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BEHAVIOUR OF DEBT: AN EMPIRICAL ANALYSIS

Gurnam Singh Rasoolpur

10

ABSTRACT

This empirical paper makes an attempt to study the behaviour of debt through a case of Dunlop India Ltd. from the tyres &

tubes industry of the Indian corporate sector by studying its impact either favourable or unfavourable on the profitability of

the company by comparing rate of return on net assets (ROIbt2 & ROIat2) with cost of debt (Kdbt & Kdat) on before and after

tax basis during the period under study which covers a time period of nine years extending from the year 1983 to 1991-92 for

the purpose of our study. Thus, the present empirical study is confined to Dunlop India Ltd. from the tyres & tubes industry of

the Indian corporate sector, which is lying in the top ten companies of tyres & tubes industry of the Indian corporate sector

based on sales for the year 1991-92 for the purpose of our study. The study reveals that debt-equity ratio2 has been varying

from 42.97 percent in the 1985 to 22.45 percent in the year 1987-88 during the period under study, whereas, aggregate debt-

equity ratio2 of the company is worked out 30.84 percent during the period under study. It is found that cost of debt on before

tax basis (Kdbt) has been varying from 15.16 percent in year 1985 to 21 percent in the years 1987-88 while cost of debt on

after tax basis (Kdat) has been varying from 17 percent in year 1984 to 7 percent in the year 1990-91 over the period under

study. It is found that rate of return on net assets on before tax basis (ROIbt2) has been declining over the period under study

excepting for the year 1986-87 when it is 21 percent while rate of return on net assets on after tax basis (ROIat2) has been

declining over the period under study excepting for the years 1985 and 1986-87 when it is 12.53 percent and 17 percent

respectively over the study period. It is observed that rate of return on total networth on before tax basis (RONbt) has been

declining and witnessing a deep decline in the years in 1984 and 1991-92 when it is 2.92 percent and 2.07 percent,

respectively, excepting for the year 1986-87 when it is 23 percent while rate of return on total networth on after tax basis

(RONat) has also been declining and witnessing a deep decline in the years in 1984, 1990-91 and 1991-92 when it is 3

percent, 2 percent and 0.96 percent, respectively, excepting for the years 1985 and 1986-87 when it is 12.21 percent and 18

percent, respectively, over the period under study. Thus, it is concluded that the company is suffering from unfavourable

leverage with regard to use of debt during eight out of nine years under study. Consequently, rate of return on total networth

(RONbt & RONat) is less than from cost of debt (Kdbt & Kdat) and rate of return on net assets (ROIbt2 & ROIat2) on before and

after tax basis in the above said eight years under study. It means that use of debt in the capital structure of the company has

negative impact on the profitability of the company during eight out of nine years under study, which consequently is not

contributing to the total networth of the company, which ultimately is not benefitting to the equity shareholders of the

company. However, on aggregate basis, the company has also been experiencing unfavourable leverage with regard to use of

debt on before and after tax basis during the period under study. It is also found that spread and net gain are positive when

leverage impact is positive and vice-versa during the period under study.

KEYWORDS

Return on Net Assets, Return on Total Networth, Cost of Debt etc.

INTRODUCTION

The primary aim of corporate management is to maximize shareholders‘ value and the value of a firm in a legal and ethical

manner. So, a financial manager would consider a number of factors to set an optimal capital structure for a firm giving

considerable weight to earning rate, collateral value of assets, age, cash flow coverage ratio, non-debt tax shield, size (net sales),

dividend payout ratio, debt service ratio, cost of borrowing, corporate tax rate, current ratio, growth rate, operating leverage and

uniqueness (selling cost/sales) etc. ―A company can finance its investments through debts/or equity. The company may also use

preference capital. The rate of interest on debt is fixed irrespective of the company‘s rate of return on assets. The company has a

legal binding to pay interest on debt. The rate of preference dividend is fixed, but preference dividends are paid when the

company earns profits. The common shareholders are entitled to the residual income. That is, earnings after interest and taxes (less

preference dividends) belong to them. The rate of equity is not fixed and depends on the dividend policy of the company.‖

(Pandey, I. M., 2010, p 317-18). The choice between debt and equity to finance a firm‘s assets involves a trade-off between risk

and return (Pandey, Chotigeat & Ranjit, 2000). The excessive use of debt may endanger the survival of a firm, while a

conservative use of debt may deprive the firm in leveraging return to equity owners. Therefore, in order to increase the advantage

of debt capital and at the same time to save the firm from the financial and other risks, it is desirable to have a reasonable debt

equity mix in the total capital structure. Thus, the decision regarding debt equity mix in the capital structure of a firm is of critical

importance and has to be approached with a great care. Every time when funds have to be procured, the financial manager weighs

10

Associate Professor (Commerce), P.G. Department of Commerce & Business Management, Guru Nanak College, Punjab, India,

[email protected]

mailto:[email protected]





the pros and cons of various sources of finance and selects the most advantageous sources keeping in view the target capital

structure. Thus, the capital structure decision is a continuous one and has to be taken whenever a firm needs additional finances.

As the objective of a firm should be directed towards the maximization of the value of the firm, the capital structure, or leverage,

decision should be examined from the point of view of its impact on the value of the firm. If capital structure or financing

decision, a firm can affect the value of the firm would like to have a capital structure, which maximizes the market value of the

firm. Therefore, the financial manager should plan an optimum capital structure for his company. The optimum capital structure is

obtained when the market value per share is maximum. Capital structure is the mix of debt, equity and preference securities that

are used to finance a company‘s assets. However, the choice between debt and equity from the point of view of shareholders and

lenders is an important one and it will be useful to list the special advantages of either form of capital relative to the other. The

greater use of debt, where the interest rate is lower than the average rate of return on the investment, increases the net return to

equity shareholders. Higher debt does not impair the control of shareholders over the enlarged operations of the firm. Debt is

cheaper source of finance, cost of debt is lower than cost of preference share capital as well as equity share capital because debt

holders‘ first claim on the firm‘s assets at time of its liquidation, payment of interest before any dividend is paid to preference and

equity shareholders, and interest is an item chargeable to profits of a firm. Deductibility of the interest on debt before computing

profits charge to tax, as against payment of dividends out of profits after tax, implies an effective lowering of the tax rate on a firm

more or less in proportion to the extent to which debt is substituted for equity in the company is financing pattern. However, it is

not desirable to resort to excessive debt financing because the excessive proportion of debt in the capital structure increases the

financial risks of the firm. This is because debt being a contractual obligation. The same along with interest must be paid out

ultimately. Any failure in doing so shall result in technical insolvency if not a real one. Further, the use of debt capital will not

automatically improve the overall return of the firm. It will increase the return if the firm‘s rate of return on assets is higher than

the cost of debt capital. Therefore, in order to increase the advantage of debt capital and at the same time to save the firm from the

financial and other risks, it is desirable to have a reasonable debt equity mix in the total capital structure. Thus, the decision

regarding debt equity mix in the capital structure of a firm is of critical one and has to be approached with a great care initially at

the time of promotion and, subsequently, whenever funds have to be raised to finance investments by the firm.

OBJECTIVES OF STUDY

The present study has the following objectives:

To measure the extent of debt-equity ratio of Dunlop India Ltd. from the tyres & tubes industry of the Indian corporate

sector.

To examine the impact of use and cost of debt on the profitability of Dunlop India Ltd. of tyres & tubes industry from

the Indian corporate sector.

DATA SOURCE & SAMPLE SIZE

For studying the behaviour of debt in the tyres & tubes industry of the Indian corporate sector, Dunlop India Ltd. from this

industry is selected. The study covers a time of nine years extending from the year 1983 to 1991-92 for the purpose of our

research paper. The company is lying in the top ten companies of tyres & tubes industry of the Indian corporate sector based on

sales for the year 1991-92 for the purpose of this study. For conducting the present study, data has been compiled from the

different volumes of the Bombay Stock Exchange Official Directory.

RESEARCH METHODOLOGY

In the present study, a maiden attempt has been made to make an in-depth analysis of the behaviour of debt through a case of

Dunlop India Ltd. from tyres & tubes industry of the Indian corporate sector. To analyses the results, analysis of empirical section

is organized into four parts. In the first part, analysis of debt-equity ratio is done. The second part explains the analysis of return

on investment and cost of debt on before tax basis. The third part gives details of the analysis of return on investment and cost of

debt on after tax basis. In the fourth part, impact of debt on return on total networth is presented. In this work, profitability means

return on total networth over the period under study. Return on net total assets, which is calculated and is shown in the research

methodology, is supplementary information, which further means that it is not a part for approaching and reaching to the

conclusions of the main study. To analyses the data, the following ratios along with simple statistical tools like tables, percentages,

etc. have been used for achieving the objectives of present study.

Debt-Equity Ratio: It can be calculated in the following manner

Debt-Equity Raio1 =

Debt-Equity Raio2 =





Return on Total Networth: It is calculated in the following manner

Return on Total Networth on Before Tax Basis (RONbt) =

Return on Total Networth on After Tax Basis (RONat) =

Return on Net Total Assets: It is calculated in the following manner

Return on Net Total Assets on Before Tax Basis (ROIbt1) =

Return on Net Total Assets on After Tax Basis (ROIat1) = ROIbt1(1-t)

Return on Net Assets: It is calculated in the following manner

Return on Net Assets on Before Tax Basis (ROIbt2) =

Return on Net Assets on After Tax Basis (ROIat2) = ROIbt2(1-t)

Cost of Debt: The following formula is used to calculate the cost of debt

Cost Debt on Before Tax Basis (Kdbt) =

Cost of Debt on After Tax Basis (Kdat) = Kdbt(1-t)

Net Gain: The following is the formula for calculating the Net Gain

Net Gain on Before Tax Basis = Return on Total Networth (RONbt) - Return on Net Assets (ROIbt)

Net Gain on After Tax Basis = Return on Total Networth (RONat) - Return on Net Assets (ROIat)

Spread: The following is the formula for calculating the Spread

Spread on Before Tax Basis = Return on Net Assets (ROIbt) - Cost of Debt (Kdbt)

Spread on After Tax Basis = Return on Net Assets (ROIat) - Cost of Debt (Kdat)

Effective Tax Rate (t): It is calculated in the following manner

Effective Tax Rate (t) =

Here Term Debt plus Short Term Loans & Advances comprise of debentures, long-term loans and short-term loans & advances.

Total Networth includes equity share capital, preference share capital, capital reserves including share premium and other

reserves & surplus less intangible assets. Intangible Assets include preliminary expenses, expenses on issue of shares and

debentures, goodwill, technical know-how charges, drawings & designs, patents, trade-marks and copyright. While computing

total networth usually accumulated losses are deducted from the aggregate of paid up share capital plus reserves & surplus.

However, in the present study in addition to accumulated losses, goodwill, trademark, patents, & copyright have also been

deducted. It is so because separate amount of accumulated losses is not available in the Bombay Stock Exchange Official

Directory. Total networth has been also adjusted for the accounting year 1988-89 due to the change in the length of accounting

year from 1st of April to 31st of March in the next year. Depreciation, interest charges and profits and/or losses have been

changed proportionately.





EMPIRICAL RESULTS

(1) Analysis of Debt-Equity Ratio

Table-1: Debt-Equity Ratio of Dunlop India Ltd.

Year Debt-Equity Ratio1 =

(In Times)

Debt-Equity Ratio2 =

(Percentage)

Dec.1983 0.6733 40.24

Dec.1984 0.7479 42.79

Dec.1985 0.7535 42.97

1986-87 0.6136 38.03

1987-88 0.2895 22.45

1988-89 0.3910 28.11

1989-90 0.4658 31.77

1990-91 0.3362 25.16

1991-92 0.4104 29.09

Dunlop India Ltd. 0.4460

Aggregate Basis

30.84

Aggregate Basis

Sources: Compiled from the Bombay Stock Exchange Official Directory, Vol. 36(iii), p. 33780

As revealed by table 1, debt-equity ratio2 has been varying from 42.97 percent in the 1985 to 22.45 percent in the year 1987-88

during the period under study. For five out of nine years under study, it has been below 32 percent. Overall, it has been declining

over the period under study excepting for the years 1984 and 1985 when it is 42.79 percent and 42.97 percent, respectively. It is

highest, i.e. 42.97 percent, in the year 1985 due to the higher interest bearing debt raised by the company. It is lowest, i.e. 22.45

percent, on account of higher profits earned and repayment of interest bearing by the company. On aggregate basis, aggregate

debt-equity ratio2 of the company is worked out 30.84 percent during the period under study.

(2) Analysis of Return on Investment and Cost of Debt on Before Tax Basis

Return on Net Total Assets on Before Tax Basis (ROIbt1)

As revealed by table 2, rate of return on net total assets on before tax basis (ROIbt1) has been varying from 12 percent in year

1986-87 to 4.39 percent in the year 1991-92 during the period under study. During six out of nine years under study, the rate of

return on net total assets on before tax basis (ROIbt1) has been below 7 percent. Overall, it has been declining with fluctuations

over the period under study excepting for the years 1986-87, 1987-88 and 1988-89 when it is 12 percent, 9 percent and 8 percent,

respectively. It is highest, i.e. 12 percent, in the year 1986-87 due to the registered satisfactory growth of turnover and profits over

the previous period when compared on an annualized basis, better market conditions and stringent control on costs of product mix

contributed to the improved working results. It is lowest, i.e. 4.39 percent, in the year 1991-92 due to the contraction of credit by

fiscal authorization which affected the procurement of raw materials and slow down of production for three months at Ambattur

factory adversely affected the results. On aggregate basis, the rate of return on net total assets on before tax basis (ROIbt1) is

worked out 6.98 percent during the study period.

Table-2: Impact of Debt on Return on Total Networth in Dunlop India Ltd

(Before Tax Basis)

Year

Return on Total Assets

ROIbt1=

(Percentage)

Return on Net Assets

ROIbt2=

(Percentage)

Cost of Debt

Kdbt=

(Percentage)

Return on Total

Networth

RONbt=

(Percentage)

Dec.1983 7 16 18 14

Dec.1984 4.42 9 17.14 2.92

Dec.1985 6.85 14.40 15.16 13.82

1986-87 12 21 19 23





Sources: Compiled from the Bombay Stock Exchange Official Directory, Vol. 36(iii), p. 33780.

Return on Net Assets on Before Tax Basis (ROIbt2)

As revealed by table 2, rate of return on net assets on before tax basis (ROIbt2) has been varying from 21 percent in year 1986-87

to 6.27 percent in the year 1991-92 during the period under study. During five out of nine years under study, rate of return on net

assets on before tax basis (ROIbt2) has been below 12 percent. Overall, it has been declining over the period under study excepting

for the year 1986-87 when it is 21 percent. It is highest, i.e. 21 percent, in the year 1986-87 due to the highest rate of return on net

total assets on before tax basis (ROIbt1) caused by reasons mentioned earlier such as improved turnover and better market

conditions resulting to improved profits. It is lowest, i.e. 6.27 percent, in the year 1991-92 caused by the lowest rate of return on

net total assets on before tax basis (ROIbt1) due to earlier mentioned reasons such as slow down of production. On aggregate basis,

the rate of return on net assets on before tax basis (ROIbt2) is worked out 11.31 percent during the study period.

Cost of Debt on Before Tax Basis (Kdbt)

As revealed by table 2, cost of debt on before tax basis (Kdbt) has been varying from 15.16 percent in year 1985 to 21 percent in

the years 1987-88 during the period under study. During eight out of nine years under study, cost of debt on before tax basis (Kdbt)

has been below 19 percent. Overall, it has been declining with fluctuations over the period under study excepting for the years

1986-87, 1987-88 and 1988-89 when it is 19 percent, 21 percent and 19 percent respectively. On aggregate basis, aggregate cost

of debt on before tax basis (Kdbt) of the company is worked out 17.80 percent during the period under study.

Return on Total Networth on Before Tax Basis (RONbt)

As revealed by table 2, rate of return on total networth on before tax basis (RONbt) has been varying from 23 percent in the year

1986-87 to 2.07 percent in the year 1991-92 during the period under study. During eight out of nine years under study, rate of

return on total networth on before tax basis (RONbt) has been below 14 percent. Overall, it has been declining and witnessing a

deep decline in the years in 1984 and 1991-92 when it is 2.92 percent and 2.07 percent, respectively, over the period under study

excepting for the year 1986-87 when it is 23 percent. It is highest, i.e. 23 percent, in the year 1986-87 due to the highest rate of

return on net total assets (ROIbt1) as well as net assets (ROIbt2) on before tax basis and highest excess gap of rate of return on net

assets (ROIbt2) over cost of debt (Kdbt) on before tax basis. It is lowest, i.e. 2.07 percent, in the year 1991-92 due to the lowest rate

of return on net total assets (ROIbt1) as well as net assets (ROIbt2) on before tax basis and highest excess gap of cost of debt (Kdbt)

over rate of return on net assets (ROIbt2) on before tax basis. On aggregate basis, the rate of return on total networth on before tax

basis (RONbt) is worked out 8.52 percent during the study period.

(3) Analysis of Return on Investment and Cost of Debt on After Tax Basis

Return on Net Total Assets on After Tax Basis (ROIat1)

As revealed by table 3, effective tax rate has been below 36 percent during the period under study. The rate of return on net total

assets on before tax basis (ROIbt1) has been varying from 12 percent in the years 1986-87 to 4.39 percent in the year 1991-92

while the rate of return on net total assets on after tax basis (ROIat1) has been varying from 10 percent in the year 1986-87 to 1.92

percent in the year 1991-92 during the period under study. During eight out of nine years under study, rate of return on net total

assets on after tax basis (ROIat1) has been below 6 percent.

Overall, it has been declining with fluctuations over the period under study excepting for the years 1985, 1986-87 and 1987-88

when it is 5.96 percent, 10 percent and 6 percent, respectively. It is highest, i.e. 10 percent, in the year 1986-87 due to the lower

effective tax rate and highest rate of return on net total assets on before tax basis (ROIbt1) caused by the reasons mentioned earlier

such as increased turnover and profits. It is lowest, i.e. 1.92 percent, in the year 1991-92 caused by higher effective tax rate, i.e. 52

percent, and the lowest rate of return on net total assets on before tax basis (ROIbt1) caused by reasons mentioned earlier such as

slow down of production. On aggregate basis, the rate of return on net total assets on after tax basis (ROIat1) is worked out 4.47

percent during the study period.

1987-88 9 14 21 11

1988-89 8 12 16 11

1989-90 7 11 19 8

1990-91 6 9 18 6

1991-92 4.39 6.27 17.53 2.07

Dunlop

India Ltd.

6.98

Aggregate Basis

11.31

Aggregate Basis

17.80

Aggregate Basis

8.52

Aggregate Basis






Note: *No tax liability has been occurred for the year 1984.

Return on Net Assets on After Tax Basis (ROIat2)

As revealed by table 3, rate of return on net assets on before tax basis (ROIbt2) has been varying from 21 percent in the year 1986-

87 to 6.27 percent in the year 1991-92 while the rate of return on net assets on after tax basis (ROIat2) has been varying from 17

percent in the year 1986-87 to 2.88 percent in the year 1991-92 during the period under study. During seven out of nine years

under study, rate of return on net assets on after tax basis (ROIat2) has been below 11 percent. Overall, it has been declining over

the period under study excepting for the years 1985 and 1986-87 when it is 12.53 percent and 17 percent respectively. It is

highest, i.e. 17 percent, in the year 1986-87 due to the lower effective tax rate and the highest rate of return on net assets on before

tax basis (ROIbt2) caused by reasons mentioned earlier such as increase turnover and exports. It is lowest, i.e. 2.88 percent, in the

year 1991-92 due to the higher effective tax rate, i.e. 52 percent, and lowest rate of return on net assets on before tax basis (ROIbt2)

on account of reasons mentioned earlier such as slow down of production. On aggregate basis, the rate of return on net assets on

after tax basis (ROIat2) is worked out 7.24 percent during the study period.

Cost of Debt on After Tax Basis (Kdat)

As revealed by table 3, cost of debt on before tax basis (Kdbt) has been varying from 15.16 percent in year 1985 to 21 percent in

the years 1987-88 while cost of debt on after tax basis (Kdat) has been varying from 17.14 percent in year 1984 to 7 percent in the

years 1990-91 over the period under study. Overall, it has been declining by witnessing rising trend during the first half and

declining trend in the remaining second and final half over the period under study. During eight out of nine years under study, cost

of debt on after tax basis (Kdat) has been below 15 percent. On aggregate basis, aggregate cost of debt on after tax basis (Kdat) of

the company is worked out 11.39 percent during the period under study.

Return on Total Networth on After Tax Basis (RONat)

As revealed by table 3, rate of return on total networth on before tax basis (RONbt) has been varying from 23 percent in the year

1986-87 to 2.07 percent in the year 1991-92 while rate of return on total networth on after tax basis (RONat) has been varying

from 18 percent in the year 1986-87 to 0.96 percent in the year 1991-92 during the period under study. During six out of nine

years under study, rate of return on total networth on after tax basis (RONat) has been below 7 percent. Overall, it has been

declining and witnessing a deep decline in the years in 1984, 1990-91 and 1991-92 when it is 3 percent, 2 percent and 0.96

percent, respectively, over the period under study excepting for the years 1985 and 1986-87 when it is 12.21 percent and 18

percent respectively. It is highest, i.e. 18 percent, in the year 1986-87 due to the lower effective tax rate, highest rate of return on

net total assets (ROIat1) as well as net assets (ROIat2) on after tax basis and highest excess gap of rate of return on net assets

(ROIat2) over cost of debt (Kdat) on after tax basis. It is lowest, i.e. 0.96 percent, in the year 1991-92 caused by higher effective tax

rate, lowest rate of return on net total assets (ROIat1) as well as net assets (ROIat2) on after tax basis and highest excess gap of cost

of debt (Kdat) over rate of return on net assets (ROIat2) on after tax basis. On aggregate basis, the rate of return on total networth

on after tax basis (RONat) is worked out 5.45 percent during the study period.

Table-3: Impact of Debt on Return on Total Networth in Dunlop India Ltd

(After Tax Basis)

Year Return on Total

Assets

ROIat1=ROIbt1(1-t)

(Percentage)

Return on Net Assets

ROIat2=ROIbt2(1-t)

(Percentage)

Cost of Debt

Kdat=Kdbt(1-t)

(Percentage)

Return on Total Networth

RONat=

(Percentage)

Dec.1983 7(1-.32)=5 16(1-.32)=12.53 18(1-.32)=13.19 10

Dec.1984* 4.42=4.42 9=9 17.14=17.14 3

Dec.1985 6.85(1-.13)=5.96 14.40(1-.13)=12.53 15.16(1-.13)=13.19 12.02

1986-87 12(1-.20)=10 21(1-.20)=17 19(1-.20)=15 18

1987-88 9(1-.32)=6 14(1-.32)=10 21(1-.32)=14 7

1988-89 8(1-.47)=4.24 12(1-.47)=6.36 16(1-.47)=8.48 5.83

1989-90 7(1-.42)=4 11(1-.42)=6 19(1-.42)=11 5

1990-91 6(1-.63)=2 9(1-.63)=3 18(1-.63)=7 2

1991-92 4.39(1-.52)=1.92 6.27(1-.52)=2.88 17.53(1-.52)=8.64 .96

Dunlop

India Ltd.

6.98(1-.36)=4.47

Aggregate Basis

11.31(1-.36)=7.24

Aggregate Basis

17.80(1-.36)=11.39

Aggregate Basis

8.52(1-.36)=5.45

Aggregate Basis





(4) Impact of Debt on Return on Total Networth

Tables 2, 3 and 4 also show the effect of use and cost of debt (Kdbt & Kdat) on rate of return on total networth (RONbt & RONat)

on before and after tax basis for a period of nine years from the year 1983 to 1991-92. Comparison of cost of debt (Kdbt & Kdat)

with rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis shows that former is higher than latter for all the

years under study excepting for the year 1986-87. This leads to conclude that the company has been suffering from unfavourable

leverage with regard to use of debt during eight out of nine years under study. Consequently, rate of return on total networth

(RONbt & RONat) is less than from cost of debt (Kdbt & Kdat) and rate of return on net assets (ROIbt2 & ROIat2) on before and after

tax basis in the above said eight years under study. It means that use of debt in the capital structure of the company has negative

impact on the profitability of the company during eight out of nine years under study, which consequently is not contributing to

the total networth of the company, which ultimately is not benefitting to the equity shareholders of the company. On aggregate

basis, the company has also been experiencing unfavourable leverage with regard to use of debt on before and after tax basis

during the period under study. Further details regarding spread and net gain on before and after basis have been in table 4. Due to

unfavourable impact of leverage by using debt in the capital structure of the company, spread between rate of return on net assets

(ROIbt2 & ROIat2) and cost of debt (Kdbt & Kdat) on before and after tax basis, and net gain calculated by deducting rate of return

on net assets (ROIbt2 & ROIat2) from rate of return on total networth (RONbt & RONat) on before and after basis have been

negative in the above said eight years under study. Spread and net gain are positive when leverage impact is positive during the

remaining one year under study.


Supplementary Information: Figures in brackets in column 2 & 6 indicate Spread between Rate of Return on Net Total Assets

& Cost of Debt on before & after tax basis and figures in brackets in column 4 & 8 indicate Net Gain on before & after tax basis

on Net Total Assets respectively.

SUMMARY AND CONCLUSIONS

In the present study, a maiden attempt has been made to make an in-depth analysis of the behaviour of debt through a case of

Dunlop India Ltd. from tyres & tubes industry of the Indian corporate sector which covers a time period of nine years extending

from the year 1983 to 1991-92 where the company is lying in the top ten companies of tyres & tubes industry of the Indian

corporate sector on the basis of sales for the year 1991-92 for the purpose of our study. The following are the conclusions and

findings of the present study.

It is observed that debt-equity ratio2 has been varying from 42.97 percent in the 1985 to 22.45 percent in the year 1987-

88 during the period under study, whereas, aggregate debt-equity ratio2 of the company is worked out 30.84 percent

during the period under study.

It is found that cost of debt on before tax basis (Kdbt) has been varying from 15.16 percent in year 1985 to 21 percent in

the year 1987-88 while cost of debt on after tax basis (Kdat) has been varying from 17 percent in year 1984 to 7 percent

in the year 1990-91 over the period under study. Overall, cost of debt on before tax basis (Kdbt) has been declining with

Table-4: Analysis of Spread and Gain In Dunlop India Ltd

(1)

Before Tax Basis

(2) (3) (4)

(5)

After Tax Basis

(6) (7) (8)

Year

Spread between

ROIbt2 & Kdbt

(ROIbt2-Kdbt)

(%age)

Debt

Impact

Net Gain

(RONbt –

ROIbt2 )

(%age)

Debt-

Equity

Ratio2

(%age)

Spread

between

ROIat2 & Kdat

(ROIat2-Kdat)

(%age)

Debt

Impact

Net Gain

(RONat-

ROIat2 )

(%age)

Dec.1983 -2(-11) Unfavourable -2(7) 40.24 -1(-7) Unfavourable -1(5)

Dec.1984 -8.14(-12.72) Unfavourable -6.08(-1.50) 42.79 -8(-11) Unfavourable -6(-1)

Dec.1985 -.76(-8.31) Unfavourable -.58(6.97) 42.79 -.66(-7.23) Unfavourable -.51(6.06)

1986-87 2(-7) Favourable 2(11) 38.03 2(-5) Favourable 1(8)

1987-88 -7(-12) Unfavourable -3(2) 22.45 -4(-8) Unfavourable -3(1)

1988-89 -4(-8) Unfavourable -1(3) 28.11 -2.12(-4.24) Unfavourable -.53(1.59)



1991-92 -11.26(-13.14) Unfavourable -4.20(-2.32) 29.09 -5.76(-6.72) Unfavourable -1.92(-.96)

Dunlop

India Ltd.

-6.49(-10.81) Unfavourable -2.79(1.54) 30.84 -4.15(-6.92) Unfavourable -1.79(.98)





fluctuations over the period under study excepting for the years 1986-87, 1987-88 and 1988-89 when it is 19 percent, 21

percent and 19 percent, respectively, whereas, cost of debt on after tax basis (Kdat) has been declining by witnessing

rising trend during the first half and declining trend in the remaining second and final half over the period under study.

Aggregate cost of debt on before and after tax basis (Kdbt & Kdat) of the company is worked out 17.80 percent and 11.39

percent, respectively, during the period under study.

It is observed that the rate of return on net total assets on before tax basis (ROIbt1) has been varying from 12 percent in

the year 1986-87 to 4.39 percent in the year 1991-92 while the rate of return on net total assets on after tax basis (ROIat1)

has been varying from 10 percent in the year 1986-87 to 1.92 percent in the year 1991-92 during the period under study.

Overall, rate of return on net total assets on before tax basis (ROIbt1) has been declining with fluctuations over the period

under study excepting for the years 1986-87, 1987-88 and 1988-89 when it is 12 percent, 9 percent and 8 percent,

respectively while rate of return on net total assets on after tax basis ( ROIat1) has also been declining with fluctuations

over the period under study excepting for the years 1985, 1986-87 and 1987-88 when it is 5.96 percent, 10 percent and 6

percent, respectively. On aggregate basis, the rate of return on net total assets on before and after tax basis (ROIbt1 &

ROIat1) is worked out 6.98 percent and 4.47 percent, respectively, during the study period.

It is found that rate of return on net assets on before tax basis (ROIbt2) has been varying from 21 percent in the year

1986-87 to 6.27 percent in the year 1991-92 while the rate of return on net assets on after tax basis (ROIat2) has been

varying from 17 percent in the year 1986-87 to 2.88 percent in the year 1991-92 during the period under study. Overall,

rate of return on net assets on before tax basis (ROIbt2) has been declining over the period under study excepting for the

year 1986-87 when it is 21 percent while rate of return on net assets on after tax basis (ROIat2) has been declining over

the period under study excepting for the years 1985 and 1986-87 when it is 12.53 percent and 17 percent respectively

over the study period. On aggregate basis, the rate of return on net assets on before and after tax basis (ROIbt2 & ROIat2)

is worked out 11.31 percent 7.24 percent, respectively, during the study period.

It is observed that rate of return on total networth on before tax basis (RONbt) has been varying from 23 percent in the

year 1986-87 to 2.07 percent in the year 1991-92 while rate of return on total networth on after tax basis (RONat) has

been varying from 18 percent in the year 1986-87 to 0.96 percent in the year 1991-92 during the period under study.

Overall, rate of return on total networth on before tax basis (RONbt) has been declining and witnessing a deep decline in

the years in 1984 and 1991-92 when it is 2.92 percent and 2.07 percent, respectively, over the period under study

excepting for the year 1986-87 when it is 23 percent while rate of return on total networth on after tax basis (RONat)

has also been declining and witnessing a deep decline in the years in 1984, 1990-91 and 1991-92 when it is 3 percent, 2

percent and 0.96 percent, respectively, over the period under study excepting for the years 1985 and 1986-87 when it is

12.21 percent and 18 percent respectively. On aggregate basis, the rate of return on total networth on before and after

tax basis (RONbt & RONat) is worked out 8.52 percent and 5.45 percent, respectively, during the study period.

It is observed that the company is suffering from unfavourable leverage with regard to use of debt during eight out of

nine years under study. Consequently, rate of return on total networth (RONbt & RONat) is less than from cost of debt

(Kdbt & Kdat) and rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis in the above said eight years

under study.

It is also found that spread and net gain are positive when leverage impact is positive and, spread and net gain are

negative when leverage impact is negative during the period under study. On aggregate basis, spread on before and after

tax basis is worked out -6.49 percent and -4.15 percent, respectively, while net gain on before and after tax basis is

worked out -2.79 percent and -1.79 percent, respectively, during the period under study.

It is also found that aggregate effective tax rate born by the company is 36 percent during the study period.

Thus, it is concluded that the company is suffering from unfavourable leverage with regard to use of debt during eight out of nine

years under study. Consequently, rate of return on total networth (RONbt & RONat) is less than from cost of debt (Kdbt & Kdat)

and rate of return on net assets (ROIbt2 & ROIat2) on before and after tax basis in the above said eight years under study. It means

that use of debt in the capital structure of the company has negative impact on the profitability of the company during eight out of

nine years under study, which consequently is not contributing to the total networth of the company, which ultimately is not

benefitting to the equity shareholders of the company. However, on aggregate basis, the company has also been experiencing

unfavourable leverage with regard to use of debt on before and after tax basis during the period under study. Due to unfavourable

impact of leverage by using debt in the capital structure of the company, spread between rate of return on net assets (ROIbt2 &

ROIat2) and cost of debt (Kdbt & Kdat) on before and after tax basis, and net gain calculated by deducting rate of return on net

assets (ROIbt2 & ROIat2) from rate of return on total networth (RONbt & RONat) on before and after basis have been negative in the

above said eight years under study. Spread and net gain are positive when leverage impact is positive during the remaining one

year under study. It is also found that effective tax rate born by the company is not high during the period under study.





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BEHAVIOUR OF DEBT: AN EMPIRICAL ANALYSISpezzottaitejournals.net/pezzottaite/images/ISSUES/V4N3/IJTGBPV4N... · considerable weight to earning rate ... That is, earnings after interest

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