, which attracted global to the Indian market to establish their plants, resulting in heightened automobile production. The surge in number of people with higher purchasing power along with strong growth in economy over a past few years has attracted the major auto manufacturers. The market linked exchange rate and availability of trained manpower at competitive cost has added to the attraction of Indian market. This increasing pull of Indian market on one hand and the near stagnant rate of growth in auto sector in markets of USA, EU and Japan have worked as a push factor for shifting of new capacities and capital in the auto industry to India. The increasing competition in auto companies has not only resulted in a spurt in choices of Indian consumers at competitive costs, it has also ensured an improvement in productivity by almost 20 percent a year in auto industry, taking it to one of the highest in Indian manufacturing sector. To maintain this high rate of growth and to retain the attractiveness of Indian market and for further enhancing the competitiveness of Indian companies the Government through the Development Council on Automobile and Allied Industries constituted a Task Force
1

55

to draw a ten year Mission Plan for the Indian Automotive Industry. The idea is to draw a futuristic plan of action with full participation of the stakeholders and to implement it in mission mode to meet the challenges coming in the way of growth of industry. Besides making concerted efforts for removal of obstacles in the way of competition, the required infrastructure be put in place well in time to alleviate its constraining impact on the growth. Through this Automotive Mission Plan, government also wants to provide a level playing field to the players in the sector and to lay a predictable future direction of growth to enable the manufacturers in making a more informed investment decision.

Tata Case Analysis:

56

Considering the Companys financial performance, the Directors have recommended a dividend of Rs.20/- per share on the increased capital of 53,83,22,483 Ordinary Shares of Rs.10/- each (previous year: Rs.15/- per share) and Rs.20.50 per share on 9,63,86,471 A Ordinary Shares of Rs.10/- each (previous year: Rs.15.50 per share) fully paid-up and any further Ordinary Shares and/or A Ordinary Shares that may be allotted by the Company prior to July 21, 2011 (being the book closure date for the purpose of the said dividend entitlement) for 2010-11 and will be paid on or after August 16, 2011. The said dividend, if approved by the Members, would involve a cash out flow of Rs.1, 467.03 crores (previous year: Rs.991.94 crores) resulting in a payout of 81% (previous year: 44%) of the standalone Profits of the Company. Operating Results and Profits: After a good year 2009-10 during which economies across the world showed signs of recovery, the economic conditions globally continued to be strong and positive in 201011, resulting in a strong growth for the automotive sector. The Indian economy continued to do well, driven by a good performance from the agricultural and the industrial sector with a GDP growth of 8.6%. The automotive sector recorded a growth of over 26% in India on the back of a robust economy. Supported by its strong distinct product offerings in both the commercial vehicle and passenger vehicle ranges, the Company recorded a turnover of Rs.52,136 crores, a growth of 35.9% over the previous year. While the Company maintained a strong focus on cost control and market pricing, the increase in raw -material cost and fixed marketing expenses resulted in a lower EBITDA margin of 9.9% as compared to 11.7% in the previous year. The Profit Before Tax and Profit After Tax for 2010-11 was Rs.2,197 crores and Rs.1,812 crores respectively, as compared to Rs.2,830 crores and Rs.2,240 crores in the previous year. It may be noted that the previous year Profit included a net positive impact of Rs.958 crores, mainly on account of Profit on certain divestments

57

which was partly set off by a loss on redemption of preference shares in a subsidiary company. Jaguar Land Rover results for 2010-11 showed a signifi cant improvement with increase, both in volumes and revenue, better product mix, favourable exchange rates and higher margins. The introduction of the new Jaguar XJ, growing momentum of the Range Rover and Range Rover Sport and, in particular, the strengthening of the Jaguar Land Rover business in China, where it opened a National Sales Company (NSC) in mid 2010, were the main drivers. In addition, Jaguar Land Rover continued to benefit from cost effi ciencies and effective cash management initiatives adopted in response to the challenging operating conditions in 2008 and 2009. As the global markets recovered coupled with a strong focus on product and market initiatives, particularly at Jaguar and Land Rover, the Tata Motors Group turnover in 2010-11 grew by 33.1% to Rs.1,23,133 crores. Tata Motors Group recorded its highest ever Consolidated Profit Before Tax of Rs.10,437 crores (Rs.3,523 crores in 2009-10) and the Consolidated Profit for the Year of Rs.9,274 crores (Rs.2,571 crores in 2009-10). Vehicle Sales and Market Shares: The overall Tata Motors Group sales at 10,80,994 vehicles crossed the 1 million mark in 2010-11, higher by 24.2% compared to the previous year. Global sales of all commercial vehicles were at 5,12,731 units, while global sales of all passenger vehicles were at 5,68,263 units. The Company recorded sale of 7,78,540 vehicles in 2010-11, a growth of 22.8% over the previous year in the Indian domestic market representing a 24.3% market share in the Indian industry. It exported 58,089 vehicles from India, a growth of 70.3% over the previous year.

58

The Company increased its commercial vehicle sales in the Indian market to an all time high of 4,58,828 vehicles in 2010-11, representing market share of 61.8%. A strong product portfolio, improved reach and penetration in the market and focus on customer oriented initiative including fi nance enablement, ensured a 22.7% growth in commercial vehicle sales. Some of the key highlights were: - The Company crossed the 4 million cumulative vehicle sales mark for its commercial vehicles. - Sale of M&HCVs grew by 26.7% to 1,96,651 vehicles representing a market share of 60.1%. The Company continued to focus on customer centric initiatives, improved the sales of the Prima, and launched product variants to strengthen its product offerings. The Company introduced its CNG Hybrid city bus range and showcased it at the Commonwealth Games in Delhi. - Sale of LCVs grew by 19.9% to 2,62,177 vehicles representing a market share of 63.2%. The new products launched such as the Ace EX, Super Ac and 407 Pickup helped increase the sales. With competition entering the small commercial vehicles segment, the market share in the segment was lower as against last year. The Companys sales of passenger vehicles in the Indian market (inclusive of Tata, Fiat and Jaguar Land Rover brands) were at its highest ever at 3,19,712 vehicles, representing a market share of 13.0% in 2010-11. The competition in the passenger car market continued to increase with more international Automobile manufacturers entering the market with a variety of product offerings. Some of the key highlights were: - The Company crossed the 2 million cumulative vehicle sales mark for its passenger vehicles. - In June 2010, the Sanand plant for the production of the Nano was inaugurated. The Company completed delivery on the bookings of the Nano and opened sales in various

59

States in a phased manner. Nano sales increased to 70,431 vehicles, a growth of 129% from 30,763 vehicles in the previous year. The Company focused on increasing the reach and penetration for the Nano and also fi nancing enablement for potential customer segments. The Nano bagged the gold prize in the Best New Product segment under the transportation category at the 2010 Edison Award, symbolizing persistence and excellence personifi ed as also the worlds oldest and coveted international award for Good Design in 2010 conferred by the Chicago Athenaeum: Museum of Architecture and Design together with the European Centre for Architecture Art Design and Urban Studies in the category of transportation. - The sales in the Small Car segment (comprising the Nano, the Indica and the Vista) increased to 1,80,091 vehicles, a growth of 13.9% representing a market share of 11.7%.

Customer financing initiatives: The vehicle financing activity in India under the brand Tata Motor Finance (TMF) of Tata Motors Finance Limited - a wholly owned subsidiary company, has shown improvements in disbursements as well as net interest margins, driven mainly by the overall economic recovery coupled with a strong focus by TMF on controlling costs, improving quality of fresh acquisitions and micro-management of collections. TMF financed 1,60,781 vehicles during the year as compared to 1,44,806vehicles in the previous year. Total disbursements at Rs.7,908 crores grew by 18% as against Rs.6,697 crores in the previous year. The disbursals for commercial vehicles were Rs.6,041 crores (94,446 units) as compared to Rs.5,123 crores (96,593 units) and for passenger cars were Rs.1,867 crores (66,335 units) as compared to Rs.1,454 crores (48,213 units) in the previous year. The market share in terms of the Tata vehicles fi nanced by TMF declined from 26% in Commercial vehicles to 21% and increased from 21% to 22% in passenger cars. TMFs strategy on managing non-performing assets (NPA), improving collection efficiencies, improvements in the Risk Scored Pricing Model approach and thrust on customer relations through a branch based re-organised field structure, has in the last 2

60

years turned around and improved its operations and Profitability, setting a robust platform to enable future growth. Factor affecting the capital structure in Automobile: The capital structure decision has to be considered by the finance manager each time the company wants to go in for a new project and has to raise finance from the public as well as other sources.

a.

Constitution of the company:

While deciding the capital structures, constitution of the company plays a very important role. If the company is a private limited company or a closely held company, control factor may play dominant role. If the company is public limited company or a widely held company, cost factor may play a dominant role.

b.

Characteristics of the company:

Characteristics of the company in terms of its size, age and credit standing play very important role in the capital structure decisions. Very small companies and the companies in their early state of life have to depend more upon the equity capital, as they have limited bargaining capacity and they do not enjoy the confidence of the investors. As such, it is better for these companies to go for equity shares capital in the early years of life, increase the capital base, increase the bargaining capacity and then go for borrowed capital in the later years of their life. Similarly, the companies having good credit standing in the market may be in the position to tap the source of their own choice, whereas the choice may not be available to the companies having poor credit standing in the market. c. Stability of earnings:

If sales and earnings of the company are stable and predictable in future, the company does not mind taking the risk and it can borrow the funds, as cost factor and control factor 61

will play more important role. However, if the sales and earnings are not likely to be stable and predictable over a period of time and are likely to be subject to wide fluctuations, the risk factor plays an important role and the company will not like to have more borrowed capital in its capital structure. d. Attitude of the management:

If the management attitude is conservative, the control factor and risk factor may play important role in the capital structure decisions. If the management attitude is aggressive, cost factor may play an important role.

Capital Structure at Tata Motors: Market Capitalization: 78185.92 crores Tata Motors Ltd is a multinational automotive corporation headquartered in Mumbai, India. The Company continues to be amongst the top three players in the passenger vehicle market which has over 25 players. Tata Motors has products in the compact, midsize car and utility vehicle segments. The company is the world's fourth largest truck manufacturer, the world's second largest bus manufacturer, and employs 24,000 workers. Analysis: The Company recorded a sale of 633,862 vehicles in 2009-10, a growth of 34%over previous year (472,885 vehicles) in the domestic market in India, representing a 25.5% share in the industry (improving from 24.4% share in the previous year).

62

The Tata Motors Group turnover was Rs.95,567 crores, a growth of 29% over previous year contributed mainly by market recovery, improved realization and successful launch of new products. Consolidated Profit Before Tax was Rs.3,523 crores (Loss of Rs.2,129 crores in 2008-09) and Consolidated Profit for the year was Rs.2,571 crores (Loss of Rs.2,505 crores in 2008-09).

The Profit Before Tax of Rs.2,830 crores and Profit After Tax of Rs.2,240 crores also grew significantly over the previous year by 179.1% and 123.7%respectively. The borrowings of the Company as on March 31, 2010 stood at Rs.16,625.91 crores (previous year Rs.13,165.56 crores).

63

The key highlights were:- In 2009-10,the Company raised Rs.4,200 crores from the issue of Secured, Rated, Credit Enhanced, Listed, 2% Coupon Non-Convertible Debentures (NCDs) with premium on redemption and Rs.200 crores from the issue of 9.95% Secured NCDs.In a challenging financial market environment, the Company successfully rolled over in May 2009, the bridge finance it had obtained for acquisition of the Jaguar Land Rover business for a period of 18 months, till December 2010.Subsequently, the Company was able to prepay this loan facility in October 2009from certain divestments, improved cash generation from operations and also through fund raised, US$ 375 million from the issue of Global Depository Receipts and US$ 375 million from issue of Foreign Currency Convertible Notes. The Company will further consider suitable steps to deleverage and hence de-risk the balance sheet from volatility and has also taken and will continue to implement suitable steps for raising long term resources to match the Companys fund requirement and to optimize its loan maturity profile. In the Last 5 years the debt equity ratio of Tata Motors is has remained around0.8 which is near to the industry average of debt to equity. Company has been making huge amount of profits and thus have sufficient surplus and reserves for funding the requirements of the company. Major proportion of the liquidity requirement of the company is met internally with the accumulated reserves and surplus. With a good interest coverage ratio in last 4 years except for the year ended on March 2009, company has been able to raise the debt easily from the market. There has been significant rise in the debt during the year 2008 because 64

of TATA-Jaguar deal. EPS of the company was around 52 at the end of the year March 2008 when the Debt-to-equity ratio was 0.7. EPS has decreased during the last year because of fall in sales and also the equity capital has increased with the right issue. During last year company has also raised fund through issue of debentures. Company is not in a healthy position to raise debt from the company because currently the interest coverage ratio is less than 2 which means that company has higher proportion of its profit to be distributed as interest

Capital Structure (Debt-Equity) Another important variable, which affect the value of the firm, is the capital structure of the firm. Finance theory tells us that, in the absence of bankruptcy costs, corporate income taxation, or other market imperfections, the value of a firm is independent of its financial structure. The theory is intuitive, because real assets determine a firms value; it cannot be changed by purely financial transactions. In other words, financial assets on the right side of the balance sheet have value only because of the real assets, including intangibles and growth opportunities, on the left side. Therefore, if markets are doing their job, it should not be possible to create value by shuffling the paper claims on the firm's real assets. However, if there are imperfections such as taxes, underdeveloped financial markets, and inefficient legal systems financial structure becomes relevant. Firms must decide whether to issue debt or equity securities to minimize the costs entailed by these imperfections. How Shareholders' Wealth Grows: Shareholders benefit financially from their investment in successful companies in three main ways: Dividends, which are a distribution of part of a company's net profit to shareholders, as part owners of the company. Most large industrial companies pay dividends twice yearly, and often these dividends have tax advantages as well.

65

 Capital growth, which is the increase in the market value of a company's shares over the total cost of those shares. It usually reflects the growth in the company's profits and assets, but it can also be affected by a change in the sentiment of the whole share market as it goes through its cycles. Prices of shares are determined by many factors, which are interrelated to each other. New Issues of shares, which may be made by a company when it requires further funds. Such new shares are usually offered at a discount to existing shareholders, based on a predetermined ratio, without having to pay brokerage. The entitlements to the new shares offered are known as Rights, as shareholders have the right to acquire the shares or to sell the rights to these new shares on the stock market. A company may also make a Bonus Issue to shareholders at no cost. 1. DIVIDEND PAYOUT A ratio showing the percentage of net profits paid out in dividends on common stock, after reducing net profits by the amount of dividends paid on preferred stock. It calculated as the percentage of dividend paid on profit after tax. In this study dividend payout ratio is expressed as the ratio of dividend paid to the net profit after tax. D/P Ratio = Dividend Paid / Net profit after tax 2. RETENTION RATIOS Retention ratio shows the rate of earnings retained by the company for financing the investments needs. Retained earnings are the main internal source of finance for the company. This explains to what extent the earnings of the firm are ploughed back to the business. Technically it is one minus the dividend paid out ratio. Retention Ratio = 1 D/P Ratio. 3. DEBT EQUITY RATIOS Debt Equity ratio shows capital structure of the firm. This represents the capital structure of the company. It is defined as the ratio of debt to equity of the firm. D/E Ratio = Debt / Equity 4. RETURNS ON SHARES Return on shares is calculated by dividing the previous year s price from the current year price and the log natural of the resultant figure is calculated as it gives a continuously compounded rate of return

66

5. VALUE OF THE FIRM The effect on the value of the firm is analyzed by studying the return on equity shares. Return on Equity share = P1 / P0, where P1 is the market price of equity share for current year and P0 is the market price of the equity share for the previous year.

Net Sales & PAT Chart:

67

P/E Chart:

68

6. RECOMMENDATION

At the current market price of Rs.602.00 the stock is trading at a P/Ex of 19.26x for FY10E and 17.41x for FY11E. The EPS of the stock is expected to be at Rs.31.26 and Rs.34.58 for FY10E and FY11E respectively. On the basis of price to book value, the stock trades at 4.84x and 3.79x for FY10E and FY11E respectively. Auto Products business added 37 new clients during the quarter taking the total active clients to 840 clients up from 830 at the end of sequential quarter. Tata Motors has entered into a multi-year contract with an iconic beverage company based in Australia for managing, supporting and provisioning the customer's automobile infrastructure, data centers, providing Disaster Recovery Services and support of different business applications across Australia, US and Europe. Tata Motors has entered into a 5 year agreement with BP to provide IT Applications Development and Maintenance (ADAM) services for BP's Fuels Value Chain and Corporate businesses globally. Despite the weakness in demand, the healthcare, energy & utility & communication media service segments have experienced double-digit growth in the last six quarters. This will help the Company in offsetting the impact of the slowdown in the other verticals. Hyundai crossing, a tata subsidiary signed a significant and large multi-year outsourcing contract with a large outsourcer of data processing services in the US. Some large UK based dealers have chosen Tata, as its IT partner, to deliver a new and robust operating model that supports the retailers strategic and commercial objectives. The Net sales and PAT of the company is expected to grow at a CAGR of 15% and 16% respectively over FY08 to FY11E.

69

7. CONCLUSION

Comparing the overall performance of the 5 companies selected, it is Hero Honda which had displayed a steady and constant performance over the past 5 years. The EPS for Hero Honda shares stood at Rs. 111.77 at yearend 2010. The EPS has been on a gradual rise till year end 2009 and has seen a swift rise in 2010. No drastic or sudden falls have been clocked. Profit of the company is rising along with EPS. Reduction in debt over the run has also helped the company to maintain its goo debt to equity ratio. Hero Hondas interest coverage ratio has been at an impressive 1262.36at year end 2010 with Bajaj auto being the next closest at 421.06 followed by Maruti Suzuki at 105.39 in the third place. However s far as the PBT are concerned Hero Honda is only second to Bajaj Auto which has a 19.78 cr. compared to its 16.01 cr. The companies in the sector which we have compared are in different segment. Within the two wheeler segment Hero Honda has the best capital structure. In the commercial vehicle segment TATA Motors has adequate ratio of debt to equity giving maximum returns to its shareholders. Seeing to its current capital structure it also has capacity to raise further capital if required for funding.

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8. RFERENCES

Jensen, M. C., "Agency Costs of Free Cash Flow, Coporate Finance and Takeovers," American Economic Review 76, 1986, pp. 323-339. Jensen, M.C., and W.H. Meckling, "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure," Journal of Financial Economics 3, December 1976, pp. 305-360. Kim, E.H., "A Mean-Variance Theory of Optimal Capital Structure and Corporate Debt Capacity," Journal of Finance 33, March 1978, pp. 45-63. Kraus, A. and R.H. Litzenberger, "A State Preference Model of Optimal Financial Leverage," Journal of Finance, September 1973, pp. 911-922. Lev, B., "On the Association Between Operating Leverage and Risk," Journal of Financial and Quantitative Analysis, September 1974, pp. 627-641. Websites: http://myiris.com/shares/research/firstcall/WIPRO_20091109.pdf http://en.wikipedia.org/wiki/Capital_structure http://www.rhsmith.umd.edu/faculty/Gphillips/courses/bmgt640/Capstr.pdf http://www.igidr.ac.in/~money/mfc_5/malabika.pdf

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QUESTIONAIRE
Q1. Which segment is growing day by day on demand? Passenger vehicle Commercial Two wheeler Three wheeler Q2. The Valuation Process in market of automobile sector? Advertising Inventory cost Cost Price Quality Judgement

Q3. Once a merger has been finalized, the capital structure of TATA becomes? Stronger Weaker Middle way Q4. As per TATA automobile industry, reason of their launch of NANO? Reach for Every segment Eat up two wheeler segment First Mover Advantage Q5. Why capital structure of tata automobile is so strong? Monopoly Quality Management Capital expenditure Work on market demand Q6. Which of the following represents a change in car? 72

 Features Cost Price Comfortability

73