Institute of Business

Administration, Karachi

Service Industries Limited

Corporate Finance Report

Prepared by:

Saif Ali Momin 08003

Muhammad Rehan 06740
Fahad Iqtidar 07869
Abdul Moiz Iqbal 08015
 Service Industries Limited

Contents

1 Introduction to Service Industries Limited .................................................................. 2

2 Corporate Governance Analysis .................................................................................... 3

3 Shareholders Analysis ................................................................................................... 4

4 Company Risk Profile and Returns .............................................................................. 7

5 Capital Structure Choices and Optimal Capital Structure ........................................... 8

6 Dividend Policy ........................................................................................................... 10

Appendix A ..................................................................................................................... 12

Appendix B ..................................................................................................................... 13

Appendix C ..................................................................................................................... 14

Appendix D ......................................................................................................................17

Appendix E ..................................................................................................................... 18

Appendix F...................................................................................................................... 19

Appendix G ..................................................................................................................... 21

Appendix H ..................................................................................................................... 23

References ...................................................................................................................... 24

1
 Service Industries Limited

1 Introduction to Service Industries Limited

Servis story begins with a group of friends from college-who established Service Industries in 1953,
the Company went public in 1959. Ch. Nazar Muhammad (Late), Ch. Muhammad Hussain (Late) -
both from Gujrat district and Ch. Muhammad Saeed (Late) from Gujranwala District, started
business in 1941 on a small scale in Lahore.

Company started with only manufacturing handbags and some other sports goods. Within years their
business flourished remarkably and they were supplying their products to every corner of India at the
time of Partition. In 1954, shoe manufacturing plant was installed at industrial area in Gulberg,
Lahore. Later management shifted the factory from Lahore to Gujrat.

SIL has annual revenues of about PKR 15 billion and is the largest manufacturer of footwear, tyres &
tubes for two-wheelers, and has been the largest footwear exporter of the country for the last 10
years. The company employs more than 8,600 people in its facilities located in Gujrat and Muridke
and exports its products in many destinations around the world.

The production side of the company today is restructured into Service Industries Limited (SIL) which
has world-class shoes, tyres, tubes and rubber production facilities in Gujrat and Muridke.

Retail side of the company, Service Sales Corporation (Pvt.) Ltd. (SSC) is a leading shoes retailer in
Pakistan with more than 450 retail outlets and roughly 2500 independent dealers. However in 2011,
SSC became an independent group after the restructuring of the Servis Group.

Footwear

Servis cater to the daily footwear needs of all the members of the family. With its multi-brand
approach, constant innovation in design and up-to-date style trends, Servis has products for all age
groups and personal tastes. Though Servis is a leader in footwear industry in Pakistan with a market
share of 7% but informal shoes Servis is lagging behind Bata. In past, Servis has more focus on sports
and casual footwear.

Annual revenues of footwear division exceed USD 83 Million of which 45% come from exports
majorly to EU countries Germany, France & Italy. In house manufacturing covers all aspects of shoe
manufacturing value chain from model designing, cutting, stitching to lasting (injection) & finishing
and downstream activities such as marketing. Present capacity is more than 40,000 pairs of shoes
every day.

Major competitors of Servis Shoe business in Pakistan are:

Hush Puppies
2
 Service Industries Limited

Bata
Stylo
Borjan

Tyre

Service Industries Ltd entered into tyre & tube business in 1970 with specialized in tyres & tubes for
Motorcycle and Bicycle of different kinds. Manufacturing of motorcycle tyres & tubes was started in
1990. SIL is major supplier of tyres & tubes to Japanese motorcycles manufacturers like HONDA,
YAMAHA and other local motorcycle assemblers in Pakistan.

Major competitors of SIL in motorcycle tyre business in Pakistan are:

General Tyres and Rubber Company of Pakistan Limited

Panther Tyres
Diamond Tyres Ltd.

2 Corporate Governance Analysis

Service Group started with group of friends and it is majorly owned and managed currently by the
succeeding family members of the founders of Service Group. Directors hold major shareholding of
more than 40% in SIL (see Appendix B). Among board of directors the chairman and executive
directors are inheritor of the SIL founders and seems to play active role in running day to day
management of the company (see Appendix A). This shows that there is not a huge separation in
management and ownership of the company. However, there seems no doubt about the capability of
the executive directors as per their education, however their positions in other companies as director
may create some problems. But as far as the authority of CEO over board is concerned, this may not
be the case here as other board members are also equally part of the ownership in business. So, CEO
is generally picked by the Board of Directors.

Under Code of Corporate Governance the company seems to fully comply with its requirements, e.g.
nomination of at-least one Independent Director which was made necessary in CCG 2012. Financial
reporting is as per the standard prescribed. Directors are not part of more than 7 listed company
boards. Formation and structure of Audit Committee, HR committee etc. is also as per the code.

Service Group ensures that any material / price sensitive information is disseminated among all
market participants at once through the stock exchanges. Financial Reports are duly published on
the website as well.

3
 Service Industries Limited

Service Industries Limited strives to be a good corporate. Corporate Social Responsibility (CSR) of
SIL is classified into the following categories;

Corporate Philanthropy
o Health Care facilities to communities where they operate
o Housing facility aims to provide shelter to the homeless senior citizens
o Schools
Community Investment
o SIL also donates to other organizations, entities and NGOs
Other areas environmental protection, industrial relation etc.

3 Shareholders Analysis
Major shareholders of SIL comprise of family of the founding members who also belong to Board of
Directors with 44.72% shareholding as discussed earlier. We may expect very little buying or selling
of shares in this part of directors. Other portion of institutional shareholders comprise of NIT,
Insurance Companies, Banks, Mutual Funds which comprise of 25.95% shareholding and around
22.81% belongs to public.

0.07%
4.82%
0.01% NIT and ICP
44.72% 1.69% 7.44%
Insurance Companies
18.43%
Associated Companies, Undertakings and
Related Parties
Others

Banks, Development Financial Institutions,

Non Banking Financial Institutions
Modarbas and Mutual Funds

General Public
22.81%
Directors, Chief Executive Officer, and their
spouses and minor children

Figure 1: Shareholders breakup by categories

4
 Service Industries Limited

14

Millions
12

10

0
2014 2013 2012 2011

Directors, Chief Executive Officer, and their spouses and minor children
General Public
Modarbas and Mutual Funds
Banks, Development Financial Institutions, Non Banking Financial Institutions
Others
Associated Companies, Undertakings and Related Parties
Insurance Companies
NIT and ICP

Figure 2: Shareholding pattern by category

5
 Service Industries Limited

14

Millions 12

10

0
2014 2013 2012

Remaining with less than 5%

National Bank Of Pakistan
CDC- Trustee National Investment (Unit) Trust
Mrs. Shahida Naeem
Mr. Omar Saeed
Mr. Hassan Javed
Mr. Arif Saeed
Chaudhary Ahmed Javed
Ch. Ahmed Saeed

Figure 3: Shareholders with more than 5% voting rights

Moreover, if we see the trend of number of shareholders for past three years in Appendix B, we do
not see any drastic changes in the number of shareholders in each category except in:

Associated Companies, Undertakings and Related Parties

Modarbas and Mutual Funds

This is also evident from the volume traded in Karachi Stock Exchange is very low for SIL. So major
trading that occur is in general public, insurance companies and some financial institutions category.
We also observe some trading of shares by directors in the financial reports but that is very limited.
An interesting observation from the trading in shares by Executive Directors follow same pattern.
The three executive directors and the chairman sell or buy shares in equal quantity as observed
through financial reports.

6
 Service Industries Limited

The marginal investors in the SIL is little complicated to identify as the firm has significant
institutional holdings and large insider holdings. In such scenarios most of the time the large insider
is the founder or original owner for the firm, and often, this investor continues to be involved in the
top management of firm as the case of SIL. However, from the pattern discussed earlier, here may be
Modarbas and Mutual Funds and some financial institutions trade on stock on regular basis and can
be marginal investors. Trading in other categories of shareholders seems very limited. It must be
noted here that insiders also trade occasionally in the stocks of SIL, so the the leading stockholder
will influence the final decision.

4 Company Risk Profile and Returns

SIL activities expose to a variety of financial risks: credit risk, liquidity risk and market risk
(including currency risk, other price risk and interest rate risk). Overall risk based on regression of
KSE100 index and SIL stock monthly returns turns out to be 0.5918 with standard error of 33.57%.
With 95% confidence we can say that the risk ranges between -0.0801 to 1.2638; and with 68%
confidence level risk ranges within 0.2551 to 0.9286 (refer Appendix C). In general global shoe
companies beta averages about 0.96 (Damodaran, 2016). Low SIL beta might be due to
diversification of SIL business into tyre manufacturing. Risk profile changes at various level of
Capital Structure remain under 1 up to 60% debt level (see Appendix G). However, company still has
too much debt above its optimum level which we would discuss later.

The R squared of the regression provides an estimate of the proportion of the risk (variance) of a firm
that can be attributed to market risk. In case of SIL market specific risk is about 5.09%, while the
94.91% is attributed to firm specific risk which is a very high number and must be diversified.

4
Levered Beta
3.5
3
2.5
2
1.5
1
0.5
0
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Debt Ratio

Figure 4: Risk Profile at different debt ratios

7
 Service Industries Limited

During the analysis period of 2010 2014, the expected return would be 19.08% per annum for
investing in SIL stocks (see Appendix C). The company outperformed the market by 17.54% annually.

The cost of equity for the firm based on market value is about 19.08%, whereas the cost of debt after
tax is 9.02%. With debt to equity ratio of 0.2882 (28.82%) based on market value of debt and equity
the cost of capital for SIL is 16.83%. This may be taken as a hurdle rate when company invest in
various projects with new or innovative product range selection to maximize the firm value.

5 Capital Structure Choices and Optimal Capital Structure

In book value terms the capital structure of SIL is at Debt Ratio of 50%, however for more realistic
measure of SIL capital structure we calculated market value of existing SIL debt and current equity
market value which arrived at the debt ratio of 22.38% (see Appendix G). Company uses long term
and short term debt and retain earnings for its financing while maintaining healthier capital ratios in
order to support its business and maximize shareholders value. To maintain or adjust the capital
structure, the Company also adjust dividend payments to the shareholders, return on capital to
shareholders or issue new shares. The Companys strategy is to maintain optimal capital structure in
order to minimize cost of capital.

SIL has optimum debt ratio of 20% which much near to its current debt ratio as per our calculation
(see Appendix G). Company tries to get the maximum advantage of tax benefit from keeping debt at
optimum level. However, company may lose its flexibility in business with increase of debt. In
general global average of shoe companies have debt ratio of about 9% (Damodaran). Such companies
retain their profits to allow flexibility during any unforeseen situations or financial crisis.

Debt to Debt to Cost of After Tax Cost of

Firm Value
Capital Equity Equity Cost of Debt Capital

0% 0.00% 17.43% 6.64% 17.43% 71,395,086.14

10% 11.11% 18.06% 6.98% 16.95% 73,813,395.42
20% 25.00% 18.86% 8.34% 16.75% 74,890,298.41
30% 42.86% 19.88% 10.55% 17.08% 73,154,479.83
40% 66.67% 21.24% 11.23% 17.24% 72,351,085.43
50% 100.00% 23.15% 12.25% 17.70% 70,075,267.98
60% 150.00% 26.01% 14.29% 18.98% 64,468,379.83
70% 233.33% 30.78% 14.29% 19.24% 63,442,520.92
80% 400.00% 40.32% 15.08% 20.12% 60,146,378.06
90% 900.00% 68.94% 18.73% 23.75% 49,634,352.13

8
 Service Industries Limited

Figure 5: Optimum Cost of Capital

Furthermore, SIL stocks are not held by huge number of individual investors and most of it is held by
family members who actively participate in running day to day operations, so more debt will not add
discipline to management.

Looking towards cost of capital schedule in figures below and detail values and calculation in
Appendix G, SIL may keep its debt ratio in between 10% to 30% without increasing cost of capital not
more than 1%. However current debt level of SIL at market value is PKR 3.05 billion which is PKR
0.324 billion above optimum cost of capital level at debt ratio of 20%. Moreover, less debt will allow
flexibility to firm and minimal level of risk in bankruptcy cost due to its nature of business and
products.

9
 Service Industries Limited

Figure 6: Cost of Funding Profile

6 Dividend Policy
Service Industries as a public listed company return its excess income to shareholders in the form of
cash dividends half yearly and sometimes only annually. Dividends during past 10 years of SIL in
figure below clearly shows that company tends to maintain or increase its dividends from previous
years and tends to follow earnings pattern. However, the rate at which earnings are growing (trend of
EPS), dividends are not growing (trend of dividends) with the same rate which illustrates that
company retain a good portion of its earnings for new projects and for bad times. Moreover, we did
not observe any stock buy back by the company from its retained earnings. While comparing
dividend payouts with global shoe companies, average dividend payout for SIL from the graph
mentioned below is around 38.69% and average of 88 global shoe companies dividend payout is
around 43.36% (refer Damodaran 2016 data).

10
 Service Industries Limited

90
78.63
80

70 64.28
60 54.94
51.49
50

40 36.03 37.50

28.32 27.28
30 25.00
20.00 17.50
20 13.42 12.50
10.59
8.13 7.50 7.50
10 4.50
3.00 7.50
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

EPS (Rs.) Dividend Linear (EPS (Rs.)) Linear (Dividend)

Figure 7: Payout ratio

During analysis period of 5 years SIL increased its reserves by PKR 1.264 billion which is 80%
increased in comparision to reserves level of 2010. Keeping in view the SIL business where
continious innovation and marketing is required it is necessary to retain earnings to cover for bad
times and for new projects. However, surplus cash that exceeds the optimum capital ratio should be
return to shareholders in the form of cash dividends. Reason for cash dividends against capital gain
is due to the fact that the number of shareholders are limited and might not change very frequently,
so they may be more interested in cash dividends rather than capital gain on the shares held to invest
elsewhere.

3,000 2,844
Millions

2,500 2,327

1,893 1,900
2,000
1,580
1,500

1,000

500

-
2010 2011 2012 2013 2014

Reserves

Figure 7: Accumulated reserves

11
 Service Industries Limited

Appendix A
Director Category Shareholding in Servis
Board of Directors
Chaudhry Ahmed Javed Non-Executive Director 2,009,936 16.7094%
(Chairman)
Mr. Omar Saeed Executive Director 995,896 8.2793%
(Chief Executive)
Mr. M Ijaz Butt Non-Executive Director 40,069 0.3331%
Shares held by family member -> 477,218 3.9673%
Mr. Arif Saeed Executive Director 999,545 8.3096%
Shares held by family member -> 94,937 0.7892%
Mr. Hassan Javed Executive Director 758,015 6.3017%
Mr. Riaz Ahmed Independent Director 4,000 0.0333%
Mr. Shaukat Ellahi Shaikh Non-Executive Director
Mr. Muhammad Amin Non-Executive Director
Mr. Manzoor Ahmed (NIT Nominee) Non-Executive Director
Advisor
Ch. Ahmad Saeed 610,460 5.0750%
Chief Financial Officer
Mr. Jawwad Faisal
Company Secretary
Mr. Waheed Ashraf
Audit Committee
Mr. Manzoor Ahmed Non-Executive Director
(Chairman) (NIT Nominee)
Mr. Riaz Ahmed Independent Director 4,000 0.0333%
(Member)
Mr. Muhammad Amin Non-Executive Directors
(Member)
Human Resource Committee
Mr. Riaz Ahmed Independent Director
(Chairman)
Mr. Arif Saeed Executive Director 999,545 8.3096%
(Member) 94,937 0.7892%
Mr. Muhammad Amin Non-Executive Director
(Member)
Auditors
M/s. S. M. Masood & Co.
Chartered Accountants
Legal Advisor
M/s. Bokhari Aziz & Karim
2-A, block-G, Gulberg-II, Lahore.

12
 Service Industries Limited

Appendix B
2014 2013 2012
Categories of Shareholders
No. of Shares % of No. of Shares % of No. of Shares % of
ShHdr Held Total ShHdr Held Total ShHdr Held Total

NIT and ICP 1 900 0.01% 1 900 0.01% 2 5,354 0.04%

Insurance Companies 2 8,554 0.07% 1 4,354 0.04% 1 10,144 0.08%

Associated Companies,
Undertakings and Related 3 580,138 4.82% 1 10,144 0.08% 2 44,214 0.37%
Parties

Others 22 203,483 1.69% 8 659,117 5.48% 4 383,848 3.19%

Banks, Development Financial

Institutions, Non Banking 22 895,332 7.44% 27 1,087,604 9.04% 27 1,781,033 14.81%
Financial Institutions

Modarbas and Mutual Funds 11 2,217,365 18.43% 4 1,823,439 15.16% 5 1,836,539 15.27%

General Public 1,254 2,743,401 22.81% 1,288 2,971,615 24.70% 1,361 2,812,241 23.38%

Directors, Chief Executive

Officer, and their spouses and 8 5,379,616 44.72% 8 5,471,616 45.49% 8 5,155,416 42.86%
minor children

2014 2013 2012

Shareholders holding more than 5% voting
rights Shares % of Shares % of Shares % of
Held Total Held Total Held Total

Ch. Ahmed Saeed 610,460 5.07% 610,460 5.07% 610,460 5.07%

Chaudhary Ahmed Javed 2,009,936 16.71% 2,032,936 16.90% 1,954,286 16.25%
Mr. Arif Saeed 999,545 8.31% 1,022,545 8.50% 942,295 7.83%
Mr. Hassan Javed 758,015 6.30% 781,015 6.49% 702,365 5.84%
Mr. Omar Saeed 995,896 8.28% 1,018,896 8.47% 940,246 7.82%
Mrs. Shahida Naeem 800,226 6.65% 800,000 6.65% 799,774 6.65%
Total 6,174,078 51.32% 6,265,852 52.08% 5,949,426 49.46%
CDC- Trustee National Investment (Unit) Trust 1,660,475 13.80% 1,660,475 13.80% 1,681,975 13.98%
National Bank Of Pakistan 842,126 7.00% 842,126 7.00% 1,002,239 8.33%
Total 2,502,601 20.80% 2,502,601 20.80% 2,684,214 22.31%

13
 Service Industries Limited

Appendix C
Calculation of Expected Return using CAPM Model for Service Industries Limited.

Expected Return = Riskfree rate + Beta * Risk Premium or

Expected Return = Riskfree Rate+ Beta * (Expected Return on the Market Portfolio Riskfree Rate)

Three inputs required in this model are calculated below:

a. Risk Free Rate

Pakistan Government Bond 10 year was quoted at 9.01% p.a. on February 25th, 2016. This can be
considered as Risk Free return in Pakistan.

b. Risk Premium

Using thumb rule on countrys bond rating and default spreads

Pakistan sovereign bonds rating from Moodys and historical risk premium for AAA rated country is
detailed below:

Country Moodys Country Default Equity Risk

Spread (Rating) Premium
US AAA 0.00% 6.25%
Pakistan B3 7.21% 13.46% (7.21+6.25)

Scale up the default spread by 50% to gauge the additional risk in stock market, so

Total Risk Premium of Pakistan = 6.25 + 7.21*1.5 = 17.07%

c. Beta

Performing regression of stock returns (Rj) against market returns KSE-100 index (Rm) for period of
5Y from Jan 2010 to Dec 2014 with monthly return data (refer Appendix H for data).

Rj = a + b * Rm

where a is the intercept and b is the slope of the regression.

From the regression output is detailed below,

14
 Service Industries Limited

a = 1.6626%

b = 0.5918 point estimate

Standard Error of Beta = 0.3357

so, b ranges between -0.0801 to 1.2638 with 95% confidence;0.2551 to 0.9286 with 68% confidence

since,

Rf = 9.01% p.a.

so, Monthly Rf = 9.01/12 = 0.7508% monthly

a Rf * (1-b)
1.6626% > 0.7508 * (1-0.5918) = 0.3065%

Jensens Alpha = 1.6626 0.3065 = 1.3561%

15
 Service Industries Limited

Service did 1.3561% better than market, per month, between 2010 and 2014.

Annualized = (1+0.013561)12 1 = 0.1186 = 17.54%

The R squared of the regression 5.09% attributed to market risk

(1 R2) = 94.91% attributed to firm specific risk

Expected Return = Riskfree rate + Beta * Risk Premium

Expected Return = 9.01 + 0.5918 * 17.01 = 19.08%

16
 Service Industries Limited

Appendix D
Measure of Operating Leverage

Fixed Costs Measure = Fixed Costs / Variable Costs

EBIT Variability Measure = % Change in EBIT / % Change in Revenues

Year Sales % Change in Sales EBIT % Change in EBIT

2010 9,421,408,000.00 - 665,659,000.00 -
2011 11,549,029,000.00 22.58% 772,314,000.00 16.02%
2012 12,167,267,000.00 5.35% 514,572,000.00 -33.37%
2013 14,685,638,000.00 20.70% 1,053,734,000.00 104.78%
2014 16,495,123,000.00 12.32% 1,276,029,000.00 21.10%
Average 15.24% 27.13%

EBIT Variability Measure = 27.13 / 15.24 = 1.78

The higher this number, the greater the operating leverage.

Unlevered / Asset beta

Year 2014 2013 2012 2011 2010

Interest Bearing Long Term Liability 958,315 514,365 400,215 233,123 240,525
Interest Bearing Short Term Liability 2,279,717 1,628,302 2,160,224 1,692,977 1,207,975
Shareholder Equity 2,963,949 2,447,086 2,019,951 2,012,906 1,699,826

Debt to Equity Ratio 1.09 0.88 1.27 0.96 0.85

*Average D/E from 2010 2014 = 1.01

0.5918 = u (1+ ((1-0.32)*1.01))

u = 0.3508

17
 Service Industries Limited

Appendix E
An interest coverage ratio for Service Industries Limited.

Interest Coverage Ratio = EBIT / Interest Expenses

000 Rs.
Year 2014 2013 2012 2011 2010
Financial Charges 331,581 306,329 322,151 237,695 177,727
EBIT 1,276,029 1,053,734 514,572 772,314 665,659

Interest Coverage Ratio 3.85 3.44 1.60 3.25 3.74

*Average Interest Coverage Ratio from 2010 2014 = 3.176

A synthetic rating (from table below) for Service Industries Limited based on Interest Coverage Ratio of
3.176 found to be Ba2/BB, for which default spread is 4.25%.

For smaller and riskier firms

If interest coverage
ratio is
greater than to Rating is Spread is
-100000 0.499999 D2/D 20.00%
0.5 0.799999 C2/C 16.00%
0.8 1.249999 Ca2/CC 12.00%
1.25 1.499999 Caa/CCC 9.00%
1.5 1.999999 B3/B- 7.50%
2 2.499999 B2/B 6.50%
2.5 2.999999 B1/B+ 5.50%
3 3.499999 Ba2/BB 4.25%
3.5 3.9999999 Ba1/BB+ 3.25%
4 4.499999 Baa2/BBB 2.25%
4.5 5.999999 A3/A- 1.75%
6 7.499999 A2/A 1.25%
7.5 9.499999 A1/A+ 1.10%
9.5 12.499999 Aa2/AA 1.00%
12.5 100000 Aaa/AAA 0.75%

A pre-tax cost of debt for your firm = Risk free Rate + Default Spread = 9.01 + 4.25 = 13.26%

Taking latest corporate tax rate of 32%, an after-tax cost of debt for Service Industries Limited would be:

After-tax cost of debt = Pre-tax cost of debt (1 tax rate) = 13.26 * (1 0.32) = 9.017%

18
 Service Industries Limited

Appendix F
Debt to Equity Ratio based on book value found to be 1.09 as per table below from Financial Statements.

Year 2014 2013 2012 2011 2010

Interest Bearing Long Term Liability 958,315 514,365 400,215 233,123 240,525
Interest Bearing Short Term Liability 2,279,717 1,628,302 2,160,224 1,692,977 1,207,975
Shareholder Equity 2,963,949 2,447,086 2,019,951 2,012,906 1,699,826

Debt to Equity Ratio 1.09 0.88 1.27 0.96 0.85

Equity / (Debt + Equity) 47.79% 53.32% 44.10% 51.10% 53.99%
Debt / (Debt + Equity) 52.21% 46.68% 55.90% 48.90% 46.01%

Debt to Equity Ratio based on Market Value

Breakup of Interest Bearing Long Term Liabilities including Current Portion with maturity is detailed
below:

Time Due Amount Due

FS Reporting Last Payment Due on % Due
(yrs) 000
31-Dec-14 31-Dec-15 1.0 2,105,352 65.02%
31-Dec-14 30-Dec-15 1.0 10,415 0.32%
31-Dec-14 30-Dec-15 1.0 11,196 0.35%
31-Dec-14 28-Jun-16 1.5 21,455 0.66%
31-Dec-14 14-Sep-16 1.7 4,551 0.14%
31-Dec-14 25-Oct-16 1.8 2,686 0.08%
31-Dec-14 25-Oct-16 1.8 2,143 0.07%
31-Dec-14 02-Nov-17 2.8 50,709 1.57%
31-Dec-14 18-Mar-20 5.2 215,595 6.66%
31-Dec-14 22-Aug-20 5.6 250,000 7.72%
31-Dec-14 02-Jan-20 5.0 563,930 17.42%
Weighted Average 2.372 3,238,032

Total debt due as at Dec 31, 2014 = 3,238,032,000.00

Total interest expense for the year 2014 = 331,581,000.00

Pre-tax Cost of Debt = 13.26%

19
 Service Industries Limited

1
1
(1 + )
=


+
(1 + )

1
1
(1 + 0.1326)2.372
= 331,581,000
0.1326
3,238,032,000.00
+ = 3,049,461,367.45
(1 + 0.1326)2.372

Cost of Equity = Risk free rate + Beta * Risk Premium = 9.01 + 0.5918 * 17.01 = 19.08%

Market Value of equity = Price of stock * No. of shares = 879.5 * 12,028,789 = 10,579,319,925.50

* Price of Service Industries Limited stock on February 25th, 2016 = Rs. 879.5

Equity / (Debt + Equity) = 10,579,319,925.50 / (10,579,319,925.50 + 3,049,461,367.45) = 77.62%

Debt / (Debt + Equity) = 3,049,461,367.45 / (10,579,319,925.50 + 3,049,461,367.45) = 22.38%

Debt / Equity = 3,049,461,367.45 / 10,579,319,925.50 = 0.2882

Cost of Capital (Based on market value) = 19.08 * 0.7762 + 9.017 * 0.2238 = 16.83%

Cost of Capital (Based on book value) = 19.08 * 0.5006 + 9.017 * 0.4994 = 14.05%

20
 Service Industries Limited

Appendix G
Capital Structure

a. Estimating Cost of Equity

Estimate the unlevered beta for the firm

u = L / (1+ (1-t)(D/E)) = 0.5918 / (1+ (1-0.32)*0.2882) = 0.4948

Since,

L = u (1+ (1-0.32)*(D/E))

Cost of Equity = Risk free rate + Beta * Risk Premium = 9.01 + L * 17.01

Debt to Capital Debt to Equity Levered Beta Cost of Equity

0% 0.00% 0.4948 17.43%
10% 11.11% 0.5322 18.06%
20% 25.00% 0.5789 18.86%
30% 42.86% 0.6390 19.88%
40% 66.67% 0.7191 21.24%
50% 100.00% 0.8313 23.15%
60% 150.00% 0.9995 26.01%
70% 233.33% 1.2799 30.78%
80% 400.00% 1.8407 40.32%
90% 900.00% 3.5231 68.94%

b. Estimating Cost of Debt

SIL Current Financials

Year 2014
Revenues 16,495,123,000
EBITDA 1,517,495,000
Depreciation & Amortization 241,466,000
EBIT 1,276,029,000
Financial Charges 331,581,000

Market value of SIL = Debt + Equity = 3,049,461,367.45 + 10,579,319,925.50 = 13,628,781,292.95

Pre-tax cost of Debt = 13.26%

Risk free rate = 9.01%

Tax Rate = 32%

21
 Service Industries Limited

Interest After
Debt to Interest Bond Spread Rate on Tax
Debt in PKR Interest Expense Tax Rate
Capital Coverage Rating a Debt Cost of
a + Rf Debt
0% - Aaa/AAA 0.75% 9.76% 32.00% 6.64%
-
10% 180,717,639.94 7.061 A2/A 1.25% 10.26% 32.00% 6.98%
1,362,878,129.30
20% 2,725,756,258.59 361,435,279.89 3.530 Ba1/BB+ 3.25% 12.26% 32.00% 8.34%
30% 4,088,634,387.89 542,152,919.83 2.354 B2/B 6.50% 15.51% 32.00% 10.55%
40% 5,451,512,517.18 722,870,559.78 1.765 B3/B- 7.50% 16.51% 32.00% 11.23%
50% 6,814,390,646.48 903,588,199.72 1.412 Caa/CCC 9.00% 18.01% 32.00% 12.25%
60% 8,177,268,775.77 1,084,305,839.67 1.177 Ca2/CC 12.00% 21.01% 32.00% 14.29%
70% 9,540,146,905.07 1,265,023,479.61 1.009 Ca2/CC 12.00% 21.01% 32.00% 14.29%
80% 10,903,025,034.36 1,445,741,119.56 0.883 Ca2/CC 12.00% 21.01% 28.24% 15.08%
90% 12,265,903,163.66 1,626,458,759.50 0.785 C2/C 16.00% 25.01% 25.11% 18.73%
100% 13,628,781,292.95 1,807,176,399.45 0.706 C2/C 16.00% 25.01% 22.59% 19.36%

As long as interest expenses are less than PKR 1,276,029,000, interest expenses remain fully tax-
deductible and earn the 32% tax benefit. At 70% debt ratio, the interest expenses are PKR
1,265,023,479.61 and the tax benefit is therefore 32% of this amount.

At 80% debt ratio, however, the interest expenses increased to PKR 1,445,741,119.56, which is greater
than the EBIT of PKR 1,276,029,000. We consider the tax benefit on the interest expenses up to this
amount:

Maximum Tax Benefit = EBIT * Marginal Tax Rate = 1,276,029,000 * 32% = 408,329,280

Adjusted Marginal Tax Rate = Maximum Tax Benefit/Interest Expenses

c. Firm Value and Cost of Capital

Value = Expected Cash flow to the firm next year / (Cost of capital g)

Suppose cash flows are PKR 10,000,000 with growth of 3%, so

Debt to Debt to Cost of After Tax Cost of

Firm Value
Capital Equity Equity Cost of Debt Capital

0% 0.00% 17.43% 6.64% 17.43% 71,395,086.14

10% 11.11% 18.06% 6.98% 16.95% 73,813,395.42
20% 25.00% 18.86% 8.34% 16.75% 74,890,298.41
30% 42.86% 19.88% 10.55% 17.08% 73,154,479.83
40% 66.67% 21.24% 11.23% 17.24% 72,351,085.43
50% 100.00% 23.15% 12.25% 17.70% 70,075,267.98
60% 150.00% 26.01% 14.29% 18.98% 64,468,379.83
70% 233.33% 30.78% 14.29% 19.24% 63,442,520.92
80% 400.00% 40.32% 15.08% 20.12% 60,146,378.06
90% 900.00% 68.94% 18.73% 23.75% 49,634,352.13

22
 Service Industries Limited

Appendix H
Monthly Return Data of KSE100 Index and SIL Stock from Jan 2010 to Dec 2014

Date KSE100 Return SRVI Return Date KSE100 Return SRVI Return
08-01-2010 9776.21 - 271.88 - 24-01-2013 17056.36 0.67% 173.17 3.86%
29-01-2010 9614.19 -1.66% 278 2.25% 22-02-2013 18074.27 5.97% 168.6 -2.64%
26-02-2010 9657.79 0.45% 326.32 17.38% 29-03-2013 18043.31 -0.17% 167.7 -0.53%
26-03-2010 10137.93 4.97% 344.01 5.42% 26-04-2013 18917.71 4.85% 220.66 31.58%
30-04-2010 10428.12 2.86% 293.36 -14.72% 31-05-2013 21823.05 15.36% 247 11.94%
28-05-2010 9521.15 -8.70% 208.03 -29.09% 28-06-2013 21005.69 -3.75% 260.99 5.66%
25-06-2010 9796.85 2.90% 212.67 2.23% 26-07-2013 23497.07 11.86% 253.1 -3.02%
30-07-2010 10519.02 7.37% 220.33 3.60% 30-08-2013 22160.85 -5.69% 311.17 22.94%
27-08-2010 9598.71 -8.75% 205.1 -6.91% 27-09-2013 22387.31 1.02% 296.53 -4.70%
24-09-2010 9909.45 3.24% 183 -10.78% 25-10-2013 22445.59 0.26% 309.14 4.25%
29-10-2010 10598.4 6.95% 207.95 13.63% 29-11-2013 24302.19 8.27% 350.89 13.51%
26-11-2010 11145.02 5.16% 229.59 10.41% 27-12-2013 25258.05 3.93% 545.92 55.58%
31-12-2010 12022.46 7.87% 240.04 4.55% 31-01-2014 26784.34 6.04% 473.46 -13.27%
28-01-2011 12462.7 3.66% 230.09 -4.15% 28-02-2014 25783.28 -3.74% 470.46 -0.63%
25-02-2011 11223.52 -9.94% 187.99 -18.30% 28-03-2014 27116.13 5.17% 487.25 3.57%
25-03-2011 11552.13 2.93% 195.81 4.16% 25-04-2014 28850.08 6.39% 550.5 12.98%
29-04-2011 12057.54 4.38% 172.34 -11.99% 30-05-2014 29737.69 3.08% 632.34 14.87%
27-05-2011 12225.52 1.39% 177.39 2.93% 27-06-2014 29343.76 -1.32% 495 -21.72%
24-06-2011 12464.26 1.95% 179.61 1.25% 28-07-2014 30314.07 3.31% 578.1 16.79%
29-07-2011 12190.37 -2.20% 192.11 6.96% 29-08-2014 28567.74 -5.76% 662.57 14.61%
30-08-2011 11070.58 -9.19% 191.92 -0.10% 26-09-2014 29705.65 3.98% 841.87 27.06%
30-09-2011 11761.97 6.25% 198.83 3.60% 31-10-2014 30376.53 2.26% 1016.8 20.78%
28-10-2011 11561.67 -1.70% 205.1 3.15% 28-11-2014 31197.98 2.70% 989.53 -2.68%
25-11-2011 11648.14 0.75% 201.87 -1.57% 26-12-2014 31993.01 2.55% 960 -2.98%
30-12-2011 11347.66 -2.58% 194.99 -3.41%
27-01-2012 11960.22 5.40% 209.95 7.67%
10-02-2012 12231.6 2.27% 202 -3.79%
30-03-2012 13761.76 12.51% 188.03 -6.92%
27-04-2012 14042.77 2.04% 171.76 -8.65%
25-05-2012 13925.06 -0.84% 166.11 -3.29%
29-06-2012 13801.41 -0.89% 165.92 -0.11%
27-07-2012 14526.41 5.25% 169.88 2.39%
31-08-2012 15391.58 5.96% 175.33 3.21%
28-09-2012 15444.82 0.35% 187.1 6.71%
25-10-2012 15812.72 2.38% 162.95 -12.91%
30-11-2012 16573.86 4.81% 168 3.10%
28-12-2012 16943.19 2.23% 166.73 -0.76%

23
 Service Industries Limited

References
http://www.servisgroup.com/

http://www.sscbrands.com/

http://www.tradingeconomics.com/pakistan/government-bond-yield

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html

http://www.investing.com/rates-bonds/pakistan-10-year-bond-yield-historical-data

http://dps.psx.com.pk/

24