Finance

Financing Decision
A Project Report
On
Financing Decision
At
Alembic Glass Industries Ltd.
As a Partial Fulfillment
Of
Master of Business Administration Programme
Prepared By
Unnati Rawal
Submitted To
N.R. Institute of Business Management
Gujarat University
Ahmedabad
24
th
July 2004

Financing Decision
PREFACE
During my training at ALEMBIC GLASS INDUSTRIES LTD.,
(AGIL), I observed that the practical very essential to import a practical
knowledge along with a theoretical knowledge provided in the four walls of the
classroom. In order to make the First Year M.B.A. student with an industrial
environment, university made it compulsory to visit at least one industry
according training has a great importance to get familiar with industrial
environment because it is to confirmed time. In objective behind the industrial
training in the First Year M.B.A. is to gain in depth knowledge about the
specialized functional area of management i.e. finance management.
During the training period at AGIL Vadodara, my things which
one are necessary for being a student of financial management. The training
explain me the meaning of financial management is true sense. It provided
me a comprehensive and analytical study of industrial environment of the
organization.
Really speaking, this unit visit has provided a encouraging and
critical analysis of growth of our industries. In this way there was a sincere
and honest attempt behind the training to give the practical knowledge of
industrial structure.
My heartily wishes are always with the company for its bright
future.

Financing Decision
ACKNOWLEDGEMENT
Practical training is an important part of the First Year M.B.A.
Programmme. The study is expected to acquire sufficient practical knowledge about
the various issues on the different management subjects taught to us during the First
Year. The main object of such training is to fill the gap between theoretical
framework and actual practice of management principles. As trainee in Alembic
Glass Industries Ltd., (AGIL) Vadodara it was my pleasure to visit individually all
the functional areas and gain in depth knowledge of financial practice of the
organizations.
It was a great opportunity for me to be there in AGIL as a trainee,
which would not have been possible without the co-operation of the AGIL staff. So, I
would like to sincerely express my gratitude to Mr. A.M. Kamdar, General
Manager, Finance and Mr. R.R. Akbari, Assistant Finance Manager for the same
without the help of them this would have not been possible.
Even I would like to thank Mr. N.M. Khandelwal, Director as well as
Mr. Neeraj Amarnani who had helped me a lot to make my theoretical knowledge
background strong which was of due importance for undergoing this training.
Last but not the least I would even like to thank the staff of AGIL,
which was also much co-operative and helped me a lot during my training.
I would like to wish AGIL best wishes for the future to come.

Financing Decision
EXECUTIVE SUMMARY
The purpose of the study was the “FINANCING DECISION” at
Alembic Glass Industries Ltd., (AGIL) wherein I was suppose to deal with the
subject for the capital restructuring.
The report comprises of the various financial long term as well as
short-term sources of finance, which were evaluated for the restructuring for AGIL. In
order to deal with the sources and to incorporate in the capital restructure the various
cost for the same are also calculated. Even the weighted average cost of the capital
was also incorporated so that the structure can be evaluated accordingly.
Apart from the sources of financing even the other ways of raising the
funds are evaluated. The firm can also raise the funds through the Mergers,
Acquisitions or even the Takeovers. Even which is the most useful way i.e. Merger to
deal out for the same is evaluated for AGIL and even the advantages of the same
within the firm and outside the firm is also known.
There are certain limitations even of the study, which are taken into
account and are incorporated in the report.

Financing Decision
BRIEF COMPANY HISTORY
Alembic Glass Industries Limited ( the Company ) was originally a division of
Alembic Limited promoted by late Shri R.B. Amin. In 1944, the company matured in
to separate organisation. The mission of the company was development of the glass
and ceramic industry and all things and materials pertaining to glass Industry.
The company was incorporated as a Private Limited Company in the Year 1944. Soon
after 7 years the decorating plant was established. In the next year, the company
started production of flint and amber horosilicate vials on automatic machines. In the
subsequent year of an automatic plant for production of press wares was installed. In
the year 1965, the Banglore plant was established for manufacturing hollow wares.
The company began the production of smoky Yera wares on MPD machines.
The company manufactures Pressed - wares such as Glasses, tumblers, bowls, cups,
dishes, mugs, plates, jars, saucers, dinner sets, gift sets, etc., required by the hotel
industries and household customers. And Hollow - wares such as bottles, vials, etc.,
required by the industrial customers such as, food processing, pharmaceuticals,
distillery, soft drink manufacturers, etc. The company’s pressed wares enjoys
consumable preference due to the following strategic advantage.
 Strategic advantage for the company :--
The following are the main strategies for the company:
• National brand:
The company is producing its products under brand name of ‘YERA’ and
‘PREMA’; ‘YERA’ is very popular and national brand. The brand equity of
the company is very high. Value of 'YERA' brand is estimated about Rs 75 to
Rs 100 crores.
• Widest distribution network:
The company has widest distribution network consist of 130 distributors and
about 10000 stockiest/ retain operators in all over India.
• Superior quality of products:
• Largest range
Largest range about 100 products of the company available, which is the highest in
India. Details of range of main products are as under: --
(a) Tumbler :-
In different designs, patterns and shapes, plain and decorating imorted stckers,
crystal, heavy bottom, tall, arrow ,cut, fluted, etc.
(b) Bottles with caps and without caps :-
Plain and decorated in different shape of round, square mouths with air tight
caps and without caps.
(c) Bowls and casseroles :-
Plain and decorated crystals, spiral, fancy, fluted bowls in different shape
of square, round, octagonal, etc. plain and decorated casseroles in different
sizes.

Financing Decision
.
(d) Juicer/ beer mugs in different pattern and design of square, crystal, L
shaped, fancy, frosted, hexagonal, etc.
(e) Plain and decorated round plates
(f) Jugs (including pourers and without pourers) in plain and decorated in
different shapes and designs of oval.
(g) Gift pack :-
Plain and decorated lemon set, plain dinner sets, pudding sets, crystal
bowls sets, gold line cups and saucers, tumbler sets, charmin/ wild
strawberry, florimunda/ Indiana sets.
(h) YERA opal:-
Plain decorated opal ware products in different size, design and shape viz.
Full and quarter plates, cups and saucers, tea/ coffee mugs, bowls,
casseroles and gift packs, pudding sets, etc.
Presently, the company has only one plant in opertion at Vadodara. The Banglore
unit which manufactured hollow wares and flint glass was closed down in past due to
severe power problem.
In 1987, the company has entered into an agreement with Dharak Limited, Vadodara,
to transfer Vadodara unit of the company. This agreement was basically made for the
labour rationalisation, whereby it was thought prudent to reduce labour cost, improve
labour efficiency and to keep troublesome elements out of the company. The
agreement was expired on 1st
October 2003.
The Company has taken pressed ware production facilities from the closed
pressed ware glass factroy near Bharuch on lease base for a period of 3 years to
enhance the production capacity and stared the production.

Financing Decision
GLASS INDUSTRIES AND the Company
 Growth potential of the Glass Industry :--
The growth of Glass Industry as a whole is expected about 5% p.a. for the next three
to 5 years. Market of plain and decorated pressed ware products (kitchen wares and
table wares viz. Cups, saucers, mugs, plates, bowls, casseroles) is about 100 crores,
where share of the Company is about 20 % in volume and 30 % in value. Market
share of plain and decorated opal ware product is about 40 crores, where share of the
Company , as a new entrant is about 5%, which will be planned to increase up to 10%
within next 2-3 years. The market of the hollow wares product is more than 600
crores.
 Competition :--
The competition in overall glass industry is very stiff and severe. Competition in case
of pressed ware products is mainly from unorganized sector, located in north India
particularly from Firozabad because they are selling the products at low price and
without charging of duty and tax . Secondly, because of global liberalization policy
of the government, the dumping of imported products, the glass wares also made
available in India having attractive designs and colors. The cut throat competition is
prevailing in case of hollow ware products. Main players in the race of competition in
these segments are Gujarat Glass Industries (GGI), Larsen and Toubro Ltd. (L&T),
Hindustan National Glass Owens Built (Thaper group), Victory Glass, Excel Glass,
etc. These are also corporate merger and acquisition cases taking place for
availability of locational benefits by way of saving in transportation cost, maximum
utilization of specialization and expertise of particular group in specific products,
thereby they are offering the product at low price.
The company will be in a better position to face the challenge in pressed ware
products. Because the company from the very beginning has widest distribution
network spread in all over the India, national brand name ‘YERA’ reaching the
consuming consumers and satisfy their dynamic requirements by making the
availability of the products at all time and at all places.
 Distribution network :--
The customers/ consumers of pressed ware products are speared and scattered in
India. The company has established widest distribution network of 130 main
distributors and about 10000 stockiest/ retail operators in all over India. Through the
well-organized distribution network, the company is reaching to its final consuming
customers and meeting their all-dynamic requirements by making availability of its
product at all time and places. The company is selling its product to the main
distributor and the are selling to stockiest/ retail operators and later are selling to the
final customers.
The customers of hollow ware products are mostly industrial corporate sector
companies which are mainly in the area of pharmaceutical and drug, food processing,
beverage, cold drinks/ soft drinks/ liquor, etc. the company was supplying hollow
ware products directly to those companies as per their requirements.
 Introduction of new products :--

Financing Decision
The company is continuously introducing new products in all its category of product
as per taste, performance, choice and requirements of consumers and alteration in its
existing products according to the need and preference of consumers.
GENERAL INFORMATION
NAME : - ALEMBIC GLASS INDUSTRIES LIMITED
REGISTERED OFFICE : - ALEMBIC ROAD, VADODARA-390003.
BOARD OF DIRECTORS : - SHRI CHIRAYU R. AMIN
SMT. MALIKA C. AMIN
MISS YERA R. AMIN
SHRI SHAUNAK C. AMIN
SHRI SURENDRA J. AMIN
DR. GANNATH R. DHOLAKIA
COMPANY SECRETARY : -
AUDITORS : - K.S.AIYAR & CO. (C.A)
4th floor, Janmbhoomi Bhavan,
24-26,Janmbhoomi Marg,
Fort, Mumbai - 400001.
BANKERS : - Pragti Sahkari Bank Ltd. , Alembic Road, Vadodara
R & T AGENTS : - M/S.INTIME SPECTRUM REGISTRY LIMITED
201,Sidcup Tower, Near Marble Arch,
Race Course, Vadodara - 390007
STOCK EXCHANGES : - THE STOCK EXCHANGE, MUMBAI
VADODARA STOCK EXCHANGE LIMITED

Financing Decision
FINANCE MANAGEMENT
INTRODUCTION
Finance Management is the managerial activity, which is concerned with the planning
and controlling of the firm's financial resources. The subject of financial management
is of great interest to practicing managers and academicians.
We can say that it is growing and there are many new things that can be researched
and developed continuously.
OBJECTIVES OF FINANCE MANAGEMENT
 Value Maximization
This is the prime objective of finance management, maximizing value of the firm and
centric goal of all other departments formulated around it. Here value of the firm
means shareholders wealth and that reflects through market price of share. This is
broad concept than other.
 Profit Maximization
It is considered to be a short term objective which is to be maximized.
 Other Objectives
Other miscellaneous objectives advocated by different scholars of the society ,
however , it is not possible for any organisation to satisfy all the stake holders
equally , therefore, there are possibilities to partial fulfillment of such objectives.
MAJOR DECISIONS INVOLVED IN FINANCE MANAGEMENT
 Investment decision
 Financing decision
 Dividend decision
 Liquidity decision
These four are the major decisions involved in finance management and taking these
decisions expediently is the task of finance manager. In this report I have been
assigned e aspects related to cost evaluation of capital restructuring and its financial
resources for the Company
Here in my study I have to evaluate different sources of financing for the proposed
investment. There are mainly two types of fund available viz. short term and long

Financing Decision
term depend upon the requirement and availability we have to select respective
sources.
SOURCES OF LONG TERM FINANCE
There are following different sources available for long term finance out of which
one or more can be adopted depend upon the nature of capex and business
requirement for investment purpose. The following are the sources:
 Equity Capital
 Preference Capital
 Debenture
 Long Term Loan
 Public Deposits
In this report I will be working on the project considering the following points for the
above sources of finance and evaluate these from the Company's point of view.
 Definition
 Criteria
 Constrains
 Procedure
 Advantages/Disadvantages
 Suitability to the company
All these points are evaluated with reference to each source of finance and after that
the short-term sources are evaluated and finally we will reach to the conclusion that
which source is more suitable for the company.

Financing Decision
EQUITY CAPITAL
Equity shares are the ownership security i.e. Equity shareholders are the real owners
of the business. They enjoy the residual profits of the company after having paid off
preference shareholders and other creditors of the company and their liability is
limited to the amount of capital they contributed to the company. The prime
advantage of issuing equity share by the company is that without any fixed obligation
for payment of dividends, it offers permanent capital with limited liability for
repayment. The funds remain with in company throughout its lifetime and are only to
be repaid at the time of liquidation of the company.
PURPOSE OF EQUITY CAPITAL
The main purpose of collecting funds through equity capital is to use them for the
longer period of time. Equity capital is raised normally at the time when the company
is floated. The funds collected through equity capital are mainly utilized for the
purpose of incurring capital expenditure. Subsequently also during its lifetime the
company can issue equity shares upto the limit specified in capital clause of
Memorandum & Articles for which the company is authorized for meeting various
purpose viz. long-term working capital requirements, expansion, modernization etc.
PROCEDURE FOR THE ISSUE OF EQUITY SHARES
Any company issuing equity shares is required to meet and satisfy the required
guidelines of related Sections, Clauses, Sub-Clauses, notifications, Circulars, press
Notes / releases of Companies Act, 1956, Security & Exchange Board of India, Stock
Exchange, The Registrar of Companies, Reserve Bank of India and to take approvals
as may be required from the concern authorities and Government Departments.
A Company can issue equity share in one of the following route:
1) Public issue
This is one of the most popular way of raising funds from public. Companies issue
equity securities to public in the primary market by making an initial public
offering and get them listed on the stock exchange(s). These securities are then
traded in the secondary market
Steps involved in making an IPO: -
1. Approval of Board
2. Appointment of Other Intermediaries: -
 Mangers, Co-Managers and Advisors
 Underwriters
 Bankers
 Brokers

Financing Decision
 Registrars
3. Filing of the Prospectus with SEBI
4. Filing of the Prospectus with ROC
5. Printing and dispatch of the prospectus with the issue form
6. Filing of initial listing application
7. Statutory Announcement
8. Collection and Processing of applications
9. Allotment of shares
10. Listing of issue
2) Right Issue
Under Sec.81 of the Companies Act, 1956 when a company issues additional equity
capital to the existing shareholders on pro-rata basis is called Right Issue.
The company sends "LETTER OF OFFER" to its existing shareholdersand they
can renounce their rights in favour of any other person(s) at market-determined
rate/premium. The cost of floating right issue will be comparatively less than that of
public offer since these shares are issued to existing shareholders, thereby eliminating
the marketing and other relevant public issue expenses.
3) Private Placement
The private placement method involves direct selling of equity shares or preference
shares or debentures securities to a limited number of institutional or high net worth
investors. This avoids the delay involved in going public and also reduces cost
related to public offer. Normally company appoints a merchant banker to network
with the institutional investors and negotiate the price of issue.
4) Preferential Allotment
An issue of equity by a listed/unlisted/private limited company to selected investors
is referred as preferential allotment. It is not related to public issue and it is subject to
following regulations: -
 The shareholders of the company must pass a necessary special resolution and the
Company must obtain government special approval under section 81(1A) before
company makes final allotment, if stipulated.
 The price at which preferential allotment of share is made should not be lower
than the higher of the average of the weekly high and low of the closing price of
the share quoted on the stock exchange during the six months period before the
relevant date.
 Securities issued to the promoter group by this method are subject to a lock in
period of three years and to other categories of investor's for a lock in period of
one year.
5) Global Depository Receipts (GDR)
A GDR is a negotiable instrument, which represents publicly traded local currency
equity share. GDR is only instrument in the form of a depository receipt or certificate
created by the overseas Depository bank outside India and issued to non-residence
investors against the issue of ordinary shares or foreign currency convertible bonds of
the issuing company. GDRs are considered as a common equity of the issuing
company and are entitled to dividends and voting rights since the date of its issuance.

Financing Decision
6) American Depository Receipts (ADR)
ADR is a dollar denominated negotiable certificate, it represents non -US company's
publicly traded equity. It was devised to help Americans invest in overseas securities
and to assist non -US companies wishing to have their stock traded in the American
Markets. A Company wishes to go for ADR needs to be financially very strong.
COST OF RAISING FUNDS THROUGH EQUITY
In this section cost has been calculated as a percentage of total issued capital and this
amount is to be considered as floating/floatation cost and is to be utilized in arriving
at the cost of equity capital.
Initial Public Offer
Underwriting Expenses 1.00%
Brokerage 1.50%
Lead manager's Fees
Registrar Fees
SEBI Procedural Charges
Promotion Expenses 5.50%
Banking Charges
ROC Expenses related to Registration and Filling
Other permissions and act related Expenses
Printing, Postage of Prospectus, Forms and other
Materials
Total Expenditure 8.00%
Right Issue
Legal charges
Approval from Shareholders and BOD 3.00%
Advertisement Expenses
Printing and Postage Charges
Private Placement
Legal charges
Brokerage 4.00%
Merchant Banker Charges
Other Miscellaneous Charges

Financing Decision
Preferential Allotment
GDR and ADR
Total Expenditure 10.0% to 12.0%
Recurring Expenses (Every Year in all the cases)
All the cost is to be equity capital and must be spread over a period of 10 to 15 years
to decide effective cost of raising shares.
COST OF EQUITY CAPITAL
There are two approaches for calculating cost of equity capital
 Dividend Capitalization Model
Cost of Capital = D/ P (1-f) + g
Where:
D = Dividend expected at the end of year one
P = Market price per share
f = floatation cost
g = Growth rate in dividend
For eg. The Company is expected to pay the dividend at 7%, the market price of the
shares is Rs. 150, the floatation for the issue of the share is 2% and the growth rate
of dividend is @12%.
Therefore, considering the above, the cost of equity arrived is
 Capital Asset Pricing Model (CAPM)
Cost of Capital = Rf + β( Rm - Rf )
Where:
Rf = Risk Free Rate of Return
Rm = Rate of Return on Market Portfolio
β = Beta of the Security
The example for the same i.e. CAPM method is stated in the later report on the page
LEGAL CONSIDERATION

Financing Decision
The following are the binding constrains that suppose to be followed by companies at
the time of issuing the Equity Capital
 The Companies Act ' 1956
 SEBI Guidelines
 Stamp Act
 Stock Exchange related rules and formalities
Some additional formalities: -
1. A company cannot issue equity shares beyond its authorized capital, if it wants to
do so then first it has to increase its authorized capital. For that
 Special Resolution is required to be passed
 Form No.5 is required to be filed with the ROC along with required stamp duty
and Registration fees.
2. According to section 292 of the Companies Act 1956 only the Board of Directors
are authorized to issue shares. As per Sec.81 of the Companies Act fresh shares
should be first issued to existing shareholders unless shareholders pass special
resolution to offer those shares to the outsiders.
3. Within 2 months of the issue company has to issue share certificate.
4. Within 30 days of allotment, intimation to ROC in Form No.2 to be given.
5. In case of public issue apart from the company law, SEBI guidelines and other
stock market related formalities to be followed.
6. New share will be ranking pari-passu with the existing shares after allotment.
ADVANTAGES OF EQUITY CAPITAL
1. Dividend is payable out of the profit subject to recommendations of Board of
Directors.
2. Dividend Declaration and rate determined by the Board of Direcotors so
Shareholders have less interference.
3. Equity capital enhances creditworthiness of the company. In general other things
are being same larger the equity base, greater the ability of the firm to raise debt
finance.
4. Presently equity dividend is tax-exempt in hands of investors.
5. Limited liability of shareholders
DISADVANTAGES OF EQUITY CAPITAL
1. Cost of equity is usually highest. The rate of return required by the equity
shareholders is generally higher as compared to other debt instruments.
2. The company has to pay tax on the dividend payment that is extra burden on
company.
3. The initial issue cost of Equity capital is higher than other sources
4. There is dilution of control if the equity base is broader.
5. Risk associated with equity shares is more than other sources so investors are
reluctant to invest in this.

Financing Decision
PREFERENCE CAPITAL
"PREFERENCE SHARE CAPITAL" means, with reference to any company
limited by shares, that part of the share capital of the company, which fulfills both the
following requirements, viz-
(a) With respect to dividends, it carries or will carry a preferential right/carry first
charge over the equity shareholders for the dividends a fixed amount or an
amount calculated at a fixed rate from the residual profit remaining with the
company.
(b) With respect to capital, at the time of liquidation of the company, their dues will
be settled prior to those of equity shareholders.
Basically preference share represents hybrid form of financing. They have certain
features of Equity shares like: -
 Preference dividend is paid out of distributable profits only.
 Preference dividend is not an obligatory payment. However, it is to be paid before
dividend on equity shares is paid.
 Preference dividend is not a tax-deductible expense.
And have certain features of debentures like:-
 Fixed dividend rate.
 They enjoy priority over equity shareholders.
 Generally, Preference shareholders do not enjoy voting rights except in certain
special cases.
PURPOSE OF ISSUING PREFERENCE SHARES
The main purpose of issuing preference shares is also to acquire long-term funds.
Funds collected through preference shares are normally utilized to finance long-term
fund requirements and to meet various other financial obligations. Sometimes
companies also issue preference shares to better their debt-equity ratio, which is one
of the crucial criteria, which banks and other financial institutions consider before
approving various loan requirements of the company.
TYPES OF PREFERENCE SHARES
• Cumulative and Non-Cumulative Preference Shares:
Cumulative preference shares are those shares in which if dividend is not
paid in a particular year, it gets carried forward and becomes payable in
the next year. For example. If dividend on 12% cumulative preference
shares is not paid for a period of 3 years, a dividend arrears of 36% is
payable. It must be noted that a company cannot declare equity dividends
unless preference dividends with arrears are paid.

Financing Decision
• Redeemable and Perpetual Preference Shares:
Redeemable Preference shares have a maturity period, on completion of
which shares have to be redeemed, while perpetual preference shares does
not have and maturity period.
• Convertible and Non-Convertible Preference Shares
Preference Shares gets converted to equity shares after a specified period
of time if they are of convertible nature, which is not the case with non-
convertible preference shares.
Preference can be combined like partly redeemable and convertible with
different options.
COST OF PREFERENCE CAPITAL
The principal cost to the company as far as preference shares are concerned is
definitely the dividend expense. The initial expenditure of preference shares is very
less compared to the equity as preference shares are normally privately placed or
given to selected investors only.
COST OF CAPITAL n
P = ∑ D/(1+kp) t + F/(1+kp)n
t=1
 kp in the above equation is approximately equal to : K = D + [(F-P) / N]
(F+P) / 2
Where,
K = Cost
D = Dividend Rate
F = Redemption Price
P = Issue Price
N = Maturity Period
The example for the same is given in the later report on the page
LEGAL CONSIDERATIONS
Following are the important points that are to be considered from legal point of view:
1 In case of redeemable preference shares, they can be redeemed subject to
following conditions:
 Such shares shall be redeemed only out of profits of the company, which
would otherwise be available for dividend or out of proceeds of fresh issue.
 No such shares shall be redeemed unless they are made fully paid up.
 Where such shares are redeemed otherwise than out of proceeds of fresh
issue, there shall out of profits which would otherwise have been available
for dividend, a sum equal to the nominal amount of the shares redeemed be
transferred to a reserve fund to be called "Capital Redemption Reserve"
2 The amount in Capital Redemption Reserve can be used to issue fully paid bonus
shares.
3 Maximum period of redemption for companies limited by shares is 20 years.
4 Preference shareholders have a right to vote in following cases:

Financing Decision
 They have a right to vote only on resolutions that directly affect their rights
attached to preference shares.
 They have a right to vote on any resolution if the preference dividends are in
arrears for a period of two or more years.
ADVANTAGES OF PREFERENCE SHARES
1 There is no legal obligation to pay dividend. A company does not face any legal
consequences if it skips preference dividend.
2 There is no dilution of control, as preference shares do not carry any voting rights.
3 Preference Capital is regarded as a part of net worth. Therefore, it enhances
creditworthiness of the company.
4 Preference dividends are tax exempt in the hands of investors.
DISADVANTAGES OF PREFERENCE CAPITAL
1 Compared to debt capital it is a little expensive source of financing as dividends
paid is not a tax-deductible expense for the company.
2 If a company skips preference dividends for a period of 2 years, it has to grant
voting rights to preference shareholders.
3 Skipping of preference dividends can be adversely affect image of the firm in the
capital market.

Financing Decision
DEBENTURES
Debentures are the creditorship securities issued by the company for the purpose of
collecting long-term funds in form of debt. A debenture certificate is a document
through which a company acknowledges the debt that it owes to the person(s) in the
certificate and which will be repayable after certain period of time. Like equity
shareholders, debentureholders are not the owners of the company but are the
creditors of the company. The obligation of the company towards its
debentureholders is similar to that of a borrower who promises to pay interest and
principal amount at specified time. Therefore, it does not matter whether company
earns profit or not it has to pay interest to debentureholders.
Certain significant features and noteworthy points related to debentures:-
1 Whenever a debenture issue is made, a trustee is appointed through a trust-deed.
The trustee is usually a bank, financial institution or an insurance company. The
principal role of a trustee is to protect interest of debentureholders and to see that
company fulfills its contractual obligation. A trustee is paid remuneration on per
annum basis.
2 Interest rates may be fixed or floating and payable annually or semi-annually.
3 Debentures are usually secured by a charge on immovable properties of the
company.
4 If a company issues debentures with a maturity period of more than 18 months, it
has to create) Debenture Redemption Reserve (DRR) and if the company is
listed one, the amount in it should be at least half of the issue amount before
redemption commences.
5 Debentures may have call and put options.
PURPOSE OF ISSUING DEBENTURES
Here also the main purpose is to obtain long-term funds for the purpose of financing
various long and short-term projects. This source is less costly when compared to
equity and preference issues as interest paid on debentures is usually fixed and is a
tax-deductible expense but the disadvantage is that a company has to regularly pay
interest irrespective of profit earning.
TYPES OF DEBENTURES
• Non Convertible Debentures
Non-Convertible debentures are redeemed on completion of maturity period and
are not converted to equity shares.
• Convertible Debentures
Convertible debentures on achieving maturity are converted to equity shares.
Convertible debentures can be further classified into following two types: -
(a) Fully Convertible Debentures:
These debentures get converted into equity shares after a specified period of
time at one stroke or in installments. These debentures may or may not carry
interest till the date of conversion. In case of companies with an established

Financing Decision
reputation and stable market price, FCD's are very attractive to the investors
as their bonds are getting automatically converted to equity shares. Which
may at the time of conversion be quoted much higher in the market
compared to what the debentureholders paid at the time of FCD issue.
(b) Partly Convertible Debentures:
These are debentures, a portion of which will be converted into equity share
capital after a specified period, whereas the non-convertible portion of the
PCD will be redeemed as per the terms of the issue after the maturity period.
COST OF ISSUING DEBENTURE
The cost of issuing the debenture which are incurred only once i.e. one time
expenditure related to issue of debenture are written in the year of issue itself and are
not spread over the life of debenture.
Nature of Expenditure
1 Fixed interest rate
2 Stamp Duty
3 Trustee's Remuneration
4 Processing Charges (Front Fees)
5 Printing and Postage
6 ROC Registration Charges
7 Mortgage Fees
8 Acceptance Fees
Note: Floatation cost to be built up and to be added on fixed interest rate for arriving
at the effective cost of preference capital.
1 A Board Resolution should be passed for approving the proposal to issue
debentures, finalize terms and conditions of Trust Deed and for convening
general meeting to secure consent of shareholders.
2 In case of private placement the company is required to hold negotiations with
prospective lenders and obtain applications.
3 Within 30 days of allotment return in Form No. 2 is to be filed with ROC.
4 Within 30 days of creation of charge return in Form No. 10 and Form No. 13
should be filed with ROC
5 Debenture Redemption Reserve (DRR) should be created for the purpose of
redemption and company shall credit adequate amount out of its profits every
year until the debenture are fully redeemed.
6 The security for debenture should be created within 6 months of the issue of
debenture. In case security is not created within 12 months, a penal interest of 2%
should be paid to debentureholders.
7 The issue proceeds shall be kept in an escrow account until documents for
creation of security are executed.

Financing Decision
ADVANTAGES OF DEBENTURE CAPITAL
1 Interest paid to debentureholders is a tax-deductible expense, whereas equity and
preference dividends are paid out of profit after tax.
2 Raising of funds through debentures does not result in dilution of control because
debentureholders are not entitled to vote.
3 Issue costs of debentures are significantly lower than that of equity and preference
capital.
4 Debentureholders do not have share in the value created by the company as
payments are limited to interest and principal.
5 The burden of servicing debentures is generally fixed in nominal terms.
DISADVANTAGES OF DEBENTURE CAPITAL
1 Financial obligation on part of company as far as payment of interest and principal
amount is concerned is fixed. Failure to meet this obligation can cause great deal
of financial embarrassment and even lead to bankruptcy.
2 Company can face financial crises and its creditability can get affected if it
defaults is paying interest to debentureholders.

Financing Decision
TERM LOANS
Term Loans constitute one of the major sources of debt finance for a long-term
project. Historically, term loans given by banks, financial institutions viz., IDBI,
ICICI etc. and state financial corporations have been the primary source of long-term
debt for private firms and most public firms. Term loans represent a source of debt
finance, which is generally acquired to finance acquisition of fixed assets and
working capital margin. Here Term loans should not be confused with short-term
bank loans, which are acquired to finance short-term working capital need and whose
maturity period is normally less than a year. In this section term loans are discussed
in both of its forms viz. rupee term loans and foreign currency term loans
TERM LOANS
RUPEE TERMS FOREIGN CURRENCY
F.C. Loan F.C. ECB’s Loan
Certain significant features and noteworthy points related to term loans: -
1 Term loans can be availed in both forms viz., rupee as well as foreign currency
2 The interest and principal repayment on term loans are definite obligations that are
payable irrespective of the financial situation of the company.
3 The interest rate on the term loan will be fixed after the financial institution
appraises the project and assesses the credit risk, which is subjected to certain
floor rate that differs from industry to industry.
4 Term loans are generally secured through mortgage or by way of deposit of title
deeds of immovable tangible or intangible properties or hypothecation of
movable properties.
5 Financial institutions apart from the security also place certain restrictive
covenants on the borrowing firm.
6 Financial Institutions also ask collateral securities to have a comfort level.
PURPOSE OF TERM LOANS
The main purpose of going for term loans is to get long-term funds for the purpose of
financing various fixed assets and other sources.
Nature of Expenditure
1 Fixed Interest Rate
2 Stamp Duty
3 Processing Charges
4 Legal and Registration Fees

Financing Decision
5 Charge Creation/Registration
6 Brokerage/Intermediary Expenses
7 Certification Charges
8 Other miscellaneous Expenses
Here for per annum cost calculation expenditure other than interest will be spread
over the loan period.
Floatation cost to be built up and to be added as fixed interest rate for arriving at the
effective cost.
TOTAL COST
Per Annum Cost = Total Cost (1-t)
TERM LOANS (FOREIGN CURRENCY)
In this source of finance the corporate obtain the term loan from the local bank but in
foreign currency. In the present scenario this is one of the cheapest source of finance
available to the companies provided they manage through effective hedging
instrument to minimize the cost of borrowing various exchange and other risks
associated with the source in an efficient manner. The funds through this source can
be utilized for various expansions and other projects.
COST OF TERM LOANS (FOREIGN CURRENCY)
The main cost here is the interest cost that the company pays to the lending bank or
financial institution.
The interest is paid in accordance with the agreed terms, which are mutually decided
by the company and the lending institution. Normally interest is paid on floating rate
basis, which is LIBOR plus agreed spread. The agreed spread here rests on the risk
associated with the project and creditworthiness of the company. For payment of
interest the company can enter into interest rate swap or currency rate swap
agreements and reduce the risk considerably.
The principal difference between External Commercial Borrowings and Foreign
Currency Term Loans is that in the later funds are borrowed from within the country
which is not so in case of External Commercial Borrowings.
To minimize the associated floating interest rate risk (LIBOR) and exchange rate
(INR/US DOLLAR), the company can take suitable hedging strategies such as Cross
Currency Swap (CCS) or Coupon Only Swap (COS) or Principal Only Swap(POS)
with or without options. The cost of Foreign Currency borrowing including hedging
cost is generally lower as compared to the term loan in INR.
RESTRICTIVE COVENANTS
In order to protect their interest, financial institutions generally impose restrictive
conditions on the borrowers. While the specific set of restrictive covenants depends
on the nature of the project, risk associated with it and the financial position of the
borrower, loan contracts may have one or more of the following as restrictive
covenants:-

Financing Decision
1 Broad base its board of directors by way of Nominee Director(s) and finalize its
management set-up in consultation with and to the satisfaction of the financial
institutions.
2 Restrain from undertaking any new project and / or expansion or make any
investment without the prior approval of the financial institutions.
3 Refrain from additional borrowings or seek the consent of financial institutions for
additional borrowings.
4 Reduce the proportion of debt in its capital structures by issuing additional equity
and preference capital.
5 Limit its dividend payment to a certain rate or seek the consent of financial
institutions to declare dividend at a higher rate.
6 Refrain from creating further charges on its assets.
7 Provide periodic information about its operations.
8 Limit the freedom of the promoters to dispose of their shareholdings.
9 Effect organizational changes and appoint suitable professional staff.
Following are the points that are to be considered from the legal point of view:-
1 According to the Companies Act 1956, charge created on assets given, as a
security to the loan must be registered with the Registrar of Companies. This
facilitates lenders for verifying whether assets are free or secured and take
decisions accordingly.
2 A board resolution should be passed for approving proposal to create/modify
charge over the asset of the company.
3 Approval from members is required incase of mortgage since creation of charge
amounts to disposal of immovable assets; the approval of members is required to
be obtained before creation of charge for every loan.
4 An application should be made to the Reserve Bank of India for creation of charge
outside India.
5 Within 30 days of creation of charge Form No. 8 and Form No. 13 should be filed
with the Registrar of Companies.
6 Every company must keep at its registered office Registrar of Charges in which
entry should be made regarding creation or modification of charge and it should
be available to members and creditors for inspection.
ADVANTAGES OF TERM LOANS
1 Interest paid on term loans is a tax-deductible expense, whereas equity and
preference dividends are paid out of profit after tax.
2 This mode of financing does not result in dilution of control, as there are no voting
rights connected with this mode of financing.
3 Cost of borrowing in term loans is significantly lower.
4 The burden of servicing debt is generally fixed in nominal terms. Hence debt
provides protection against high-unanticipated inflation.

Financing Decision
DISADVANTAGES OF TERM LOANS
1 This mode of financing entails fixed interest and principal repayment obligation.
Failure to meet these commitments can cause great deal of financial
embarrassment and even lead to bankruptcy.
2 Financial institutions impose restrictive covenants, which limits operating
flexibility of the firm.
3 If the rate of inflation turns out to be unexpectedly low, the real cost of debt will
be greater than expected.
An Alternative way to deal with:
Other structured financing to suit the specific financing requirements of the corporate
say brand financing where Bank will provide the finance against brand finance under
following structure:
AGI sales the National Brand to Bank with condition to resale to AGI at maturity
with predetermined price or incase of consecutive default in making payment of
interest or principal by AGI, the Bank will sell the Brand to Alembic Ltd., at agreed
price and Alembic Ltd. will pay the outstanding balance to Bank and balance to AGI.
Alembic may provide comfort level and undertaking to purchase the Brand from
Bank on default by AGI.
DIAGRAM PRESENTATION:
SPECIAL PURPOSE VEHICLE (SPV) THROUGH PASSED THROUGH
CERTIFICATE (PTC):
Sales Brand
AGI BANK
Sales Proceeds/Loan with Rent/Lease
Rent Payment/ Lease Payment
Resale on Maturity
ALEMBIC LTD.
Resale on Default
Remaining Balance Outstanding Balance

Financing Decision
PUBLIC DEPOSIT
Deposits from the public are an important mode of finance from the corporate sector.
Companies prefer to raise finance by accepting deposits rather than borrowing from
banks and financial institutions, because these are in the nature of unsecured debts and
not backed by any security in the form of hypothecation, mortgage lien, etc. Further
deployment of funds raised through deposits is at the discretion of the company unlike
loans from banks and financial institutions.
The companies (Acceptance of Deposits) Rules, 1975 defines public deposits as any
deposit of money including any amount borrowed by the company but excludes:
 Any amount received from or guaranteed by central or state government.
 Amount received from foreign government or foreign citizens.
 Any borrowings from banks and financial institutions.
 Inter corporate deposits.
 Security deposit received from an employee or an agent.
 Advance received for supply of goods or services.
 Amount received towards subscription to shares or debentures.
 Any amount received from a local authority.
 Any amount received from a director of the company.
 Bonds or debentures secured by mortgage of immovable property of the company
or with conversion option.
 Any unsecured loan brought in by promoters in pursuance to any stipulation by
financial institutions to that effect.
COST OF PUBLIC DEPOSITS
As far as public deposits are concerned the principal cost that the company bears as is
the interest on deposits paid to the deposit holders.
The total net cost to the company with regard to public deposits is after tax payment
of interest.
1 The total amount of public deposits cannot exceed 25% of the aggregate of paid-
up capital and free reserves.
2 Company can accept deposits from its shareholders up to a maximum limit of
10% of the aggregate of paid-up capital and free reserves.
3 The minimum tenure for which public deposits can be accepted or renewed is 12
months. It is stipulated that the maximum maturity period for the deposits cannot
exceed 60 months.
4 If the company, for the purpose of meeting its short-term requirement of funds,
may accept or renew deposits for less than 3 months, but such deposits should not
exceed 10% of the aggregate of paid-up capital and free reserves.
5 The company shall maintain liquid assets to the extent of 15% of the deposits
maturing during the financial year ending 31st March next year.

Financing Decision
ADVANTAGES OF PUBLIC DEPOSITS
1 The procedure for obtaining public deposits is fairly simple.
2 No restrictive covenants are involved.
3 No security is offered against public deposits. Hence, the mortgageable assets of
the firm are kept free for future fund requirements against such assets.
4 The post-tax cost is fairly reasonable.
DISADVANTAGES OF PUBLIC DEPOSITS
1 The quantum of funds that can be raised by way of public deposits is limited.
2 The maturity period is relatively short.
3 Complex legal compliance is to be followed.

Financing Decision
WORKING CAPITAL FINANCING
The expression working capital is used to mean the gross current assets and not net
current assets. The part of the business requirement are met by the current liabilities
which the company or business may incur. Thus, the business may procure the stock
of raw material on credit that will constitute liability at that point of time and thereby
the requirement of the funds will be reduced to that extent.
BANK FINANCE AND MARGIN MONEY REQUIREMENTS:
The banks or financial institutions and the promoters can finance the working capital
requirement. Mainly commercial banks finance working capital requirements of the
company. As the part of the funds are made available to the business through the
current liabilities, the bank will like to finance only that portion of assets which are
not financed by the creditors. Thus, the net working capital is the amount, which is
taken into consideration for the purpose of the sanction of various kinds of limits.
The amount of portion that is financed by the bank is known as the "bank
borrowings" in financial parlance. But the bank will not finance entire 100% i.e.
some amount of assets is put in by the company and rest of amount must be financed
by the bank. The banks may have their own norms for providing finance against the
net working capital requirement is also called "margin money for working
capital", which may vary from industry to industry and from bank to bank.
NET WORKING CAPITAL Promoter's contribution
Margin money for WC
GROSS
CURRENT
ASSETS
CURRENT LIABILITY
(OTHER THAN BANK
BORROWINGS)
NET WORKING CAPITAL
(REQUIREMENT
CONSIDERING FOR
FINANCING BY BANK)
NET WORKING
CAPITAL
ASSETS
Promoters’ contribution
for margin money of W.C.
BANK FINANCE

Financing Decision
SIGNIFICANCE OF MARGIN MONEY:
The Central Bank had set up various committees for evolving suitable norms for this
purpose. The Tandon committee and Chore committee are two noteworthy
committees, which had made important and significant recommendations in this
regard. This prime importance of the margin money for the working capital is that
the amount to some extend should be brought in by the promoter. In the running
Company or the on going project, the margin money will be brought in by way of
internal cash accruals, bringing fresh capital, assets etc.
The company has to approach any commercial bank for getting finance for the
working capital requirement. The company is required to submit certain documents
and financial data i.e. past current and also future projections, to the bank. Various
informations's required by the bank to assess the working capital proposal is to be
provided.
Even profitability statement, balance sheet, fund flow statement, statement of
assessment of working capital requirement, statement of ratio analysis, Schedules for
repayment of loans, interest calculation, depreciation, working capital and break-up
of important items of balance sheet.
On the bases of above information, the bank assess the working capital requirement
of the company the bank would finance the amount after keeping some percent of
total Working Capital Requirement (WCR) to be poured by the Promoters.
CREDIT MONITORING ARRANGEMENTS (CMA):
It is in the form of application to be submitted by the borrowers to the bank requested
for sanction/renewal/extension of banking facilities for working capital requirements.
CMA normally discloses data of last two years actual and next two years
estimates/projections of profitability statement, balance sheet, ratio analysis
calculation of permissible bank finance, fund flow statement assumption made while
preparing CMA, basis of calculation of various norms, other relevant information
and details, etc.

Financing Decision
FORMS OF FINANCING WORKING
CAPITAL
Current liability management focuses on short term financing facilities for working
capital requirement. Short-term financing facilities are of two types:
1. Fund based facilities
2. Non-Fund based facilities
 FUND BASED FACILITIES:
Credit facilities, which actually involve development of funds by the banks,
are known as funds based facilities. It includes trade credit, cash credit, bank
loans and commercial papers.
• TRADE CREDIT:
Trade credit refers to credit that a customer gets from suppliers of goods in
normal course of business. In practice the buying firms do not have to pay
cash immediately for the purchase made. This deferral of payment is a short
term financing called trade credit. Generally everyone wants to delay
payments upto most favorable extend and want receivable as early as
possible. The firm's supplier of materials and outside service extends trade
credit, which appears as accounts payable on the balance sheet. Trade credit
payment terms may include a discount if payment is made within a specified
period, the discount is forgone and the full amount is due on specified date.
Normally the total period would not be less than 6 months. But some times it
can be upto 1 month also. The repayment will be in installments. According
to RBI, the interest rate would be the prime leading rate (PLR). But now the
banks and the borrower as per their requirements decide the interest, i.e. it
may be more or even less than PLR. In most cases, the interest and
installments are payable on the quarterly bases.
It may be generally divided into two parts: Bills payable/ bill discounting
means domestic bills discounting and Foreign bills payable/Foreign bills
discounting means export bills discounting.
• BANK BORROWINGS:
Short-term borrowings are loans with maturity of one year or less. The loan
may be secured or unsecured; Short-term loans are very important source of
financing for a company. The cost of using public debt is considerably higher
than bank debt as fixed cost associate with issuing public debt. It can be
availed in the forms of overdraft, cash credit, purchase/discount of bills and
loan.
Signaling through bank loans:
Company's supplier or customers receives signal regarding companies'
financial health through its ability to raise bank loans.

Financing Decision
- Self liquidating bank loans:
Borrowers use these loans to finance their operating/cash flow . The loans
called self-liquidating because bankers expected the loans to be repaid from
the conversion of raw materials into cash. Inventories and receivables would
be liquidated at the end of the operating cycle, and cash would be used to
repay the bank loan prior to the next operating cycle.
- Lines of credit:
A line of credit is non-contractual agreement between the company and its
bank, which permits the company to borrow upto a stated sum during the
course of year. The prime future and requirement of line of credit arrangement
is cleaning up. It is that must repay the line (Zero credit balance) sometimes
during a year.
- Revolving credit lines:
A revolving credit agreement is a legally enforceable line of credit agreement.
The bank is legally committed to provide the funds to the borrower when
requested.
• OVER DRAFT FACILITIES:
It is over permitted by the bank in current account of the borrower upto a
certain specified limit during a stipulated period. For all operational purpose, it
is equivalent to cash credit facility except for the security - it may be clean i.e.
without security or may be secured against tangible securities such as fixed
deposit receipts against banks, national saving certificates and other such
securities.
• CASH CREDIT/ GETTING CREDIT IN INR OR IN FC:
A major part of working capital requirement of any company would consist of
Inventory viz. raw materials, semi finished goods, finished goods, stores and
spares and book debts/receivables.
Finance against such current assets is generally granted by the banks in the
shape of cash credit here drawings will be permitted against stocks and
receivables. The borrower is allowed to withdraw funds from the bank upto
the sanctioned credit limit but not at once. The interest charged on the amount
actually utilizes by the borrower. The credit is the most flexible arrangement
from the viewpoint of the borrower. It is the most popular method of bank
finance for working capital in India.
It is running account where deposits and withdrawals are permitted as
frequently as required. Here the drawings are secured against the current
assets and a periodical statement of the current assets is to be submitted. The
credit is of two types based on the types of charged created.

Financing Decision
• PACKING CREDIT RECEIVABLES:
Packing credit refers to credit that a customer gets from suppliers of goods
for the packaging of materials. In Indian market receivables are linked to the
prime-leading rate (PLR).
The company, which also exports its good to one or more foreign countries,
can also get this facility as export financing. It cannot be in the form of short-
term loan.
It is broadly divided into two parts: -
1. Pre-shipment advances/packing credit advances:
Here, financial assistance is sanctioned to exporters to enable them to
manufacture, trade and pack the goods meant for export and arrange for
their eventual shipment to foreign countries. An advance to be taken by an
exporter is required to be liquidated within 180 days from the date of its
commencement by negotiation of export bills or receipt of export
proceeds.
Types of packing credit:
(a) Clean packing credit: It is made available to an exporter only on
production of the export order or a letter of credit without exercising any
change or control over raw material or finished goods.
(b) Packing credit against hypothecation of goods: Export finance is available
on certain terms and conditions where the exporters has pledge interest and
goods are hypothecated to the bank as security with stipulated margin.
(c) Packing credit against pledge of goods: Export finance is made available
on certain terms and conditions where the exportable finished goods are
pledged to the banks with approved clearing agent who will ship the same
from time to time as required by the exporter. The possession of the goods
so pledged lies with the bank are kept under its lock and key.
2. Post shipment advance:-
It takes following advance:
(a) Purchase/document of exports bills: After completion of shipment of goods
for exports, the exporter in almost all cases is required to draw a bill on
foreign buyer for submission to his banker for collection. The bill
purchase/ discount facility granted is termed as “post-shipment advance”.
It is backed, by the document of the title of goods, such as bill of leading,
post parcel receipts or air consignment notes.
(b) Advance against export bill sent for collection: Finance is provided by
banks to exporters by the way of advance against export bills forwarded
through them for collection, appropriate margin is kept taking into account
the creditworthiness of the party, nature of goods exported, etc.

Financing Decision
(c) Advance against duty drawbacks, cash subsidy, etc.: To finance export
losses sustained by exporters, bank advance against duty drawbacks, cash
against export performance. Such advances are of clean nature.
Hypothecation of Stocks:
Possession of goods remains with the borrower and floating charge over the
stocks is created in favor of the bank. Drawings are permitted on the bases of
stock statement submitted by the borrower subject to margin stipulated for
each type of stock.
Hypothecation of Book Debts:
Here, a floating charge over the receivables is created with subject to margin
stipulated for each type of debt.
For the purpose of delivery of the bank credit, loan credit, loan system was
introduced in April 1995. This system is made available to the cases; where
the maximum permissible bank finance (MPBF) exceed Rs. 10 crore.
Under this system, the total amount of bank finance would be identified into
two categories:
- Cash credit components
- Loan components
Now a day, the loan components can be minimum as 10 to 15 days also. The
borrowers are required to have a demand loan component of at least 25%. For
this purpose, the MPBF has been divided into two categories:
The accounts where the MPBF is ≥ Rs. 10 crore and Rs. 20 crore
The accounts where the MPBF is ≥ Rs. 20 crore.
This facility is equivalent to overdraft facilities.

Financing Decision
BREAK UP OF MPBF INTO LOAN AND CASH CREDIT
However, the borrower is free to have larger share of the “loan component” in its
MPBF.
Limit of MPBF Credit components Loan
components
Rs.10 crore and Rs. 20 25%
crore 75%
Rs.20 crore 80% 20%
MPFB Rs.10 to
Rs.20 crore
Cash credit
components Rs. 4
to 8 crore
(40% of MPBF)
Cash credit
components
(25% MPBF)
Loan components
Rs.6 to 12 crore
(60% of MPBF)
Loan components
(Balance of
MPBF)
MPFB Rs. to
Rs.20 crore

Financing Decision
• FACTORING OF RECEIVABLES:
Factoring is a financial service, which is rendered by the specialised persons
known as "factors", who deal in realizing the book debts, bills receivables,
managing sundry debtors and sales registers of the commercial or trading
firms. They charge commission for it. Factoring can be with or without
resources; i.e.-ultimate risk may or may not be on the borrower. Thus
factoring helps in realization of credit sales of trading firms. It is useful for
domestic sales as well as export sales. These minimize the risk of bad debts
arising on account of non- realization of credit sales. It is usually for trade
credit transaction of short-term maturity not exceeding 6 months. Cost of
factoring is born by seller.
Parties to factoring contract:
1. Buyer of goods who has to pay for goods brought on credit terms.
2. Seller of goods who has realizes credit terms from buyer.
3. Factor who act as agent in realizing credit sales from buyer and passes on
the realized sum to seller after deducting his commission.
In case of default in repayment by the debtor, the receivables are reversed in
company's accounts.
 NON-FUND BASED FACILITIES:
Credit facilities, which do not involve actual development of funds by banks
but help the borrower to obtain certain credit facilities from third parties are
termed as non-fund based facilities, they include Letter of Credit (L/C) and
Bank guarantee.
• LETTER OF CREDIT:-
Letter of Credit (L/C) is the method of settlement of payment of domestic or
international trade transaction and is widely used to finance purchase of
machinery and raw materials, etc from any foreign country or domestic
supplier particularly PSU’s having monopoly in their business. It contains a
written undertaking given by the bank on behalf of the buyer or the seller to
make payment of a stated amount on presentation of stipulated documents and
fulfillment of the terms and conditions incorporated therein. Here, in most
cases the buyer and seller don’t know each other and the bank functions as the
intermediary for them. The bank generally asks from the borrower to give
bond and stipulated margin/collateral security.
The main parties to L/C transactions:
1. Seller

Financing Decision
The person to whom the guarantee is given to due fulfillment of the
contract by principal debtor. Principal creditors are also sometimes
referred to as beneficiary.
2. Issuing Bank
The bank that agrees requests of the applicant and issues its L/c. As per the
instruction of the applicant.
3. Advising bank
The bank usually in the beneficiary’s country (issuing banks own Branch
or correspondent bank) requested to advise the credit to the beneficiaries.
4. Conforming Bank
Sometimes, the Issuing Bank requests another bank (usually the advising
bank) to add conformation to the L/c. When the bank is requested to
confirm the credit, agrees and adds it’s to the credit. Then such a bank is
known as “Confirming Bank”.
5. Nominated Bank
This is the bank (usually the advising bank) that is nominated by the
Issuing Bank to pay to the seller or to accept the seller or to accept the
draft from him or to negotiate with him.
• BANK GUARANTEE:
Here, the bank commits on behalf of the borrower, to pay the
compensation to the creditor in case, the borrower makes the default in the
payment at maturity. This commitment is called 'Bank Guarantee'. Bank
provides guarantee facilities to its customers who may requires these
facilities for various purposes. It is used when the capital equipment is to
be sold or brought. The guarantee can be given to Government Department
for releasing disputed claims as excise refunds, custom duty refunds, sales
tax, etc. The bank asks the borrower to provide counter guarantee and
stipulated margin/ collateral security.
The guarantee may broadly be divided in three categories as under,
- Financial Guarantee:
The bank gives these kinds of guarantees to the creditor, purely to
discharge the monetary obligation of the customer in case of default.
- Performance Guarantee:
The guarantees are issued for the performance of a specific contract or
the obligation. In case of non-performance of the obligation, the bank
compensated the losses due to the non-fulfillment of the obligations.
- Deferred Payment Guarantee:
If the equipment is brought on deferred payment bases, the bank can give
guarantee to the supplier that the buyer will pay all instruments when
they fall due. Now, if he doesn’t pay the installment in time to the
creditor, the creditor can invoke the guarantee for the defaulted
installment or balance amount. This guarantee is called “Deferred
Payment Guarantee”.

Financing Decision
• SECURITY REQUIRED IN BANK FINANCE :
Banks generally not provide working capital finance without adequate security
the following are method of security, which the banks may require.
1. Hypothecation: Under hypothecation, the borrower is required to provide
security of moveable property. The borrower does not transfer the property
to the bank; it remains in the possession of borrower.
2. Pledge: Under this arrangement, the borrower is required to transfer the
physical possession of the property offered as a security to the bank has
right to lien and goods pledge unless payment of the principal, interest and
any other expense is made.
3. Mortgage: Mortgage is the transfer of a legal or equitable interest in a
specific immovable property for the payment of the debt. In case of
mortgage, the possession the property may remain with the borrower, with
the lender getting the full legal title. The following are the various types of
the mortgage:
a. Simple Mortgage
b. Mortgage by conditional sale
c. English Mortgage
d. Anomalous Mortgage
4. Lien: Lien means right of the lender to retain property belonging to the
borrower until he repays credit. It can be either a particular lien where the
right to retain property until the claim associated with the property is fully
paid/settled. Generally lien, on the other hand, is applicable till dues of the
lender are paid/settled. Banks usually enjoys general lien.

Financing Decision
COMMERCIAL PAPER
Commercial Papers (CPs) are short-term unsecured promissory notes issued at a
discount to face value by well-known companies that are financially strong and carry
a high credit rating. They are sold directly by the issuers to investors, or else placed
by the borrowers through agents like merchant banks and security houses. The
flexible maturities at which they can be issued is one of the main attractions for
borrowers and investors since issues cater to the needs of both. The CP market has the
advantage of giving highly rated corporate borrowers cheaper funds than they could
obtain from the banks while still providing institutional investors with higher interest
earnings than they could obtain from the banking system. The issue of CP imparts a
degree of financial stability to the system as the issuing company necessarily to
remain financially strong.
Commercial Paper (CP) is an important money market instrument issued by the large
corporate. It is a short term secured promissory note issued at a discount to face
value by the reputed companies, who carry high credit rating and have strong
financial background.
CPs may be called as the existing Working Capital Facility or Stand Alone Facility.
FEATURES OF COMMERCIAL PAPER
Following are the features of CP: -
 They are negotiable by endorsement and delivered like pro-noted and hence are
highly flexible instruments.
 They are issued in multiples of Rs. 5 lakhs, but the amount should not be less
than Rs. 5 lakhs by any single investor.
 The maturity varies between 15 days to a year.
 They are purely unsecured, as any assets of the issuing company do not back
them.
 They normally have a buy- back facility; the issuers or dealers can buy-back the
CPs if needed.
 No prior approval of RBI is needed for CP issues and underwriting of the issue is
not mandatory.
REGULATIONS
Since commercial paper represents an unsecured instruments of financing. The
Reserve Bank of India has stipulated certain conditions meant primarily to ensure
that only financially strong companies can issue commercial paper. According to
these conditions, a company can issue commercial paper provided.
 It has a net worth of at least Rs.4 crore, MPBF of minimum Rs. 4 crore and are
listed on stock exchange can issue CP.
 The company should be sanction working capital limit by banks or All India
financial institutions.
 The face value of commercial paper issued by it does not exceed 75% of its
working capital limit.
 Rating Certificate of quantum of CP is to obtain from specialised rating agency
like CARE, ICRA, and CRISIL etc. Rating must not be more than two months.

Financing Decision
 It can be secured or unsecured. But it is usually unsecured and if it is unsecured
the rate of interest will be slight lower.
 If a company issues commercial paper, its working capital limit is lowered. On
repayment of commercial paper, the bank may review the working capital limit.
 For issuing CP, NOC from lead monetary bank is required. Three days in
advance, the intimation is to be sent to RBI through Issuing and Paying Agent
(APG).
CPs can be issued by lower rated companies followed by guarantee of rated group
company say AGI can issue CPs followed by guarantee of Alembic Ltd.
COST ASPECT RELATED TO COMMERCIAL PAPERS
A Commercial paper is sold at a discount from its face value and redeemed at its face
value. CPs is sold at present value of the face value. Hence, the effective cost of
commercial paper can be arrived as under:-
Face Value - Net Amount Realized * 360
Net Amount Realized Maturity Period
The discount cost is the principal cost associated with this source of finance but there
are certain other fees and charges that the company is required to pay which are
described in the proceeding part.

Financing Decision
SHORT TERM LOANS
These are short-term loans provided by the banks for meeting working capital
requirements or for other short-term needs. The repayable period of this sort of loans
is generally 12 months or less than 12 months. They carry a fixed obligation on the
part of the company in form of interest, which is to be paid to the bank by the
company on the terms mutually agreed upon.
The company in two forms can borrow these loans:
 Rupees
 Foreign Currency
COST OF LOANS SHORT TERM ( IN RUPEES)
For the cost purpose the following are the parameters that are taken into
consideration:
 Amount
 Interest
 Margin
 Security
COST OF SHORT TERM LOANS ( IN FOREIGN CURRENCY )
Here also the main cost is the interest cost which the bank and the company, may
mutually agree upon, which is generally.
LIBOR + Agreed Spread
MIBOR LINKED SHORT TERM LOANS
Banks also provide short-term loans for which interest calculation is based on
Mumbai Inter Bank Offering Rate (MIBOR) plus agreed spread. Such loans are
meant for working capital requirement or other short term needs of the company.
Interest Cost = MIBOR + Agreed Spread
The fixation of MIBOR and spread depends on the credit worthiness of the company.
AGI may avail this route of financing followed by guarantee of Alembic Ltd., if it is
available.

Financing Decision
COST OF CAPITAL
FLOATATION COST
CALCULATED
Preference
capital
CASH FLOW
99
7 yrs 1 1.075 1.08 1.085 1.09 1.095
7.50% 8.00% 8.50% 7.50% 8.00% 8.50% 9.00% 9.50%
0 -99 -99 -99
red at par 1 7.5 8 8.5 0.93 0.93 0.92 0.92 0.91
ISSUED @ 2 7.5 8 8.5 0.87 0.86 0.85 0.84 0.83
PAR 3 7.5 8 8.5 0.80 0.79 0.78 0.77 0.76
4 7.5 8 8.5 0.75 0.74 0.72 0.71 0.70
5 7.5 8 8.5 0.70 0.68 0.67 0.65 0.64
6 7.5 8 8.5 0.65 0.63 0.61 0.60 0.58
7 107.5 108 108.5 0.60 0.58 0.56 0.55 0.53
8% 8% 9%
7.69% 8.20% 8.70%
Here, the option of evaluating the preference share capital cost thus it is being issued
at par and redeemed at par with a floatation cost of 1%. Thus in order to arrive at the
appropriate cost the various rate of interest are taken and there present value
incorporated.
7.5 8 8.5
AT 7.5 AT 8 AT 8 AT 8.5 AT 8.5 AT 9
6.98 6.94 7.41 7.37 7.83 7.80
6.49 6.43 6.86 6.80 7.22 7.15
6.04 5.95 6.35 6.26 6.65 6.56
5.62 5.51 5.88 5.77 6.13 6.02
5.22 5.10 5.44 5.32 5.65 5.52
4.86 4.73 5.04 4.90 5.21 5.07
64.80 62.73 63.02 61.01 61.29 59.35
TOTAL 100 97.40 100 97.44 100 97.48
DIFF-A 1 1 1
DIFF-B 2.60 2.56 2.52
QUATIONT 0.19 0.20 0.20
7.5 8 8.5
COC 7.69 8.20 8.70
The cost of capital of the various rates is stated as above at the present value.
CASH FLOW 99

Financing Decision
7 yrs
red at 5%pr 7.50% 8.00% 8.50%
ISSUED @ 0 -99 -99 -99
PAR 1 7.5 8 8.5
2 7.5 8 8.5
3 7.5 8 8.5
4 7.5 8 8.5
5 7.5 8 8.5
6 7.5 8 8.5
7 112.5 113 113.5
8% 9% 9%
8.26% 8.75% 9.25%
Here, is the different option of evaluating the source at different rates which is issued
at par value as well as redeemed at the 5% premium and the redemption takes place
after 7 years.
7.5 8 8.5
AT 7.5 AT 8.5 AT 8 AT 9 AT 8.5 AT 9.5
6.98 6.91 7.41 7.34 7.83 7.76
6.49 6.37 6.86 6.73 7.22 7.09
6.04 5.87 6.35 6.18 6.65 6.47
5.62 5.41 5.88 5.67 6.13 5.91
5.22 4.99 5.44 5.20 5.65 5.40
4.86 4.60 5.04 4.77 5.21 4.93
67.81 63.55 65.93 61.81 64.12 60.13
TOTAL 103.01 97.71 102.92 97.70 102.82 97.70
DIFF-A 4.01 3.92 3.82
DIFF-B 5.31 5.22 5.13
QUATIONT 0.76 0.75 0.75
7.5 8 8.5
COC 8.256224 8.751156 9.25
DEBENTURE
1 1.07 1.08 1.09 1.1

Financing Decision
6YEARS REDEMPTION in 3 installments
2% DISC ISSUE 30% 6th year, 30% 7th year, 40% 8th year
RED. @ PAR 1 2 3 4 5 6 7
7% 8% 9% 7% 8% 9% 10%
FLOATATION COST 0 -97 -97 -97
IS 1.2% 1 7.05 8.05 9.05 0.93 0.93 0.92 0.91
2 7.05 8.05 9.05 0.87 0.86 0.84 0.83
3 7.05 8.05 9.05 0.82 0.79 0.77 0.75
4 7.05 8.05 9.05 0.76 0.74 0.71 0.68
5 7.05 8.05 9.05 0.71 0.68 0.65 0.62
6 37.05 38.05 39.05 0.67 0.63 0.60 0.56
7 34.935 35.635
36.33
5 0.62 0.58 0.55 0.51
8 42.82 43.22 43.62 0.58 0.54 0.50 0.47
8% 9% 10%
7.62% 8.64% 9.66%
Here the premium will be paid in the last installment to the debenture holders
The remuneration will be paid at 0.05% p.a.
CASH
FLOW 97
7 8 9
AT 7 AT 8 AT 8 AT 9 AT 9 AT 10
6.59 6.53 7.45 7.39 8.30 8.23
6.16 6.04 6.90 6.78 7.62 7.48
5.75 5.60 6.39 6.22 6.99 6.80
5.38 5.18 5.92 5.70 6.41 6.18
5.03 4.80 5.48 5.23 5.88 5.62
24.69 23.35 23.98 22.69 23.28 22.04
21.76 20.38 20.79 19.49 19.88 18.65
24.92 23.13 23.35 21.69 21.89 20.35
100.27 95.01 100.26 95.18 100.25 95.34
DIFF-A 3.27 3.26 3.25
DIFF-B 5.26 5.08 4.91
QUATIONT 0.62 0.64 0.66
7 8 9
COC 7.622384 8.642391 9.662691

Financing Decision
7.00 8.00 9.00
AT 7 AT 8 AT 8 AT 9 AT 9 AT 10
6.59 6.53 7.45 7.39 8.30 8.23
6.16 6.04 6.90 6.78 7.62 7.48
5.75 5.60 6.39 6.22 6.99 6.80
5.38 5.18 5.92 5.70 6.41 6.18
5.03 4.80 5.48 5.23 5.88 5.62
24.69 23.35 23.98 22.69 23.28 22.04
21.76 20.38 20.79 19.49 20.04 18.80
27.83 25.84 26.05 24.20 24.40 22.68
TOTAL 103.18 97.72 102.96 97.69 102.93 97.83
DIFF-A 4.18 3.96 3.93
DIFF-B 5.47 5.27 5.10
QUATIONT 0.77 0.75 0.77
7.00 8.00 9.00
COC 7.77 8.75 9.77
ISSUE @ PAR
RED. @ 5% PREM.
7% 8% 9%
-99 -99 -99
7.05 8.05 9.05
7.05 8.05 9.05
7.05 8.05 9.05
7.05 8.05 9.05
7.05 8.05 9.05
37.05 38.05 39.05
34.935 35.635 36.635
47.82 48.22 48.62
8% 9% 10%
7.77% 8.75% 9.77%

Financing Decision
 COST OF EQUITY:
For the calculation of the cost of equity there are various methods for the same. But
from the AGIL'S point of view it is not possible to raise the funds by the way of the
equity. But while evaluating the various it is necessary to even know the cost of
equity though not used for the fund raising.
For the cost calculation, the dividend growth model will not be used, since AGIL
has not paid the dividend to the shareholders since a long time. Thus, to
determine the cost of the equity the alternative method such as capital asset
pricing method is to be used, through which appropriate cost can be derived.
 CAPITAL ASSET PRICING METHOD:
An alternative model for calculating AGIL'S cost of equity is the capital asset pricing
model (CAPM). The use of CAPM requires the following information:
- the expected risk- free rate of return
- the expected risk premium
- beta of the company's return
Risk Free Rate: The risk free rate is generally approximated by the highly liquid,
short-term Government Security. The yield on one year Government Bonds in India
is about 605%. This rate could be used as a proxy for the risk-free rate.
Market Premium: The difference between the expected market rate of return and
the risk free rate of return is the expected market premium. The average monthly
sensex return during the period April '02 to March '04. This implies an annual market
rate of return as 28.8%. This seems to be too sensitive and this is not reasonable for
the calculation and thus we have taken 14.4%.
So, if we assume that the investor expects to earn this rate of return, then the risk
premium is: 0.144 - 0.065 = 0.079%
CALCULATION OF THE BETA FOR CAPM CALCULATION
BETA = N ∑ (XY) - ∑ (X) ∑ (Y)
N ∑X² - (∑X)²
= 24(0.2219) - (0.5717) (0.0725)
24(0.1179) - (0.5717)²
= 5.3256 - 0.9944
2.8296 - 0.3268
= 4.3312 / 2.5028
= 1.731

Financing Decision
COST OF EQUITY:
Ke = Rf - β (Rm - Rf)
Rf. = Government Bonds at 6.5%
Rm. = market return 0.024 p.m.
0.024*12 = 0.288
0.288 / 2 = 0.144
14.4%
Ke = Rf - β (Rm - Rf)
= 6.5 - 1.731 (14.4 - 6.5)
= 20.174

Financing Decision
CAPITAL ASSET PRICING METHOD (CAPM)
RATE OF RETURN
PRICE IN THE BEGINNING - PRICE IN THE END / PRICE IN THE BEGINNING
R = Pt – Pt-1/Pt-1
stock
price
indices company
return
market return
APR. '02 81 3338.16 NIL NIL
MAY
'02
70.6 3125.73 -0.13 -0.06
JUN.
'02
133.8 3244.70 0.90 0.04
JUL. '02 112.95 2987.65 -0.16 -0.08
AUG.
'02
97.8 3181.23 -0.13 0.06
SEP. '02 84 2991.36 -0.14 -0.06
OCT.
'02
93.9 2949.32 0.12 -0.01
NOV.
'02
77.3 3228.82 -0.18 0.09
DEC.
'02
83.95 3377.28 0.09 0.05
JAN.
'03
76.2 3250.38 -0.09 -0.04
FEB.
'03
96.85 3283.66 0.27 0.01
MAR.
'03
90 3048.72 0.07 -0.07
APR. '03 90 2959.79 NIL -0.03
MAY
'03
94 3180.75 0.04 0.07
JUN.
'03
109.8 3607.13 0.17 0.13
JUL. '03 127.9 3792.61 0.16 0.05
AUG.
'03
217.85 4244.73 0.70 0.12
SEP. '03 143 4453.24 -0.34 0.05
OCT.
'03
144.55 4906.87 0.01 0.10
NOV.
'03
163.1 5044.82 0.13 0.03
DEC.
'03
241.6 5838.96 0.48 0.16
JAN.
'04
204.75 5695.67 -0.15 -0.02
FEB.
'04
192 5667.51 -0.06 0.00
MAR.
'04
165 5590.60 -0.14 -0.01
SUM 1.74 0.57
AVERAG
E
0.07 0.02

Financing Decision
CAPITAL ASSET PRICING METHOD
market return(X) company return(Y) (X*Y) (X)2 (Y)2
APR. '02 NIL NIL
MAY
'02
-0.06 -0.13 0.01 0.00 0.02
JUN.
'02
0.04 0.90 0.03 0.00 0.80
JUL. '02 -0.08 -0.16 0.01 0.01 0.02
AUG.
'02
0.06 -0.13 -0.01 0.00 0.02
SEP. '02 -0.06 -0.14 0.01 0.00 0.02
OCT.
'02
-0.01 0.12 0.00 0.00 0.01
NOV.
'02
0.09 -0.18 -0.02 0.01 0.03
DEC.
'02
0.05 0.09 0.00 0.00 0.01
JAN.
'03
-0.04 -0.09 0.00 0.00 0.01
FEB.
'03
0.01 0.27 0.00 0.00 0.07
MAR.
'03
-0.07 0.07 -0.01 0.01 0.00
APR. '03 -0.03 NIL NIL 0.00 NIL
MAY
'03
0.07 0.04 0.00 0.01 0.00
JUN.
'03
0.13 0.17 0.02 0.02 0.03
JUL. '03 0.05 0.16 0.01 0.00 0.03
AUG.
'03
0.12 0.70 0.08 0.01 0.49
SEP. '03 0.05 -0.34 -0.02 0.00 0.12
OCT.
'03
0.10 0.01 0.00 0.01 0.00
NOV.
'03
0.03 0.13 0.00 0.00 0.02
DEC.
'03
0.16 0.48 0.08 0.02 0.23
JAN.
'04
-0.02 -0.15 0.00 0.00 0.02
FEB.
'04
0.00 -0.06 0.00 0.00 0.00
MAR.
'04
-0.01 -0.14 0.00 0.00 0.02
SUM 0.57 1.74 0.22 0.12 1.98
AVERAG
E
0.02 0.07

Financing Decision
WEIGHTED AVERAGE COST OF CAPITAL
Once the component costs have been calculated, they are multiplied by the weights of
the various sources of capital to obtain a weighted average cost of capital (WACC).
The composite, or overall sources of capital are the weighted average of the costs of
various sources of funds, weights being proportion of each source of funds in the
capital structure. It should be remembered that it is the weighted average concept, not
the simple average, which is relevant in calculating the overall cost of capital. The
simple average cost of capital is not appropriate to use because firms hardly use
various sources of funds equally in the capital structure.
The following steps are involved to calculate the weighted average cost of capital:
• Calculate the cost of the specific sources of funds (i.e. cost of debt, cost of equity,
cost of preference capital etc.
• Multiply the cost of each source by its proportion in the capital structure.
• Add the weighted component costs to get the firm's weighted average cost of
capital.
In financial decision-making, the cost of capital should be calculated on an after-tax
basis. Therefore the component costs to be used to measure the weighted cost of
capital should be the after-tax costs. If we assume that a firm has only debt and equity
in its capital structure, then its weighted average cost of capital (ko) will be:
Ko = kd (1-T) wd + kewe
Where, ko is the weighted average cost of capital, kd (1-T) and ke are respectively the
after-tax cost of debt and equity, D is the amount of equity.
Tax rate charged for the cost calculation is at 36% as per the corporate tax rate.
The weighted average cost of capital of the amount to be raised for the Capital
Restructuring:
Sources of Finance are as follows:
1. Preference shares issued at par and redeem at par at 7.5%. Preference shares
worth Rs.8 crores are issued.
2. Debentures issued at par and redemption at par at 8%. Debentures amounting
to Rs. 10 crores issued.
3. Term Loan at 9.5% for 6 years, one year is the monotoring period. Interest is
paid semi-annually. Rs. 2 crores by term loan to be raised.
4. Cash credit to be raised at 12%. Rs. 50 lakhs to be raised by the way of cash
credit.
5. Commercial Paper with face value Rs. 100 maturing after 90 days subject to
roll over with discounting rate of 5%. Interest is payable quarterly.
Commercial Paper amounting to Rs. 2 crores are issued.

Financing Decision
PROPORTION OF THE SOURCES IN THE CAPITAL STRUCTURE:
FORMULA: Amount to be raised by source
Total amount to be raised
PREFERENCE SHARES: 8,00,00,000 / 22,50,00,000 = 0.356
DEBENTURES: 10,00,00,000 / 22,50,00,000 = 0.444
TERM LOANS: 2,00,00,000 / 22,50,00,000 = 0.089
CASH CREDIT: 50,00,000 / 22,50,00,000 = 0.022
COMMERCIAL PAPER: 2,00,00,000 / 22,50,00,000 = 0.089
SOURCES AMOUNT
TO BE
RAISED
PROPORTION COST
AFTER TAX
WEIGHTED
COST
Preference
shares
8,00,00,000 0.356 0.075 0.0267
Debentures 10,00,00,000 0.444 0.0587 0.0261
Term Loans 2,00,00,000 0.089 0.06547 0.0058
Cash Credit 50,00,000 0.022 0.0768 0.0017
Commercial
Paper
2,00,00,000 0.089 0.0337 0.0030
TOTAL
WACOC
22,50,00,000 0.0633*100
= 6.33%
SOURCES AMOUNT TO BE
RAISED
COST AFTER
TAX
AMOUNT
AFTER TAX
Preference shares 8,00,00,000 0.075 60,00,000
Debentures 10,00,00,000 0.0587 58,70,000
Term Loans 2,00,00,000 0.06547 13,09,440
Cash Credit 50,00,000 0.0768 3,84,000
Commercial Paper 2,00,00,000 0.0337 6,74,000
TOTAL 22,50,00,000 1.42,37,440
WEIGHTED AVERAGE COST OF CAPITAL = 1,42,37,440 = 6.33%
22,50,00,000

Financing Decision
FINANCING WORKING CAPITAL GAP (WCG)
Reserve Bank of India has form time to time appointed committee to investigate into
the realistic needs of various types of manufacturing industries, to eliminate the evils
of the bank credit system and devise scientific methods for ascertaining their working
capital needs. But post liberalization, the lending policy of commercial banks has
under gone a change. The format proposed in CMA of RBI is being extensively used
by the commercial bank for the purpose of the assessment of WCR of a borrowing
unit. Earlier banks used to decide the amount of financing required for working
capital by the companies, by the methods of Tandon Committee Approach of MPBF-
Maximum Permissible Bank Finance.
TANDON COMMITTEE APPROACH:
The recommendations of the Tandon Committee are based on the operating plan,
production based financing, or partial bank financing. The following are the major
Recommendations;
 Inventory and Receivables Norms:
The committee has rightly pointed out that the borrower should be allowed to
hold only a reasonable level of current assets, particularly inventory and
receivable. The norms for reasonable level of inventory and receivable are needed
to ensure rational allocation of resources and to avoid the undesirable holding and
financing of current assets.
The Tandon Committee suggested norms for 15 industries excluding heave
engineering and highly seasonal industries, like sugar. The norms where applied
to industrial borrowers, including small-scale industries, with aggregate limits
from the banking system in excess of 10 lakhs.
The committee admitted that the norms cannot be followed rigidly. It allowed
flexibility in the application of norms when a major change in the environment
justifies. The committee visualized the circumstances, such as power cuts, striks,
transport delays, etc. under which the deviation from norms could be permitted.
 Lending Norms:
The committee felt that the main function of the banker as a lender was to
supplement the borrower's resources to carry an applicable level of current assets.
This implied
(a) The level of current assets must be reasonable and based on norms,
(b) A part of the fund requirements for carrying current assets must be financed
form ling term funds comprising owned funds and term borrowing including
other non-current liabilities.
The banker was required to finance only a part of working capital gap; the other
part to be finance by the borrower from the long term sources. Working capital
gap is defined as current assets minus current liabilities excluding bank
borrowings. Current assets will be taken at estimated value or as per the Tandon

Financing Decision
committee norms, whichever is lower. The current assets will be consisting of
inventory and receivables, referred as chargeable current assets (CCA) and other
current assets (OCA).
The Tandon Committee, constituted by RBI, has suggested Maximum
Permissible Bank Finance (MPBF) for the fixation of credit limits. These
methods are known as Method-I, Method-II, and Method-III of Tandon
committee for assessment of WCR. Although as per recent announcement, the
bankers are free to fix the limits, yet the practice of following the Method-II will
continue for quite sometime to come.
Method-I:
Under this method, the bank will provide 75% of working capital gap i.e. (current
assets-current liabilities). Also sometimes called the net working capital. Under
this method the current ratio would work out to atleast 1:1 (it may be even more
than this).
Units engaged in the export activities, units engaged in the SSI/village and tiny
sector product trading/marketing. Sick unit and the units under rehabilitation use
method 1st for getting finance from the bank.
Method-II:
Under the 2nd method the borrower provides 25% of total current assets as
permanent funds of the borrower and current liabilities and bank borrowings etc
provide the balance. Under this method the minimum current ratio works out
1.33:1. Generally, the large corporate use 2nd method for getting finances.
Method-III:
As per this method the follower is required to finance the core assets of the
company. Generally, RBI suggested the limits to the extent of 25% of the total
assets. This is the level of the assets, which the borrower has to maintain
essentially in the project. The funds in the core assets remain permanently
blocked like the investments made in the fixed assets, such as building and plant
and machinery. Here, the required current ratio is 1.5:1. This is shown as under:
25% BORROWER'S
TOTAL
CURRENT
ASSETS
CURRENT
ASSETS
BALANCE Current
Liabilites
Bank
Borrowing

Financing Decision
The MAXIMUM PERMISSIBLE BANK FINANCE (MPBF) from the AGIL's
point of view as per the Tandon Committee Recommendations from the various
methods, Method-I is most appropriate for the calculation.
So, the calculations of MPBF is given below:
)
As per the current years' financial results the following figures are stated:
Current Assets 2124.04
Less: Current Liabilities Less Secured Loans 1348.57
(1377.94 - 29.37)
NET CURRENT ASSETS 775.47
MPBF = 0.75 (C.A. - C.L.)
= 0.75 (775.47)
= 581.6025 Less 29.37
= 552.2325
Only Method-I is applicable from the AGI point of view, the remaining tow
method is not applicable to AGI and it is not evaluated.
METHOD-I: 0.75% ( CURRENT ASSETS - CURRENT
LIABILITIES)

Financing Decision
EVALUATION OF FINANCIAL SOURCES
FROM AGIL POINT OF VIEW:
 EQUITY SHARES:
In order to meet the contingent liability of AGIL, the Capital Restructuring is to be
done in order to finance, and thus meet the requirement generated through long-term
and short-term sources of financing.
Thus, to meet the requirement generated AGIL can issue either fresh equity
shares to the new investors or even issue the same to the existing shareholders.
But considering the Auditor's Remarks in last year's Report and Legal Opinion
taken thereon by the Company Board of Directors had made a reference BIFR
under provision of Sick Industrial Companies (Special Provision) Act, 1985.
There has been no further development except that the reference has only been
registered.
Considering this point we can evaluate that it is not possible for AGI to issue
equity shares, as the investors will be least interested in such a company that has
been registered under BIFR. Even for the same reason existing shareholders will
not be willing to invest further in AGI.
Even the existing shareholders are not interested for the same due to the reason
that AGI has not paid the dividend since long time.
The trading volume of AGI stock is quite low as compared to the other stocks
and thus even this will adversely affect the new issue of shares.
CONCLUSION:
Thus, considering the above mentioned consideration it is not possible for AGIL
to issue the equity shares, as it is not feasible. So, meeting the financial
requirement by the way of equity is not possible as the cost incurred will also be
quite high for the issue.
 PREFERENCE SHARES:
Considering the AGI requirement it can raise the capital requirement from the
issue of preference shares by the way of two options. As even in this source it is
not possible to have more investors for the sake of convenience there will be
preferential allotment of preference shares privately placed, for the reason of
BIFR registration.
The amount to be raised by the way of the preference shares is 10 crores for
meeting the requirement. In order to raise the preference share capital the
company is required to amend in the Article of Association by passing the
resolution in the Extra Ordinary General Meeting with the consent of the of
shareholders & BOD and even prior permission from the Company Registrar.

Financing Decision
THE TWO WAYS OF ISSUE OF PREFERENCE SHARES ARE:
1. issue of preference shares at par and redemption at par.
 there is a preferential placement of the preference shares.
 the preference shares issued are the cumulative preference shares.
 the issue expenditure of the preference shares is 1%
 the redemption of the preference shares is after 7 years at par
 the face value of the preference shares is Rs. 100
 the cost is evaluated taking into account different dividend rates i.e. 7%,
7.5%,8%
2. issue of preference shares at par and redemption at premium.
 there is a preferential placement of the preference shares.
 the preference shares issued are the cumulative preference shares.
 the issue expenditure of the preference shares is 1%.
 the redemption of the preference shares is after 7 years at 5% premium.
 the face value of the preference shares is Rs. 100.
 the cost is evaluated taking into account different dividend rates i.e.
7%,7.5%,8%.
Thus, by issuing the preference shares whichever is having the cost effectiveness
is to be incorporated in the capital structure for the payment of the liability. The
structure is stated below:
Rate of dividend 7.5% 8% 8.5%
Issue @ par & redeem @ par 7.69% 8.20% 8.70%
Issue @ par & redeem @ 5% premium 8.26% 8.75% 9.25%
 DEBENTURES:
As we, have already seen that there are certain limitations as well as problems
associated with the issue of the equity shares as well as with the preference
shares. So, in order to meet the financial requirement it is possible to issue
debentures by the way of private placement. Issuing the debentures by making it
attractive with higher interest payment or by issuing at discount we can raise the
funds.
By the way of debenture to meet the requirement we may raise 10 crores. For the
of debenture the land will be mortgaged. The following banks will be approached
for the trusteeship: ICICI BANK, IDBI, ING VYSYA. Even for doing so we
have two options.
THE TWO WAYS OF THE ISSUE OF DEBENTURES:
1. issue of debenture at 2% discount and redemption at par:
 the issue of the debenture is also done through the private placement only as
it is not possible to issue debenture in the open market as there will be less
number of investors to invest.
 the debentures issued are non-convertible in nature.]

Financing Decision
 the issue expenditure of debenture is 1%.
 as the company needs the trustee for the issue of debenture, trusteeship
expenditure to be incurred is 0.05% p.a.
 the redemption of debenture at par in three installments i.e. 30%, 30%, 40%
in the year 6,7,8 respectively
 the cost of debenture to be evaluated at the different interest rates i.e. 7.5%,
8%,8.5%.
2. issue of debenture at par and redemption at 5% premium:
 even these shares are to be privately placed as response in the open market is
supposed to be not effective.
 the debentures issued are non-convertible in nature.
 the issue expenditure of debenture is 1%.
 as the company needs the trustee for the issue of debenture, trusteeship
expenditure to be incurred is 0.05% p.a.
 the redemption of debenture at par in three installments i.e. 30%, 30%,40% in
the year 6,7,8 respectively and the premium is paid in the last year of
redemption.
 the cost of debenture to be evaluated at the different interest rates i.e. 7.5%,
8%, 8.5%
Thus, the debenture having the least cost of capital by taking into consideration is
to be incorporated in the capital structure. The below stated are the various costs
with the different interest rates:
Rate of Interest 7.5% 8% 8.5%
Issue @ 2% discount & redeem @ par 7.62% 8.64% 9.66%
issue @ par & redeem @ 5% premium 7.77% 8.75% 9.77%
 TERM LOAN:
For meeting the capital requirement the company can even raise capital by the
way of the Term Loan that is attainable easily as compared to the other
instruments and thus term loans will become a part of the capital structure.
The below stated criteria is to be taken into account for the raising of the funds:
 the term loans are raised from the private banks
 in order to raise funds by term loans either land is used for the mortgage or
the Brand is used for the security purpose.
 Alembic Ltd., will stand besides as a Guarantor for the term loan from the
bank.
 the term loan will be repaid over a period of 7 years either by the way of
equal installments or unequal installments depending upon the cashflows
generated.
 in the first year only interest is payable.
 the principal and the interest is spread over a period of 6years.
 in order to raise term loan the processing charges incurred are 0.5%
 for the purpose of the cost evaluation different rate of interest are taken i.e.
9%, 9.5% & 10%

Financing Decision
So, in order to incorporate the term loan in the capital structure the most effective
rate is to be incorporated so that the overall cost of capital is reduced. The below
stated are the various rate of interest for getting the effective cost:
Rate of Interest 9% 9.5% 10%
cost of raising term
loan
9.05% 9.55% 10.05%
 PUBLIC DEPOSITS:
The public deposits can also be raised for the financing the requirement. Even for
the public deposits the below stated considerations are to be taken into account:
By this source of financing the amount to be raised is also 10 crores.
 in the public deposits the lenders have the option of carrying forward the
public deposit even after the maturity.
 the interest is compounded semi-annually.
 in order to arrive at the effective cost the different rates of interest is to be
considered i.e. 6.5%, 7%,7.5% p.a.
Rate of Interest 6.5% 7% 7.5%
Cost of Capital 6.60% 7.12% 7.64%

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