Financial Management – I Project

Report

Risk Analysis - Hindalco vs Nalco

Submitted to:
Prof. V.NARENDAR

Submitted by:

GROUP No – 15,
SEC - A

MADHUSUDAN MOHAPATRA
(09BSHYD0419)

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 SANTOSH ANAND DHARWAR
(09BSHYD0736)
MADAN SINGH (09BSHYD0417)
DEEPTI
(09BSHYD0249)

OBJECTIVE:

To calculate risk & return, weighted average cost of capital (cost of equity and cost of debt), of
two companies: Hindalco & Nalco and thereby determine the riskier company of the two
companies and find the factors influencing the risk in the two companies.

INTRODUCTION:

Aluminum Industries in India is one of the leading industries in the Indian economy. The growth
of the aluminum Metal industry in India would be sustained by the diversification and
exploration of new horizons for the industry. India has huge deposits of natural resources in form
of minerals like copper, chromite, iron ore, manganese, bauxite, gold, etc. The India aluminum
industry falls under the category of non iron based which include the production of copper, tin,
brass, lead, zinc, aluminum, and manganese.
The main operations of the of the India aluminum industry is mining of ores, refining of
the ore, casting, alloying, sheet, and rolling into foils. At present, Hindalco and Nalco are one of
the most economical in the production of aluminum in the world. For the sustenance of the
growth the aluminum industry in India has to develop research and development units to assist
the production and improve on the quality measures to keep a stringent quality control.
The India aluminum Metal Industries sector in the previous decade experienced substantial
success among the other industries. The India aluminum industry is developing fast and the
advancement in its technologies is boosting the growth even faster. The utilization of both
international and domestic resources was significant in the rapid development of the India
aluminum industry. This rapid development has made the India aluminum industry prominent
among the investors. The India aluminum industry has a bright future as it can become one of the
largest players in the global aluminum market as in India the consumption is fairly low, the
industry may use the surplus production to cater the international need for aluminum which is
used all over the world for several applications such as aircraft manufacturing, automobile
manufacturing, utensils, etc.

The companies under the India aluminum industry:

Hindalco (Hindalco Industries Ltd)
Indal (Indian Aluminum Co Ltd)
Nalco (National Aluminum Co Ltd)
Balco (Bharat Aluminum Co Ltd)
Malco (Madras Aluminum Co Ltd)

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Methodology:

The assignment involves calculation of risk & return, cost of capital of two companies: Hindalco
and Nalco. All the values of share prices of both the companies were taken from Bombay Stock
Exchange (BSE). Their respective returns are compared with returns from SENSEX. The
analysis is done taking into consideration share prices for 4 years and 4 months years i.e. from
April, 2005 to August, 2009.

Calculation of Beta:

Beta value is calculated for the entire period for both the companies. Return of market and
security is calculated using the formulas given below:

BETA (β): A measure of the volatility, or systematic risk, of a security or a portfolio in

comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a
model that calculates the expected return of an asset based on its beta and expected market
returns. It is also known as "beta coefficient".

β=COVAR(security,market)/Var(market)

• The covariance between the market return and that of the companies was calculated
directly using Microsoft Excel.

• The market returns of each day of respective months were used to arrive at the
Market Variance.

• Returns for all the months are also calculated in a separate table and also plotted to
see the graphical comparison of returns on stock with the market.

Cost of Capital:

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Calculation of Cost of Equity (Ke)
Cost of equity is calculated using two approaches: Dividend Growth Model and Capital Asset
Pricing Model (CAPM).

CAPM Model:
The capital asset pricing model (CAPM) is used in finance to determine a theoretically
appropriate price of an asset such as a security. Under CAPM Model the cost of equity was
calculated using the formula

Es = Rf + β *(Rm-Rf)

Where,
Es, the expected return for a security
Rf, the expected risk-free return in that market (government bond yield)
β, the sensitivity to market risk for the security
RM, the historical return of the stock market/ equity market
(RM-Rf), the risk premium of market assets over risk free assets.
The model states that investors will expect a return that is the risk-free return plus the security's
sensitivity to market risk times the market risk premium. The risk free rate is taken from the
lowest yielding bonds in the particular market, such as government bonds.

Dividend Growth Model:

Under Dividend Growth Model the growth rate was calculated using the dividend value change
over the period of 4 years. Formulae that was used:

Ke = (Do/Po) + g

Dividends declared by both the companies have been taken out from published sources for
calculation purposes.

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Cost of debt
The amount of interest rate is directly mentioned in the annual report of respective companies.
So the weighted average of all the debt are taken and used to find the Total Cost of Debt.

Weighted average cost of capital

To find the weighted average cost of capital I have used the total cost of equity and total cost of
debt. As both the companies have not issued any preferential shares, the formula used for
calculating the total cost of capital is

WACC= [Ke*We+Kd(1-t)*Wd+Kt*Wt(1-t)]

Where,
Ke, total cost of Equity
Kd(1-t), after tax total cost of debt
Kt, after tax total cost of loans
Wt, weight of loans in total capital (total value of loans/ total value of capital)
We, weight of equity in total capital (total value of equity/ total value of capital)
Wd, weight of debt in total capital (total value of debt/ total value of capital)

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HINDALCO:
Hindalco Industries Limited, the metals flagship company of the Aditya Birla Group, is an
industry leader in aluminium and copper. A metals powerhouse with a consolidated turnover of
Rs.600, 128 million (US$ 15 billion), Hindalco is the world's largest aluminium rolling company
and one of the biggest producers of primary aluminium in Asia. Established in 1958, Hindalco
commissioned its aluminium facility at Renukoot in Eastern U.P. in 1962. Later acquisitions and
mergers, with Indal, Birla Copper and the Nifty and Mt.Gordon copper mines in Australia,
strengthened the company's position in value-added alumina, aluminium and copper products,
with vertical
integration through Stock Info
access to captive
copper concentrates. Sector ALUMINIUM
In 2007, the Market cap 7929.10 (Crore)
acquisition of
Novelis Inc. a world High/Low 116.00 /98.50
leader in aluminium
rolling and can Face Value (Rs) 1
recycling marked a
significant milestone NSE Code HINDALCO
in the history of the
aluminium industry in India. With Novelis under its fold Hindalco ranks among the global top
five aluminium majors, as an integrated producer with lowcost alumina and aluminium facilities
combined with high-end rolling capabilities and a global footprint in 12 countries outside India.
Its combined turnover of US$ 15 billion, places it in the Fortune 500 league.

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Risk &Returns:
Returns for the
period from 30
MARKET RETURN: -9.19%
April, 2005 to 31
August, 2009 have Covariance: 125.90
been calculated variance(market): 421.896
(Click for β=(cov(X,Y)/б²x) 1.469457476
Calculations).

As there is a negative covariance, there is a negative relation between the stock and market
returns. Since the value of beta (slope of regression line) is greater than 1, it can be inferred that
if the market will fall stock price will fall with a higher pace and vice versa. So we infer that the
risk of the asset is greater than the market risk. The investor assigns a higher risk premium to
asset than to the market.

BSE vs HINDALCO
Calculations:

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 CAPM Model
Rf 4.5842%
Rm -9.19%
beta(β) 1.469457476
Cost of Equity(Ke) -15.655%

Dividend Growth Model

Average growth rate: 10.0%

Expected dividend: 203.5

Market price of stock on 31st August'09: 107.15

Cost of equity (Ke)= -15.655%

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NALCO
Incorporated in 1981, as a public sector enterprise of the Government of India, National
Aluminium Company Limited (Nalco) is Asia's largest integrated aluminium complex,
encompassing bauxite mining, alumina refining, aluminium smelting and casting, power
generation, rail and
port operations. Stock Info
Commissioned Sector ALUMINIUM
during 1985-87,
Nalco has emerged Market cap 21407.0 (Crore)
to be a star
performer in High/Low 352.00 /298.25
production, export
of alumina and Face Value 10.00
aluminium, and NSE Code NATIONALUM
more significantly,
in propelling a self-
sustained growth.

Risk & Returns:

Returns for the period from 30 April, 2005 to 31 August, 2009 have been calculated.

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 MARKET RETURN: 49.41%
Covariance: 185.16
Variance(market): 271.9201
β=(cov(X,Y)/б²x) 0.681048931

As there is a positive covariance, there is a positive relation between the stock and market
returns. Since the value of beta (slope of regression line) is less than 1 (0.681048931), it can be
inferred that if the market will fall stock price will fall with an increasing slower pace and vice
versa. So we infer that the risk of the asset is lesser than the market risk. The investor assigns a
less risk premium to asset than to the market.

BSE vs NALCO
Calculation:

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Calculations:
CAPM Model
Rf 4.5842%
Rm 45.49%
0.681048
beta(β) 931
Cost of Equity(Ke) 32.44%

Dividend Growth Model

average growth rate: NIL
expected dividend: 15
market price of stock on 31st August'09: 348.05
cost of equity (Ke)= 32.44%

Findings:
• As the beta of Hindalco (1.469457476) is higher than Nalco (0.681048931), we
conclude that former is more risky than the latter.
• Returns provided by Hindalco are much higher than its counterpart.
• The stock of Hindalco has seen more volatility compared to Nalco in recent months.
• So we should invest in Nalco as it is more stable in comparison to Hindalco though
investing in Hindalco would yield higher retrun.

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Bibliography:
Books-

Financial management by Chandra, Prasanna

Financial management by IUP
Financial management by Pandey, I M
Financial management by Khan, Y K & Jain, P K

Web Links-
www.nseindia.com
http://www.hindalco.com/about_us/index.htm
http://www.nalcoindia.com/home.html
www.finance.yahoo.com
www.money.rediff.com
www.rbi.org.in
www.investopedia.com
www.wikipedia.org
http://www.finance30.com/forum/topics/calculating-wacc-in-the-real

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