CHANAKYA NATIONAL LAW

UNIVERSITY

SUBJECT: FINANCIAL MANAGEMENT

Project topic: COST OF CAPITAL AND CAPITAL STRUCTUREO OF

CANARA BANK FOR THE YEAR 2012-13,2013-14,2013-14,2014-
15,2015-16

Submitted To : Dr. KAMESHWAR

PANDEY

Submitted By: AMIT DIPANKAR

B.B.A.LLB

181609 ,2 ND SEMESTER
 TABLE OF CONTENT

ACKNOWLEDMENT

RESEACH METHODOLOGHY

CHAPTER 1: Introduction

CHAPTER 2: Financial Management

CHAPTER 3: Cost of Capital

3.1 Cost of debt

3.2 Cost of Preference capital

3.3 Cost of Equity capital

3.4 The weighted average cost of Capital

CHAPTER 4: Balance Sheet

CHAPTER 5: CANARA BANK

CHAPTER 6: Annual Report

CHAPTER 7: Calculation of Cost of Capital of CANARA BANK

CHAPTER 8: Conclusion

BIBLIOGRAPHY
 ACKNOWLEDMENT
Any project completed or done in isolation is unthinkable. This project, although prepared by
me, is a culmination of efforts of a lot of people. Firstly, I would like to thank our Professor of
Financial management, Dr. Kameshwar Pandey Sir for his valuable suggestions towards the
making of this project.

Further to that, I would also like to express my gratitude towards our seniors who were a lot of
help for the completion of this project. The contributions made by my classmates and friends are,
definitely, worth mentioning.

I would like to express my gratitude towards the library staff for their help also. I would also like
to thank the persons interviewed by me without whose support this project would not have been
completed.

Last, but far from the least, I would express my gratitude towards the Almighty for obvious
reasons.

THANK YOU
 RESEACH METHODOLOGHY

Method of Research

The researcher has adopted a purely doctrinal method of research. The researcher has made
extensive use of the library at the Chanakya National Law University and also the internet
sources.

Aims and Objectives

The aim of the project is to present an overview of “cost of equity, debt, preference share capital,
bond, weighted average cost of capital of canara bank and its impact on profitability of the
company” through qualified information.

Limitation:

The presented research is confined to a time limit of one month and this research contains
doctrinal works, which are limited to library and internet sources and empirical research.
 Introduction
This project deal with the calculation of cost of equity, debt, preference share capital, bond, and
weighted average cost of capital of TVS. For calculating this first researcher need to understand
does the cost of capital is and how to calculate it. The researcher has also dealt with capital
structure. The relative proportion of various sources of funds used in a business is termed as
financial structure. Capital structure is a part of the financial structure and refers to the
proportion of the various long-term sources of financing. It is concerned with making the array
of the sources of the funds in a proper manner, which is in relative magnitude and proportion.
The capital structure of a company is made up of debt and equity securities that comprise a
firm’s financing of its assets. It is the permanent financing of a firm represented by long-term
debt, preferred stock and net worth. So it relates to the arrangement of capital and excludes short-
term borrowings. It denotes some degree of permanency as it excludes short-term sources of
financing. Again, each component of capital structure has a different cost to the firm. In case of
companies, it is financed from various sources. In proprietary concerns, usually, the capital
employed, is wholly contributed by its owners. In this context, capital refers to the total of funds
supplied by both—owners and long-term creditors. Capital structure maximizes the market value
of a firm, i.e. in a firm having a properly designed capital structure the aggregate value of the
claims and ownership interests of the shareholders are maximized. It minimizes the firm’s cost of
capital or cost of financing. By determining a proper mix of fund sources, a firm can keep the
overall cost of capital to the lowest. There are usually two sources of funds used by a firm: Debt
and equity. A new company cannot collect sufficient funds as per their requirements as it has yet
to establish its creditworthiness in the market; consequently they have to depend only on equity
shares, which is the simple type of capital structure. After establishing its creditworthiness in the
market, its capital structure gradually becomes complex.
 Financial Management
Financial Management means planning, organizing, directing and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying
general management principles to financial resources of the enterprise.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as capital budgeting).

Investment in current assets are also a part of investment decisions called as working
capital decisions.

2. Financial decisions - They relate to the raising of finance from various resources which
will depend upon decision on type of source, period of financing, cost of financing and
the returns thereby.

3. Dividend decision - The finance manager has to take decision with regards to the net
profit distribution. Net profits are generally divided into two:

a. Dividend for shareholders- Dividend and the rate of it has to be decided.

b. Retained profits- Amount of retained profits has to be finalized which will depend
upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning
capacity, market price of the share, expectations of the shareholders.
 3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized
in maximum possible way at least cost.

4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.

5. To plan a sound capital structure-There should be sound and fair composition of capital
so that a balance is maintained between debt and equity capital.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with

regards to capital requirements of the company. This will depend upon expected costs and
profits and future programmes and policies of a concern. Estimations have to be made in
an adequate manner which increases earning capacity of enterprise.

2. Determination of capital composition: Once the estimation have been made, the capital
structure have to be decided. This involves short- term and long- term debt equity
analysis. This will depend upon the proportion of equity capital a company is possessing
and additional funds which have to be raised from outside parties.

3. Choice of sources of funds: For additional funds to be procured, a company has many
choices like-

a. Issue of shares and debentures

b. Loans to be taken from banks and financial institutions

c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of
financing.

4. Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager.
This can be done in two ways:

a. Dividend declaration - It includes identifying the rate of dividends and other

benefits like bonus.

b. Retained profits - The volume has to be decided which will depend upon
expansion, innovational, diversification plans of the company.

6. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current liabilities,
maintenances of enough stock, purchase of raw materials, etc.

7. Financial controls: The finance manager has not only to plan, procure and utilize the
funds but he also has to exercise control over finances. This can be done through many
techniques like ratio analysis, financial forecasting, cost and profit control, etc.
 Cost of Capital

In economics and accounting, the cost of capital is the cost of a company's funds
(both debt and equity), or, from an investor's point of view "the required rate of return on a
portfolio company's existing securities".1It is used to evaluate new projects of a company. It is
the minimum return that investors expect for providing capital to the company, thus setting a
benchmark that a new project has to meet.

For an investment to be worthwhile, the expected return on capital has to be higher than the cost
of capital. Given a number of competing investment opportunities, investors are expected to put
their capital to work in order to maximize the return. In other words, the cost of capital is the rate
of return that capital could be expected to earn in the best alternative investment of equivalent
risk; this is the opportunity cost of capital. If a project is of similar risk to a company's average
business activities it is reasonable to use the company's average cost of capital as a basis for the
evaluation. However, for projects outside the core business of the company, the current cost of
capital may not be the appropriate yardstick to use, as the risks of the businesses are not the
same.2

A company's securities typically include both debt and equity, one must therefore calculate both
the cost of debt and the cost of equity to determine a company's cost of capital. Importantly, both

1Brealey, Myers, Allen. "Principles of Corporate Finance", McGraw Hill, Chapter 10

2Fernandes, Nuno. 2014, Finance for Executives: A Practical Guide for Managers, p. 17.
cost of debt and equity must be forward looking, and reflect the expectations of risk and return in
the future. This means, for instance, that the past cost of debt is not a good indicator of the actual
forward looking cost of debt.

Once cost of debt and cost of equity have been determined, their blend, the weighted average
cost of capital (WACC), can be calculated. This WACC can then be used as a discount rate for a
project's projected free cash flows to firm.

3.1 Cost of debt

Cost of debt refers to the effective rate a company pays on its current debt. In most cases, this
phrase refers to after-tax cost of debt, but it also refers to a company's cost of debt before taking
taxes into account. The difference in cost of debt before and after taxes lies in the fact
that interest expenses are deductible. Cost of debt is one part of a company's capital structure,
which also includes the cost of equity. A company may use various bonds, loans and other forms
of debt, so this measure is useful for giving an idea as to the overall rate being paid by the
company to use debt financing. The measure can also give investors an idea of the riskiness of
the company compared to others, because riskier companies generally have a higher cost of debt.
To calculate its cost of debt, a company needs to figure out the total amount of interest it is
paying on each of its debts for the year. Then, it divides this number by the total of all of its debt.
The quotient is its cost of debt.

The formula can be written as:

Value of Debt =
Annual Dividend + (Redeemable Value - Sale value) / Number of years for redemption
(Redeemable Value + Sale value) / 2
Or

Kd = D +(RV - SV) / N
(RV + SV) / 2
3.2 Cost of Preference capital
The cost of preference share capital is apparently the dividend which is committed and paid by
the company. This cost is not relevant for project evaluation because this is not the cost at which
further capital can be obtained. To find out the cost of acquiring the marginal cost, we will be
finding the yield on the preference share based on the current market value of the preference
share. The preference share is issued at a stated rate of dividend on the face value of the share.
Although the dividend is not mandatory and it does not create legal obligation like debt, it has
the preference of payment over equity for dividend payment and distribution of assets at the time
of liquidation. Therefore, without paying the dividend to preference shares, they cannot pay
anything to equity shares. In that scenario, management normally tries to pay a regular dividend
to the preference shareholders.
Broadly, preference shares can be of two types – Redeemable and Irredeemable.

COST OF REDEEMABLE PREFERENCE SHARES

Redeemable Preference Shares: A company may issue this type of shares on the condition that
the company will repay the amount of share capital to the holders of this category ofshares after
the fixed period or even earlier at the discretion of the company.

Cost of Redeemable preference shares =

Annual Dividend + (Redeemable Value - Sale value) / Number of years for redemption
(Redeemable Value + Sale value) / 2

Or

Kp = D +(RV - SV) / N
(RV + SV) / 2

COST OF IRREDEEMABLE PREFERENCE SHARES

Irredeemable preference shares are those shares issuing by which the company has no obligation
to pay back the principal amount of the shares during its lifetime. The only liability of the
company is to pay the annual dividends. The cost of irredeemable preference shares is:
Kp (cost of pref. share) = Annual dividend of preference shares
Market price of the preference stock

Cumulative preference shares:

In case of cumulative preference shares, the market price of the preference stock will be
increased by such amount of dividend in arrears. Cumulative preference shares are those shares
whose dividends will get accumulated if they are not paid periodically. All the arrears of
cumulative preference shares must be paid before paying anything to the equity share holders.

Non-cumulative preference shares:

These are preference shares whose dividends do not get carried forward to the next year if
they are not paid during a year.

If the company issues new preference shares, the cost of preference capital would be:

Kp = Annual dividend / Net proceeds after floatation costs, if any.

If the floatation costs are expressed as percentage, the formula will take the following shape:

Kp = Annual dividend/Net proceeds(1-floatation costs)

3.3 Cost of Equity capital

In finance, the cost of equity is the return (often expressed as a rate of return) a firm theoretically
pays to its equity investors, i.e., shareholders, to compensate for the risk they undertake by
investing their capital. Firms need to acquire capital from others to operate and grow. Individuals
and organizations who are willing to provide their funds to others naturally desire to be
rewarded. While a firm's present cost of debt is relatively easy to determine from observation of
interest rates in the capital markets, its current cost of equity is unobservable and must be
estimated. Finance theory and practice offers various models for estimating a particular firm's
cost of equity such as the capital asset pricing model, or CAPM. Another method is derived from
the Gordon Model, which is a discounted cash flow model based on dividend returns and
eventual capital return from the sale of the investment. Another simple method is the Bond Yield
Plus Risk Premium (BYPRP), where a subjective risk premium is added to the firm's long-term
debt interest rate. Moreover, a firm's overall cost of capital, which consists of the two types of
capital costs, can be estimated using the weighted average cost of capital model.

The cost of equity is the return that stockholders require for their investment in a company. The
traditional formula for cost of equity (COE) is the dividend capitalization model:

Cost of Equity = (Dividend per share( for next year) / Current Market Value) + growth of
dividend

CAPM Method

On this basis, the most commonly accepted method for calculating cost of equity comes from the
Nobel Prize-winning capital asset pricing model (CAPM): The cost of equity is expressed
formulaically below:

Re = rf + (rm – rf) * β

Where:

 Re = the required rate of return on equity

 rf = the risk free rate

 rm – rf = the market risk premium

 β = beta coefficient = unsystematic risk

But what does this mean?

 Rf – Risk-free rate - This is the amount obtained from investing in securities considered
free from credit risk, such as government bonds from developed countries. The interest
rate of U.S. Treasury Bills is frequently used as a proxy for the risk-free rate.
  ß – Beta - This measures how much a company's share price reacts against the market as
a whole. A beta of one, for instance, indicates that the company moves in line with the
market. If the beta is in excess of one, the share is exaggerating the market's movements;
less than one means the share is more stable. Occasionally, a company may have a
negative beta (e.g. a gold-mining company), which means the share price moves in the
opposite direction to the broader market. (Learn more in Beta: Know The Risk.)
For public companies, you can find database services that publish betas. Few services do
a better job of estimating betas than BARRA. While you might not be able to afford to
subscribe to the beta estimation service, this site describes the process by which they
come up with "fundamental" betas. Bloomberg and Ibbotson are other valuable sources of
industry betas.

 (Rm – Rf) = Equity Market Risk Premium (EMRP) - The equity market risk premium
(EMRP) represents the returns investors expect to compensate them for taking extra risk
by investing in the stock market over and above the risk-free rate. In other words, it is the
difference between the risk-free rate and the market rate. It is a highly contentious figure.
Many commentators argue that it has gone up due to the notion that holding shares has
become more risky.
The EMRP frequently cited is based on the historical average annual excess
return obtained from investing in the stock market above the risk-free rate. The average
may either be calculated using an arithmetic mean or a geometric mean. The geometric
mean provides an annually compounded rate of excess return and will in most cases be
lower than the arithmetic mean. Both methods are popular, but the arithmetic average has
gained widespread acceptance.

Once the cost of equity is calculated, adjustments can be made to take account of risk factors
specific to the company, which may increase or decrease a company's risk profile. Such factors
include the size of the company, pending lawsuits, concentration of customer base and
dependence on key employees. Adjustments are entirely a matter of investor judgment, and they
vary from company to company.
3.4 The weighted average cost of Capital

The weighted cost of capital (WACC) is used in finance to measure a firm's cost of capital.
WACC is not dictated by management. Rather, it represents the minimum return that a company
must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital,
or they will invest elsewhere.3

The total capital for a firm is the value of its equity (for a firm without
outstanding warrants and options, this is the same as the company's market capitalization) plus
the cost of its debt (the cost of debt should be continually updated as the cost of debt changes as
a result of interest rate changes). Notice that the "equity" in the debt to equity ratio is the market
value of all equity, not the shareholders' equity on the balance sheet. To calculate the firm's
weighted cost of capital, we must first calculate the costs of the individual financing sources:
Cost of Debt, Cost of Preference Capital, and Cost of Equity Cap.

Calculation of WACC is an iterative procedure which requires estimation of the fair market value
of equity capital.

To calculate WACC, multiply the cost of each capital component by its proportional weight and
take the sum of the results. The method for calculating WACC can be expressed in the following
formula:

WACC = (E/V) * Re + (D/V) * Rd * (1-Tc)

Where:

Re = Cost of Equity

Rd = Cost of debt

E = Market value of firm’s equity

V= E + D

E/V = percentage of financing that is equity

D/V = percentage of financing that is debt

Tc = Corporate tax rate

3Fernandes, Nuno. 2014, Finance for Executives: A Practical Guide for Managers, p. 32.
Uses of Weighted Average Cost of Capital (WACC)

Securities analysts frequently use WACC when assessing the value of investments and when
determining which ones to pursue. For example, in discounted cash flow analysis, one may apply
WACC as the discount rate for future cash flows in order to derive a business's net present value.
WACC may also be used as a hurdle rate against which to gauge ROIC performance. WACC is
also essential in order to perform economic value added (EVA) calculations.

Limitations of Weighted Average Cost of Capital (WACC)

The WACC formula seems easier to calculate than it really is. Because certain elements of the
formula, like cost of equity, are not consistent values, various parties may report them differently
for different reasons. As such, while WACC can often help lend valuable insight into a company,
one should always use it along with other metrics when determining whether or not to invest in a
company.
 Balance Sheet
A balance sheet lays out the ending balances in a company’s asset, liability, and equity accounts
as of the date stated on the report. The most common use of the balance sheet is as the basis for
ratio analysis, to determine the liquidity of a business. Liquidity is essentially the ability to pay
one’s debts in a timely manner. The information listed on the report must match the following
formula:

Total assets = Total liabilities + Equity

The balance sheet is one of the key elements in the financial statements, of which the other
documents are the income statement and the statement of cash flows. A statement of retained
earnings may sometimes be attached.

The format of the balance sheet is not mandated by accounting standards, but rather by
customary usage. The two most common formats are the vertical balance sheet (where all line
items are presented down the left side of the page) and the horizontal balance sheet (where asset
line items are listed down the first column and liabilities and equity line items are listed in a later
column). The vertical format is easier to use when information is being presented for multiple
periods.4

The balance sheet presents a company’s financial position at the end of a specified date. Some
describe the balance sheet as a “snapshot” of the company’s financial position at a point (a
moment or an instant) in time. For example, the amounts reported on a balance sheet dated
December 31, 2015 reflect that instant when all the transactions through December 31 have been
recorded.
Because the balance sheet informs the reader of a company’s financial position as of one moment
in time, it allows someone—like a creditor—to see what acompany owns as well as what
it owes to other parties as of the date indicated in the heading. This is valuable information to the
banker who wants to determine whether or not a company qualifies for additional credit or loans.
Others who would be interested in the balance sheet include current investors, potential

4www.accountingcoach.com/balance-sheet/explanation
investors, company management, suppliers, some customers, competitors, government agencies,
and labor unions.5

CANARA BANK – A PROFILE

5http://www.accountingcoach.com/balance-sheet/explanation
Introduction

Finance is regarded as the life blood of a business enterprise. This is because in the modern
money – oriented economy, finance is one of the basic foundations of all kinds of economic
activity. It is the master key which provides access to all sources of being employed in
manufacturing and merchandising activities. It has rightly been said that business needs money
to make more money, only when it is properly managed. In general finance may be defined as
the provision of money at the time it is wanted. However, as a management function it has a
special meaning finance function may be defined as the procurements of funds and their effective
utilization. Sources of authoritative definition as follows:“Business finance is that business
activity which is concerned with the acquisition and conservation of capital fund in meeting
financial needs an overall objective of a business enterprise”. Harward and Upten says “Finance
is an administrative area or set of administrative functions in an organization which relate with
arrangement of Cash and credit so that the organization may have the means to carry out its
objectives as satisfactory as possible”.

Canara bank is one of the leading commercial banks in India. The bank celebrated its centenary
in 2006 and has occupied a preeminent position among the Indian banking majors both under
business volumes and earnings. The bank has led the Indian Public Sector Banks under aggregate
business. Canara bank in financial year 2011 surpassed yet another milestone of Rs. 5 lakh crore
in total business to attain the status of the ‘Systematically Important Financial Institution’ in the
country. The banks net profit crossed Rs. 4000 crore mark in 2011. As one of the leading public
sector banks in India, Canara Bank during 2014-15, further expanded its network by adding 930
branches and 2221 ATMs, taking the number of branches to 5682 and ATMs to 8533 as at March
2015. The Bank is catering to 6.6 crore customer accounts. The Bank continues to invest in
delivery channels, IT infrastructure, customer service, business process reengineering, innovative
products/services and staff knowledge to strengthen market position.

Canara Bank is an Indian state-owned bank headquartered in Bangalore, Karnataka. It was

established at Mangalore in 1906, making it one of the oldest banks in the country. The
government nationalized the bank in 1969.as of September 2016; the bank had a network of 5849
branches and more than 10026. ATM‟ s spread across India. The bank also has offices abroad in
London, Hong Kong, Moscow, Shanghai, Doha, Bahrain, South Africa, Dubai, Tanzania and
New York.

Statement of Problem

Banking is a vast subject many economic researchers have studying and focusing their attention
on various spheres of banking. The studies available on the performance of commercial banks
are minimum in number. There are, still many unexplored areas that are needed to be explored.
In their context "Financial performance of Canara Bank “is selected for the present study. This
study is meant to assess the performance of commercial banks with special reference to Canara
Bank in terms of branch expansion, deposit mobilization, credit expansion and priority sector
advance and also in the light of objectives of nationalization.

Objective

 To study the products and services in CANARA Bank.

 To analyses the financial statements of the corporation to assess its true financial position
by the use of ratios.
 To find out the recent Trend through the analysis of CANARA Bank.
 To suggest some of the measures to CANARA Bank for future development.