Capital Structure & Leverage Analysis: A Case Study of Steel Authority of India Ltd. (SAIL)

IntroductionCapital structure, or what is generally known as capital mix, is very important to control the overall cost of capital in order to improve the earnings per share of share holders. After globalization and liberalization, various financial sector reforms were started by governments, such as reducing rates of interest etc., which directly affected the capital structure planning of firms. Today, the financing of capital structure is one of the most significant managerial decisions of every corporate. Initially, the company has to plan its capital structure at the time of its promotion. Subsequently, whenever funds have to be raised for finance and investment, a capital structure decision is involved.Relevance of the Study: Despite decades of intensive research, and hundreds of papers after Modigliani and Millers' seminal work, surprisingly there is lack of consensus even today among the finance experts on this basic issue of corporate finance. In practice, it is observed that finance managers use different combinations of debt and equity. Academicians and practitioners alike have found it difficult to find out how a firm decides its capital structure in the perfect capital markets of the west as well as in the imperfect capital markets, as in India. This has led to an upsurge in research on company finance, particularly aimed at understanding how companies finance their activities and why they finance their activities in these specific ways. A practical question therefore is: What determines the capital structure? Many profitable companies fail each year just because of the failure of their management to manage the capital structure properly. Now the corporate are full of financial restructuring by a proper mix of capital structure of debt and equity capital so as to get maximum leverage from the mix by adding value to the shareholders. The present study attempts to identify the impact of capital structure mix for future profitability of the company.Identification of the Problem Area: An attempt has been made to evaluate the performance of Steel Authority of India Limited (SAIL) through Capital Structure Analysis during the period of study from 1996-97 to 2003-04. The main problem areas of the study are:* Computation of value of firm* Analysis of existing capital structure* Performance evaluation with respect to capital structureObjectives of the study: The followings are the main objectives of the study:1) To study the existing capital structure maintained by the firm2) To study the influence of various factors in determining capital structure3) To study the nexus between capital structure and value of firm4) To evaluate the firm's performance with respect to capital structureTheoretical Framework:Concept of Capital Structure: The basic objective of financial management is to maximize the shareholder's wealth and therefore all financing decisions must be taken in the light of this objective. The theory of capital structure has derived its importance from the relationship between the financial leverage and the earnings available to the equity shareholders. In case of favorable financial leverage, the increase in sales or more particularly the increase in earning before interest and tax (EBIT) will have a magnifying effect on the earning per share (EPS). The firm should therefore, select such a capital structure or financial leverage which will maximize the expected EPS. The decisions regarding the capital structure or the financial leverage or the financing mix should also be based on the objective of achieving the maximization of shareholder's wealth.Determinants of capital structure:The following are the various factors which determine the capital structure of a company:i) Cost of capital : Cost of capital of different sources of capital influences capital structure. A company would be interested in less overall cost of capital and that a source that is less expensive will be used more than the one that is more costly. …