Summary

Company: Larsen & Turbo

Listed: BSE

Debt: Rs.3139.72 Cr

Equity (Net worth): Rs. 9440.69 Cr

Equity shares outstanding: Rs. 29.232 Cr

Share price: Rs.3024.80

Market Capitalization: Rs. 88423 Cr

Cost of Equity: Rs. 10.088%

Cost of Debt: 2.58%

WACC: 9.83%

Note: All data pertains as on 31st March 2008

INTRODUCTION

Larsen & Toubro Limited (L&T) is a technology, engineering, construction and manufacturing company. It is one of the largest and most respected companies in India's private sector.

L&T has an international presence, with a global spread of offices. A thrust on international business has seen overseas earnings grow significantly. It continues to grow its overseas manufacturing footprint, with facilities in China and the Gulf region.

In December 1950, L&T became a Public Company with a paid-up capital of Rs.2 million.  The company's businesses are supported by a wide marketing and distribution network, and have established a reputation for strong customer support. L&T is part of SENSEX and BSE Capital goods index.

The company has manufacturing facilities in India, China, Oman and Saudi Arabia.It has a global supply network with offices in 10 locations worldwide, including Houston, London, Milan, Shanghai, Seoul.

Customers include global majors in over 30 countries.

Operating Divisions:

Engineering & Construction Projects (E&C)

Heavy Engineering (HED)

Engineering Construction & Contracts (ECC)

Electrical & Electronics (EBG)

Machinery & Industrial Products (MIPD)

Information Technology & Engineering Services

Calculation of cost of capitalThe Weighted average cost of capital has been calculated as on 31st march 2008. We have taken the current annual report for the calculation i.e for the financial year ended Mar 2008. We have calculated the cost of capital of L&T on a standalone basis.

The calculation of cost of capital requires the following steps

1) Calculation of Cost of equity2) Calculation of cost of debt3) Calculation of cost of preference share capital4) Calculation of Market value of debt and equity

Calculation of cost of equity

The cost of equity has been calculated using the capital asset pricing model (CAPM) approach. This requires the following information

1) The expected risk free return (Rf)2) The expected risk premium 3) Beta of L&T (β)

Calculation of Beta of L&T

The beta has been calculated using monthly returns of L&T Stock prices and SENSEX monthly returns for the last five years 2004-2009. The data has been attached in the annexure

The beta has been calculated using the regression approach.

Returns(L&T)=a+ bReturn (SENSEX) ,Where b indicates beta

The output for the regression analysis is

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.669277R Square 0.447931Adjusted R Square 0.438413Standard Error 0.109355Observations 60

ANOVAdf SS MS F Significance F

Regression 1 0.56276 0.56276 47.05942 5.04E-09Residual 58 0.693593 0.011959Total 59 1.256353

CoefficientsStandard Error t Stat P-value Lower 95% Upper 95%Lower 95.0%Upper 95.0%Intercept 0.019323 0.014194 1.36132 0.178678 -0.00909 0.047735 -0.00909 0.047735X Variable 1 1.222415 0.178195 6.859987 5.04E-09 0.865719 1.579112 0.865719 1.579112

The value of beta is 1.22. This implies that L&T stock is high risk stock. The chances of the stock outperforming the market are quite high.

The coefficient of correlation of .67 between SENSEX returns and L&T returns shows moderate positive relationship. The implies the movement in L&T follows with the movement of SENSEX.

However the value of Beta available on BSE website is 1.04. This beta is calculated using one year period i.e. Dec-07 to Nov-08. The same beta can be calculated if we take monthly return for the same period as taken by the BSE. However, for our purpose we have calculated Beta using monthly return of five year period.

Risk Free rate of return

The 91 day T-bill rate as on 5 Dec 2008 has been taken as the risk free rate of return. The T bill rate is 6.6048%

Market risk premium

It is the excess of market return over the risk free return. We have calculated the Market return Using SENSEX values for the last 5 yrs.

The market return is approximately 9.46%

CAPM Model

Rf = 6.6048%

Rm = 9.46%

Beta (L&T) =1.22

Cost of equity = Ke

Ke = Rf + β (Rm-rf)

Ke = 6.6048+1.22(9.46-6.6048)

Ke = 10.088%

Hence the cost of equity is calculated as 10.088%

Calculation of cost of debt

The debt cost has been calculated on a standalone basis. The after tax cost of debt has been calculated using statutory tax rate which is 33.99%. The data used in the debt calculation can be referred in Annexure.

Kd (after tax) =2.58%

Calculation of Cost of Preference share capital

Since the company has no preference share in its balance sheet. Hence the cost of preference share capital has been assumed to be NIL

Calculation of Market value of debt and equity

Book Value:

Particulars Book value Weights

Debt 3139.72 24.96%

Equity (Net worth) 9440.69 75.04%

Total 12580.41 100.00%

Market value:

Equity shares outstanding: 29.2327390 Cr

Market price as on 31 Mar 2008: Rs 3024.80

Market Capitalization: Rs. 88423 Cr

Particulars Market Value WeightsDebt 3139.72 3.43%

Equity 88423 96.57%

Total 91562.72 100.00%

DebtParticulars Amount

Secured LoanOther loans 0.07

Unsecured LoanLoans from subsidiary companies 8.5

Short term loansBanks 608.5

Lease finance 0.43

Other loansFrom banks 2436.95

Lease finance 0.27Others 85Total 3139.72

Interest Paid 122.66Cost of debt 3.91%

Cost of debt (After Tax) 2.58%

Calculation of Weighted average cost of capital

WACC= D/D+E*Kd+E/D+E* Ke

D= Debt

E=Equity

Kd=Cost of debt

Ke=Cost of equity

Using the values calculated as above

WACC= .0343*.0258+.9657*.10088

WACC=9.83%

Hence, the Weighted average cost of capital of L&T is 9.83%

Annexure