Monday, May 19, 2008

Infosys - Cost of Capital

The management states that

“ Our policy is to earn a minimum return of twice the cost of capital on average capital employed and thrice the cost of capital on average invested capital. The current cost of capital is 13.3%. At present we earn 41.4 % on average capital employed and 71.1% on average invested capital. We aim to maintain adequate cash balances to meet our strategic objectives while earning adequate returns”.

So Infosys is effectively stating that it cost of equity capital is about 13.3% since it is virtually a zero debt company.

As per its current balance sheet over 55% of the capital employed is in cash and equivalent assets which at max might earn about 5-6 % on a post tax basis clearly lower than the 13.3 % cost of capital.

Infosys has defined for itself a hurdle rate of twice the cost of capital as the basis for deciding capital outlay for both organic growth and acquisitions. Considering that the company has today deployed over 50% of the capital at less than cost of capital, it might make sense for the company to either return money back to the shareholders or should be open to look at options which can deliver returns around the cost of capital.


Rohit Chauhan said...

in the 90s infosys invested the money, if i recall correctly, in the stock market and had major losses. since then they have become overcautious with cash.

however considering that they have more or less followed an organic growth policy, keeping such large cash reserves seem to be more tradition than need ..they could easily borrow if they needed to. but i guess old habits die hard


Ninad Kunder said...

Hi Rohit

You are right old habits die hard.

I also think that Indian IT has reached a inflexion point esp for the Big 3 where inorganic growth will start playing a imp role going forward.

I can see that clearly in the BPO space where a lot captives especially the financial services ones will be up for grabs.



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