Post on 30-Apr-2020
CA-IPCC-FM-SHORT NOTES Contact No. 9133430222, 9133530222, Page | 1
1. TIME VALUE OF MONEY
1. Future Value: PV x (1+r)n
(or)
PV x FVF (r, n)
2. Present Value: FV X1
(1+r)n
(or)
FV x PVF (r, n)
3. Future Value of Annuity = Periodic Payment x FVAF (r, n)
(or)
PP x (1+r)
n-1
r
4. Future Value of Annuity due (payment made at the beginning of each period)
PP x FVAF (r, n) + (i+r)
(or)
PP x [(1+r)
n-1
r] X (i+r)
5. PV of Annuity = PP x PVAF (r, n)
(or)
PP x [1-(1+r)
-n
r]
Where r = Interest Rate per period
n = no. of periods.
Period may be one month, quarter, half year or one year.
6. PV of perpetuity = Cash Inflows (c)
r
C = Cash inflows per period
r = Interest Rate per period
Discount Rate
(or) Investors expected rate of return
7. PV of growing per petuity = C
r−g
Where C = Cash inflows per period
r = Interest rate per period
(or)
g = Growth rate
8. Effective Rate of Interest = [1+r
m]m
-1
Where r= Interest Rate per annum
m = No of times compounding in a year.
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2. CAPITAL BUDGETING
How to define cash flows
Step1: Calculation of initial cash out flows
Investment in fixed assets = xxx
Investment in working capital = xxx
xxx
Note1: Sunk Cost i.e. already incurred costs must be ignored in cash out flows
e.g.: Cost of own land research cost already incurred etc.
Step2: Calculation of Depreciation
Depreciation = SLM / WDV
Step3: Calculation of operating cash in flows
Particulars Amount (Rs.) year (i-n)
A) Sales XXX
B) Total Cost
Variable Cost XXX
Fixed Cost XXX
(Other than Depreciation) XXX
XXX
PBDT A –B XXX
(-) Depreciation XXX
PBT XXX
(-) tax XXX
PAT XXX
(+) Depreciation XXX
CFAT/ Operating Cash in flows
Note:
1. Total Cost = Variable Cost + Fixed cost
2. Total Cost = COGS + Admin expenses + Selling and dist. expenses
3. Total Cost can be given in any form
4. Total Cost = COGS + Fixed Cost + Admin Exp +Advertisement expenses
5. Allocation (or) Apportionment of factory admin, corporate overheads must be ignored in total cost
computation.
6. Opportunity Cost must be deducted while calculating CFAT
Opportunity Cost
Before tax opportunity Cost
After tax opportunity Cost
It must be deducted from sales
(or) gross revenue before
It must be deducted from CFAT
directly i.e. after-tax deduction
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deducting tax i.e. before tax
deduction
7. If there is no tax then PBDT can be considered as CFAT.
8. Sometimes fixed cost will be loaded with depreciation we have to identify it and separate it carefully.
9. Identify all the revenue expenses in the problem like operating cost variable cost, fixed cost, COGS,
Advert expenditure, admin expenditure etc., and carefully deduct all such expenses while calculating
PDBT.
10. The profit terms can be given in any form
• Profit after tax = PAT
• Profit before tax = PBT
• Profit after tax and depreciation = PAT
• Profit after tax but before depreciation = CFAT
• Profit after depreciation = PBT
• Cash flows after tax = CFAT
• Cash flows before tax = PBDT
(or)
Before tax cash flows
Step4: Calculation of terminal cash flow
A) Gross Sale Proceeds XXX
(-) Book Value XXX
Capital gain/ capital loss XXX
B) Capital gain tax / Tax shield XXX
Net Sale proceeds XXX
(A) – (B), (A) +(B)
(+) Realisation of WC XXX
Capital Budgeting Techniques
Non-Discounting Techniques Discounting Techniques
➢ ARR NPV
➢ Payback period Profitability Index
IRR
Discounted Payback period
Modified NPV
Modified IRR
ARR: Average Rate of Return
Annual Rate of Return
Accounting Rate of Return
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ARR = Average PAT
Average Investement
Average Investment = 1
2 [Initial Investment - Salvage Value] + Salvage Value + Additional Working Capital
Average Investment = 1
2 [Initial of Investment - Salvage Value] + Salvage Value + Additional Working
Capital
Initial Investment Basis:
ARR = Average PAT
Initial Investement
Average PAT = Total PAT
No.of years
Payback Period:
1. If the cash flows are equal
Payback Period = Initial Investement
Annual Cash in flows
2. If the Cash flows are unequal
Payback Period = on proportionate basis
Illustration:
Initial Investment = Rs.10,00,000
Life of the project = 5 years
Year 1 2 3 4 5
Cash flows 2,00,000 3,00,000 4,00,000 2,00,000 2,00,000
Solution:
Year EFAT Cumulative CFAT
1 2,00,000 2,00,000
2 3,00,000 5,00,000
3 4,00,000 9,00,000
4 2,00,000 11,00,000
5 2,00,000 13,00,000
Investment Covered by the end of year 3 = Rs. 9,00,000
Balance of Investment to be Covered = 10,00,000 – 9,00,000 =Rs. 1,00,000
1. Year - 2,00,000
2. Year - 1,00,000
Payback Period = 3 year + 1,00,000 x 1
2,00,000 = 3.5 years.
Net Present Value (NPV):
Step1: Calculation of PV of Cash out flows
Investment in fixed assets = xxx
Investment in working capital = xxx
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Step2: Calculation of PV of Operating Cash in flows
Particulars Year (1-n)
A) CFAT pa XXX
B) PVF (r, n) XXX
PV of Operating Cash in flows XXX
(A x B)
Step3: Calculation of PV of Terminal Cash in flows
NSP of the fixed asset XXX
(+) Realisation of WC XXX
A) TCF XXX
B) PVF(r,n) XXX
PV of terminal cash inflow (A X B) XXX
NPV: PV of Operation Cash Inflows XXX
(+) PV of Terminal Cash in Flow XXX
(-) PV of Cash out flows XXX
NPV XXX
Profitability Index (or) Present value Index (or) Benefit Cost Ratio
Profitability Index = PV of Operating Cash inflows + PV of Terminal cash inflow
PV of cash out flows
PV of cash out flows
Relevant Discount Rate:
For NPV - Cost of Capital
For Profitability index = Cost of Capital
Internal Rate of Return (IRR)
IRR is the discount Rate at which
PV of Cash Inflows = PV of Cash out flows
PV of Cash Inflows - PV of Cash out flows = 0
NPV =0.
If the Cash flows are equal (No Terminal Cash flow)
Setp1: IRR is the discount Rate at which PV of Cash inflows = PV of Cash out flows
Cash Inflows x PVAF (r,n) =Cash Out Flow
Cash Inflow = xxx
Trace the PVAF (r,n) in PVAF table and Identify IRR. If it lies in between two discount rate then we can
use Interpolation.
Using Interpolation:
IRR = L1 + NPV at L1
NPV at L1−NPV at L1 (L2 − L1)
L1 = Lowest guess Rate L2= Highest of less rate
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If the Cash flows are unequal:
Trail & Error Method:
Step1: Calculate NPV at 10%
Step2: If Step1: is positive then we will use 20%.
Step3: If Step2: is positive then we will use 30% if Step3: NPV is –ve then we will use Interpolation
between 20% & 30%.
IRR = 20% +NPV at 20%
NPV at 20% −NPVat30% x (30-20)
Discounted Payback Period:
Same as payback period but the only differentiation is investment will be recovered from PV of Cash inflows
Year PV of Cash Inflows Cumulative PV of Cash Inflows
1 xxx xxx
2 xxx xxx
3 xxx xxx
4 xxx xxx
5 xxx xxx
Discounted Payback Period will be calculated proportionately
Relevant Discount Rate: Cost of Capital
Modified NPV:
Step1: Covert all the cash inflows into project ending period by using re investment rate.
Step2: The aggregate of all the converted cash flows is terminal cash inflow.
Step3: Modified NPV
PV of Terminal Cash inflow = xxx
(Discounted at Cost of Capital)
(-) PV of Cash out flows = xxx
Modified NPV = xxx
Year Cash Inflows Calculation
1 xxx xxx (1 + 𝑟)2 = xxx
2 xxx xxx (1 + 𝑟)1 = xxx
3 xxx xxx (1 + 𝑟)𝑞 = xxx
Terminal Cash Inflow = xxx
Where r = Re Investment Rate
Annualised NPV
Annualised NPV = NPV
PVAF (r,n)
r = Cost of Capital
n = life of the project.
Equivalent Annualised Cost
(or)
Equated Annual Cost
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Equated Annual Cost = PV of Cash out flows
PVAF (r, n)
Note1: No Operating Cash Inflows will be given in the problem.
Note2: Cost of the machine, Running and operating expenses will be given in the problem salvage value
will be given in the problem.
Calculation of PV of net Cash out flows:
year Cash flows PVF PV of Cash flows
0 Cash of the machine 1 Cash flow
1-n Running expenses xxx xxx
n Salvage Value xxx xxx
Calculation of PV of net cash out flows
year Particulars Cash flows PVF PV of Cash flows
0 Cash of the machine xxx xxx xxx
1-n Running expenses xxx xxx xxx
n Salvage Value xxx xxx xxx
PV of net Cash out flows = xxx
Relevant Discount Rate: Cost of Capital
Modified IRR:
Step1: Convert all the Cash Inflows into terminal year by using Cost of Capital
year Cash flows Re-investment
period
calculation
1 xxx 2 xxx (1 + 𝑟)2 = xxx
2 xxx 1 xxx (1 + 𝑟)1 = xxx
3 xxx 0 xxx (1 + 𝑟)0 = xxx
Terminal Value = xxx
Step2: Modified IRR is the discount rate at which PV of terminal value = PV of Cash out flows
TV X PVF (r, n) = PV of Cash out flows
PVF (r, n) = Cash out flows
Termila Value
= xxx
Trace this PVF (r, n) in PVF table and identify the modified IRR.
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3. COST OF CAPITAL
1. Cost of Debentures
2. Cost of PSC
3. Cost of Equity
4. WACC(K)
Debentures
Irredeemable debentures Redeemable Debentures
Redemption in lump sum
Irredeemable Debentures:
In Case of fresh Issue
Cost of Debentures (Kd) = I (1-T)
NP
In Case of existing Debentures:
Cost of Debentures (Kd) = I (1-T)
MP
Where I = Interest, MP = Market Price of debentures
t= tax rate
NP
Face Value =xxx
(+) (-) Premium/ discount =xxx
Issue Price =xxx
(-) Issue expenses
Flotation Cost = xxx
Underwriters
Commission = xxx
Brokerage = xxx
Net Proceeds = xxx
Note:
1. If there is no information regarding market price of debentures we assume that MP = face value
2. Generally, the market price of the debenture will be near to the face value of debenture.
E.g.: If MP of debenture is Rs.90 (or) Rs.110 then the face value must be Rs. 1000 if MP of debenture
is Rs.12 or Rs.8 then the face value must be equal to Rs.10.
3. Interest must be calculated on face value of debentures.
4. Sometimes Issue expenses can be expensed as a % of face value or Issue price. Then Issue expenses
must be calculated as per the instruction given in the problem.
5. If the problem is not specific about issue expenses then the % of Issue expenses will be applied on
face value or Issue price whichever is higher.
6. If there is no information regarding market price (or) Net proceeds in the problem then the cost of
debentures can be calculated by using the following formula.
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Cost of debentures (kd) = I (1-t)
Where I = Interest Rate (or) company Rate
T = Tax Rate.
The above formula is applicable only for irredeemable debentures .It only for Irredeemable Debentures.
It should not be applied to cost of redeemable debentures.
Redeemable Debentures:
In Case of fresh Issue
Cost of Debentures (Kd) = I (1-t) + RV−NP
N
RV+NP
2
In Case of Existing Debentures:
Cost of Debentures (Kd)= I (1-t) + RV−MP
N
RV+MP
2
Where RV = Redemption value
N = Life of Debentures.
Note:
1. If there is no information regarding ‘RV’ then redemption value must be face value (i.e. Redemption at
par).
2. If there is no information regarding face value it can be considered as Rs.100. But if the market price
is given then the face value will be near to the market price must be considered.
Cost of PSC:
Irredeemable PSC
In case of fresh Issue
Cost of PSC (Kp) = PD
NP
In case of existing PSC
Cost of PSC (Kp) = PD
MP
Where PD = Preference Dividend
NP = Net Proceeds
MP Market Price Preference Shares.
Note 1: If there is no information regarding NP (or) MP then Kp Can be considered as follows.
Cost PSC Kp = Preference Dividend Rate.
Redeemable PSC:
• In Case of fresh issue
Cost of PSC (Kp) = PD+ RV−NP
N
RV+NP
2
• In Case of Existing PSC
Cost of PSC (Kp) = PD+ RV−MP
N
RV+MP
2
CA-IPCC-FM-SHORT NOTES Contact No. 9133430222, 9133530222, Page | 10
RV = Redemption Value of PSC
N = Life of PSC
Cost of Equity (Ke)
1. Dividend
Price Approach:
In Case of fresh Issue
Cost of Equity (Ke) = DPS1
Np
DPS1 = Expected Dividend per Share
NP = Net Proceeds
MPO = Current Market Price of Equity Shares.
2. Earnings
Price Approach:
In Case of fresh Issue
Cost of Equity (Ke) = EPS1
NP
In Case of Existing Instrument
Cost of Equity (Ke) = EPS1
MPO
EPS1 = Expected Earnings per share
3. Dividend
Price + Growth Approach.
In case of fresh Issue
Cost of Equity (Ke) = DPS1
NP+ g
In Cash of Existing Instrument
Cost of Equity (Ke) = DPS1
MPO+ g
Where DPS1 = Expected DPS at the end of year -1
= DPSO [1+g]
g = Growth Rate
MPo = Current Market Price of the Debentures
Dividend Just Paid
Dividend Just payable DPSo
Last year dividend paid
Expected DPS at the end of current year
Expected DPS at the end of next year DPS1
4. Earnings
Price + g Approach
In Case of fresh Issue
Cost of Equity (Ke) = EPS1
NP +g
In case of Existing Instrument
Cost of Equity (Ke) = EPS1
MPO +g
5. Realised yield Approach
Cost of Equity (Ke) = IRR Technique will be used
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6. Capital Asset Pricing Model (CAPM)
Cost of Equity (Ke) = Rf + β (Km − Rf)
Where Rf = Risk free Rate of return
Rm = Return on market portfolio
β = Systematic Risk
Rm = Average Market Return
Rm−Rf = Market Risk Premium (or) Average Market Risk Premium.
Note1: Rf = Interest Rate on Treasury bills (or) GOI bonds (or) RBI bonds.
Cost of Reserves: If opportunity Cost of Capital is not given
Cost of Reserves Kr = Cost of Existing Equity Ke
If opportunity Cost of Capital of Equity Share holder is given
Cost of Reserves Kr = (1 − tp) – Brokerage Rate.
Where tp Personal Tax Rate.
Weighted Average Cost of Capital (WACC)
Based on Book Value Weights
Based on Market Value Weights
Balance Sheet Figures will be
considered while calculating weights
Market Values will be Considered while
Calculating weights
Reserves and Surplus will be
considered as one of the source
Reserves & Surplus will be ignored
while calculating Market Value weights
Calculation of WACC:
Sources Amount (Rs.) Proportion C/C Prop x C/C
Equity (1) xxx (1)
(T) XX
xx xx
PSC (2) xxx (2)
(T) XX
xx xx
Debt (3) xxx
(T) xxx
(3)
(T) XX
xx xx
Market Value Weights:
MV of Equity = No. of Equity Shares X MPS
MV of PSC = No. of Preference Shares X Market Price per Preference Share.
MV of Debentures = No. of Debentures Market Price Per Debentures.
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4. CAPITAL STRUCTURE
For all the Alternative Capital Structures EBIT is same.
P/E Ratio = MPS
EPS
MPS = EPS x P/E Ratio
Calculation of MPS at different alternative Capital Structures.
Particulars Alternative
I II III
EBIT xxx xxx xxx
(-) Interest xxx xxx xxx
EBT xxx xxx xxx
(-) Tax xxx xxx xxx
EAT xxx xxx xxx
(-) Preference dividend xxx xxx xxx
(A) EAESH xxx xxx xxx
(B) No. of Equity Shares xxx xxx xxx
(C) EPS A/B xxx xxx xxx
(D) P/E Ratio MPS / EPS xxx xxx xxx
EBIT Indifference Point/ EPS Equivalency Point
It is the level of EBIT at which EPS of alt –I = EPS of alt –II
(EBIT-Interest)(1-t)-PD
No. of Equity Shares =
(EBIT−Interest)(1−t)−PD
No.of Equity Shares
Note:
1. EBIT is a variable term in the above formula and we have to find out EBIT
2. Remaining all the terms will be given in the problem
3. EBIT =?
Financial BEP:
It is the level of EBIT at which EASH = 0
Financial BEP i.e., EBIT = Interest + Preference Dividend
(1-t)
Where t = Tax Rate
Capital Structure Theories:
1. Net Income Approach:
Step 1: EBIT = xxx
(-) Interest = xxx
EAESH = xxx
Step 2: Calculation of Value of Equity and Value of the firm
Particulars Amount Rs.
Value of Equity = EAESH
Ke
xxx
(+) Value of debt xxx
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Value of the firm xxx
Step 3: Calculation of Overall Cost of Capital Ko
Overall Cost of Capital Ko = EBIT
Value of the firm
2. Net Operating Income Approach (NOT Approach):
Step1: Calculation of Value of the firm and value of Equity.
Value of the firm = EBIT
Ko = xxx
(-) Value of debt = xxx
Value of Equity = xxx
Step2: Calculation of Value of the firm and value of Equity.
EBIT = xxx
(-) Interest = xxx
EAESH = xxx
Step3: Calculation of Cost of Equity
Cost of Equity (Ke) EAESH
Value of Equity
3. Traditional Approach:
Valuation same as in NI Approach.
4. Modigliani & Miller Approach (Without Taxes):
Proposition I:
Value of levered firm = Value of unlevered firm = EBIT
Ko
Where Ko = Ke of 100% Equity (At Equilibrium Level)
Proposition II:
Cost of Equity (Ke) of levered firm = EAESH
Value of Equity
Value of Equity of levered firm = Value of levered firm – Value of debt
(or)
Ke of levered firm = Ko of unlevered. Firm + (Ko of unlevered firm - Kd)Debt
Equity
5. Modigliani & Miller Approach (With Taxes):
Proposition I:
Value of Unlevered firm = EBIT (1+T)
Ko = Ko of Unlevered firm.
Value of levered firm = Value of Unlevered firm + debt x tax rate
Proposition II:
Ke of levered firm = EAESH
Value of Equity
Value of equity of levered firm = Value of levered firm – Value of debt
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Ke of levered firm = Ko of levered firm + (Ko of unlevered firm - Kd) Debt
Equity [1-t]
Ke of levered firm = Ko + (Ko − Kd =Debt
Equity (1-t)
Ko of levered firm = EBIT (1-t)
Value of levered firm
5. LEVERAGES
1. Degree of operating Leverage (DOL) = % Change in EBIT
% Change in Sales
(or)
Contuibution
EBIT
2. Degree of Financial Leverage (DFL) = % Change in EPS
% Change in EBIT
EBIT
EBT-PD1-t
It there is no PSC then DFL = EBIT
EBT
3. Degree of Combined Leverage (DCL) = % Change in EPS
% Change in Sales
(or)
Contuibution
EBT −PD
1 − t
If there is no PSC
DCL = Contribution
EBT
DOL of 2 means for every 1% change in sales EBIT change by 2%
DFL of 1.5 means for every 1% change in EBIT, EPS changes by 1.5%.
DCL of 3 means for every 1% change in sales, EPS changes by 3%
6. WORKING CAPITAL MANAGEMENT
Estimation of Working Capital Requirement particulars:
Particulars Amount (Rs.)
(A) Current Assets xxx
Investment in stock of RM xxx
= Raw Material Consumption units
X RMHP
365 / RM / 52W X RM Cost per
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Invest in Stock of WIP:
* Raw Material = xxx
Production units x WIPHP
365/ 12M / 52W x RM Cost per unit
* Labour = xxx
Production units x WIPHP
365 / 12M / 52W x Labour Cost Per unit
* Overheads xxx
Production units x WIPHP
365 / 12M / 52W x OH Cost per unit / FOH Cost per unit
Invest in stock of FG
Sales units x FGHP
365 / 12M/ 52W x Total Cost per unit
(or)
Outstanding overheads xxx
Production units x Time leverage in OH
365 / 12M / 52W x OH Cost per unit
Provision for tax xxx
xxx
Net Working Capital (A) – (B)
Note:
1. It is advice table to value the debtors always at total cost of sale if there is no information in the
problem in this regard.
2. Depreciation must be excluded while preparing cost statement.
3. COGS/ Cost of production = Sales – Gross Profit.
4. If there is no information about opening and costing closing inventory.
Cost of production = Cost of goods sold
Gross Works Cost = Cost of production.
5. Cost Statement
Raw Material Consumption
Particulars Amount
Opening Stock of RM xxx
(+) Purchases xxx
(-) Closing Stock of RM Xxx
xxx
Direct labour xxx
Factory overhead xxx
Gross works Cost xxx
(+) Opening Work – in – progress xxx
xxx
(-) Closing WIP xxx
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Cost of production xxx
(+) Opening Stock of finished goods xxx
(-) Closing Stock of finished goods xxx
Cost of goods Sold xxx
(+) Administration Expenses xxx
(+) Selling & Distribution Expenses xxx
Cost of Sales xxx
6. Stock of finished goods must be value at cost of production.
7. Debtors must be valued at total cost of sales.
8. While Calculating Debtors we should consider credit sales but not total sales.
9. RMHP = Raw Material Holding Period
10. WIPHP = Work – In – Progress Holding Period
FGHP = Finished goods holding period
DCP = Debtors Collection period
CPP = Creditors Payment Period
Calculation of net operating cycle period
Particulars Period (in days)
RMHP = Average stock of RM
Total RM Consumption for the year x 365
xxx
WIPH = Average stock of WIP
Total Cost of production x 365
xxx
FGHP = Average stock of FG
Total Cost of goods Sold x 365
xxx
Debtors Collection Period = Average Debtors
Total Credit Sales x 365
xxx
Gross operating cycle period Xxx
(-) Creditors payment period =Average Creditors
Total Credit Purchases x 365
Xxx
Net operating cycle period xxx
Notes:
1. No of operating cycles = 365 days
Net operating cycle period
2. Net working capital = Cost of Sales (or) Total Operating Cost
No. of operating cycle
3. If there is no. information regarding no of days in a year, then we a leverage assume that 1 year = 365
days
4. Operating cycle is also known as working capital cycle or cash to cash cycle.
Debtors Management
Evaluation of Alternative credit policies
Particulars Policy Option –I (existing) Policy Option –II
(A) Credit Sales xxx xxx
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(B) Total Cost Other
than bad debts & Cash discount
Variable Cost xxx xxx
Fixed Cost xxx xxx
xxx xxx
Profit before adjustment of bad debts
& cash discount
(A) – (B) xxx xxx
(-) Bad debts xxx xxx
Cash discount xxx xxx
PBT xxx xxx
(-) tax xxx xxx
PAT xxx xxx
PAT xxx xxx
(-) Opportunity Cost of Invest in
Deters xxx xxx
Net Benefit xxx xxx
Incremental Net
Benefits II –I - xxx
Note:
INVETSTMENT IN DEBTORS
Sales Value basis
Total Cost Basis Variable Cost Basis
Credit Sales x DCP
365 Total Cost x
DCP
365 Variable Cost x
DCP
365
Sales Value Basis:
Opportunity Cost of Investment in Debtors = Credit Sales x DCP
365 x Required Rate of Return
Total Cost Basis:
Opportunity Cost of invest in debtors = Total cost of sales x DCP
365 x Required Rate of Return
Variable Cost Basis:
Opportunity Cost of Invest in Debtors = Variable cost x DCP
365 x Required Rate of Return.
1. It is always advisable to value the debtors at total cost (or) variable cost if there is no information in the
problem.
2. If the before tax required rate of return is given in the problem it should be converted to after tax required
rate of return.
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Factoring:
Evaluation of factoring agreement:
a) Benefit:
Savings in bad debts XXX
Savings in admin expenses XXX
Savings in opportunity cost XXX
XXX
b) Costs:
Factors commission XXX
Interest in advance XXX
XXX
Net benefit a) – b) XXX
Effective cost of factoring = net cost of factoring
net advance amount receivable
Calculation of net cost of factoring:
a) Cost
Factors commission XXX
Interest in advance XXX
XXX
b) Benefits:
Savings in bad debts XXX
Savings in admin cost XXX
Savings in opportunity cost XXX
Net cost of factoring a) – b) XXX
Net advance amount:
Amount of debtors = credit sales × debtors collection period
365
Debtors XXX
Factor
Client Company
Customer
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(-) factors reserve XXX
Debtors X reserve %
XXX
(-) factors commission (Debtors X commission %) XXX
A) Advance before deducting interest XXX
(-) interest on advance XXX
(A) Interest rate pa X DCP / 365 365
Net advance amount receivable XXX
Note 1: while calculating net cost of factoring all the costs and benefits must be converted to one year.
Cash management
Cash budget:
Particulars Jan Feb March
A) Opening balance XXX XXX XXX
B) Receipts
Cash sales XXX XXX XXX
Collection from debtors XXX XXX XXX
Sales of fixed assets / investment XXX XXX XXX
Interest received / dividend received XXX XXX XXX
XXX XXX XXX
C) Payments:
Particulars Jan Feb March
Payment of purchase XXX XXX XXX
Wages XXX XXX XXX
Over heads XXX XXX XXX
Instalments XXX XXX XXX
Interest payment XXX XXX XXX
Repayment of loan XXX XXX XXX
Payment of tax XXX XXX XXX
XXX XXX XXX
Closing balance (A) + (B) – (C) XXX XXX XXX
Optimum cash balance models
Baumol’s model Miller orr model
Or Or
Inventory model stochastic model
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Baumol’s model:
Optimum lot size or cash balance = √2fT
r
Where f = annual cash disbursement or cash out flow
T = Cost per transaction
r = Opportunity cost of capital or interest rate per amount.
No. of transaction = annual cash disbursement
lot size
Total transaction cost = No. of transaction X cost per transaction.
Average cash balance = lot size
2
Opportunity cost = Average cash balance X Interest rate p.a.
Miller orr model:
H
2Z
R
Z L
Lower level = L
R = Return level
= L + Z
H = Upper level
= L + Z + 2Z
= L + 3Z
Average cash balance = L + R + H
3
Spread between lower level and higher level = 3Z
Spread between return level and lower level = Z
Spread between return level and higher level = 2Z.
Note:
1. If the cash balance touches lower level we should sell ‘Z’ worth of securities in order to touch higher
level
2. If the cash balance touches the higher level we should buy ‘2Z’ worth of securities of securities to touch
return level.
Ca
sh
bala
nce
Time
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Z = √3TV
4i
3
Where, T = cost per transaction
V = Variance of duty cash flows
I = Interest rate per day.
Variance = (Standard deviation)2
Cost of non-avoiding cash discount = d
1-d ×
365
n-p × 100
Where d = discount
N = normal credit period
P = discount period
2
10 net 30 means 2% cash discount if payment is made with in 10 days normal credit period is 30 days.
RATIO ANALYSIS
A) Liquidity ratios:
1) Current ratio = current assets
current liabilities
2) Quick ratio = quick assets
current liabilities
Quick assets = CA – stock – prepaid expenses
3) Absolute cash ratio / super quick ratio / cash reservoir ratio.
Absolute cash ratio = cash + Bank + marketable securities
current liabilities
4) Defensive interval ratio / interval measure ratio:
Defensive interval ratio = liquid assets
project daily cash expenses
B) Capital structure ratios / solvency ratios:
➢ Capital employed / Long term fund = ESC + reserves & surplus + PSC + Long term Debt –
miscellaneous expenditure not W / off
Or
Fixed assets + current assets – current liabilities.
➢ Equity / proprietors fund / shareholders fund = ESC + Reserves & surplus + PSC – miscellaneous
expenditure not W / off.
Or
FA + CA – CL – LTD
➢ Equity shareholders fund = ESC + Reserves & surplus – miscellaneous expenditure not W / off.
Or
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FA + CA – CL – LTD – PSC
➢ Debt ratio = debt
capital employed
➢ Equity ratio = equity
capital employed
➢ Debt equity ratio:
Are two types –
1) Debt -equity ratio = long term debt
equity
2) Debt -equity ratio = total debt
equity
Total debt = LTD + CL
Capital gearing ratio = LTD + PSC
ESC + reserves & surplus - miscellaneous expenditure
Debt to total assets ratio = total debt
total assets
Proprietary ratio / Shareholders equity ratio = shareholders fund / proprietors fund
total assets
Fixed assets to capital employed ratio = fixed assets
capital employed
Working capital to capital employed ratio = working capital
capital employed
Coverage ratios:
• Interest coverage ratio = EBIT
interest
• Preference dividend coverage ratio = EAT
preference dividend
• Equity dividend coverage ratio = EAESH
equity dividend
5. Debt Service Coverage Ratio = Earning avilabe for debt service
Interest+Instalment
Earnings available for debt service = PAT + Interest + Noncash Expenses + Non-operating losses
e.g.: Non-Cash Expenses
Depreciation, write off of preliminary expenses, good will etc.
Non- operating losses
Loss on sale of fixed assets and investments.
Fixed charges converge ratio = EBIT+Depreation
Interest+Repayment of loan / 1−t
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Activity Rations:
Capital turnover Ratio = Net Sales
Capital Employed / Net assets
Net Assets = FA + CA –CL = Capital employed
In the absence of sales we can also use COGS for calculating capital turnover Ratio
Fixed assets turnover ratio = Net Sales
Fixed Assets
Total Assets turnover ratio = Net Sales
Total Assets
Total Assets = FA + CA
Current Assets turnover ratio = Sale
Current Assets
• Working Capital turnover ratio = Not Sales
Working Capital
• Stock turnover Ratio = COGS
Average stock
• Stock velocity = 365 days / 12 months / 52 weeks
Stock turnover Ratio
• Debtors turnover Ratio = Credit Sales
Average Debtors
• Debtors velocity = 365 days / 12 months / 52 weeks
Debtors turnover Ratio
• Creditors turnover ratio = Credit Purchases
Average creditors
• Creditors value city = 365 days / 12 months / 52 weeks
Creditors turnover Ratio
Profitability Ratios:
A. Based on Sales:
i) Gross profit Ratio = Gross Profit
Sales
ii) Net profit Ratio = Net Profit (or)PAT
Sales
(or)
Net Profit Ratio = EBIT (1-t)
Sales
iii) Operating profit ratio = Operating Profit
Sales
(or) EBIT
Sales
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Operating Profit (From P & L A/c) = Sales –COGS – Admin & Selling & distribution expenses –
depreciation..
B. Expenses ratios:
i) COGS ratio = COGS
Sales
ii) Operating expenses ratio = administrative expenses + selling & distribution overheads
Sales
iii) Operating ratio = COGS + operating expenses
Sales
iv) Financial expenses ratio = financial expenses
Sales
C. Profitability ratios related to overall return on assets / investment:
• Return on capital employed [Pre-tax] = EBIT
average capital employed
×100
• Return on capital employed [Post tax] = EBIT [1-t]
average capital employed
• Capital employed = FA + CA – CL
• Return on assets (ROA) = PAT
Average total assets or
EBIT [1-t]
average total assets
Note 1: Most of the cases in problems the first formula will be used.
• Return on equity [From ESH point of view] = EAESH
Equity shareholders fund
EAESH = PAT – preference dividend.
• Return on equity (from shareholders point of view) = PAT
shareholders fund
Based on market / valuation / investors:
➢ Price earnings ratio = MPS
EPS
➢ EPS = EAESH
no. of equity shares
➢ DPS = total dividend paid to equity shareholders
no. of equity shares out-standing
➢ Dividend pay-out ratio = DPS
EPS
➢ Dividend yield = DPS
MPS
➢ Earning yield = EPS
MPS
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➢ Market value to book value ratio = market value per share
book value per share
➢ Book value per share = ESC + reserves & surplus - miscellaneous expenditure not w/off
no. of equity shares
Q – ratio = market value of equity & liability
estimated replacement cost of the assets
➢ The formulae with star mark are much important to solve all the problems.