CORPORATE FINANCE - 2

By K Jagadish Rao, M.Tech, FICWA, ACS, Professor, Bangalore

TIME VALUE OF MONEY

• ANNUITY: MONEY REPAID AT EQUAL MONTHLY OR YEARLY INSTALMENTS FOR LOAN MADE

• ANNUITY FACTOR = (1/R) – 1/[R * (1+R)^N] – Problem: Find the EMI for hoam loan 20 lakhs

repayable in 15 years at 10.9% pa– AF = 88.47. EMI = Rs. 22,606

TIME VALUE OF MONEY

• Problem: Find PV of an amount due in 3 years to Rs. 1000 , if cost of capital is 11% and inflation rate = 6%pa?

• PV = FV/[(1+R)^N][(1+g)^N] where g = annual inflation rate. Real PV = notional PV after inflation

TIME VALUE OF MONEY

• NPV – NET PRESENT VALUE = present cash outflow – present value of cash inflow in future.

• Take all cash outflow as MINUS and inflow as PLUS.• Pr: machine cost Rs. 3,80,000, and cash flow • Net cash inflow in 10 years is (‘000) cost of cap 12%• 50,57,75,80,85,92,92,80,68,50. find NPV• NPV = -380000 + 403697 = Rs. 23697 • IRR= internal rate of return = NPV/invest * 100

MAKING INVESTMENT DECISIONS WITH NPV RULE

• Only cash flow to be discounted to PV• Cash flow on actual in/out go basis• Cash flow after tax to be considered• cash flow on incremental cost benefit basis• Include all incidental effects of cash flow• Include working capital requirements• Include opportunity cost of capital • Forget irrecoverable sunk costs• Treat inflation consistently

TIME COST OF MONEY

• Equivalent annual cost: annual cash flow sufficient to cover capital investment.

• Useful in choosing between long life and short life equipment

• Useful to decide when to replace an existing equipment

• Equal annual cost = PV of CF / annuity factor

TIME VALUE OF MONEY

• Pr. To choose machine A or B based on Equivalent annual cost

• The annual costs of A and B are (‘000)• Mac C0 C1 C2 C3 PV @6%• A -15 -5 -5 - 5 - 28.37• B -10 -6 -6 -21.00• Eq,An cost A 10.61 10.61 10.61 AF=2.673 • Eq.An cost B 11.45 11.45 AF=1.83• Conclusion: Mac A better than B even if PV higher

TIME VALUE OF MONEY

• Pr. When to replace existing machine• Mac. Gives cash inflow of Rs. 4000/year this year

and next year. A new machine gives inflow of Rs. 8000 /year for 3 years.

• New m/c C0 C1 C2 C3 (‘000) NPV@6%• -15 8 8 8 6.38• Eq. ann cash flow 2.387 2.387 2.387 AF 2.673• Conclusion: Machine not be replaced.

ACCOUNTING RATIOS

• OBHECTIVES:• 1. BAROMETER OF INDUSTRIAL PERFORMANCE• 2. USEFUL FOR MAKING PERIODIC PERFORMANCE COMPARISON

– last year to this.• 3. USEFUL FOR MAKING INTERFIRM COMPARISONS – between

similar industries.• 4. TREND ANALYSIS OF RATIOS GIVES LONG TERM STABILITY

INDICATION. • 5. INDICATES EMPLOYEE STABILITY, LIQUIDITY, EFFICIENCY OF

OPERATIONS, ETC.• 6. RATIOS HELP FINANCIAL INSTITUTIONS, BANKS, SHARE

HOLDERS TO TAKE BETTER DECISIONS IN INVESTING.

ACCOUNTING RATIOS

• 1. IS YOUR BUSINESS SOLVENT? CAN IT PAY ITS DEBTS AS IT BECOMES DUE?• I. current ratio = cur assets / cur. liabilities• cur asset=stock(inventory)+debtors+cash• cur liab=creditors+bank OD+tax liability• current ratio of 2:1 is considered a very healthy figure.

ACCOUNTING RATIOS

• II. QUICK RATIO (ACID TEST RATIO)• quick ratio = quick assets / cur. liabilities• quick asset=debtors+cash• cur liab=creditors+bank OD+tax liability• quick ratio of 1.5:1 is considered a very healthy figure.

ACCOUNTING RATIOS

• 2. IS YOUR BUSINESS PROFITABLE? • I. GROSS PROFIT MARGIN (GPM)• GPM % = Gross profit / Turn over X 100• Gross profit = sales – cost of production • Turn over = sales

ACCOUNTING RATIOS

• 2. IS YOUR BUSINESS PROFITABLE? • I. NET PROFIT MARGIN (NPM)• NPM % = net profit / Turn over X 100• Net profit = sales – cost of production – cost

of sales – cost of administration – finance cost (all costs)

• Turn over = sales

ACCOUNTING RATIOS

• 3. WHAT IS THE RETURN ON ASSETS?• Return on asset = Net profit / Net Asset X 100• Net profit = sales – cost of production – cost of

sales – cost of administration – finance cost (all costs)

• Net Asset = Total Asset – Total Liabilities or amount of Capital Employed in the business.

ACCOUNTING RATIOS

• 4. HOW IS YOUR BUSINESS PERRFORMING IN KEY ATEAS?

• 2. Debt to Equity Ratio (gearing) = total debt / Total equity

• Total debt = secured debt + unsecured debt • Total equity = total Share holder’s fund =

equity + reserves and surplus. A ratio of 1:2 is considered healthy.

ACCOUNTING RATIOS

• 5. OVERALL PERFORMANCE RATIOS• 1. Earnings per share (EPS) = Net profit/ No. of

equity and Preference shares• 2. Price Earnings ratio = Market price per

share / EPS• 3. Dividend Yield = Dividend per share /

Market price per share

Thank you