COST OF INTERNAL AND EXTERNAL EQUITY WITH SPECIAL REFERENCE TO RAMCO CEMENTS, ALATHIYAR, ARIYALUR (DT), TAMIL NADU

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1 163 COST OF INTERNAL AND EXTERNAL EQUITY WITH SPECIAL REFERENCE TO RAMCO CEMENTS, ALATHIYAR, ARIYALUR (DT), TAMIL NADU ABSTRACT DR.N.SUBRAMANI*; DR.K.UMA**; L.LEO FRANKLIN**; **Research Advisor & Head, Department of Commerce, Urumu Dhanalakshmi College, Trichy. **Assistant Professor of Management studies, J.J. Collegeof Arts & Science, Pudukkottai. **Assistant Professor of Commerce, J.J. Collegeof Arts & Science, Pudukkottai. Each and every firm may raise equity capital internally by retained earnings & externally by Issuing New shares. In both cases shareholder are providing kinds to the firms to finance their capital expenditures. Therefore the equity they supply funds by purchasing new shares or by foregoing dividends, which could have been distributed to them. The firm may have to issue new shares at a price lower them the current market price. Also it may have to incur flotation costs. Thus, external equity will cost more to the firm than the internal equity. It is a formidable task to measure the cost of equity the difficulty devices from two factors. I. It is very difficult to estimate the expected dividends. II. The future earnings and dividends are expected to grow over time. Growth in dividends should be estimated and incorporated in the computation of the cost of equity. The estimation at growth in not an easy task. The cost of external equity is, however greater than the cost of internal equity for one reason. The selling price of the new shares may be less than the market price. INTRODUCTION Each and every firm may raise equity capital internally by retained earnings & externally by Issuing New shares. In both cases shareholder are providing kinds to the firms to finance their capital expenditures. Therefore the equity they supply funds by purchasing new shares or by foregoing dividends, which could have been distributed to them. The firm may have to issue new shares at a price lower them the current market price. Also it may have to incur flotation costs. Thus, external equity will cost more to the firm than the internal equity.

2 164 Sometimes it is argued that the equity capital is free of cost. The reason for such argument is that is not legally binding for firms to pay dividends to ordinary share holders. The equity dividend is not fixed. Ordinary share holders supply funds to the firm in the exception of dividends and capital gains commensurate with their risk of investment. The market value of shares, determined by the demand supply forces in well functioning capital market, reflects the return required by ordinary share holders. Thus, the shareholders required rate of return, which equates the present value of the expected dividends with the market value of the share, is the cost of equity. The cost of external equity would be more than the shareholders if the issue price were different from the market price of the share. It is a formidable task to measure the cost of equity the difficulty devices from two factors. I. It is very difficult to estimate the expected dividends. II. The future earnings and dividends are expected to grow over time. Growth in dividends should be estimated and incorporated in the computation of the cost of equity. The estimation at growth in not an easy task. OBJECTIVES OF THE STUDY The objectives of the study are as follows: METHODOLOGY To assess the overall financial performance of Ramco cements ltd, Alathuyar, Ariyalur (Dt). To examine the firms cost of equity capital the dividend growth model (Internal & External) The present study is based on secondary data. The data have been collected from sample units, mainly their Annual reports & journals, periodicals & websites in the field. The collected data were analyzed in the light of the dividend growth in both (Internal & External equity). SAMPLING In Ariyalur district there were seven cement units working in November There were one public sector & six private sectors units among these one units have been selected for the present study based on the investment and turnover raw meters. PERIOD OF THE STUDY The study period is five years from 2006 to 2010 the financial years commencing 1 st April to and ending 31 st March.

3 165 LIMITATIONS OF THE STUDY The present study is based on secondary data only. The selected area is only Ramco cemets ltd. Further the study deals with the firm s cost of equity (Ke) but does not consider production methods, personal & Problem s forced by the unit. REVIEW OF LITERATURE Das.P.K. (2006) examined the dividend practices followed by the associated cement companies from to He found that the company followed a conservative dividend policy during the study period there was a significant increase in profitability due to earnings per share capital employed current ration was on a declining trend. Jyotimoy Bhatturcharya: (2009) there is no reason. Why larger borrowing by the government need raise internet rates in the economy. It is case of prejudice in favour of Small Government. That the reason for the continued currency of the view. Even if the expressed view is due to desire of keep foreign institutional investors happy, should it not be better of Control speculative capital directly instead of recommending Deflationary fiscal policies in the mildest of recession. Arunasaini & Ram Dhan sain (2010) In their study analyse of liquidity management and hade-off between liquidity, risks profitability. They found that the efficient management of liquidity could be ascertained by a firm s ability to meet maturity debts or obligations. ALATHIYUR UNIT PROFILE The manufacturing unit at Alathiyur near trichy were setup in two phases. The line I has the designed. Capacity of 2200 TPD commissioned in the year Which was upgraded to 2950 TPD in the year The Line II has designed capacity of 3000 TPD, Which comprises the South Asis s first SF Cross Bar Cooler and largest Vertical Roller Mill for clinker grinding and commissioned in the year This is one of the very few energy efficient plants in the world and it is very friendly to ecology and environment. Plant has the State of the Art Technology and equipment at every stage of production. Surface miners for mining, Energy efficient MMD crusher for limestone, Vertical roller mills for Raw materials and Clinker grinding.

4 166 The manufacturing products are: Ordinary Portland Cement Portland Pozzolana Cement There is 20 MW (6MW*2 & 4 MW*2) captive power generation, which will meet 75% of plant Power demand. Operating efficiency of the equipment in each section in the plant range from 100 to 115 % of installed capacity. At Plant & Mines 1. Green belt development in plant and mines. 2. Development of full fledged roads in and around the plant and mines, to suppress fugitive emission. 3. Rain Water Harvesting in both the plant and mines are carried out, so as to conserve the available water resources. 4. Output water of the treatment plant used for the plantation purposes in the plant and in the mines. 5. Transportation of limestone to plant is done through closed belt conveyors of 3 km distance. This is unique in cement plant thereby avoiding usage of heavy vehicles and its fuel, spillages and fugitive emissions coming out from the vehicles. Also ensures safety by avoiding heavy traffic in the mines. 6. All the materials transfer points were connected to unit bag filters. Concrete Roads inside the plant were made. 7. Purchased a road sweeper machine to keep the plant clean Madras Cements has the following arrangements for achieving zero accident in plant. a. Employees should wear safety shoes and helmets in the plant. b. The plant has safety and fire protection equipments. C. Safety audits are conducted by (internal) safety committee members. COST OF INTERNAL EQUITY A firm internal equity consists of its retained earnings. The opportunity cost of the retained earnings is the rate of return foregone by equity shareholders. The shareholders generally expect dividend and capital gain from their investment. The required rate of return of shareholders can be determined from the dividend valuation model.

5 167 NORMAL GROWTH The valuation model for a firm where dividends are expected to grass at a constant rate of is as follows Po = where div= Div (l+g) calculating the cost of equity (Ke) as follows Ke= + g The cost of equity is thus, equal to the expected dividend yield (Div/Po) plus capital gain rate as reflected by expected growth in dividend (g). It may be noted that equation is based on the following assumptions. The market price at the ordinary share Po is a function of expected dividends. The dividend, DIV, is positive. The dividend grow at a constant growth rate g, is the growth rate is equal to the return as equity, ROE, time the retention ration b(ie.g=roe*b) The dividend payout ratio is constant. CONSTANT GROWTH MODEL AND THE COST OF INTERNAL EQUITY Year Dividend Share price Growth Ke RS IN LAKHS Sources: Annual Reports

6 168 COST OF EXTERNAL EQUITY The firm external equity consists of funds raised externally through public. The minimum rate of return which the share holders require on finds supplied by them by purchasing new shares to prevent decline in the existing market price of the equity share, is the cost of external equity. Not only India, but almost countries, the new issues of ordinary shares are generally sold at a price less than the market of price prevailing at the time of the announcement of the share issue. The cost of new issues of equity is calculated as Ke= + g CONSTANT GROWTH MODEL AND THE COST OF EXTERNAL EQUITY RS IN LAKHS Year Dividend Share price Growth Ke Source : Annual reports RESULTS & DISCUSSION: Cost of internal equity is fluctuating trend over the study period. In 2006, the cost of internal equity, 2.5, which slightly decrease to 1.46 in In 2008 it was 1.62, In 2009 and 2010 event up to and due to market price decreased. Cost of external equity is also fluctuating trend over the study period. In 2006, the cost of external equity, 2.5 which is slightly decrease to 1.46 in 2007, In 2008 it was 1.62 In 2009 is 2010 goes down to 1.58 & 1.52 due to decrease of rate of growth.

7 169 CONCLUSION The cost of external equity is, however greater than the cost of internal equity for one reason. The selling price of the new shares may be less than the market price. Ramco Cements has market price is less than the new issues share price for 2009 & 2010 only due to the low rate of dividend. The researcher conclude that this cost of equity is same for both (Internal & External) for Ramco Cements. REFERENCE 1) Finanacial management, I.M.Pandey. Vikas publications, 10 th editions. P.P ) Financial & Management Accounting S.N.Maheswari, sultan chand & Sons, New Delhi. 3) Management Accounting, principles & practice M.A. Shaf, Vikas publishing house ltd. 4) Das.P.K (2006) Dividend practices in selected companies an empirical analysis, The Management Accountant, Vol.41 no April 2006 PP ) Jyotimoy Bhattacharya, Indian institute of nagt, Kodhikode, Economic political weekly, June 5, 2009, P.20. 6) Aruna saini & Ram Dhan saini, the Journal of Accounting is Finance volume 24 No.2, April September 2010.