FM Rule

Time Value of Money

CVIFA = Compounded value interest factor annuity; PVIFA = Present value interest factor annuity
Terminal/Future Value
T or F = A (1+R)N = A (1 + R/M)MN [if interest rate is same for diff. year; M = Multi Year Compounding]
T = A [(1+R1) X (1+R2) X (1+R3)] [Where interest rate differ year to year]
For fraction of Year, say 31/5 year, T = A (1+R)3 (1+R/5)
For continuous compounding, F = A X ei.n [e = 2.71828]
Effective Interest Rate (ER) or annual percentage (AP) rate, EIR = (1+R/M) M -1 [work only with interest]
Present value of a Perpetuity, = A/I (where, A = receipt, i = discount rate)

Yearly PXR A = Principal Amount/Cash Out Flow/Annuity; N = No. of Years; R =

=
Installment, A 1 – [1/(1 + R) N] Interest/Discounting/yield Rate/opportunity cost; A = Pn/PVIFAi.n

R
In case of Annual simple interest rate: T = A+(AXRXN) = A + (A X X MN)
M

Fv Fv Discounting is just reversal of

PV = ∑ = FV = PV (1 +R) N compounding; apply IRR rule where R is
(1+R)N (1+R/M)MN not available

If annuity paid at the beginning of the year

A (1 + R) {(1+R)N – 1}
T (Sn) =
R
1 1
PV of Annuity(Pn) = A + A [ - ]
R R(1+R)N

If annuity paid at the year end Future Value of an annuity, Sn = A ∑ (1+R)t

A {(1 + R)N – 1} Present Value of an annuity, Sn = A ∑ 1/(1+R) t
TV(Sn) = Rate of growth, Fn = P X FVIF i.n so, FVIF = Fn/ P
R
1 1
PV Annuity (Pn) = A [ - ]
R R(1+R)N

Co’s Wealth or Value = EAT/Expected Return of Shareholders [converting return at 100%].

[Dividend or return to Shareholders = EAT; Shareholders return (EAT) is the cost of capital of the
company, so if it EAT is divided by the return %, we get value of the firm]
4 16 = 16 ^.25 = 2; log 32 = log -> 32; Anti log 5 = shift>log>5.

Equivalent Annual Return, EAR = (1 + HPR)1/N – 1; Geometric Mean, GM = {(1+R1) X (1+R2)}1/N – 1

HPR = (P1 – P0) ÷ P0 ;Price indicates unit respect and value indicates total respect
2PC FV – SV 360 days 1
EIR = X 100 = X =
A (N + I) NSV Re-payment Period in days 1/R – 1/N
Credit Sales during the Year 360 days A/R – Accounts
A/R Turnover = X
Average A/R Balance Days of Credit Receivables
Average A/R = Annual Cr. Sales X (Average Collection Period/360 days)

Page 1 of 24
 FM Rule
Problem: Deferred Annuity - What is the PV, if Int rate 12% and received Tk. 10,000/- per year for 10
years after 10th year.
Solution:
PV of Tk. 1/- @ 12%, 19 Years
1 1
1 [ .12
-
.12 (1+.12)19 ] = 7.366

PV of Tk. 1/- @ 12%, 9 Years

1 1
1 [ .12
-
.12 (1+.12)9 ] = 5.328

So, PV of total annuity = 10,000 (7.366-5.328) = 20,380/-

Problem determining growth rate/Compound annual rate: Earnings per share in year - 1 (one
time deposit) is Tk. 3/-. It increased to Tk. 4.02/- over a 10 year period. Compute the rate of growth or
compound annual rate of growth of the EPS.
Solution:
We know, FV = PV X FVIF I,n
So, 4.02 = 3 X FVIF I,n According to Table – 1, an FVIF of 1.340 at 10 years is at
3% interest. The compound annual rate of growth in EPS
So, FVIF I,10 = 4.02/3
is therefore 3%
So, FVIF I,10 = 1.340

Problem determining growth rate/annual interest rate: A borrowed Tk. 1,000/- to be paid in 12
monthly installments (indicates annuity) of Tk. 94.56/-. Compute the annual interest.
Solution:
We know, Pn = A X PVIFA I,n
According to Table – 4, a PVIFA of 10.5753 for 12
So, 1,000 = 94.56 X PVIFA I,n
periods at 2% interest. So, the annual interest rate is
So, PVIFA I,n = 1,000/94.56
2% X 12 = 24%.
So, PVIFA I,n = 10.5753

Put/Call Ratio = Nos of Put Purchase ÷ Nos of Call Purchase

Page 2 of 24
 FM Rule
Leverage (Assets / Equity): from Mina & Kalam
➢ Financial leverage indicates financial risk whereas operating leverage determines business risk.
➢ Debt & Equity Ratio = Degree of total Leverage = Degree of combined Leverage = (Debt + Preference
Share) ÷ Total Capital = Debt/Totao Capitao = D/V
➢ Financial Leverage (Trading on Equity) is the ratio between equity capital and debt capital
➢ Leverage is the ability of a firm to use fixed cost assets or fund to magnify the return to the
shareholders.
➢ OL is the firm’s ability to use fixed operating costs to magnify the effects of changes in sales on its
operating profit or CM or EBIT or NOI.
➢ FL is the potential use of fixed financial costs to magnify the effects of changes in EBIT on its EPS.
➢ Total Leverage can be defined as the firm’s ability to use fixed cost (both operating and financial) to
magnify the effect of change in sale on the it’s EPS.
➢ DFL is the percentage changes in EPS that results from a given % changes in EBIT.
➢ Financial BEP = Interest + Preference Dividend
(1-T)
DOL = % changes in Operating Profit (EBIT) X 100 = CM (Sales –VC) X 100
% Changes in Sales Profit (EBIT)
DFL = % changes in EPS = EBIT
% Changes in EBIT EBIT - I
= EBIT
EBIT - I – PD [PD = Preferred Stock Dividend]
1–T
% change in (EBIT) % changes in EPS % changes in EPS
= DOL X DFL = X =
% Changes in Sales % Changes in EBIT % Changes in Sales
DTL
CM (Sales –VC) EBIT Sales –VC CM
= X = = BEP = FC/CM
EBIT EBIT - I EBIT - I EBT
If sales increase as a result of using debt equity, then new EPS will be,
EPS1 = EPSo + EPSo X DTL X %Changes in Sales

CAPITAL STRUCTURE PLANNING (Khan & Jain)

The Indifference Point (BEP), for a new company – where EPS will be same for different alternatives
X (1 – t) (X – I) (1 – t)
= Equity Shares vs. Debentures
N1 N2
X (1 – t) X (1 – t) - DP
= Equity Shares vs. Preference Shares
N1 N2
X (1 – t) (X – I) (1 – t) - DP
= Equity Shares vs. Preference Shares & Debentures
N1 N2
(EBIT – C1) X (1-T) (EBIT – C2) X (1-T)
=
S1 S2
S1, S2 = No of Shares of alternative financing; C1, C2 = Payable Int and Div in different Financing Method

The Indifference Point (BEP), for an existing company -

(X – I1) (1 – t) (X – I1 – I2) (1 – t) I1 – interest paid on existing debt
=
N1 N2 I1 – interest payable on additional debt
The Indifference Point (BEP),, From the point of view of MPS
X (1 – t) (X – I) (1 – t) - DP
P/E1 * = P/E2 * Equity Shares vs. Pref Shares & Debentures
N1 N2

Page 3 of 24
 FM Rule
Capital Structure (Value determination of firm, Debt & Equity then cost)
Value of the Firm – No effect of Taxes
NI/Traditional: Leverage effect the value NOI/MM Approach: Leverage has no effect on value
Net Operating Income (EBIT) Net Operating Income (EBIT)
Less: Interest (B X Kd) Overall Capitalization Rate (Ko)
Earning available to Equity holder (NI) Total market value of the firm, V = EBIT/Ko
Equity Capitalization Rate (Ke) Market value of Debt (B) = I/Kd
Market value of Equity (S) = NI/Ke Market value of Equity (S) = V – B
Market value of Debt (B) = I/Kd V = {(EBIT – I)/Ke} + B
Overall Cost of Capital, Ko or WACC = EBIT/V or Ko = Ke (S/V) + Kd (B/V); EBIT = NOI
➢ Ko = overall cost of capital (Debt + Equity), S = value of equity capital, B = value of debt, Total
value of the firm, V = (S + B)
➢ Kd Decrease Ko Increase and vice versa
➢ WACC = ∑ (Weight X Cost of Source)
➢ NI is the return of Equity holder. So we get total value of Equity from conversion of Ke at 100%;
➢ Ko = Ke – (Ke – Kd) X B/V; Ke = Ko + (Ko – Kd) X B/S [where int N/A and thus NI to
shareholders can not be determined]
➢ Equity Capitalization Rate (Ke) = (EBIT – I)/ (V – B) = (EBIT – I)/S = NI/S [NI Approach; residual
value of S = V – B;]
MM Hypothesis with Corporate Tax:
Vu = [EBIT (1 – T)] ÷ Ko
VL = Vu + PV of interest Tax Shield = Vu + {(T X Kd X Debt) ÷ Kd} = Vu + TD----MM Hypo
Cost of equity of levered firm, KeL = {(EBIT – I)/MP of Equity} X (1 – T) = Ku + (Ku – Kd)X(1 – T) X D/E
WACC of Levered Firm = WACCu X [1 – (T X {D/(D+E)}] = WACCu X (1 –TL) [L – Debt on total fund]
Value of livered firm is greater than unleavered firm, due to tax effect on interest.
o Residual Value of Equity, S = V –B
o KE>KO>KD; always, KE>g, otherwise price will be negative which is absurd.
o Retention Ratio = Plow back ratio
o WACC = Composite Cost of Capital = Combined Cost of Capital
o Capital structure is optimum under NI or Traditional Approach
o KO = Overall Capitalization Rate; In growth firm, R>K; In normal firm, R = K and In decline firm, R<K
o Under NI or Traditional Approach, KE and KD constant
o Under NOI or MM Approach, Ko and KD constant, changed KE
o Increase debt or leverage, reduce WACC anf hence increase total value of the firm
o BEP or indifferent point analysis is the determination of that point where EBIT or EPS is same under different
financing.
o Investors = Shareholders + Debtors
o Financial Structure = Capital Strutcure + Current Debt
o Capital Strutcure = Net Equity + Pref. Share + Long Term Debt
o Net Equity = Common Stock + Share Premium + Retained Earnings
o Levered Firm = Debt Cap + Equity Cap

Page 4 of 24
 FM Rule
Merger & Acquisition (Khan & Jain)
Merger refers to the process of combinning two or more firms. Merger covers 3 financial concepts –
➢ Determining the firm’s value
➢ Financing technique for merger
➢ Merger as a capital budgeting technique
Acquisition costs include: Payment to the target firm’s shareholders + Payment to discharge the external
liabilities – Sale of assets of target firm.
Determining the firm’s value -
EATA + EATT EATA = EAT of acquiring firm; EATT = EAT of Target firm
Detremination of
= NA = Nos. of equity share outstanding of acquiring firm
combined EPSM NA + NT NT = Nos. of equity share issued to the shareholders of target firm
Detremination of market Total Value = VM X Nos. of shares outstanding
= EPSM X P/EA
value of merged firm VM VM = Market value of merged firm
Total Gain from Merger = VM – (VA + VT) VA = EPSA X P/EA; VT = EPST X P/ET
Gain for acquiring firm (G A) G A = Post-merger value of firm A – Pre-merger value of firm A
=
and target firm (GT) G T = Post-merger value of firm T – Pre-merger value of firm T
BVPS or Intrinsic Value of Share = Net Worth ÷ No of ordinary Shares outstanding;
Net Worth = Equity + Reserve & Surplus
Equivalent EPST after merge = EPSM X Exchange Ratio
Nos of Share after merge = EATM ÷ EPS before merge
As MPS = E X P/E Ratio; So, P/E Ratio = MPS/EPS
Nos of Share = Total Earnings ÷ EPS [where Total earnings is distributed to the shareholders]
EPS = BVPS X ROE%
Source of Finance (ICAB & ICAEW – P/169)
Normal (Par) value of Bond
Conversion ratio =
Conversion Price
Normal (Par) value of Bond
Conversion Price =
No. of shares into which bond may be converted
Conversion Conversion Price – Market Price
=
Premium Conversion Price
Conversion Current Share Price X Conversion Ratio
=
Value = Po (1+g)N X R
Pre-right Market Value of Share + Proceeds from Right Issue + NPV of Projects
Ex-right Price =
Total Shares
Value of the right to subscribe for each new share = Ex-right Price – Subscription Price
Value of the right to subscribe for each existing Share = (Ex-right Price – Subscription Price)/2 [where2right
for 1 existing share]
Put/Call Ratio = Nos. of Put Purchase/ Nos. of call Purchased
Book Value per Share = (Paid Up Equity Capital + Reserve + Surplus)/Nos. of ordinary shares outstanding
P/E Ratio = MPS/EPS; K = EPS/MPS, So, K = 1/PE
EPS = ROE% X Book Value per Share; ROE = Return on Equity

Page 5 of 24
 FM Rule
Common Stock/Equity Share VALUATION
Share valuation Approach:
o Dividend Discounting Model: 1) Single Period Valuation and 2) Multi Period Valuation
o Constant Growth Model/Gorden Model
o Zero Growth in Dividend
o Variable growth in Dividend
o P/E Ratio
o Price to Cash Flow Ratio
o Price to BV Ratio
o Price to Sales Ratio
o Earning Multiplier Approach
o Discounted Cash Flow Approach
If any share is kept for a long duration, the value of the matured date will be virtually zero.
Present value discounts the future flows, so Po = D1÷Ke
Po = Intrinsic Value
Dividend Discount Model (DDM) – like Dividend Policy:
D1 P1 D1 + P1 One Year holding period/M. M Hypothesis
Po = + =
(1+k)1 (1+k)1 (1+k)1 K = {(D1 + P1) ÷ P0} - 1

D1 D2 D3 Dn + Pn Multi Year holding period,

Po = + + +…+
(1+k)1 (1+k)2 (1+k)3 (1+k)n where dividend is same for various years

D0 (1 + g)1 D0 (1 + g)2
Po = + +…. Constant dividend growth/Gordon/Super growth model
(1 + k) 1 (1 + k) 2

D1 Zero growth dividend model,Here g = 0; Ke > g

Po =
K-g Equilibrium cost formula

D1 D2 Dn Dt
Po = V1 + V2 V1 = + +…+ = ∑
(1+k)1 (1+k)2 (1+k)n (1+K)t
Dt DN (1+g) DN (1+g) DN+1 = DN (1+g)1 Multiple growth
Po = ∑ + V2 =
(1+K)t (K-g)(1+k)N (K-g)(1+k)N DN+2 = DN (1+g)2 model

PV of D1 D2 Dn
= + +… + Non-constant or super-normal dividend growth model
Dividends (1+r)1 (1+r)2 (1+r)n
D1
Expected ROR, r o k = + g
Po
Relative valuation technique:
= MPS/ EPS = [DPS/(K – g)] ÷ EPS = D/K-g X 1/EPS
P/E ratio
= (DPS/EPS) ÷ (K – g) = (D1/E1) ÷(Ke– g) = D/P ratio/(Ke– g)

Po = P/E ratio X EPS Capitalization of Earning Method

Dividend = EPS X D/P ratio EPS = Dividend/DP ratio
Market price per share at time T
Price to Book Value Ratio (MP/BV ratio) =
Book Value per share at time T

Page 6 of 24
 FM Rule
Earning Multiplier Approach:
Po
Po = E1 X
E1
D1 D1 D0 (1+g)
Po = = =
K-g K - br K - br
EPS1 (1-b) EPS0 (1+g) (1-b)
Po = = Gordon/Growth Model
K-g K – br
Po/ 1-b 1-b
= =
EPS1 K-g K – br R = Return on Equity
Discounted Cash Flow Technique (discounting or capitalizing of future cash flow) : Estimated value of any
security = Estimated Future Cash Flow/(1+K)T
V = ∑Ct/(1+r)t (V-intrinsic or present value of an asset/security; Ct – expected future cashflow
M-maturity or par value; N-loan term or years to maurity;
v = ∑I/(1+r)t + M/(1+r)n I-interest payment each year = coupon rate (Int Rate) X par value;
v = ∑(I÷2)/(1+r/2)t + M/(1+r2)2n Semi annual interest payment
I + (M-V)/N
Yield = Yield to Maturity
(M+V)/2
I + (Discount/No of years to maturity)
Yield =
(Current Price + Par Value)/2
Yield to Maturity of bond
I - (Premium/No of years to maturity)
Yield =
(Current Price + Par Value)/2
Yield to the Dt + {(Cp – Pi)/N} Pi = Current market price
=
call date,Yc (Cp + Pi)/2 Cp = Call price

Yieldb = I/M Current Yield = Rate of Return

Coupon Yield + %
The planning or holding period return, HPYb = (It + ΔP)/Po = It /Po + ΔP/Po
change in bond price
PV (CFb)
Duration = ∑ X t
Pb
Duration in Years
Modified Duration =
1 + Yield to Maturity
Normal P/D multiple = P/E norm ÷ D/P norm
Capitalization of dividend value = DPS X P/D norm
Price to sales ratio = Price/Sales X 100
Return = Earning = Dividend = Yield = Required Rate of Return (ROR) = Opportunity Cost = Discount
Rate = Capitalization Rate = Yield to Maturity Rate (YTM) = Expected Rate of Return = K = r
Holding Period Return or Total Return or Stock’s expected Return
= Dividend Yield + Capital Gain (Price Appreciation) = D + (P1 – P0)
P0
P1 = P0(1+g); g = N√(FV of Dividend÷ PV of Dividend) – 1
g = br = Retention Ratio X ROE (Return on Equity)
Price to Cash flow Ratio = Price/CF; Price to Sales Ratio = Total Market Value/Total Sales
The value of growth opportunity, PVGO = Po – (E1/Ke) [where 100% earnings pay as dividend]
CFAT means after tax but included with Depreciation in cash flow.
Preference share is also called hybrid share.
Opportunity Cost, COL= ∑[CFAT/(1+K)N ]; , COL – Cash out Lay

Page 7 of 24
 FM Rule
RF = RR + EI [RF – Short term Treasury Bill Rate, RR – Real Risk Free Rate of Interest, ER – Expected
rate of Inflation over the term of the inflation.
Total Ending Wealth – Total Return + Cost of the Bond
% Change in Price, ∆P = -1 X D* X % Change in Interest (∆Int.) [Where D* = Modified Duration}

Cost of Capital
Theoritically, Ex-right Price = (Existing O/S Share X MP) + (New Right Share X Issue Price)
Gross then per Share Existing Share + New Share
Theoritically, value of Right = (MP + Right Price) ÷ Right Term [say, 1:4 = 1+4]
➢ The cost of capital has three elements: Risk free rate of return + premium for business risk +
premium for finance risk
➢ Costs of debt considers psot tax interest but pre-tax market value
➢ Interest and K may not be equal always
➢ FV is Fair Value or Redeemption Value or Par Value (at par/Face Value/Par Value)
➢ The cost of capital refers to the discount rate that would be used in determining the present value
of estimated future benefits associated with capital projects.
➢ Required/Expected rate of return (ROR) = Opportunity Cost = Discount Rate = Capitalisation Rate
= Yield to Maturity Rate (YTM) = K = R
➢ Cut of rate means minimum expected rate of return (ROR)
➢ Kr (personal tax Rate) & Kd (corporate tax rate) always to be determined after tax.
➢ No tax effect is considered for Kps & Ke
➢ WAMCC (marginal weighted average cost of capital) is same as WACC.
➢ Appropriate WACC is based on MV
➢ WACC formula is used for evaluating long term investment project.
➢ Marginal cost of capital is the cost of additional required capital
➢ If cost of debt is increased then WACC is increased due to increase risk.
➢ Where MV (Market Value) is higher than BV (Book Value) then the difference between these two
is regaded as retained earnings.
➢ Expected Rate of Return = Expected Dividend Yield + G%
➢ Three methods to determine cost of common stock: 1) Capital Assets Pricing Model (CAPM); 2)
Dividend Model (past dividend); 3) Dividend Growth Model
➢ Ke = Cost of Common Stock (in respect of per share); Do = Current Dividend, Po = Market Price,
F = Flotation cost (charged on issue price/MP not no net issue price/NSP, if not mentioned
to be charged on par value or Face value. In case of common stock F is charged on MP, if
issue price is N/A.)
➢ Where dividend is available for few years, then D1= latest dividend (1+g)
➢ Current year’s dividedn is paid in the next year.
➢ Kr = Cost of Retained Earnings; Flotation cost excluded, Kr is always < Ke, Kr is ascertained after
adjusted personal tax with Ke, kr indicates after tax and Preference stock
➢ Dividend on PS is paid from after tax profit. If nothing is mentioned, assumed dividend is after tax
here and convert it before tax effect. Like interest on debt, no effect of tax saving is determined D
(1-T).
➢ D6 is required for K6 and D7 is required for P6

Do EPS Do (1+g)
Ke = = = D1/Po + G = +g Do applied where dividend is constant
Po Po Po (1-f%)

D1 This formula is used where available flotation cost and all earning
Ke = +G not distributes to shareholders. D1 = Do (1+g)
Po - F Dividend yield plus dividend growth, past growth uses for future
Ke - G = D/Po If F N/A Po = D/(Ke – G) Ke = Div Yield + g%
Amount of Paid – up Share Capital, after paid Stock Dividend = No. of Sahre Increase X (MV – FV) =

Page 8 of 24
 FM Rule
20,000 (8-5) = 60,000 it will reduce retained profit.

EPS EPS - DPS (1+Dt) EPS - DPS (1+Dt)

G = BR G= X RE% = EPS/ Po X =
MPS or Po EPS Po
G = Retained earning Ratio (RE) X ROR [ROR = EPS/Po = g/RE%]; Retention/plowback = 100% - Payout Ratio
G = Ke% - Dividend Yield%

Dividend Pay out ratio (1-B) DPS Total Dividend Paid

= X 100 = X 100
[B = ratention ratio] EPS Total Earnings for Common Stock

Retention or retained earning EPS – Do DPS

= X 100 = 1 – D/P ratio = 1-
or ploback ratio, RE% EPS EPS

G DPS (1+Dt) EPS - DPS (1+Dt) E-D

B = = 1- = = X 100
R EPS EPS E

Breaking point Total investment of

= 4,00,000 ÷ .50 = 8,00,000
of CS or RE respective source ÷ Weight

Kr Ke (1-TP) But Ke is to be calculated seperately where F is available

=
Where TP is N/A, then Ke = Kr

DPS Do
Kpps = = Kpps = Cost of Perpetual irredemable Prefered Stock
MPS Po - F
Dp (1+Dt)
Kp = Kpps = Cost of Prefered Stock;
Po (1-f)

Dp Pn
Po (1-f) = ∑ + Cost of Prefered Stock (Repayment of Principal)
(1 + KP)t (1 + Kp)N

D + (FV – NSV) ÷ N To determine NSV, Flotation cost is deducted

Krps = X 100 Cost of redeemable prefered stock,
(FV + NSV) ÷ 2 Apply this formula where MV and NSV is available

Int (total) Before tax, cost of debt (always one year respect)
Kd =
Dmkt (SV) SV – Net Sale Proceeding or Matured value
Int (total) After tax, cost of debt
Kd = X (1-t)
Dmkt (SV) Kd = {I(1-t)} ÷ MV or SP, where FV N/A.
[I + (FV – NSV) ÷ N] (1- t)
Kd = If issue at premium or dicount
(FV + NSV) ÷ 2
1 Maturity Value
1 -
Po = Int [
R
(1+ R) N
] +
(1+ R) N
-→ PVIFA + PV of MV

Page 9 of 24
 FM Rule
Under CAPM , Expected ROR on Common Stock = Risk Free Return + Risk Premimum
Ke = RF + (RM – RF) β; if data available for more years, average of (RM–RF) is to be considered

∑M.J – N. M‾J‾ M = (RM – RF); J = (Rj – RF); Rj = Co’s Income

βJ =
∑ M – N.M‾
2 2
M‾2 = (RM – RF)2 (apply where data for more years is given)

Cost of Redeemable Debt (Lumpsum Repayment of Principal)

I (1-T) COPn CIo = Cash inflow
CIo = ∑ +
(1 + Kd)t (1 + Kd)N COPn = Principal payment at maturity
I (1-T) + (f+d+Pr-Pi)/Nm RV – Reedemable value of debt
Kd =
(RV + SV) ÷ 2 Apply where there is maturity value

Cost of Redeemable Debt (Repayment of Principal in instalments )

CoLt (1-T) COPt
CIo = ∑ t
+ CoLt = after tax interest payment at different periods
(1 + Kd) (1 + Kd)t

I I I+M
Vd = + +….+
(1 + Kd)1 (1 + Kd)2 (1 + Kd)N

I M
Vd (1-F) = ∑ + M – FV repaid at maturity
(1 + Kd)t (1 + Kd)N

R (1-t) Cn Vc = Cost of convertible dibenture (Vc at Issue Price); Apply

Vc = ∑ +
(1+K)t (1+K)n IRR Rule; N = nos. of year to maturity
Dp Cn Vc = Cost of convertible prefered stock; Dp = Fixed Dividend; Cn
Vc = ∑ + = Fv or Redeemp. Value (Int + FV); Apply IRR Rule
(1+K)t (1+K)n

= Wd.Kd + Wp.Kp + Wr.Kr + We.Ke Both Book & Market Value Weight; this
WACC (Ko) cost formula avoid cost of CL
= (Ke+Kd+Kr+Kp)/4

Ko = Total cost of capital (EBIT) ÷ Total Capital (FV or MP) Ko MP base > Ko FV base

D1 D2 Dn+Pn
P = + + …. +
(1 + K)1 (1+K)2 (1+K)N
N indicates year where dividend growth rate change; Where dividend grows phase by phase, apply IRR
(interpolation) rule to determine K (can be assumed if N/A)

Int. + (MV - Vd)/N

YTM (Appx.) =
(2 Vd + M)/3
Market Value of Levered Firm, VL = VU + DT [ According to MM thesis]
Cost of Equity of Levered Firm, Kg = Ku + {(1-T) (Ku-Kd) X D/E or {(EBIT – I)/MV of Equity} X (1-T)
WACCg = WACCu (1-TL)
1 1
Duration = 1 + YTM -
Y Y (1+Y)N
Modified Duration = Duration/(1+Y)
Realized = N√ Total Ending Wealth - 1

Page 10 of 24
 FM Rule
Coupon Yield Purchase Price
According to Hamada Model,
Ke of a levered firm = RF + (RM – RF)βU + (RM – RF)βU (1-T) X D/S; βL = βU + VU (1-T) X D/S

Dividend Policy (Market price or value determination of Equity Share)

DPS + R/K X (EPS-DPS) Walter Model (relevant with dividend) suggests pay
MPSo = dividend where R<K
K
D/K = Value of Dividend;
D R/K X (EPS-DPS) Capital Gain, = R/K X (EPS-DPS)
MPSo = K + K K
R = IRR or ROR;
No outsource for investment, No Risk, R & K constant, EPS & DPS constant, Pay Income as Dividend or retain;

E (1-B) D Gordon Model(relevant with dividend); G = Growth Rate; 1-B =

MPSo = = Dividend Payout Ratio; K = Cost of Capital; B = Retention Ratio; G =
K-G K-G B X ROR (ROE); E = EPS; [P/E = (1-B)/(Ke – g)—from the rule]
OnIy ordinary shares consists in capitaI structures; other conditions like Walter Model

Present market Price of Ordinary Share, - Like Gordon Model

EPS (1-b) B = retentio ratio
PO =
K - br R = rate of return

D1 + P1 M. M Hypothesis (irrelevant with dividend); through arbitrage process market

will be equilibrium,Perfect merket, mobilizatin of informatin
[year’s dividend is paid in the end of the year + year end price = Market price
MPSo =
of share ÷ discouting rate = MPSo]
1+K P1= Po (1+K) – D1 {may be determined from M.M Equation} ;
Price = MPS+Dividend; Po = MPSo

E-Expected Profit, M-Number of New Shares, I-Required Investment, P1 –

MP1 = I – (E-ND1)
MPS at year 1 end; ND1 – Total Dividend at Year 1 end

➢ Share in Capital means Share Premium; if stock dividend is paid, increase share premium and share
account but reduce reserve for the same amount
➢ Under Residual Dividend Policy, Dividend = Net Income – Investment
➢ Growth firm, R>K; declining firm, R<K and normal firm, R=K
➢ Pay-Out ratio = DPS/EPS X 100
➢ If Pay-Out is 20%, then Retntion is 100% - 20% = 80%
➢ Retention means what is retained after payment of dividend from earnings.
➢ Growth rate, g is calculated on RE retained after allocation and met up of expenses.
➢ Theoritically, FV = MP
➢ Cost of capital and rate of return is same, if not given seperately.
➢ Deividend is usually pay at the year end or next year, so where N/M current year/ at currently,
assumed it is D1
➢ Po = (D1 + P1)/(1+K); 1 + K = (D1 + P1)/Po; K ={(D1 + P1)/Po} – 1; K = [(D1 + (P1- Po)]/Po.
➢ P/E ratio = MPS/EPS; K = EPS/MPS; K = 1/PE ratio; P/E = (1-B)/(k-g) = DP ratio/Ke-g
➢ Holding Period Return (HPR) or Total Return = D/Po + (P1-Po)/Po
Bonus share can be issued from-
o Credit balance of P/L
o Share Premium Account
o General Reserve
o Capital Revenue/Profit
Page 11 of 24
 FM Rule
o Retained Earnings
o Capital Redemption Fund A/C

Capital Budgeting
Discounted cash flow method (DCF): NPV, IRR, PI
Conventional Method: PBP, ROI/ARR, PBR, MAPI
CFAT is used in any other cases except ARR -→ where used EAT (if EAT N/A, CFAT is used)
Net Cash Outlay = Cost + Working Capital
NI or NP = Cash inflow (given) – Calculated or given Depreciation.
Discount Factor = Initial Invesntment/Average of Annual Cash Inflow. = PV of Cash Inflow/ Average of
Annual Cash Inflow (CFAT)

Dividend + Dividend + (Sale Price – Purchase Price)

ROI = =
Capital Gain Purchase Price

Pay Back Period = Net Cash Outlay (NCO or Investment)

Annual Cash Inflow (NCB)---→ CFAT
= A + NCO – C
D
A = the year in which the cumulative net cash flow is nearer to NCO; C = Cumulative net cash flow of year
A; D = Net cash flow of the year following the year A.
NCB after tax but before depreciation, residual value is not considered.
Average Annual Net Profit (NCB--->EAT/CFAT)
ARR = X 100
NCO (original) or Average Capital NB: Profit after tax & Depreciation as
Ave. Income (EAT + Dep) dep is a non cash item
ARR = X 100
Ave. Investment

Ave. Initial Invest + Ending Invest Initial Invest + Salv. Value

= =
Investment 2 2
Ave. Initial Invest + Salv. Value - SP Initial Invest + Slv. Val
= = NWC +
Investment 2 2
Average EAT
ROI =
Initial Investment (Not Average Invest)

NCB
PBR = X 100 Where inflow is inequal
NCO
1
PBR = Where inflow is equal
PBP

NPV = PV of NCB – PV of NCO (if outflow occurs at the beginning, discounting is not required)
NPV = [ A1 + A2 +….. + AN ] – C
(1 + K) (1 + K)2 (1 + K)N
K = cost of capital/profit rate/discounting rate; A = Net Cash Benefit (NCB) or Net Cash Inflow; C
= Initial Cash Outlay or Investment; NCB = EAT + Depreciation.
[NPV to be considered always +]

IRR (interpolation)= A + C/D X (B-A)

Page 12 of 24
 FM Rule
A = Lower discounting rate, B = Higher discounting rate; C = NPV at lower discounting rate; D =
difference between the NVP at higher and lower discounting rate. Project is accpted if
Discounting Rate < IRR.
IRR formula is used for discounted cash flow determination. It equals inflow and outflow.

PV of all NCBs
PI = X 100 (initial out flow, not require discounted NVP)
PV of NCO
Total Present Value (TPV) PI =Cost-Benefit Ratio
PI = X 100
PV of outflow PI = Profitability Index
NPI = PI – 100%
NPV of inflow
NPI = X 100
PV of outflow
D+C-B-E D = Next Year Income, C = Next Year SV, B = Next
MAPI = X 100 year value reduction, E = Excess IT, A = Additional In
A vestment, MAPI = Machinery Alied Products Institute.

1 + NRR RRR = Real Rate of Return/Effective rate; NRR = Nominal Rate of

RRR = - 1
1 + IRR Return/Money Rate, IRR = Inflation Rate of Return
NRR = (1+RRR) (1 + IRR) – 1 = (RRR + IRR) + (RRR X IRR)
N
MGR = (1+PI) -1 MGR = Marginal Growth Rate

Real Cash Flow = NCF2/(1+IRR)2

TV of inflow (benefit) PV of cost or MIRR = Modified Internal Rate of

MIRR , = Return; MIRR = 8√2.69 – 1 = ?
(1 + MIRR)N Outflow

PV of ∑CFn Exam 20,000 2,000

= +
Outflow (1+K)N -ple (1+.10)1 (1+.10)2

Terminal Value of Inflow, TVn = PVo (1+K)N =10,000 (1+.10)7 + 5,000 (1+.10)5

Revaluation of Investment Projects with Unequal Lives-

1) Replacement Chain Approach: three steps- a) NPV determination; b) Short term project- Gi NVP - †K Avevi Long
term project -Gi Aewkó mg‡qi Rb¨ wewb‡qvM Kiv nq Ges D³ mg‡qi NPV wbY©q K‡i short term NVP - Gi mv‡_
†hvM Kiv nq c) Comparison of NVP :

5784
NVPB= (5784) + 5784 – NPV of short term project
(1.115)6-3
2) Annualized NVP Approach: Three Steps - a) NVP determination; b) annualized NVP = NVP/PV factors
of annuity; c) comparison of annualized NVP
1 1
PV factor of an annuity = -
R R (1 + R)N

NPV
Annualized NVP =
1 - 1

Page 13 of 24
 FM Rule
R R (1 +R)N
Sensitivity = NPV of Projects ÷ PV of cash flows subject to uncertainty
o Depreciation under Fixed Installment/Straight Line Method = (Cost – Scrap Value) ÷ Nos. of Year
of Estimated Life. (Scrap Value is assumed)
o Rate of Depreciation, under Straight Line = Depreciation per Annum ÷ (Cost – Scrap Value) X 100
o Rate of Depreciation, under Reducing = 100 – 100 X Nos. of Year X (Scrap Value ÷ Cost)
o Under Reducing Balance Method, Scrap Value is the Year end retained value.
o Deprival value is the lower of Replacement Cost and Recoverable Amount.
o Recoverable Amount is the higher of value in use/economic value and net realisable value.
o Replacement Cost is the cost of replacing the asset with one of a similar age and
condition.
o Value in use/economic value is the present value of the cash generated from using the
asset. If the value in use ever dropped below the NRV, the asset would not be worth
keeping.
o Net realisable value is the asset’s worth if it were to be sold, net of selling costs.
o Full depreciation is charged in the year of purchase but not in the year of dispose.
o Real rates of Interest: The rate of interest that would be required in the absence of inflation
in the economy.
o When real rates of interest are adjusted for the effect od general/inflation, measured by the
consumer prices index (CPI/general inflation), the results are referred to as money (or
nominal) rates of interest.
o (1 + m) = (1 + r) (1 + i) [m – money/nominal rates of interest; i – general inflation; r – real
rate]
o Limitations of Replacement Analysis: Changing Technology, Inflation, taxation
o Capital rationing is the situation where insufficient funds exist to undertake all positive NPV
projects, so a choice must be made between projects. Types – Hard rationing, Soft
Rationing
o Hard rationing where the external capital market (Bank, Stock Exchange, etc) limit the
supply of funds.
o Soft Rationing where the firm internally inposes its own constraint on the amount of funds
raised.

Page 14 of 24
 FM Rule

Lease (ICAB-Page-182)
Factors to be considered for buy or lease decision: Cash Flow (where inflow higher or outflow
lower will be accepted), Admissible Expenses (where expenses more and cause less tax or
more tax save) [lease-Installments, Maintenance Cost; Rent-Interest, Depreciation, Installment
Allowance, Maintenance Coat], PV consideration. Where tax saving is higher, Investment tax
credit, Salvage Value – Not applicable for lease.
Evaluation of lease from the view point of the lessor: before lease, lessor will calculate cost-
benefit, if return is higher than cost of capital (Ko), should lease out, if NPV (benefit)> NCO is
positive then should lease out.
1) determination of NCO:
Cost of the assets Tk. 5,00,000/-
Less: Investment Allowance (if any) -
Tk. 5,00,000/-
2) Determination of cash Inflow: yearly respect-
Lease Rental (Revenue) 1,80,000 Alternative
Less: Tax Payment (40%) 72,000 Lease Rental 1,80,000
Add: Tax shield on Dep (5,00,000/5 X40%) 40,000 Less: Depreciation 1,00,000
Cash Inflow (NCB) 1,48,000 PBT 80,000
Less; Tax 40% 32,000
Now lets calculate the NPV at 12% cost of capital- PAT 48,000
NPV = Tk. 1,48,000 [(1/.12) – 1/.12 (1+.12)5] – 5,00,000
Since, the NPV is +, the lessor should lease out the assets. Add: Depreciation 1,00,000
Cash Inflow (NCB) 1,48,000

Example: MV of accounting software Tk. 50 lakh. A leasing co agrees to lease the software for
annual rent Tk. 70,000 for 8 years. Leas rental have to be paid at the beginning of the year.
Opprotunity cost assumed 10%. Co. can buy debt for 8 year @ 8%, 8 annual installments Tk.
87,000 each. The system can be sold at Tk. 40,000/- after 8 years. Straight line Depreciation,
Tax Rate-45%.
Solution Procedures:
Detremine PV of Net Cash Outflow of both alternatives, Assmume interest factor of lease as not
availbale – say 10%, if were available reqired to determine after tax interest.
PV of NCO under Lease Alternative
Year 1) Rental 2) Tax Shield 45% 3) NCO (1-2) 4) PV Factor 5) PV in Tk. (3 X 4)
0 70,000 - 70,000 1 70,000
1-7 70,000 31,500 38,500 *4.8684 1,87,433
8 - 31,500 (31,500) **0.4665 (14,695)
Total 2,42,738

Page 15 of 24
 FM Rule
Tax shield of one year can get in the next year.
* PVIFA (10%, 7 years) = 0.909+0.826+0.751+0.683+0.621+0.564+0.513 = 4.868
** PV of 8th year at 10% = 1/(1+.10)8 = 0.4665
Alternative way of calculation,
38,500 38,500 38,500 38,500 38,500
70,000 + + + + + +
(1+.10)1 (1+.10)2 (1+.10)3 (1+.10)4 (1+.10)5
NPV =
38,500 38,500 31,500
+ -
(1+.10)6 (1+.10)7 (1+.10)8

Or, as NCO of 1-7th year is equal

PV = 70,000 +38,500 (1/R – 1/R (1+R)N – 31,500 (1.10)8
lessor gets tax shield under operating lease

Working Capital Management

Total working capital = Aggregate of Current Assets; Net Working Capital= CA – CL (determine liquidity
position of the company)
Calculation with closing figure; Ideally, CA:CL = 2:1; BD = Book Debt (Debtors & A/R); CA Level = CA ÷
FA; Positive Working Capital: CA>CL;
Nos. of cycle depend on ratio of sales & CA.
Important for two reasons: profitabilty and liquidity => Risk – Return Trade off
Determinants of level of working capital: working capital cycle, size of the business, nature of the firm,
nature of raw materials, depreciation poilicy, price level changes, amount of sale, function of business,
production policy, adequacy of credits, profit margin, competition, dividend policy, efficiency, risk
management, inventory management.
Three policy for working capital finacing: Conervative, Aggressive and Matching Policy

Policy Source Uses

Long-Term Fixed Assets + Permananet Current Assets + Part of Fluctuating Current Assets
Conservative
Short-Term Part of Fluctuating Current Assets
Long-Term Fixed Assets + Part of Permananet Current Assets
Aggressive
Short-Term Part of Permananet Current Assets + Fluctuating Current Assets
Long-Term Fixed Assets + Hard core of Permananet Current Assets
Matching
Short-Term Fluctuating temporary or variable Current Assets

Types of Current Assets: Permanent (Minimum Stock) and Fluctuating. Procedures of estimating working
capital requirements-
Sales X 100
Ratio Basis
(Inventory+Receivable)
Sales X 100
% of Sales Basis
Working Capital
(CA-CL) X 100
% of Fixed Assets Basis
Fixed Assets

Page 16 of 24
 FM Rule
ROR on total EBIT
= X 100
Assest Total Assets

Return on EAT
= X 100
Equity Capital Equity

Calculation of Working Capital Cycle (Operating Cycle)

Oeprating Cycle or Working Capital Cycle, OC = ICP+ BDCP-PDP [ICP = Inventory Conversion Period,
BDCP = Book Debt Conversion Period, PDP = Payable Deferred Period]. ICP = RMCP+WIPCP+FGCP
RMI X 360 days RMI–Raw Material Inventory
RMCP
RMC RMC–Raw Materila Consumption
WIPI X 360 days
WIPCP COP-Cost of Production/Cost of Goods (not consider Depreciation)
COP (after WIP Charge)
FGI X 360 days
FGCP CGS-Cost of Goods Sold (not consider Depreciation)
CGS
BD X 360 days BD-Book Debt (Debtors & A/R), BD recognised at cost not with
BDCP
Credit Sale at cost profit; CS-Cost of sales during the period
Creditors X 360 days
PDP Purchase of materials during the periods
Credit Purchase
Net Operating Cycle = RMCP+WIPCP+FGCP+BDCP-PDP

Example- folowing are the statement of cost of sales and other infromation of a company-
Items of Expenditures Actual -1997 Projected-1998
Purchase of RM (Crdit) 47 61
Add: O/S of RM 5 9
Less: C/S of RM (8) (10)
RM Consumed 44 60
Add: DL 16 19
Add: Dep 2 3
Add: Other Factory OH 6 7
Total Costs 68 89
Add: O/S of WIP 2 3
Less: C/S of WIP (4) (5)
Total costs of Goods Purchased 66 87
Add: O/S of FG 4 6
Less: C/S of FG (6) (10)
COGS 64 83
Add: Selling, Administrative and other Exp. 6 7
Cost of Sales 70 90
Total Credit Sales 87 108
Opening Book Debt 8 12
Closing Book Debt 11 14
Opening Creditors 4 5
Closing Creditors 6 7

Page 17 of 24
 FM Rule
Other Additiona Information: The co. is also planning to invest Tk. 6 lakh for purchasing marketable securities
and to pay expenses in advance Tk. 1 lakh. It is also expected that the minimum cash balance should be
maintained 4lakh. Time lag in payment of wages 15 days; Time lag in payment of other OH 30 days. The co.
has arranged for short term bank loans of Tk. 304,191 for next year. U r required to estimate the WC for 1998.

Calculation of Working Capital Cycle (Operating Cycle)

1997 1998

RMI X 360 days 8 X 360 = 65.45 days 10 X 360 = 60.00 days

RMCP
RMC 44 60
WIPI X 360 days (Dep. Ignored) 4 X 360 = 22.50 days 5 X 360 = 21.43 days
WIPCP
COP (66-2) (87-3)
FGI X 360 days 6 X 360 = 34.84 days 10 X 360 = 45 days
FGCP
CGS (64-2) (83-3)
BD X 360 days (Collection Period) 11 X 360 = 56.57 days 14 X 360 = 56 days
BDCP
Credit Sale at cost 70 90
Creditors X 360 days 6 X 360 = 45.98 days 7 X 360 = 41.31 days
PDP
Credit Purchase 47 61

Summary of the calculation of Operating Cycle-

Inventory Conversion Period 1997 1998

RMCP 65.45 days 60.00 days
WIPCP 22.50 days 21.43 days
FGCP 34.84 days 45.00 days
A) Total ICP 122.79 days 126.43 days
B) BDCP 56.57 days 56.00 days
C) Gross OC (A+B) 179.36 days 182.43 days
D) PDP 45.98 days 41.31 days
E) Net OC (C-D) 133.38 days 141.12 days

Estimated WC requirement for 1998 (how much money require in each item of the cycle)
Investment in Inventory
RM Consumption X RM CP 60,00,000 X 60
Investment in RM
360 360
COP X WIPCP 84,00,000 X 21.43
Investment in WIP
360 360
COGS X FGCP 80,00,000 X 45
Investment in FG
360 360
A) Total Investment in Inventory 25,00,000
Cost of sales X Credit Period 90,00,000 X 56
B) Investment in BD
360 360
C) Investment in Securities 600,000
D) Cash Balance Requirement 400,000

Page 18 of 24
 FM Rule
E) Estimated prepaied Expenses 100,000
F) Total investment in CA 50,00,000
Less: Current Liabilities
Credit pur of RM X Credit Period 61,00,000 X41.31
G) Creditors
360 360
DL X Deferred Period 19,00,000 X15
H) Deferred Wages
360 360
All OH X Time Lag 14,00,000 X30
I) OH Exp
360 360
J) Bank Loan 304191
K) Total Current Liabilities 12,00,000
Net Working Capital (F-K) 38,00,000

Problem:
Present selling goods of Tk. 6 crore with a terms of net 30 days. Average collection period is 45 days.
Company wants to extend credit period to 60 days on all sales that would help increasing sale by 15%
After change the credit policy the average collection period is expected to be 75 days.
VC 80/unit and SP100/unit. Required ROR (opportunity cost) on its investments in 20%.
Should company extend its credit period?
Particulars Tk Tk
Additional Sales (Tk. 6 crore X .15) 90,00,000
Additional contribution 90,00,000 X .20 18,00,000
Present investment in A/R 6,90,00,000 X 75 days/360 days 1,43,75,000
Original investment in A/R = 6,00,00,000 X 45 days/360 days 75,00,000
Additional investment in A/R 68,75,000
Cost of additional investment in A/R = 68,75,000 X .20 13,75,000
Additional profit 4,25,000

Since the new credit policy will contribute additional profit of Tk. 4,25,000; the company should ecyend its
credit period from 30 days to 60 days.
Probloem: Selling goods of Tk. 24 crore with an average collection period of 30 days. Product Price Tk. 200/unit,
VC Tk. 160/unit, Opportunity Cost on Investment in A/R = 25%. Which policy should be accepted on the basis of
total profit. Now deciding alltenatives are –
Tk. in Lakh
Particulars Policy A Policy B Policy C Policy D
Increase in Sales (Tk.) 25 18 12 6
Average Collection Period (ACP) for incremental sales (days) 45 30 30 30
Bed Debt losses on Incremental Sales 5% 4% 3% 2%
Collection and Administration Cost (% on incremental Sales) 4% 3% 2.5% 2%

Statement of Evaluation of Credit Policy Amount in Lakh

Particulars Policy A Policy B Policy C Policy D
A) Incremental Sale 28.00 18.00 12.00 6.00
B) Incremental Contribution = ince sale X .20 = (200-160) ÷ 200 5.60 3.60 2.40 1.20
C) Incremental Investment in A/R = (Credit Sale X ACP) ÷ 360 3.50 1.50 1.00 0.50
D) Opportunity cost of investment in A/R (25%) = C X .25 0.87 0.375 0.250 0.125
E) Bad Debt loss = A X BD% 1.40 0.720 0360 0.120
F) Collection and Administrative Cost 1.12 0.540 0300 0.120
G) Total Cost (D+E+F) 3.395 1.635 1.910 0.370
H) Incremental Profit (B-G) 2.205 1.965 1.490 0.830

Solution:
Page 19 of 24
 FM Rule
Particulars Tk Tk
Contribution MarginA = (50-35) ÷ 50 = 30%
Additional contribution = 5,00,000 X .30 1,50,000
Less:
Bed Debt loss = Tk. 5,00,000 X .04 20,000
Incremental Administrative Cost 15,000
Total Incremental Cost 35,000
Incremental Profit before Tax 1,15,000
Tax Rate 40% 46,000
Incremental Profit after Tax 69,000
Investment in Proposed level of A/R = (75,00,000+5,00,000) X 60 days/360 days 13,33,333
Investment in Present level of A/R = 75,00,000 X 45 days/360 days 9,37,500
Incremental investment in A/R 3,95,833
Incremental cost of Investment in A/R 3,95,833 X 0.15 59,375
Incremental Net Profit 9,625

Since incremental profit of Tk. 69,000 is higher than the incremental cost on investment in A/R by (69,000
– 59,375) = Tk. 9,625, the policy should be accepted.

Ratio Analysis:
A) Liquidity Ratio:
o Net Working Capital (NWC) = CA – CL; Current Ratio = CA ÷ CL;
o Acid Test/Qucik Ratio = (CA – Stocks - Prepaid Expenses) ÷ CL
= (Cash + Marketable Securities + Debtors) ÷ CL
o Super Quick Ratio = (Cash + Marketable Securities) ÷ CL

B) Capital Structure/Leverage Ratio: 1) Debt-Equity or Debt-Assets and 2) Coverage

o Shareholder’s Equity = Share/Equity Capital + Irredeemable Preference Shares + Share Premium
+ General Reserve + Tax Holiday Reserve + Retained Earnings + Gain on Marketable Securities
o Debt - Equity Ratio = Long Term Debt ÷ Shareholder’s Equity = Total Debt (Long term + CL) ÷
Shareholder’s Equity
o Debt to Total Capital = Long Term Debt ÷ Permanent Capital (Shareholder’s Equity + Long Term
Debt)
o Debt to Total Assets Ratio = Total Debt (Long term + CL) ÷ Total Assets
o Proprietary Ratio = Owner’s Fund ÷ Total Assets
o Capital Gearing Ratio = Loan Capital ÷ Equity Fund = (Redeemable Preference Share Capital +
Debentures + Other borrowed Fund) ÷ Equity Shareholder’s Fund (Net Worth)
o Interest Coverage Ratio or Times Interest Earned = EBIT ÷ Interest
o Dividend Coverage Ratio = EAT÷ Dividend on Preference Share

C) Activity/Turnover/Efficiency Ratio:
o Operating Profit Ratio/Margin = EBIT ÷ Net Sales
o Gross Profit Ratio/Margin = Gross Profit (Sales – COGS) ÷ Net Sales
o Cost of Goods Sold (COGS) Ratio = COGS ÷ Net Sales
o Net Profit Ratio/Margin = Net Profit (EAT) ÷ Net Sales
o Operating Expenses Ratio = (Administrative Expenses + Selling Expenses) ÷ Net Sales
o Selling Expenses Ratio = Selling Expenses ÷ Net Sales
o Administrative Expenses Ratio = Administrative Expenses ÷ Net Sales
Page 20 of 24
 FM Rule
o Operating Ratio = (COGS + Operating Expenses) ÷ Net Sales
o Return on Total Assets = (EAT + Interest) ÷ Average Total Assets
= (EAT + Interest – Tax Advantage on Interest) ÷ Average Total Assets
o Return on Capital Employed = (EAT + Interest) ÷ Average Total Capital Employed
= (EAT + Interest – Tax Advantage on Interest) ÷ Average Total Assets
o Return on Shareholder’s Equity = EAT÷ Average Total Shareholder’s Equity
o Return on Equity Funds = (EAT – Preference Dividend) ÷ Average Ordinary Shareholder’s Equity
(Net Worth)
o EPS = (EAT – Preference Dividend) ÷ Nos. of Ordinary Shares
o DPS = Dividend Paid to Equity Holders ÷ Nos. of Ordinary Shares
o Earnings Yield (Cost or Return or Interest) = EPS ÷ MPS
o Dividend Yield = DPS ÷ MPS
o Dividend Payment (D/P) Ratio = DPS ÷ EPS
= (Total Dividend Paid ÷ Total Earning for Common Stock) X 100
o P/E Ratio = MPS ÷ EPS
o BVPS = Ordinary Shareholder’s Equity ÷ Nos. of Ordinary Shares Outstanding
o ROI = EAT÷ Total Sales = Average EAT ÷ Initial Investment

Current Assets/Circulating Assets/Floating Assets

Ficticious Assets
Wasting Assets – Mine, Oil, Gas

Risk (Beta/SD/CV/Variance) & Capital Budgeting: Variance, SD & Co-Efficient of Variance

➢ There is a positive relation between risk and return.
➢ Business risk is defined as the uncertainty in protection of future return on assets or on equity if the
firm uses no debt.
➢ Finacial risk is the chance that investment will not generate sufficient cash flows to cover interest
payment of money borrowed or pricipal payments on the debt.
➢ Market/systemetic/unavoidable risk
➢ Diversifiable/unsystematic/avoidable risk
➢ Risk is the deviation of expected return from real return.
➢ Forms of market efficiency – Waek, Semi-Strong and Strong
Risk Evaluation Techniques are -
➢ Risk Adjusted Discounted Rate Approach (RAD) – like NPV, but here R or K = RF + Risk Premium
➢ Certainty Equivalent Approach, CE Approach - like NPV, but here K = RF only and CF adjusted for
Tax rate, if Tax rate is available. Future Cash Flow is multiplyed by certainty (δ) factors = riskless
cash inflow/risky cash inflow. riskless cash inflow<risky cash inflow.
CFAT X δ
NPV = ∑ - NCO
(1+K)T
➢ Probability Distribution Approach, PD Approach; Decision Tree Approach, DT Approach; Sensitivity
Approach; Scenarioo Analysis
➢ CF = P1 X CFAT1 + P2 X CFAT2 + ------
Measurement of risks: 1) on the basis of historical data; 2) on the basis of estimation – a) probability
distribution, b) discrete probabilty distribution.
Economic Conditions: Deep Recession, Moderate Recession, Normal Condition, Moderate Prosperity,
Great Prosperity.

Page 21 of 24
 FM Rule
`yB ev Z‡ZvwaK cÖK‡íi Investment and NPV mgvb n‡j Zv‡`i SD and CV Gi wfwˇZ cÖKí gyj¨vqb Ki‡Z nq|
Expected/probable return, Div + End Price D P1 – Po
- 1 = +
R or K = Initial Invest Po Po

Risk measurement procedures: Standard deviation is the absolute risk measurement.

SD, δ = √ V V = δ2 V = Variance High δ indicates high risk
SD, δ = √∑[(X -‾X)2 X P ‾X = Expected Value = ∑(X*P); Probability given and single project
(X1 -‾X1)2 + (X2 -‾X2)2
SD, δ = √ If probability not given and for single project
N
δ of (R1 -‾R1) + (R2 -‾R2)2
2
= √
Assets N-1

δ `yB ev Z‡ZvwaK cÖK‡íi wewfbœ erm‡ii Expected Retun mgvb n‡j Zv‡`i NPV mgvb
CV = ‾X X 100 n‡e| For severa years projects, determine X and δ for each year at first and
then CV
δ
CV =
Investment
SD and CV can be determined for different conditions in a year or for several years –
➢ Determine expected value (‾X) for each year
➢ Determine SD for each year, δ
➢ Determine SD of the project, δp
➢ Determine NPV of the project, NPVP
➢ Determine CV of the project, CVP
δp wewfbœ erm‡ii determined Expected value
CVP = X 100 Gi NPV wbY©q Ki‡Z n‡e|
PVP
δ12 δ22 δ32 SD of project of various years
δp = √ + + (Independent Inflow); same
(1 + R)2 X 1 (1 + R)2 X 2 (1 + R)2 X 3 formula for SD of NPV
δt
δp = √∑ dependent Inflow
(1 + R)t
(Rm –‾ Rm)2
δ2m = ∑ Variance with Market
(N – 1)
δp = √∑ (NPVx – ‾NPV)2 X Px Where inflow of 2nd year is conditional to 1st year CIF
‾X 1 ‾X 2 ‾X 3 Discounting Rate ® can be
NPVP = + + - NCO
(1 + R) 1 (1 + R) 2 (1 + R) 3 assumed if not available

= Pjm δj δm Pjm = co-relation between stock j and market portfolio m

CovJM ∑ (Rj –‾ Rj) (Rm -‾Rm) If Probability is not available, apply N – 1
=
(N – 1) Not squared for Cov where squared for δ2
(Rm -‾Rm)2 Cov AB
δ2M = ∑ Cor PAB = P - Portfolio
N-1 δA δB
δp δp = Risk of new project; rpf = Co-relation between P & F
Corporate Risk, bPF = X rpf
δf δf = Corporate risk before accepting new project

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 FM Rule
CV of Portfolio Risk, CovAB = ∑P (RA – ‾RA) (RB – ‾RB) ‾R – Expected Return
CV of Portfolio Risk, CovAB = δA δB RAB
Portfolio Return, Rp = WARA + WBRB
Return of single security = R1P1 + R2P2 + ---
Risk of investment in portfolio,
δp = √ W12δ12 + W22δ22 + WN2δN2 Where there is no co-variance
δp = √ WA2δA2 + WB2δB2 + WC2δC2 + 2WA WBCovAB + 2WB WCCovBC + 2WC WACovCA If co-relation
Total Risk = Business Risk + Financial Risk
Business Risk = ROA or ROI or ROE
ROA = Return to Investors ÷ Total Assets
ROA = (NI to Common Stockholders + Interest Payment) ÷ Total Assets
ROI = (NI to Common Stockholders + Interest Payment) ÷ Total Investment
Financial Risk = Δ ROE (L) - Δ ROE (U) = bL - bU = bU (1 – T) X D/S; bL = bU + bU(1 – T) X D/S
Investment in particular Instrument
Weight =
Total investment in Portfolio

E(Rj) = RF + (Rm - RF) X βJ βJ is the market risk of particular share, Sequrity market line equation
E(Rj) = RF + (Rm - RF) X {PJM δj δM/δ2M} CML Equation, E (Rp) = RF + (Rm - RF)/δM X δj → Where PJM = 1, CML
Slope = (Rm - RF)/δM; SML Slope = Rm - RF’ SML Equation , E (Rj) = RF + (Rm - RF) X βJ
Slope of SML E®j – Rf
=
Risk Premium δj
E®p = Rf + Slope X δp
SML is the relation between E(Rj) and βJ E(Rj) is the expected return of specific security
βa = βe + βL = βeWe + βdWd = βe {Ve/Ve+Vd (1-T)} + βd {Vd (1-T)/Ve+Vd(1-T)}
Βu = βL X E/(E+D); = βe {Ve/Ve+Vd (1-T)} [---- where debt is risk free & βd = 0]
= βe {Ve/(Ve+Vd) [---- where debt is risk free & βd = 0 and no tax effect]
βe = βa X [{E+D (1-T)}]/E = βa X [{1+ (1-T)}]X D/E = βa + (βa – βd) X D/S
E E + D (1-T)
BU = Bg X Bg = BU X
E + D (1-T) E
CovJM PJM δj δM PJM δj Covariance between market porfolio & particular security
β = = =
δ2M δ2M δM Market Variance

∑M.J – N. M‾J M = (RM – RF); J = (Rj – RF); Rj = Co’s Income

βJ =
∑ M2 – N.M‾2 M‾2 = (RM – RF)2

Charecteristic Line, ‾R = a + β‾R; on X – Axis plot composite price index and on Y – Axis plot share
return.
Sensitivity = NPV of the project/PV of cash flows subject to uncertainty
Arbitrage Pricing Theory (APT):
Concept of Risk, E(RJ) = RF + (β1F1 + β2F1 + ……. + βNFN) + UR [where F – Factor, UR –
Unanticipated Return; β – Sensitivity of Asset “J” to Factor]
Concept of Return, E(RJ) = RF + (β1Y1 + β2Y2 + ……. + βNYN) + UR [where Y – Risk Premium for
Factor, β – Sensitivity of Asset “J” to Factor]
Total Return, TR = {D1 + (P1 – P0)}/P0; Return Relative, RR = (D1 + P1)/P0;

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 FM Rule
Arithmetical Mean = TR/N
Normal Probability Distribution:
Total Area = 1; Probability = (X – X‾)/δ; Z vaue is takes from Z Table
Probability of result beyond 3δ is zero
Probability of result within +/- 1δ is 68.26%
Probability of result within +/- 2δ is 95.46%
Probability of result within +/- 3δ is 99.74%

Swap Ratio: how many shares have to be given to T co by the Acquiree Co for T’s entire Share
MPS = Market Capitalization ÷ No of outstanding Shares
EPS = MPS ÷ P/E Ratio
BVPS = Equity Fund ÷ No of outstanding Shares

Value for
MPS X Weight for Swap
EPS X Weight for Swap
BVPS X Weight for Swap

Intrinsic value of a Call = Share Price – Exercise Price

Time Value of Options = Option Price – Intrinsic Value

ERP = Enterprize Resources Planning; SAP = Systems Apllications and Products

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