List of Financial Formulae

List of Formulae
Chapter 1 introduCtion to finanCial management

Risk Return Trade Off
Return expected = Risk free return + Risk premium
Economic Value Added (EVA)

EVA = Net Operating Profit after Tax – Cost of Capital Employed
List of Formulae LF.1
List_of_Formulas—Online.indd 1 1/23/2014 2:46:49 PM

Chapter 2 Time Value of Money
Future Value of a Single Cash Flow

F = P 3 (1 + r)n
Future Value of Annuity

(1 + r ) n - 1
FV = A 3
r
Sinking Fund
1
Sinking Fund (Annuity) = FV 3
FVIFA
r
Sinking Fund (Annuity) = FV ¥
(1 + r ) n - 1
Present Value of a Single Cash Flow

F
P=
(1 + r ) n
Present Value of an Annuity
PV = A ÏÌ - ¸
1 1

r n ˝
Ó r ¥ (1 + r ) ˛
PV = A 3 PVIFA(r, n)
Capital Recovery
PV
A=
PVIFA( r , n )
Present Value of Perpetuity

Annual payment
=
Interest rate (r )
Present Value of Growing Annuity

ÏÔ n¸
Ï n¸
1 1 Ê1 + g ˆ Ô A Ô Ê1 + g ˆ Ô
A
PV = Ì - Á ˜ ˝ = r - g Ì1 - Á 1 + r ˜ ˝
ÔÓ r - g r - g Ë 1 + r ¯ Ô˛ ÔÓ Ë ¯ Ô
˛
Present Value of Growing Perpetuity

GP
PVGP =
r-g
Present Value of Annuity Due
PVAD = A ÏÌ - ¸ (1 + r )
1 1

r n ˝
Ó r (1 + r ) ˛
LF.2 Financial Management

Future Value (Multi-Period Compounding)
Annual compounding F = P (1 + r)n
2n
Ê rˆ
Semi-annual compounding F = P Á 1 + ˜
Ë 2¯
4n
Ê rˆ
Quarterly compounding F = P Á 1 + ˜
Ë 4¯
12 n
Ê r ˆ
Monthly compounding F = P Á 1 + ˜
Ë 12 ¯
36 n
Compounding by 36 parts of year F = P Ê 1 + r ˆ
Ë 36 ¯
mn
If m is the number of parts of the year, F = P Ê 1 + r ˆ
Ë m¯
Future value (Continuous Compounding)
Continuous Compounding
Future value (F) = P 3 er 3 n
Present value (Continuous Discounting)

F
Continuous Discounting: Present value P =
r¥ n
e
Doubling Period
72
Doubling Period =
Interest rate (i)

Chapter 3 Valuation of Long-Term Securities
Present Value of the Bond

INT INT INT MV
Po = + ++ +
(1 + kd ) (1 + kd )2 (1 + kd ) n
(1 + kd )n
n
INT MV
Po = Â +
t
t =1 (1 + k d ) (1 + kd )n
Present Value of the Bond (Semi-annual Compounding of Interest)

INT
2n
2 MV
V=Â +
t 2n
t =1 Ê kd ˆ Ê kd ˆ
ÁË 1 + ˜ ÁË 1 + ˜
2 ¯ 2 ¯
INT
= ¥ PVIFA( kd /2 , 2 n ) + MV ¥ PVIF( kd /2 , 2 n)
2
Present Value of the Bond (Zero Coupon Bond)

MV
V=
(1 + kd )n
V = MV 3 PVIF(k
d, n)
Present Value of the Bond (Perpetual Bond)

•
INT INT INT INT INT
V= + + + =Â
(1 + kd ) (1 + kd ) 2 (1 + kd )3 (1 + kd ) •
t =1 (1 + k d )
t
Approximate Yield (Yield to Maturity)

RV - MV
INT +
N
Approximate yield =
( RV + MV )
2
Yield to Maturity for Perpetual Bond

INT
P0 =
kd
INT
kd =
P0
Current Yield
[Coupon of the security (in %) ¥ Face value of the security ]
Current yield =
Market price of the security
Macaulay Duration
n t ¥ Ct n¥M
Â t
+
t =1 (1 + k) (1 + k )n
Macaulay Duration =
P

Modified Duration
Macaulay Duration
Modified Duration =
Ê YTM ˆ
ÁË 1 + ˜
n ¯
Valuation of Irredeemable Preference Shares

•
DP = DP
V=Â
t =1 (1 + k p )t kp
Valuation of Redeemable Preference Shares

n
DP + MV
V=Â
t
t =1 (1 + k p ) (1 + k p )n
= DP 3 PVIFA(kp, n) + MV 3 PVIF(kp, n)
Present Value of the Share (Dividend Capitalisation Method)

D1 D2 D3
P0 = + + +
(1 + ke ) (1 + ke ) 2
(1 + ke )3
Present Value of the Share (Dividend Capitalisation Method) - Zero Dividend Growth Rate
P0 = D
ke
Present Value of the Share (Dividend Capitalisation Method) - Constant Growth in Dividend
(Gordon Growth model)
D1 D2 D3
P0 = + + +
(1 + ke ) (1 + ke ) 2
(1 + ke )3

D0 (1 + g ) D0 (1 + g )2 D0 (1 + g )3
= + + +
(1 + ke ) (1 + ke )2 (1 + ke )3

D0 ¥ (1 + g ) D1
P0 = =
( ke - g ) ( ke - g )
Value of the Share (Earnings Capitalisation Method)

EPS1 (1 - b ) EPS1 (1 - b )
P0 = =
ke - g ke - r ◊ b
EPS1 DPS1
P0 = = (when b = 0, g = 0)
ke ke
Required Rate of Return

DIV1
ke = +g
P0
Value of Growth Opportunities

b ¥ EPS1 (ROE - ke )
V=
ke ( ke - g )

Chapter 4 Introduction to Risk and Return
Rate of Return on Single Asset in Year 1

Ê Div1 ˆ Ê P1 - P0 ˆ
R1(%) = Á ˜ ¥ 100 + Á ˜ ¥ 100
Ë P0 ¯ Ë P0 ¯
Div1 + ( P1 - P0 )
R1(%) = ¥ 100
P0
Average rate of return

1 (R + R + ... + R )
R = 1 2 n
n
1 n
R = Â Rt
n t =1
Variance
n
Variance = 1 Â ( Rt - R )2
n t =1
Standard Deviation
1 n
Standard deviation = Â ( Rt - R )2
n t =1
Expected Rate of Return

E(R) = R1P1 + R2P2 + … + RnPn
n
E(R) = Â Rt ¥ Pt
t =1
Variance of Return
n
s2 = Â [ Rt - E ( R )]2 ¥ Pt
t =1
Coefficient of Variation
= Standard deviation = s
Expected return E ( R)
s
Cv =
E ( R)
Standardising Normal Distribution

R - E ( R)
S=
s

Chapter 5 Risk and Return: Portfolio Theory and Assets Pricing Models
Expected Rate of Return of a Portfolio

n
E(R) = Â Rt ¥ Pt
t =1
Expected Rate of Return on Two-Asset Portfolio

E(RP) = wA 3 E(RA) + (1 – wA) 3 E(RB)
Covariance of Return of Two Assets

n
CovAB = Â [RA – E(RA)] [RB – E(RB)] 3 Pt
t =1
Correlation of Return of Two Assets

Covariance AB
CorrelationAB =
Standard deviation of A ¥ Standard deviation of B
Cov AB
CorAB =
σA ¥ σB
Variance of Two-Asset Portfolio

σ P2 = σ A2 w A2 + σ B2 wB2 + 2 w A wB Cov AB
σ P2 = σ A2 w A2 + σ B2 wB2 + 2 w A wB (σ A σ B CorAB )
Minimum Variance of Two-Asset Portfolio

σ B2 - Cov AB
wA =
σ A2 + σ B2 - 2 ¥ Cov AB
Minimum Variance of Two-Asset Portfolio (Case of Zero Correlation between Assets)

σ B2
wA =
σ 2A + σ B2
Portfolio Variance
È 1 ˘
Portfolio variance = σ 2p = n ÈÍ 1 ˘˙ 3 Average variance + n(n – 1) Í 2 ˙ 3 Average Covariance
2
În ˚ În ˚
È ˘
1 È 1 ˘
= Í ˙ Average variance + Í1 - ˙ Average covariance
În˚ Î n˚
Total Risk
Total risk = Unsystematic risk + Systematic risk
Total risk = Variance caused by factors attributable to the firm + Variance attributable to general economic factors
Reward-to-Variability Ratio (Slope of CML)

E ( Rm ) - R f
Slope of CML =
σm

Expected Return on a Portfolio on CML
È E ( Rm ) - R f ˘
E(Rp) = Rf + Í ˙σp
ÎÍ σm ˙˚
Expected Return on an Asset

RA = Rf + (Rm – Rf)b
Expected Return on Security

È E ( Rm ) - R f ˘
E(RA) = Rf + Í ˙ 3 (CovAm)
ÎÍ σ m2 ˚˙
E(RA) = Rf + [E(Rm) – Rf] 3 bA
Expected Return of an Asset (APT Approach)

E(RA) = Rf + UR
E(RA) = Rf + USf + UEm
E(RA) = Rf + USf + Rm + URm
E(RA) = Rf + (b1F1 + b2F2 + p + bnFn) + USf
Sharpe Ratio
Risk premium of portfolio return
Sharpe ratio =
Risk level ( σ p )
RP - R f
=
σp
Treynor Ratio
Risk premium of portfolio return
Treynor ratio =
Risk level ( βP )
RP - R f
=
βp
Differential Return (Jensen’s Index, Jensen’s Alpha or Jensen’s Ratio)

aP = RP – Expected return of the portfolio
Beta
Cov AM
b=
Variance of Market Returns
σ A ¥ σ M ¥ CorAM
b=
Variance of Market Returns
σ A ¥ CorAM
b=
σM

Chapter 7 Analysis of Financial Statements
Current Ratio
Current assets
Current ratio =
Current liabilities
Quick Ratio
Current assets - Inventories
Quick ratio =
Current liabilities
Cash Ratio
Cash + Amount in bank + Marketable securities
Cash ratio =
Current liabilities
Interval Measure
Current assets – Inventory
Interval measure =
Average daily operating expenses
Net Working Capital Ratio

Net working capital (NWC)
=
Net assets (NA)
Debt Ratio
Total debt (TD)
Debt ratio =
Net worth (NW) + Total debt (TD)
Total debt (TD)
Debt ratio =
Capital employed (CE)
Total debt (TD)
Debt ratio =
Net assets (NA)
Debt-Equity Ratio
Total debt (TD)
Debt-equity ratio =
Net worth (NW)
Capital Employed to Net Worth Ratio

Capital employed (CE)
CE to NW ratio =
Net worth (NW)
Total debt (TD) + Net worth (NW)
CE to NW ratio =
Net worth (NW)
Total Liabilities to Total Assets Ratio

Total liabilities
TL to TA ratio =
Total assets

Long-term Debt to Long-term Capitalisation Ratio
Long-term debt (LD)
=
Long-term debt (LD) + Net worth (NW)
Debt Ratio
Total debt + Value of lease
Debt ratio =
Total debt + Value of lease + Net worth
Debt-Equity Ratio
Total debt + Value of lease
Debt-equity ratio =
Net worth
Interest Coverage Ratio

Earnings before interest and taxes (EBIT)
Interest coverage ratio =
Interest
Earnings before interest, taxes, depreciation and amortisation
Interest coverage ratio =
Interest
EBITDA
=
Interest
Fixed Charge Coverage Ratio

EBITDA
Fixed charge coverage ratio =
Principal
Interest +
(1 – Tax rate)
Fixed Charge Coverage Ratio

= EBITDA
Principal + Preference dividend
Interest + Lease rentals +
(1 – Tax rate)
Inventory Turnover Ratio

Cost of goods sold
Inventory turnover ratio =
Average inventory
Alternatively,
Sales
Inventory turnover ratio =
Inventory
Raw Material Inventory Turnover Ratio

Material consumed
=
Average raw material inventory
Work-in-Progress Inventory Turnover Ratio

Cost of production
=
Average work-in-progress inventory

Debtors Turnover Ratio
Credit Sales
Debtors turnover ratio =
Average debtors
Alternatively,
Sales
Debtors turnover ratio =
Debtors
Average collection period

365
Average collection period =
Debtors turnover ratio
365 ¥ Average debtors
=
Credit Sales
Net Assets Turnover Ratio

Sales
Net assets turnover ratio =
Net assets
Capital Employed Ratio

Sales
Capital employed ratio =
Capital employed
Total Assets turnover ratio

Total assets turnover ratio = Sales
Average total assets
Fixed Assets Turnover Ratio

Sales
Fixed assets turnover ratio =
Net fixed assets
Current Assets Turnover Ratio

Sales
Current assets turnover ratio =
Current assets
Net Working Capital Turnover Ratio

Sales
=
Net working capital
Gross Profit Margin Ratio

Sales – Cost of goods sold
=
Sales
Gross profit
=
Sales

Net Profit Margin Ratio
Profit after Tax (PAT)
Net profit margin ratio =
Sales
Net Profit Margin Ratio Based on NOPAT

NOPAT EBIT (1 - T )
Net profit margin ratio = =
Sales Sales
Operating Expenses Ratio

Operating expenses
Operating expenses ratio =
Sales
Return on Total Assets (Return on Investment)

EBIT (1 – T)
ROI = = ROTA
Total Assets
Return on Net Assets (Return on Investment)

EBIT (1 – T)
ROI = = RONA
Net Assets
Return on Equity
Profit after tax PAT
ROE = =
Net worth NW
Earnings per Share

Profit after tax (PAT)
=
Number of ordinary shares outstanding
Dividend per Share

Earnings paid to shareholders
=
Number of ordinary shares outstanding
Dividend Payout Ratio

Amount of dividends
Dividend payout ratio =
Profit after tax
Dividend per share
=
Earnings per share
Dividend Yield
Dividend per share DPS
Dividend yield = =
Market value per share MV
Earnings Yield
Earnings per share EPS
Earnings yield = =

Price-Earnings Ratio
= =
Earnings per share EPS
Market Value to Book Value Ratio

Market value per share
MV to BV ratio =
Book value per share
Book Value per Share

Net worth
BV per share =
Number of shares outstanding
Earning Power
Earnings after tax Sales
Earning Power = ¥
Sales Total Assets
Earnings after tax
=
Total assets

Chapter 8 Financial Planning, Forecasting and Strategy
Sustainable Growth for a Single Product Firm

Net margin ¥ retention ¥ leverage
=
Assets to sales – (Net margin ¥ retention ¥ leverage)
PAT ¥ RE ¥ D + E
S PAT E
=
NA Ê PAT D + Eˆ
-Á ¥ RE ¥ ˜
S Ë S PAT E ¯
Sustainable Growth for a Multi Product Firm

Retained earnings ¥ (1 + debt : equity ratio)
Growth =
Net assets
gs = RE Ê 1+ D ˆ
NA Ë E¯
Return on Net assets

= Profit margin ¥ Net Asset turnover
S
= PBIT ¥
S NA
Retained Earnings as Fraction of Net Assets

RE = PBIT ¥ PAT ¥ RE
NA NA PBIT PAT
Sustainable Growth for a Multi Product Firm

D+E
gs = Ê ¥ PBIT ˆ ¥ PAT ¥ RE ¥
S

Ë NA S ¯ PBIT PAT E
PAT ¥ RE
gs =
E PAT
= Return on equity ¥ Retention ratio
Sustainable Growth Rate

= ROE ¥ Retention rate
È D ¥ (r - i) ˘
= Ír + ˙ ¥ (1 - T ) ¥ b
Î E ˚
= b ÍÈr + ( r - i ) ¥ ˙˘ ¥ (1 - T )
D
Î E˚

Chapter 10 The Basics of Capital Budgeting and Evaluation Techniques
Net Present Value

C1 C2 C3 C4 Cn
NPV = + + + +º+ - C0
1 2 3 4
(1 + r ) (1 + r ) (1 + r ) (1 + r ) (1 + r ) n
n Ct
= Â - C0
t = 1 (1 + r )t
XNPV
n Pi
XNPV = Â
i =1
(1 + rate )
( di ¥ d1
365 )
IRR (by Trial and Error)
C1 C2 C3 C4 Cn
C0 = + + + +º+
1 2 3 4
(1 + r ) (1 + r ) (1 + r ) (1 + r ) (1 + r ) n
n Ct
C0 = Â
t = 1 (1 + r )t
Profitability Index
Present value of all future cash inflows
PI =
Initial cash outlay
n ÏÔ ¸Ô
Ct
ÂÌ ˝
Ô (1 + r )t ˛Ô
t =1 Ó
PI =
C0
Average Income (Accounting Rate of Return Method)

Average income
ARR =
Average investment
n (1 - T )
Average Income = Â EBITt ¥
t =1 n
( I0 + In )
Average Investment =
2
Payback Period
Initial investment or Initial cash outflow
=
Annual constant cash inflow

Chapter 11 Cost of Capital
Opportunity Cost of Capital

C1 C2 Cn
C0 = + +º+
(1 + k ) (1 + k ) 2
(1 + k )n
Cost of Debt Issued at Par

INT
kd = i =
P0
Cost of Debt Issued at Discount or Premium

n INTt Pn
P0 = Â +
t = 1 (1 + k d )t (1 + kd )n
After Tax Cost of Debt (Short cut method)

Ê P - P0 ˆ
INT ¥ (1 - T ) + Á n ˜
Ë n ¯
kd =
( Pn + P0 )
2
Relation between ‘before tax cost of debt’ and ‘after tax cost of debt’ for perpetual debt
INT ¥ (1 - T )
kd = i =
P0
Relation between ‘before tax cost of debt’ and ‘after tax cost of debt’ for redeemable debt
n INTt ¥ (1 - T ) Pn
P0 = Â t
+
t =1 (1 + kd ) (1 + kd ) n
Cost of Irredeemable Preference Shares

Dp
kp =
P0
Cost of Equity - Dividend Capitalisation Approach

D1
ke = +g
P0
Cost of Equity - Earnings based approach

EPS1
ke =
P0
Cost of Equity - Capital Asset Pricing Model Approach

ke = rf + b (rm – rf)
Cost of External Equity

D0 (1 + g )
Cost of external equity = +g
P0 (1 - f )

Chapter 12 Determining Cash Flows for Capital Budgeting
Profit
Profit = Revenue – Expenditure – Depreciation
P=R–E–D
Cash Flow
Cash Flow =Revenue – Expenditure – Capital Expenditure
CF = R – E – CAPEX
Cash Flow = Profit + Depreciation – Capital Expenditure
CF = P + D – CAPEX
Net Cash Flow

Net Cash Flow = Revenue – Expenses – Tax
NCF = R – E – T
Net Cash Flow

NCF = EBDIT ¥ (1 – t) + t ¥ D
Depreciation Tax Shield

Depreciation tax shield = Tax rate ¥ Depreciation
Net Cash Flow

NCF = R – E – D – T + D
NCF = EBIT – T + D
NCF = EBIT – t ¥ (R – E – D) + D
= EBIT – t ¥ EBIT + D
= EBIT (1 – t) + D
Net Cash Flow (Considering NWC also)

NCF = EBIT ¥ (1 – t) + D – increase (or + decrease) in NWC
Incremental Free Cash Flow

DNCF (FCF) = DEBIT ¥ (1 – t) + DD – DNWC – DCAPEX
Present Value of Depreciation Tax Shield

Td
PVDTS = ¥ (BV – SV)
(k + d )
Present Value of all Future Cash Flows beyond nth year at the end of nth year
NCFn +1
PVn =
(k - g)
Nominal Discount Rate

= [{1 + real discount rate (r¢)} ¥ {1 + inflation rate (i)}] – 1

Chapter 13 Some Complex Issues in Capital Budgeting
Equivalent Annual Annuity (EAA)

NPV
EAA =
Annuity factor
NPV (Perpetuity or Infinity)

NPVn ¥ (1 + r ) n
NPV• =
(1 + r ) n - 1
Nominal Discount Rate

= [{1 + real discount rate (r¢)} ¥ {1 + inflation rate (i)}] – 1

Chapter 14 Analysing Risk and Uncertainty in Capital Budgeting
Expected Net Present Value

n ENCFt
ENPV = Â - C0
t =1 (1 + r )t
Expected Net Cash Flow

ENCFt = NCFet ¥ Probability (pet)
Variance of Net Cash Flow

n
= Â (NCFi – ENCF]2 ¥ Pi
i =1
Coefficient of variation
Standard deviation of probability distribution
=
Expected net cash flow (ENCF)
σ
=
( ENCF )
Risk Adjusted Discount Rate

r¢ = rf + rp
NPV - Certainty Equivalent Method

( a1 ¥ NCF1 ) ( a 2 ¥ NCF2 ) ( a3 ¥ NCF3 ) ( a n ¥ NCFn )
PV of cash flows = + + + +
(1 + rf )1 (1 + rf ) 2 (1 + rf )3 (1 + rf ) n
n (a t ¥ NCFt )
NPV = Â - C0
t =1 (1 + rf )t

Chapter 15 Real Options
Worth of a Project
Worth of a project = NPV + Real options’ value
Risk Neutral Probability

P 3 u + (1 – P) 3 d = rf
Call Premium (Price of call option) - Black Scholes Option Pricing Model
Co = So N (d1) – Xe–rf t N (d2)
Put Option Price - Black Scholes Option Pricing Model

Po = Xe–rf t N (–d2) – So N (–d1)
= Xe–rf t [1 – N (d2)] – So [1 – N (d1)]
Ê S0 ˆ È σ2 ˘
ln Á ˜ + Írf + ¥t
Ë X¯ Î 2 ˙˚
d1 =
σ t
Call Premium (Price of call option) - Robert Merton Model
Co = So e–qt N (d1) – Xe–rf t N (d2)
Put Option Price - Robert Merton Model

Po = Xe–rf t [1 – N (d2)] – So e–qt [1 – N (d1)]

Chapter 16 Operating and Financial Leverage
Degree of Operating Leverage

(% Change in EBIT)
DOL =
(% Change in sales)
Q ¥ (P – V )
DOL =
Q ¥ (P – V ) – F
Debt Ratio
D
L1 = =D
(D + E) V
Debt Equity Ratio

L2 = D
E
Interest Coverage Ratio

Net operating income (EBIT)
=
Interest charges
EBIT
L3 =
Interest
Debt Service Coverage Ratio
Earnings before interest and taxes (EBIT)
=
Principal payments
Interest expense +
1–T
Earnings Per Share
(EBIT – I ) ¥ (1 – T )
EPS =
N
Return on Equity
(EBIT – I ) ¥ (1 – T )
ROE =
E
Earnings Per Share (Preference Share is Present in Firm’s Capital Structure)
(EBIT – I ) ¥ (1– T ) – Preference Dividence(Dp)
EPS =
N
Return on Equity (Preference Share is Present in Firm’s Capital Structure)
(EBIT – I ) ¥ (1– T ) – Preference Dividend (Dp)
ROE =
E
Interest Tax Shield

Interest tax shield = Tax rate ¥ Interest
Return on Equity
{
ROE = r ¥ (1 – T ) + (r – i ) ¥ D
E } ¥ (1 – T)

Earnings Before Interest and Taxes (EBIT)
( N1 ¥ I )
EBIT =
( N1 – N 2 )
( N1 ¥ I 2 – N 2 ¥ I1 )
EBIT =
( N1 – N 2 )
N1 Pd
EBIT = ¥
( N1 – N 2 ) (1 – T )
Degree of Financial Leverage

% change in EPS
DFL =
% change in EBIT
Q ¥ (P – V ) – F
DFL =
Pd
[Q ¥ ( P – V ) – F – I ] –
(1 – T )
Degree of Combined Leverage

% change in EBIT % change in EPS
DCL = ¥
% change in sales % change in EBIT
Q ¥ (P – V ) Q ¥ (P – V ) – F
= ¥
Q ¥ (P – V ) – F Q ¥ (P – V ) – F – I
Contribution EBIT
= ¥
EBIT PBT
Contribution
=
PBT
EBIT + Fixed cost
=
PBT

Chapter 17 Capital Structure and Cost of Capital
Value of Equity
Net Income NI
E= =
Cost of equity ke
Value of Debt
Interest Interest
D= =
Cost of debt kd
Value of Firm
V=E+D
Firm’s Cost of Capital

Net Operating Income NOI or EBIT
= =
Value of the firm V
= NOI
V
Weighted Average Cost of Capital

kf = ke E + kd D
V V
Ê V - Dˆ D
k f = ke Á + kd
Ë V ˜¯ V
= ke Ê 1 - ˆ + k d
D D
Ë V¯ V
D
= ke - ( ke - k d )
V
Value of the Firm (NI Approach)

È k ˘
V = NOI + D Í1 - d ˙
ke Î ke ˚
Tatal value of the firm (NOI Approach)

V = EBIT
kf
Cost of equity capital (NOI Approach)

EBIT – INT
Cost of equity capital ke =
V -D
Value of a Levered Firm (MM Approach)

VL = VU = SL + D
Cost of Equity (MM Proposition II)

ke = kf + (kf – kd) D
E

Value of a Levered Firm (MM Hypothesis with Corporate Tax)
VL = VU + Value of side effects
= VU + Value of interest tax shield
Interest Tax Shield

Interest tax shield = ( Corporate income tax rate) 3 (Interest)
After-tax Income of Levered Firm

After-tax income of levered firm = X (1 – T) + T 3 kd 3 D
Present Value of Interest Tax Shield

T ¥ kd ¥ D
PVINTS = =T3D
kd
Value of the Unlevered Firm

(1 - T ) ¥ (NOI)
VU =
kU
Value of the Levered firm

(1 - T ) ¥ (NOI) T ¥ kd ¥ D
VL = +
kU kd
VL = VU + TD
Equity Income after Personal Income Tax

Equity income after personal income tax = (1 – T) (1 – Ts)
Net Tax Benefit of Debt

Net tax benefit of debt = (T – Td) + Ts (1 – T)
Net tax benefit of debt = (T – Tp) + Tp(1 – T) = T(1 – Tp)
Interest Tax Shield Covering All Taxes

INTS = kd DT(1 – Tp)
Levered Firm’s Income After All Taxes

= X(1 – T)(1 – Tp) + kd TD(1 – Tp)
Present Value of Interest Tax Shield (Miller’s Model)

T kd D
PVINTS = = TD
kd
Unlevered Firm’s Shareholders’ Income after all Taxes

Unlevered firm’s shareholders’ income after all taxes = X(1 – T)(1 – Ts)

Value of the Unlevered Firm with Corporate Income Tax and Personal Income Tax
X (1 - T ) ¥ (1 - Ts )
VU =
k f (1 - Ts )
Levered Firm’s Equity-holders’ Income after all Taxes

= (X – kd D) (1 – T) (1 – Ts)
= X (1 – T) (1 – Ts) – kd D (1 – T) (1 – Ts)
Levered Firm’s Debt-holders’ Income after Personal Taxes

Levered firm’s debt-holders’ income after personal taxes = kd D (1 – Td)
Levered Firm’s Total Income after all Taxes

= X (1 – T) (1 – Ts) + kd D [(1 – Td) – (1 – T) (1 – Ts)]
Value of Levered Firm (Miller’s Model)

Value of levered firm = Value of unlevered firm + Present value of interest tax shield
È (1 - T ) ¥ (1 - Ts ) ˘
VL = VU + Í1 - ˙ 3D
Î (1 - Td ) ˚
Value of Levered Firm (Miller’s Model)

VL = VU + PVINTS – PVFD

Chapter 18 Capital Structure Valuation, Planning and Designing
Sustainable Growth
Sustainable growth = ROE (1 – payout ratio)
Return on Equity
ROE = È ROCE + (ROCE – kd ) D ˘ (1 – T)
ÍÎ E ˙˚
Asset Beta
n
ba = Â biwi
i=1
ba = be ¥ Ê E ˆ + βd ¥ Ê D ˆ
ËV¯ ËV¯
Equity Beta
Ê Dˆ
be = ba + (ba – bd) ¥ Ë ¯
E
Opportunity Cost of Capital

ka = rf + rp ba
Cost of Debt
kd = rf + rp ¥ bd
Cost of Equity
ke = rf + rp ¥ be

Ê Dˆ
WACC (Pre-tax) = kd ¥ Ë ¯ + ke ¥ Ê E ˆ
V ËV¯

WACC (Pre-tax) = rf + rp Ê βd ¥ D + βe ¥ E ˆ
Ë V V¯
WACC (Pre-tax) = rf + rp ¥ ba
Levered Cost of equity

ke = rf + rp ba + rp (ba – bd) D
E
Equity beta (With Risk-free debt)

D+E È1 + D ˘
be = ba = ba
E ÍÎ E ˙˚

Cost of equity (With Risk-free debt)
ke = rf + rp ba + rp ba D
E
Interest Tax Shields and Asset Beta
ba = Èβe E + βd D ˘ È ˘
1

ÍÎ V V ˙˚ Í Ê D ˆ ˙
Í1 – T Ë ¯ ˙
Î V ˚
Interest Tax Shields and Equity Beta
be = βa È1 + D (1 – T )˘ – βd D
ÍÎ E ˙˚ E
WACC = ke E + kd(1 – T) D
V V
Opportunity Cost of Capital assuming MM Proposition I is true

OCC = Pre-tax WACC = ke E + kd D
V V
Value of Levered Firm

VL = Vu + TD
Adjusted Present Value

APV = Pure-equity NPV + Value of financing effects
Minimum Rate of Return

= ka È1 – TD ˘
C
Minimum rate of return =
I0 Í I 0 ˙˚
Î
= (rf + rp ba) ÊÁ 1 – T ˆ˜
D

Ë I0 ¯
Adjusted Cost of Capital (k*)

k* = (rf + rp ba) Ê 1 – T D ˆ
Ë V¯
Miles-Ezzell formula
D È 1 + ka ˘
k* = ka – T kd Í ˙
V Î 1 + kd ˚
WACC formula
WACC = ka – T kd D
V

Value of a Firm
• FCFt
V= Â
t =1 (1 + k 0 )t
Value of a Firm (For constant value of FCF)

FCF
V=
k0
Free Cash Flows

FCF = ( Sales) ¥ (Profit margin) ¥ (1 – T) + DEP – D NWC – Capex
Value of the Firm

H FCFt TVH
V= Â t
+
t =1 (1 + k0 ) (1 + k0 ) H
Terminal value of future cash flows in the horizon period

FCFH + 1
TVH =
k0
FCFH (1 + g ) FCFH + 1
TVH = =
k0 – g k0 – g
Value of a Firm
N FCF (1 + gH )t FCF (1 + gH) N È 1 ˘
V= Â +
Í (1 + k ) H ˙
t =1 (1 + k0 )t k0 - g N Î 0 ˚
È Ï1 + g ¸ N ˘ FCF(1 + g ) N (1 + g )
V= FCF Í1 – ÔÌ H Ô
˝ ˙+
H N
¥
1
k0 - g H ÍÎ ÓÔ 1 + k0 ˛Ô ˚˙ k0 – g N (1 + k0 ) H

Chapter 20 Long-Term Sources of Finance
Book Value Per Share

Net worth
=
Number of ordinary equity shares
Number of New Shares (Rights Issue)

Funds to be raised
=
Subscription price of rights share
Number of Rights Required to Buy One New Share

Number of existing shares
=
Number of new shares
Effective Price of a New Share (Rights Issue)

MPNS = N ¥ V + IPNS
Value of Rights Per New Share

= MPNS – IPNS
Ex-rights Price of a Share

= Value of the rights per new share + Issue price of new share
N ES ¥ MPES + N NS ¥ IPNS
MPNS =
N ES + N NS
Current Yield
Current annual return
Current yield =
Current market price

Chapter 21 Convertible Debentures, Exchangeable Bonds and Warrants
Conversion Ratio
Issue price of convertible debenture
=
Conversion price
Valuation of Partially Convertible Debenture

n It bPn m Ij F
V0 = Â t
+
n
+ Â +
t =1 (1 + kd ) (1 + ke ) j = n (1 + kd ) j (1 + kd ) m
Valuation of Fully Convertible Debenture

n It b ¢Pn
V0 = Â +
t
t =1 (1 + kd ) (1 + ke ) n
Straight/Non-convertible Debenture Value

n It F
SDV = Â t
+
t =1 (1 + kd ) (1 + kd ) n
Conversion Value
CVn
CVp =
(1 + ke )n
Theoretical Value of Warrant

TVW = (Po – Pe) ¥ N
Warrant Premium
(MVW - TVW) ¥ 100
WP =
TVW
Value of Call Option by using the Black Scholes Model

C0 = S0N(d1) – Xe–rf t N(d2)
Current Market Value of the Share after the Issue of Warrant Issued at a Cost
(Current share price ¥ Number of existing shares) + Warrant issue cost
=
Number of existing shares
Value of the Warrant at Expiration

1
= [Maximum {(S¢ – X), 0)}]
1 + wp

Chapter 22 Lease, Hire Purchase and Project Financing
Net Advantage of Leasing
n (1 - T ) LRt + DTSt n (1 - T ) OCt SV ( AT ) n

NAL = C0 - Â t
+ Â t
-
t =1 {(1 + kd (1 - T )} t =1 (1 + k ) (1 + k ) n

Chapter 24 Introduction to Working Capital Planning and Management
Gross Operating Cycle (GOC)

GOC = RMCP + WIPCP + FGCP + DCP
Raw Material Conversion Period (RMCP)

Raw material inventory
=
Raw material consumption
365
RMC RMI ¥ 365
RMCP = RMI ∏ =
365 RMC
Work-in-Progress Conversion Period (WIPCP)

Work-in-progress inventory
=
Cost of Production
365
COP WIPI ¥ 365
WIPCP = WIPI ∏ =
365 COP
Finished Goods Conversion Period (FGCP)

Finished goods inventory
=
Cost of goods sold
365
COGS FGI ¥ 365
FGCP = FGI ∏ =
365 COGS
Debtors (receivables) Conversion Period (DCP)

Debtors Debtors ¥ 365
= =
Credit sales Credit Sales
365
Creditors (payables) Deferral Period (CDP)

Creditors Creditors ¥ 365
= =
Credit purchases Credit purchases
365
Net Operating Cycle or Cash Conversion Cycle

Net Operating Cycle = Gross Operating Cycle – Creditors Deferral Period

Chapter 25 Cash and Marketable Securities Management
Baumol’s Model
2 tT
C* =
k
Miller-Orr Model
1/3
Ê 3
¥ Transaction cost ¥ Daily Cash flow variance ˆ
4
G = 3¥Á ˜
Ë Interest per day in percentage ¯

Chapter 27 Inventory Management

Cost of goods sold (COGS)
Inventory Turnover Ratio =
Average inventory
Inventory Holding Period

360**
=

Raw Material (RM) Consumption (Annual)
=
Average RM Inventory
Raw Material Inventory Holding Period

360
=
Work-in-progress (WIP) Turnover Ratio

Annual Cost of Production
=
Average WIP Inventory
Work-in-progress (WIP) Inventory Holding Period

360
=
Work-in-Progress (WIP) Turnover Ratio
Finished Goods (FG) Turnover Ratio

Cost of Sales
=
Average FG Inventory
Finished Goods (FG) Inventory Holding Period

360
=
Finished Goods (FG) Turnover Ratio
Economic Order Quantity

2¥ X ¥O
EOQ =
C
Reorder Level
Reorder Level = Maximum Consumption 3 Maximum delivery time
Minimum Stock Level

Minimum Stock Level = Re-order level – (Normal consumption 3 Average delivery time)

Maximum Stock Level
Maximum Stock Level = Re-order Level – (Minimum consumption 3 Minimum delivery time) + Re-order quantity
Average Stock Level

Minimum stock level + Maximum stock level
=
2
Rate of Return
Rate of return (ROR) = P
W

Chapter 28 Working Capital Financing
Annual Interest Rate or Implicit Interest Rate or Cost of not availing the discount
d 365
= ¥
100 - d c - p
Interest Yield (Commercial Paper)

Face value – Sale price 365
= ¥
Sale price Days to maturity

Chapter 29 Dividend Theory and Valuation
Net Earnings
Net Earnings = Operating profit – Interest – Tax – Dividend on preference shares
Payout Ratio
Amount paid out as dividend
Payout ratio =
Net earnings of the firm
Retention Ratio
Amount held back as retained earnings
Retention ratio =
Net earnings of the firm
Market Price of Share (Walter’s Model)

r (EPS – DPS)
DPS k
P= +
k k
Present Value of Firm’s Share (Gordon’s Model)

• DPS(1 + g )t
P0 = Â
t =1 (1 + k )t
DPS1
P0 =
k–g
EPS1 (1 – b )
P0 =
k –b¥r
Present Value of Firm’s Share (Gordon’s Model) - Declining Firm

P0 = rA
k
Present Value of Firm’s Share (Gordon’s Model) - Normal Firm

EPS1 (1 – b )rA(1 – b )
P0 = =
k –b¥r k –b¥r
k ¥ A(1 – b ) k ¥ A(1 – b )
= = =A
k–b¥k k (1 – b )
Rate of Return for Shares held for 1 Year (MM Hypothesis)

DPS + ( P1 – P0 )
r=
P0
Market price of share at time 0 (MM Hypothesis)

DPS1 + P1 DPS1 + P1
P0 = =
(1 + r ) (1 + k )

Value of the Firm at time 0 (MM Hypothesis)
nDPS1 + ( n + m ) P1 – mP1
nP0 =
1+ k
Value of the New Shares to be Issued (MM Hypothesis)

mP1 = I1 – (X1 – nDPS1)
Value of the Firm at time 0 (MM Hypothesis)

( n + m ) P1 – I1 + X1
nP0 =
1+ k

Chapter 30 Practical Aspects of Dividend Policy
Dividend for the Current Year (Lintner’s Model)

D1 = EPS1 3 SA 3 DPR + (1 – SA) 3 D0

Chapter 31 Mergers, Acquisition and Restructuring
Net Economic Advantage

Net Economic Advantage = [VAB – (VA + VB)] – (C – VB)
Net Operating Profit After Tax (NOPAT)

NOPAT = Sales revenue – Cost of goods sold – Taxes
Free Cash Flow

Free cash flow = NOPAT + Depreciation + Amortization – (CAPEX) – Increase in NWC
Share Exchange Ratio (Based on EPS)

EPS of acquired firm
Share exchange rate =
EPS of acquiring firm
Share Exchange Ratio (Based on Market Price (MP))

MP of shares of acquired firm
Share exchange ratio =
MP of shares of acquiring firm
Share Exchange Ratio (Based on Book Value (BV))

BV of shares of acquired firm
Share exchange rate =
BV of shares of acquiring firm
Number of Shares to be Exchanged

Number of shares to be exchanged = Share exchange ratio 3 Number of pre-merger shares of the acquired firm
Combined EPS (After Acquisition)

After merger combined PAT
Combined EPS =
After merger combined shares
PE Ratio of Combined Firm After Merger

PATA PATB
PEC = PEA 3 + PEB 3
PATC PATC
Growth Rate in EPS of Combined Firm

PATA PATB
gC = gA 3 + gB 3
PATC PATC

Chapter 32 Derivatives as a Tool of Managing Financial Risk
Futures Price of Financial Securities

= Spot price (1 + rf)t – Dividend foregone
Spot Price of Financial Securities

Future price Dividend foregone
Spot price = +
t
(1 + rf ) (1 + rf )t
Dividend foregone Future price
Spot price – =
t
(1 + rf ) (1 + rf )t
Dividend earned Futures price
Spot price = +
t
(1 + rf ) (1 + rf )t
Spot Price of Commodity Futures

Futures price Storage costs Convenience yield
Spot price = – +
(1 + rf )t (1 + rf )t (1 + rf )t
Futures Price of Commodity Futures

Futures price È Storage costs Convenience yield ˘
= Spot price + Í – ˙
(1 + rf )t Í (1 + rf )t (1 + rf )t ˙
Î ˚

Chapter 33 Valuation of Options
Present Value of Share and Put Option

S0 + P0 = C0 + PV(X)
Present Value of Share and Put Option (Considering Continuous Compounding)

S0 + P0 = C0 + X e–rf t
Put-Call Parity
S0 + P0 = C0 + X e–rf t
Present Value of Put Option

P0 = C0 – S0 + X e–rf t
Present Value of Call Option

C0 = P0 + S0 – X e–rf t
Value of a Call Option

Value of a call option = Maximum [(Share price – Exercise price), 0]
Option Delta
Difference in option values
Option delta (D) =
Difference in share price
Expected Return (Risk-Neutrality Valuation)
Expected return = (Probability of price increase) 3 (Percentage increase in price)

+ (1 – probability of price increase)
3 (Percentage decrease in price)
Current Value of Call Option (Black-Scholes Model)

C0 = S0 N(d1) – Xe–rf t N(d2)
d1 Value for Calculating Cumulative Normal Probability Density Function N(d1)
ÊS ˆ È σ2 ˘
ln Á 0 ˜ + Írf + t
Ë X¯ Î 2 ˙˚
d1 =
σ t
d2 Value for Calculating Cumulative Normal Probability Density Function N(d2)
d2 = d1 – σ t

Value of Put Option
P0 = C0 – S0 + Xe–rf t
P0 = S0 N(d1) – Xe–rf t N(d2) – S0 + Xe–rf t.

= S0 [N (d1) – 1] + Xe–rf t [1 – N(d2)]
Value of Call Option (Options with Continuous Dividends) - Black-Scholes Model

C0 = S0 e–d3t N(d1) – Xe–rf t N(d2)

Chapter 34 International Financial Management
Forward Premium (or Discount) - If Direct Quote given

Spot rate – Forward rate 365
= ¥
Spot rate Number of days
Forward Premium (or Discount) - If Indirect Quote given

Forward rate – Spot rate 365
= ¥
Spot rate Number of days
Bid-Ask Spread
Ask price – Bid price
Spread =
Ask price
Interest Rate Differential (Interest Rate Parity Theory)

(1 + rb ) Fb/a
=
(1 + ra ) Sb/a
Inflation Rate Differential (Purchase Power Parity Theory)

(1 + ia ) Fa/b
=
(1 + ib ) Sa/b
Forward and current spot rate differential

Fa/b E ( Sa/b )
=
Sa/b Sa/b
Nominal Interest Rate

(1 + nominal interest rate ‘rn’) = (1 + real interest rate ‘r’) 3 (1 + inflation rate)
Nominal Interest Rate Differential

1 + ra E (1 + ia )
=
1 + rb E (1 + ib )
Cost of Forward Contract (Annualized) - If Direct quote given

Forward Rate – Expected Spot Rate 365
= ¥
Forward Rate Number of days
Cost of Forward Contract (Annualized) - Indirect quote given

Expected Spot Rate – Forward rate 365
= ¥
Expected Spot Rate Number of days

Chapter 35 Corporate Governance
Value of the Firm

V= FCF
WACC
Free Cash Flow of the Unlevered Firm

FCFu = EBIT (1 – T) – Interest – Principal repayments + DEP + DONCFI + DNWC – DCAPEX
Value of the Unlevered Firm (Economic Value Method)

n FCFu TVn
VU = Â t
+
t = 1 (1 + ku ) (1 + ku )n
Value of Interest Tax Shield

n ITSt
VTS = Â
t = 1 (1 + k d )t
Value of the Levered Firm (Economic Value Method)
n FCFt TVn n ITSn
VL = Â + + Â
t = 1 (1 + ku )t (1 + ku )n t = 1 (1 + k d )t
Market Value Added

MVA = Market value – Capital Employed
Value Creation
VC2012 = MVA2 – MVA1
Market Value per Share

• Dt • EPSt (1 - b )
M= Â t
= Â
t = 1 (1 + ke ) t =1 (1 + ke )t
• Do (1 + g )t • EPSo (1 - b ) (1 + g )t
M= Â = Â
t =1 (1 + ke )t t =1 (1 + ke )t
D1 EPS1 (1 - b )
M= =
ke - g ke - g
Market-to-Book Value
M = ROE - g
B ke - g
È Ê 1 + g ˆ n ˘ È 1 + g ˘n
M = Ê ROE - g ˆ Í1 - Á ˙+Í
B ÁË ke - g ˜¯ ˙
ÍÎ Ë 1 + ke ˜¯ ˙˚ Î 1 + ke ˚

Economic Value Added
Economic Value added = PAT – Cost of equity 3 Equity capital
Economic Return
Economic return = Return on equity (ROE) – Cost of equity (COE)
Net Operating Profit after Tax

NOPAT = PBIT (1 – T) = PAT + INT(1 – T)

List of Financial Formulae

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List of Financial Formulae

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List of Formulae

Chapter 1 introduCtion to finanCial management

Economic Value Added (EVA)

List of Formulae LF.1

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Future Value of a Single Cash Flow

Future Value of Annuity

Present Value of a Single Cash Flow

Present Value of Perpetuity

Present Value of Growing Annuity

Present Value of Growing Perpetuity

Present Value of Annuity Due

LF.2 Financial Management

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Present value (Continuous Discounting)

List of Formulae LF.3

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Present Value of the Bond

Present Value of the Bond (Semi-annual Compounding of Interest)

Present Value of the Bond (Zero Coupon Bond)

Present Value of the Bond (Perpetual Bond)

Approximate Yield (Yield to Maturity)

Yield to Maturity for Perpetual Bond

LF.4 Financial Management

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Valuation of Irredeemable Preference Shares

Valuation of Redeemable Preference Shares

Present Value of the Share (Dividend Capitalisation Method)

Value of the Share (Earnings Capitalisation Method)

Required Rate of Return

Value of Growth Opportunities

List of Formulae LF.5

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Rate of Return on Single Asset in Year 1

Average rate of return

Expected Rate of Return

Standardising Normal Distribution

LF.6 Financial Management

List_of_Formulas—Online.indd 6 1/23/2014 2:46:50 PM

Expected Rate of Return of a Portfolio

Expected Rate of Return on Two-Asset Portfolio

Covariance of Return of Two Assets

Correlation of Return of Two Assets

Variance of Two-Asset Portfolio

Minimum Variance of Two-Asset Portfolio

Minimum Variance of Two-Asset Portfolio (Case of Zero Correlation between Assets)

Reward-to-Variability Ratio (Slope of CML)

List of Formulae LF.7

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Expected Return on an Asset

Expected Return on Security

Expected Return of an Asset (APT Approach)

Differential Return (Jensen’s Index, Jensen’s Alpha or Jensen’s Ratio)

LF.8 Financial Management

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Net Working Capital Ratio

Capital Employed to Net Worth Ratio

Total Liabilities to Total Assets Ratio

List of Formulae LF.9

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Interest Coverage Ratio

Fixed Charge Coverage Ratio