Cost of capital is on rise: EY survey

The average cost of equity capital in India is around 15 per cent, a survey conducted by consultancy agency EY (formerly Ernst & Young) has revealed. It has increased over last 3-4 years and higher than most of the developed nations.

Cost is highest in sectors such as real estate and telecom sectors while FMCG (fast moving consumer goods) and IT/ITES (Information technology/information technology enabled services) are perceived to be at the lower end of the range, the survey said. The survey covered a sample size of 250 plus response sets from CFOs (Chief Financial Officers) and/or senior members of CFOs’ teams.

The respondent profile spanned across diverse sectors including automotive, chemicals, diversified industrial products, banking & financial services, FMCG, infra, IT & ITES, media and entertainment, life sciences, power and utilities, real estate, retail, telecom, among others.

“The trend in the rising cost of capital in India is reverse to those in the developed countries,” Navin Vohra, Partner (Transaction Advisory Services) of EY said while adding that this is not surprising since India has witnessed a significant rise in interest rates and inflation during the last few years, unlike developed countries, which opted for a reduction in risk free rates to drive monetary stimuli.

It may be noted that a company’s cost of capital generally comprises two elements, debt and equity costs and the debt equity ration. The debt cost of the company is easier to calculate, since it is paid in cash in the form of interest. The equity cost is not so obvious and can only be estimated by taking into consequence the factors encapsulated in a specific approach such as the risk-free rate, the market risk premium, the expectations of investors in a behavioral finance model, besides others.

Furthermore, the debt equity ratio (D/E ratio) is also not a straightforward calculation, since ratios can vary at different stages of a project or acquisition and also from company to company and industry to industry.

The survey highlighted the fact that the average difference in the cost of capital for investment in India is 3.6 per cent in comparison to developed countries. It also said that for overseas expansion or acquisitions funded out of India, the majority of respondents expect returns that are based on Indian parameters.

“This could make Indian acquirers less competitive in instances where they are evaluating potential targets in developed countries and competing with potential acquirers from developed countries with a lower cost of capital,” Vohra said.

The survey has some good news on the sustainability front. One of the findings was that about half of the respondents adjust their cost of capital downwards for investing in projects that contains sustainability parameters like pollution control or green energy.

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