The automobile company is planning to enter the hospitality sector by building hotels costing 580 crores. It can fund 40% of the project through its own funds but needs suggestions on raising the remaining funds through shares and debentures/bonds. The financial advisor is asked to prepare a report analyzing the company's options for raising finance through different types of shares and debentures/bonds and recommending an optimal capital structure. The report concludes that a combination of debt and equity provides the best approach to maximize the company's value, as it lowers costs through tax benefits of interest payments while also employing outsider funds efficiently.

1. Comprehensive Report on a prospective Hospitality Company
Prepared by
Nikhil Priya and Prof. D.S Ray
CASE STUDY
A premier Car manufacturing Firm in Chennai has future plans to enter into new business
say in Hospitality Sector in 2017 for building Premier Hotels at all metros of southern states
at an estimated project cost of Rs.580 Crores. Now, The Firm has approached you to suggest
them the options for mobilizing long term sources of Finance. The Firm can manage around
40% of the total project Cost from its own funds and other credit sources but the balance
has to be mobilized from other sources say through Shares & Debentures/Bonds. Now, in
your assumed role as financial advisor, you are required to design, prepare and present a
Comprehensive Report to the above firm, duly incorporating your suggestions on the
various options and methods for raising finance through Shares (various types) and
Debentures / Bonds (various types). The report must also suggest action steps the firm
should take in the above exercise and each of your suggestion must be justified with valid
points. Any required data can be assumed but the same has to be mentioned in your report.
ANALYSIS
The automobile giant isinterestedto create a new vertical in the hospitalityindustryby building
premierhotelsat a cost of 580 crores. The Firm isunsure of how to mobilize itssource of funds so
it has approached a financial advisor to seekhelp.The firm can manage to fundonly 40% ofthe
project from its own fundsbut the balance has to be mobilizedfromothersources. As per a
research done,the hospitalitysector in India was raising its fundsmainly through the issue of
equityshares. Examplesinclude ITC Hotels,Taj Hotels,etc. This processhas beenrepeatingitself
for past twenty years.
Capital structure isthe mix of the long-termsourcesof fundsusedbyafirm.It ismade of debtand
equitysecuritiesandreferstopermanentfinancingof afirm.Itis composedof long-termdebt,
preference share capital andshareholder’sfunds.The followingpointsare tobe keptin mindwhile
determininganideal capital structure:
 It shouldminimize costof capital
 It shouldreduce risks
 It shouldgive requiredflexibility
 It shouldprovide requiredcontrol tothe owners

2.  It shouldenable the companytohave adequate finance
 It shouldmaximizethe value of the firm
We needtohave an optimal capital structure bycombiningdebtwithequitywhichwill inturn
maximize the value of the company.Optimalcapital structure maybe definedasthatrelationshipof
debtand equitywhichmaximizesthe value of company’sshare inthe stockexchange.
Comparative Study of Capital Mix:
Situation 1 (only equity) Situation 2 (debt and equity)
EBIT 100 crores EBIT 100 crores
Interest Nil Interest 20 crores
EBT 100 crores EBT 80 crores
Tax (30%) 30 crores Tax (30%) 24 crores
EAT 70 crores EAT 56 crores
No. of shares 58 crores No. of shares 38 crores
EPS 1.21 EPS 1.47
Debt is often cheaper than equity, and interest payments are tax-deductible. So, as the level
of debt increases, returns to equity owners also increase — enhancing the company's value.
If risk weren't a factor, then the more debt a business has, the greater its value would be.
Using debt helps to lower a company's taxes because of allowable interest deductions. Tax
rules permit interest payments as expense deductions against revenues to arrive at taxable
income. .Therefore, tax savings help further reduce a company's debt financing cost, which
is an advantage that equity financing lacks.
In the above situation,EBIThasbeentakenas 100 crores and debtforthe secondsituationis200
crores.Out of the total requirementof fundsof 580 crores,Situation1 consistsof onlyequity(580
crores) whereasSituation2consistsof 200 crores of debtand 380 croresof equity.Inthe post-tax
scenario,Situation2indicateslessEATincomparisontoSituation1.EPS iscomparativelyhigherin
Situation 2 than inSituation 1.
Conclusion:
We can conclude thata combinationof debtandequityisideal forthe firmtomaximize itsvalue in
the stock exchange. Withoutdebt,therewillbe non-employmentof funds. Fora firmcreatinga new
vertical, acombinationof debtandequitycreatesawin-winsituationforbothownershipaswell as
outsiders’ funds.A little exposuretodebtgivesrise tohigherefficiencyinthe utilisationof funds.
Thisstudyhas beenundertakentodevelopandenlightenthe mindsof finance studentsof variouss
universitiesinthe world.
(Nikhil isanAnalystwithEY,andProf.Ray is a facultyaffiliatedtoBangalore University)