Chapter 1 - Ratios Brahmastra Revision – One shot, full Revision

Financial Analysis & Planning - Ratio Analysis

I. PROFITABILITY RATIOS BASED ON SALES:
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
i. Gross Profit Ratio= 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 (In %)

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡
ii. Operating Profit Ratio= 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
(In %)

​ Net Profit as per P & L Account

​ (+) Non-Operating Expenses (e.g. Loss on sale of assets, preliminary Expenses written off, etc.)
​ (-) Non-Operating Income (e.g. Rent, Interest & Dividends received)
Significance = Indicator of Operating Performance of business.

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
iii. Net Profit Ratio= 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
(In %)

Net Profit = Net profit as per P & L A/c (either before tax or after tax, depending upon data).

iv. Contribution Sales Ratio [or] Profit Volume Ratio= Contribution/ Sales

Contribution = Sales Less Variable Costs.

II. COVERAGE RATIOS:

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑓𝑜𝑟 𝐷𝑒𝑏𝑡 𝑆𝑒𝑟𝑣𝑖𝑐𝑒 𝑃𝐴𝑇+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡+𝑁𝑜𝑛 𝑐𝑎𝑠ℎ (𝑜𝑟 𝑛𝑜𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔) 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
i. Debt Service Coverage Ratio= (𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 + 𝐼𝑛𝑠𝑡𝑎𝑙𝑚𝑒𝑛𝑡)
= (𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 + 𝐼𝑛𝑠𝑡𝑎𝑙𝑚𝑒𝑛𝑡)
(In Times)

Earnings for Debt Service = Net Profit after Taxation

(+) Interest on Debt Funds
(+) Non-Cash Operating Expenses(e.g. depreciation & amortizations)
(+) Non-Operating Items/Adjustments (e.g. Loss on sale of Fixed Assets,etc.)
Interest + Instalment = Interest + Principal (Instalment of Loan Principal)
Non cash expenses like depreciation and non operating expenses like loss on sale of assets is added back in
numerator
𝐸𝐵𝐼𝑇
ii. Interest Coverage Ratio= 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 (In Times)

𝐸𝐴𝑇
iii. Preference Dividend Coverage Ratio= 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 (In Times)

𝐸𝐴𝐸𝑆
iv. Equity Dividend Coverage Ratio= 𝐸𝑞𝑢𝑖𝑡𝑦 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
(In Times)

𝐸𝐴𝑇
v. Dividend Coverage Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 +𝑃𝑟𝑒𝑓 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
(In Times)

III. TURNOVER/ACTIVITY/PERFORMANCE RATIOS

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑑

i. Raw Material Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙
(In Times)

Cost of Raw Material Consumed = Opening Stock of Raw Materials

​(+) Purchases of Raw Materials
​(-) Closing Stock of Raw Materials
(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑅𝑀 𝑆𝑡𝑜𝑐𝑘 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑅𝑀 𝑆𝑡𝑜𝑐𝑘)
Average Stock of Raw Material= 2

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑐𝑜𝑠𝑡
ii. WIP Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝑊𝐼𝑃 (In Times)

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 Chapter 1 - Ratios Brahmastra Revision – One shot, full Revision

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 𝑜𝑟 𝑆𝑎𝑙𝑒𝑠 (𝑙𝑒𝑠𝑠 𝑝𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑)

iii. Finished Goods or Stock Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑡𝑜𝑐𝑘 𝑜𝑓 𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝐺𝑜𝑜𝑑𝑠
(In Times)

Cost of Goods Sold = For Manufacturers: OpeningStock of FG (+)Cost of Production (-) Closing Stock of FG.
​ For Traders: Opening Stock of FG + Cost of Goods Purchased (-) Closing Stock of FG.
(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐹𝐺 𝑆𝑡𝑜𝑐𝑘 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐹𝐺 𝑆𝑡𝑜𝑐𝑘)
Average Stock of Finished Goods = 2

𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
iv. Debtors Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 (In Times)

Average Accounts Receivable = Average Accounts Receivable (i.e. Debtors + B/R)

(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐷𝑟𝑠 & 𝐵/𝑅 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐷𝑟𝑠 & 𝐵/𝑅 )
​ 2

𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
v. Creditors Turnover Ratio= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
(In Times)

Average Accounts Payable = Average Accounts Payable (i.e. Creditors + B/P)

(𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐶𝑟𝑠 & 𝐵/𝑃 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝐶𝑟𝑠 & 𝐵/𝑃)
2
​ ​
𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 (𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠)
vi. Working Capital Turnover Ratio= 𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 (In Times)

[Also called Operating Turnover (or) Cash Turnover Ratio]

Net Working Capital = Current Assets Less: Current Liabilities
(Average of Opening and Closing balances may be taken)

𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
vii. Fixed Assets Turnover Ratio= 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 (In Times)

Net Fixed Assets = Net Fixed Assets (Average of Opening and Closing balances may be taken)

𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
[Link] Turnover Ratio = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
(In Times)
​
Capital Employed = (Average of Opening and Closing balances may be taken)

ALSO STUDY CONCEPT OF DEBTOR, CREDITORS & STOCK VELOCITY

IV. CAPITAL STRUCTURE RATIOS

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
i. Debt to Total Assets Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Debt = Borrowed Funds (or) Loan Funds

​ = Debentures + Long-Term Loans from Banks, Financial Institutions, etc.

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
ii. Debt Ratio = 𝑁𝑒𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝐸𝑞𝑢𝑖𝑡𝑦
iii. Equity to Total Funds Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐹𝑢𝑛𝑑𝑠

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
iv. Equity Ratio = 𝑁𝑒𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

v. Debt – Equity Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦
OR 𝐸𝑞𝑢𝑖𝑡𝑦

𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝐷𝑒𝑏𝑒𝑛𝑡𝑢𝑟𝑒𝑠 + 𝑜𝑡ℎ𝑒𝑟 𝑏𝑜𝑟𝑟𝑜𝑤𝑒𝑑 𝑓𝑢𝑛𝑑𝑠

vi. Capital Gearing Ratio = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠

𝑃𝑟𝑜𝑝𝑟𝑖𝑒𝑡𝑎𝑟𝑦 𝐹𝑢𝑛𝑑𝑠
vii. Proprietary Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

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 Chapter 1 - Ratios Brahmastra Revision – One shot, full Revision

Proprietary Funds = Net Worth (or) Shareholders’ Funds (or) Proprietors’ Funds (or) Owners’ Funds (or) Own
Funds
= Equity Share Capital + Preference Share Capital + Reserves & Surplus Less: Miscellaneous Expenditure (as
per Balance Sheet) and Accumulated Losses.

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
viii. Fixed Asset to Long Term Fund Ratio = 𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐹𝑢𝑛𝑑𝑠

V. LIQUIDITY RATIO
These ratios show a company's ability to meet its short term financial obligation like current ratio and quick
ratio.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
i. Current Ratio= 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

ii. Quick Ratio= Quick Assets / Current Liabilities

𝐶𝑎𝑠ℎ+𝐵𝑎𝑛𝑘+ 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠

iii. Absolute Cash Ratio [or] Cash Ratio [or] Absolute Liquidity Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Cash + Marketable Securities = Cash in Hand

(+) Cash at Bank
(+) Marketable Investments/Short Term Securities(current investments)

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
iv. Basic Defence Interval Measure= 𝐶𝑎𝑠ℎ 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦
(In days)

Quick Assets = Current Assets

​ (-) Inventories
​ (-) Prepaid Expenses
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
Cash Expenses per Day = 365
Cash Operating Expenses = COGS + Selling admin other expenses ( excluding depreciation and non cash exp)
Cash Expenses = Total Expenses (-) Depreciation& write-offs.
Significance= Ability to meet regular Cash Expenses.

VI. OVERALL RETURN RATIOS - OWNER VIEW POINT

i. Return on Investment (ROI) [or] Return on Capital Employed (ROCE) =

𝐸𝐵𝐼𝑇
Pre-tax ROCE: = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
𝐸𝑎𝑡 +𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝐵𝐼𝑇(1−𝑡)
Post-tax ROCE: = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
= 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
(least preferred method)

ii. Return on Net Worth (RONW) =

𝐸𝐴𝑇
RONW: = 𝐸𝑆𝐻𝐹 + 𝑃𝑆𝐶

Equity (or) Net Worth (or) Shareholders’ Funds (or) Proprietors’ Funds (or) Owners’ Funds (or)Own Funds

iii. Return on Assets (ROA) =

𝐸𝐵𝐼𝑇
Pre-tax ROA: = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝐸𝐴𝑇 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝐵𝑇(1−𝑇)
Post-tax ROA: = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 or 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
iv. Earnings per Share (EPS)= 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠
​

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𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
Number of Equity Shares outstanding = 𝐹𝑎𝑐𝑒 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑

v. Dividend per share(DPS)= 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

vi. Price Earnings Ratio (PE Ratio)= 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
vii. Dividend Yield (%)= 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

𝐸𝑆𝐻𝐹
viii. Book Value per Share= 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠

𝐸𝑞𝑢𝑖𝑡𝑦 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
Number of Equity Shares outstanding = 𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 𝑀𝑃𝑆

ix. Market Value to Book Value= 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
= 𝐵𝑉𝑃𝑆

𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑎𝑛𝑑 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑜𝑚𝑝𝑎𝑛𝑦

X. Q Ratio = 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑟𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠
or 𝐴𝑠𝑠𝑒𝑡 𝑅𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝐶𝑜𝑠𝑡
​

Du Pont Models

i. ROI = Net Operating Ratio × Capital Turnover Ratio

[Link] on Equity = Net Profit Margin × Asset Turnover Ratio × Equity Multiplier

Net Profit Margin = Net Income ÷ Revenue

Asset Turnover Ratio = Revenue ÷ Assets
Equity Multiplier = Assets ÷ Shareholders’ Equity

Important Notes
1.​ We prefer to use averages in denominator if it can be consistently applied, otherwise we have to use
closing values to maintain consistency.
2.​ Compare Operating expenses/ operating cost / operating profit ratio

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 Chapter 2 - Cost of Capital Brahmastra Revision – One shot, full Revision

Cost of Capital
Concept 1 - Cost of Debt (Bonds/Debentures/Bank loans - LongTerm etc)
Method 1: Irredeemable Debt (approximation method)
Method 2: Redeemable Debt (approximation method)
Method 3: Yield to Maturity Method (YTM)

Method 1 Irredemable Debt

●​ We don’t have to repay Debt
●​ When Life of Debt is not specified in Question

𝐼 (1−𝑡) 𝐼 (1−𝑡)
Kd = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠
or 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 (𝑤ℎ𝑒𝑛 𝑖𝑠𝑠𝑢𝑒 𝑝𝑟𝑖𝑐𝑒 𝑖𝑠 𝑛𝑜𝑡 𝑔𝑖𝑣𝑒𝑛)

●​ Net Proceeds = (𝐹𝑎𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 + 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 − 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡) 𝑜𝑟 (𝐼𝑠𝑠𝑢𝑒 𝑃𝑟𝑖𝑐𝑒) - Expenses on issue (Flotation
cost, Brokerage, Commission, Management exp etc)
●​ Current Market Price may be used in place of issue cost

Note: If we calculate kd for one Debenture or All Debentures, the answer will be the same. So, better to
calculate for one Debenture.

Method 2 Redeemable Debt (approximation method)

𝑅𝑉 − 𝑁𝑃
𝐼 (1−𝑡) + ( )
Kd = 𝑅𝑉 + 𝑁𝑃
𝑛

( 2
)
RV = Redemption value
NP = Net Proceeds = Issue Price - Floatation Cost
n = Number of years left for Maturity

Method 3 Yield to Maturity Method (YTM)

●​ Rate at which NPV = 0
●​ By using the formulae of interpolation
𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑅𝑎𝑡𝑒
YTM = Lower Rate + Lower Rate NPV x 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑁𝑃𝑉

Concept 2 - Cost of Preference shares (Kp)

Method I : Irredeemable Preference Share (Approximation Method)
Method 2: Redeemable Preference Share (Approximation Method)
Method 3: YTM

Method I : Irredeemable Preference Share (Approximation Method)

𝑃𝐷
​ Kp = 𝑁𝑃 𝑜𝑟 𝑀𝑃

Method 2: Redeemable Preference Share (Approximation Method)

​
𝑅𝑉− 𝑁𝑃
𝑃𝐷 + ( 𝑛
)
Kp = 𝑅𝑉+ 𝑁𝑃
( 𝑛
)
PD = Preference Dividend
NP = Net proceeds = Issue price - Flotation cost
RV = Redemption value
n = Life of preference shares

Method 3: YTM for Kp (same rules as YTM of Kd)

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 Chapter 2 - Cost of Capital Brahmastra Revision – One shot, full Revision

Concept 3 - Cost of Equity (ke)

Equity doesn't have a fixed rate, so Ke has multiple formulae-

[Link] Price Model ( same as dividend yield)

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝐷𝑃𝑆 𝐷
Ke = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒
= 𝑀𝑃𝑆
= 𝑃𝑜

2. EPS model ( earning price model) (earning yield)

𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝐸𝑃𝑆
Ke = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒 = 𝑀𝑃𝑆

3. Dividend Growth Model (Gordon)

𝐷1
Ke = 𝑃𝑜
+g

D1 = Proposed dividend / will pay dividend/ future dividend

g = growth rate of share price / company/dividend/earning
Ke = Cost of Equity
Po = price of share at 0 period (Today)
Note:
●​ Paid Dividend (Fast Tense) = 𝐷0
●​ Expected dividend (Future Tense) = 𝐷1
●​ Pays dividend – Do

Note: We must use Ex dividend price (not cum dividend price)

Cum dividend price ​ ​ ​ ₹238

- Dividend ​ ​ ​ ₹30
Ex dividend price ​ ​ ​ ₹208
(This price should be used as “Po”)
4. Earning Growth Model

𝐸𝑃𝑆1 𝐸𝑃𝑆𝑜(1+𝑔)
Ke = 𝑃0
+ g or 𝑃0
+g

5. Capital asset Pricing model (CAPM)

Ke = 𝑅𝑓 + β (𝐸𝑅𝑚 – 𝑅𝑓)

➔​ Beta of whole market = 1

➔​ Risk free rate examples-
●​ Government Bonds
●​ Treasury Bond
●​ Risk Free Investments
●​ Sovereign Bond

6. Realised Yield Approach

𝐷𝑃𝑆1 + (𝑀𝑃𝑆1 − 𝑀𝑃𝑆0) 𝐷𝑃𝑆1 (𝑀𝑃𝑆1 − 𝑀𝑃𝑆0)

​ Ke = 𝑀𝑃𝑆0
= 𝑀𝑃𝑆0
+ 𝑀𝑃𝑆0

Concept 4 - How to calculate Growth rate (g)

when we have old value and new value g=bxr
b = Retention Rate
r = Rate of Return
Dividend Payment Rate + Retention Rate = 100%

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 Chapter 2 - Cost of Capital Brahmastra Revision – One shot, full Revision
1
𝑁𝑒𝑤 𝑉𝑎𝑙𝑢𝑒 𝑛
g =( 𝑂𝑙𝑑 𝑉𝑎𝑙𝑢𝑒
) -1

New note : How to solve fractional power​ (𝑥) 𝑛

Step 1: Type “x”
Step 2: Press “ ” 12 Times
Step 3: Type “-1=”
Step 4: ÷ n =
Step 5: +1 =
Step 6: “x & = “ 12 times

Concept 5 - Cost of Retained Earning

I. Kre = Ke (1-tp) (1-β)

tp= Personal Tax
β – brokerage
II. ​ When we have to calculate Kre for old shareholders
Retained earnings and Ke separately for new shares

𝐷1 𝐷1
Kre = 𝑀𝑃𝑆
+ g (for old shares) (New shares) Ke = 𝑁𝑃
+g

III. ​ Ke = Kre (If no other information given in question )

Concept 6 - Calculation of WACC (Weighted Average Cost of Capital) or Ko (Overall Cost of

Capital)

Ko/WACC

Book Value Weights - ​ ​ ​ ​ ​ Market Value Weights -

The weight are dependent on book values ​ ​ ​ ​ The weights are based on market value of
(from balance sheet)​ ​ ​ ​ ​ ​ ​ securities not book value​ ​
​ ​ ​ ​ ​ ​ ​ ​ ​ ​
(i) WACC by Book Value Weights
Source Book Value Weights (A) Rate (B) WACC (AxB)
Equity SC a a/Total Ke ✔
R&S b b/Total Kre ✔
PSC c c/Total Kp ✔
Debt d d/Total Kd ✔
Total WACC or Ko
(ii) WACC by MarketValue Weights
Source Book Value Weights (A) Rate (B) WACC (AxB)
Equity SC a a/Total Ke ✔
(MV of E)
R&S b b/Total Kre ✔
PSC x x/Total Kp ✔
Debt y y/Total Kd ✔
Total WACC or Ko

Concept 7 - Derive NP of New Debentures

The company proposes to issue 11 years 15% Debentures but yield on similar maturity Debentures is 16%.
Floatation cost 2%
Floatation cost is calculated on face value

Concept 8 - Shortcut method of calculation WACC (ko)

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 Chapter 2 - Cost of Capital Brahmastra Revision – One shot, full Revision

Shortcut method
𝐸 𝑃 𝐷
Ko (WACC) = Ke X 𝐸+𝑃+𝐷
+ Kp X 𝐸+𝑃+𝐷
+ Kd X 𝐸+𝑃+𝐷

Ko = Ke X We + Kp X Wp + Kd X Wd

If we don't have preference share in question

Ko = Ke X We + Kd X Wd
​
𝐸 𝐷
= Ke X 𝐸+𝐷 + Kd X 𝐸+𝐷

Concept 9 - How to Calculate Equilibrium Price

Step 1: Calculate Ke by CAPM
​ ​ Ke = 𝑅𝑓 +β (𝐸𝑅𝑚 - 𝑅𝑓)
Step 2: Use this Ke in any other formulae to find Po

Ex: Dividend Growth Model

𝐷1
Ke = 𝑃𝑜
+g
​ ​ ​ (Derive Po using this)

Concept 10 - Additional Marginal Cost of Capital Weighted Marginal Cost of Capital (WMCC)
●​ The average cost of additional fund used (when we calculate weighted average cost only for new funds
which are raised)

Concept 11 - Kd for Deep Discount Bond / Zero Coupon Bond

●​ They are issued at low value and redeemed at high face value
●​ They don't pay interest

Concept 12 - Convertible Debentures

At end we have to decide the higher of the following option
●​ Redemption value ( usually face value of debentures)
or
●​ Conversion value when debentures converted to shares at end

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 Chapter 3 - Capital Structure Brahmastra Revision – One shot, full Revision

Capital Structure
Capital Structure:
When a company decides the ratio in which it will raise finance from different sources.

Concept 1 : Decide Capital Structure

Find our EPS/MPS and select the highest EPS/MPS option.
Particulars Option I Option II Option III
100% Equity 50% Equity, 50% Debt 50% Equity , 50% PSC
EBIT
-​ Interest Old
New
EBT
-​ Tax
EAT
-​ Pref Div Old
New
EAES
÷ No. of Equity Shares ÷(n0 + n1) ÷(n0 +n2) ÷(n0 +n3)
EPS * * *
× P/E Ratio × × ×
MPS * * *

Note 1
𝑀𝑃𝑆
P/E Ratio = Price Earning Ratio = 𝐸𝑃𝑆
P/E Ratio×EPS =MPS

Concept 2: How to calculate EBIT at new level

Step 1: Calculate total existing capital.
Step 2: Calculate ROI at existing capital
𝐸𝐵𝐼𝑇
ROI = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 × 100 (Before Tax)
Step 3: New Total Capital Employed = Old Capital Employed + New (Additional) Capital Employed
Step 4: New EBIT = New Total Capital Employed × ROI

Concept 3: Indifference Point

Level of EBIT at which EPS of two options will be same (equal)
EPS1 = EPS2
(𝐸𝐵𝐼𝑇 −𝐼𝑛𝑡 1)(1−𝑡)−𝑃𝑟𝑒𝑓 𝐷𝑖𝑣1 (𝐸𝐵𝐼𝑇−𝐼𝑛𝑡2)(1−𝑡)−𝑃𝐷2
𝑛1
= 𝑛2
Cross multiply and solve for EBIT.

Note 1: Indifference point is always calculated for two plans.

Note 2: If we have three plans.
We will have to find 3 Indifference points, one for each pair.

Concept 4: Financial BEP.

Level up EBIT at which EPS = 0
𝑃𝑟𝑒𝑓 𝐷𝑖𝑣
= Interest + (1−𝑡)

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 Chapter 3 - Capital Structure Brahmastra Revision – One shot, full Revision

Concept 5: Diagram for Indifference Point × Financial BEP

●​ Financial BEP is plotted on the X axis, because it has EPS = 0.

●​ Before Indifference Point : Plan A is better.
●​ After Indifference Point : Plan B is better.

Note : You can solve by diagram or by taking two calculations

●​ One below Indifference EBIT
●​ One above Indifference EBIT

Concept 6 — Arbitrage
The process of earning riskless profit by buying securities of higher Roi companies & selling securities in lower
Roi companies.
Arbitrage can be done in two ways:
1.​ Invest all money and earn more.
2.​ Invest less money and earn the same amount as before.
Assumptions
1.​ If you disinvest from a levered company then you can borrow proportional debt also.​
(Yani agar aap levered Co se apni investment nikal rahe hai toh aap sirf equity ka paise hi nahi jabki
proportional debt bhi raise karke money le jayenge.)
2.​ If you invest in a levered company then you will invest in equity and also in proportional debt.​
(Yani agar aap levered company me invest karne jaa rahe ho toh aap sirf equity mei invest nahi karoge
jabki proportional debt mei bhi invest karoge.)
3.​ We always move investment from lower Roi to higher Roi companies.

Concept 7 - Concept of Capital Structure Theories

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 Ch 4 - Leverages Brahmastra Revision – One shot, full Revision

Leverages Notes
Concept 1: Income Statement
Sales XXX
(-) Variable Cost - XXX
Contribution XXX
(-) Fixed Cost - XXX
Earnings Before Interest & Tax (EBIT) Operating Profit
(-) Interest XXX
Earnings Before Tax (EBT) -XXX
(-) Tax (e.g., 30%) XXX
Earnings After Tax (EAT) XXX
(-) Preference Dividend -XXX
Earnings Available to Equity Shareholders (EAES) XXX
No. of Shares XXX
Earnings Per Share (EPS) EAES / No. of Shares
Dividend Distributed -XXX
Retained Earnings XXX

Concept 2: Before Tax to After Tax Conversion

Formula: 1. After Tax Amount = Before Tax Amount * (1 - t)
2. After-Tax Amount ÷ (1 - Tax Rate) = Before-Tax Amount
Example: Profit Before Tax = 1,00,000, Tax = 30%
Profit After Tax = 1,00,000 * (1 - 0.3) = 70,000

Concept 3: Impact of Preference Dividend on Tax

●​ Preference Dividend is paid after tax deduction, making it costlier.
●​ To understand its actual impact, it should be converted into a pre-tax equivalent.

Concept 4: Leverages as a Measure of Risk

Degree of Operating Leverage Degree of Financial Leverage Degree of Combined Leverage
(DOL) (DFL) (DCL)
Measures the risk of Operating Measures the risk of Financial Fixed Measures Total Risk (Operating +
Fixed Costs Costs Financial)
Formula Formula Formula

Note - Financial Leverage Ratio = Debt / Equity

Concept 5: Calculation of Percentage Change

Formula Application

{Change in Value /Original Value} ​×100 Used to calculate the percentage change in Sales,
Contribution, EBIT, or EPS

Concept 6 : Profit-Volume Ratio (P/V Ratio)

Formula Explanation

P/V Ratio = Contribution / Sales Measures the relationship between contribution

& sales.

P/V Ratio + Variable Cost Ratio = 100% The sum of P/V Ratio & Variable Cost Ratio is
always 100%.
Concept 7: Asset Turnover Ratio
Formula Interpretation

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 Ch 4 - Leverages Brahmastra Revision – One shot, full Revision

Asset Turnover Ratio = Sales / Total Assets Higher Asset Turnover indicates better
asset utilization.

Concept 8: Balance Sheet Equation

●​ Both sides of a Balance Sheet must always be equal:
●​ Total Assets=Total Liabilities (including Equity)

If we know Total Liabilities, we can determine Total Assets.

Concept 9: Return on Investment (ROI), ROE & ROCE

Return on Investment (ROI) Return on Shareholders funds/ Return on Equity (ROE)
Or Return on Capital Employed Return on Proprietors funds /
(ROCE) Return on Net worth
Measures profitability of total Measures efficiency of share capital Measures return earned on equity
investments. usage. capital.

General Note -
Indian System Western System
Thousand 1,000 Thousand 1,000
Lakh 1,00,000 Million 1000,000
Crore 1,00,00,000 Billion 1,000,000,000

Concept 10: Trading on Equity

Trading on Equity - When a company earns more by using low-cost funds like debt or preference shares.
Favorable Financial Leverage - When the cost of debt is lower than the return on investment, leading to higher
equity earnings.
Unfavorable Financial Leverage - When the cost of debt is higher than the return on investment, reducing
equity earnings.

Concept 11: Break-Even Point (BEP)

Operating BEP Financial BEP Combined BEP
The level of sales required to cover The level of EBIT required to cover The point at which EPS becomes
all fixed operating costs. interest & fixed financial costs. zero, meaning no profit or loss for
equity shareholders.

Concept 12: Missing Figures in Questions

●​ If DOL, DFL, or DCL is given in a question but not required, be cautious.
●​ If your calculations match the given values, it's just additional information.
●​ If your calculations do not match, then a figure might be missing, and further verification is needed.

Concept 13: Relationship Between MOS & DOL

Operating Leverage & Margin of safety have an inverse relationship.
DOL = 1/ MOS

Concept 14: Shortcut for Finding EPS

EPS = {(EBIT - Interest) (1 - Tax Rate) - Pref Div } / No. of Equity Shares

Concept 15: Segments of Return on Equity (ROE)

ROE = Segment of equity earnings on Equity funds +
Segment of equity earnings on Pref funds +
Segment of equity earnings on Debt funds

ROE = E/E (ROI × (1 - Tax Rate)) + P/E (ROI × (1 - Tax Rate) - PD) + D/E (ROI - Interest) (1 - Tax Rate)

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Chapter 5 - Dividend Decisions Brahmastra Revision – One shot, full Revision

Dividend Decisions
I.​ Dividend is that part of profit which the company pays out (gives) to shareholders.
II.​
Theories of Dividend
Relevance of Dividend Irrelevance of Dividend
The company's value will be impacted by dividend The company's value is not impacted by dividend
decisions. decisions.
1.​ Walter Model 1.​ M M Approach
2.​ Gordon Model
III.​ Traditional Models:
●​ Graham Dodd Model
●​ Linter’s Model

Concept 1. Walter’s Model

●​ Dividend is relevant.
P=
(𝐷+ (𝐸−𝐷)×𝑟
𝐾𝑒 )
𝐾𝑒

P = Price of share
D = Dividend per share
E = Earning per share
r = rate of return
Ke = Cost of equity
(E - D) = Retained Earning per share.

Dividend Decision Criteria:

1.​ If r > Ke , Zero optimum Dividend.(All money should be reinvested in business.)
2.​ If r = Ke , Any Dividend Payout is optimum.
3.​ If r < Ke , 100% Dividend Payout.

➔​ It means if a company earns less than shareholders expectation, then the company should distribute all
earnings as dividend.

Concept 2. Gordon Model

●​ Dividend is relevant.
𝐷1
P = 𝐾𝑒−𝑔

D1 = Do(1+g) = Dividend that will be paid at end of year 1.

Ke = Cost of equity (expectation of equity shareholders)
g = Growth rate
Do = Dividend which is already paid at ‘0’ period.

Dividend Decision Criteria:

1.​ If r > Ke , Zero optimum Dividend.(All money should be reinvested in business.)
2.​ If r = Ke , Any Dividend Payout is optimum.
3.​ If r < Ke , 100% Dividend Payout.

Concept 3: How to calculate Growth rate

Growth Rate
1
g = b × r (b = Retention Rate ; r = Rate of return)
g= ( 𝑁𝑒𝑤 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑂𝑙𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 ) 𝑛
−1 1.​ Dividend Payout Rate + Retention Rate = 100%
(𝐷𝑃𝑆
𝐸𝑃𝑆
× 100 +) ( 𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝐸𝑃𝑆
𝐸𝑃𝑆 )
× 100 = 100%
2.​ (1 - b) = Dividend Payout Rate
1 - Dividend Payout Rate = Retention Rate

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Chapter 5 - Dividend Decisions Brahmastra Revision – One shot, full Revision

Note : If Ke is not given , we can estimate Ke by using the following formulae.

1 1 𝐸𝑃𝑆
Ke = 𝑃/𝐸 𝑅𝑎𝑡𝑖𝑜 ⇒ Ke = 𝑀𝑃𝑆 = 𝑀𝑃𝑆
𝐸𝑃𝑆
𝐸𝑃𝑆 1
Ke = 𝑀𝑃𝑆
= 𝑃/𝐸 𝑅𝑎𝑡𝑖𝑜

Concept 4: Concept of Present Value.

Year Amount (A) PV Factor (B) PV (A × B)

1 CF1 1
1 = 0. 909 *
(1.10)
2 CF2 1
2 = 0. 826 *
(1.10)
3 CF3 1
3 = 0. 751 *
(1.10)
4 CF4 1
4 = 0. 683 *
(1.10)
Present Value

Concept 5: Types of Questions in Gordon’s Model.

No Growth Constant Growth Multiple Growth Rate
g=0 Po =
𝐷1
𝐷 𝐾𝑒−𝑔
Po = 𝐾𝑒−0 (Constant Growth)
𝐷1
Po = 𝐾𝑒
Here (Do = D1) Step 1: Calculate Dividend for D1 , D2 & D3.
Step 2: Calculate price at start point of constant growth
rate. (Yani 2nd year ke end par P2 nikal lo)
𝐷3
P2 = 𝐾𝑒−𝑔
Step 3: Now discount all dividends and terminal price to
get Po.

Note : Overpriced / Underpriced shares.

a)​ If Market price of share > Intrinsic Value (Value which we calculate)
Share is overpriced in market,
⇒Sell shares if you have it.
⇒Don’t buy such shares.

b)​ If Market price of share < Intrinsic value

⇒Share is underpriced in market,
⇒Buy shares
⇒Hold shares if you have them.

Concept 6: M M Approach
(Dividend Irrelevance Theory)
⇒ The value of a firm is not dependent on dividend decisions.
Step 1:
Price today of share = PV of (Price & Dividend)
(
𝑃1+𝐷1
Po = (1+𝐾𝑒) )

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Chapter 5 - Dividend Decisions Brahmastra Revision – One shot, full Revision

Step 2: Calculate Number of additional shares (fresh) shares to be issued (∆𝑛)

Amount of Investment made in the year xxx
Amount of Dividend Distributed xxx
− Earnings during the year (--)
Deficit *
÷ Price of fresh equity ÷ P1
Additional Shares issued = ∆n = ∆n

Step 3: To Verify
Value of firm Today = PV of (Value of firm at end year 1)
(𝑛+∆𝑛)×𝑃1 + 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 − 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑒𝑥𝑝.
n × Po = 1
(1+𝐾𝑒)

Concept 7: Graham Dodd

(
P=m 𝐷 +
𝐸
3)
P = Multiplier(𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 )
𝐸𝑎𝑟𝑛𝑖𝑛𝑔
+ 3
(given)

Concept 8: Linter Model

D1 = Do + (𝐸𝑃𝑆 × 𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑖𝑜 − 𝐷𝑜) × 𝐴𝑓(Adjustment factor or speed of adjustment)

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 Chapter 6 - Investment Decisions Brahmastra Revision – One shot, full Revision

Investment Decision

Traditional Method(Non Discounted )

1.​ Average Rate of Return or Accounting Rate of return (ARR)
2.​ Payback Period

Modern Methods (Discounted CF Techniques

3.​ Discounted Payback Period
4.​ NPV (Net Present Value)
5.​ Profitability Index (PI) Desirability Index
6.​ NPV Index
7.​ Internal Rate of Return (IRR)
8.​ Modified Internal Rate of Return
9.​ Payback Reciprocal

Method 1: Average Rate of Return / Accounting Rate of Return (ARR)

Note: It is the only method which uses PAT

𝑃𝐴𝑇1 + 𝑃𝐴𝑇2 +.........+ 𝑃𝐴𝑇𝑛

Step 1 : Calculate Average Profit = 𝑛
​ Initial Investment = 10,00,000
Terminal Value = 200000

𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 + 𝑇𝑉 10 + 2
Average Investment = 2
= 2
= 6,00,000

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝐴𝑇
Type 1 ARR = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝐴𝑇
Type 2 ARR = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

Concept I. Accounting Profit Vs Cash Flows

Accounting Profit Cash Flows
Sales Sales xxx
-​ VC -​ VC (-)
-​ FC -​ FC (-)
-​ Depreciation & amortization -​ Dep & Amortization
Profit before Tax PBT
-​ Tax . -​ Tax .
PAT PAT
+​ Dep & Amortization
CFAT → Cash flow after tax

Method 2: Payback Period

We calculate time period in which we get back our investment

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Decision - Lower PBP is considered better.

Short cut method (if we have equal annual CFAT)

(𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡)
PBP = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝐹𝐴𝑇

Example:
Initial Investment = ₹ 10,00,000
Year 1 2 3 4 5 6
CFAT 4,00,000 3,00,000 2,00,000 4,00,000 6,00,000 4,00,000

Solution :
Initial Investment = ₹ 10,00,000
Year Cash Flow Cumulative CF
1 4,00,000 4,00,000
2 3,00,000 7,00,000
3 2,00,000 9,00,000
4 4,00,000 13,00,000
5 6,00,000
6 4,00,000

(𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 − 𝐶𝑢𝑚𝑢𝑙𝑎𝑡𝑖𝑣𝑒 𝐶𝐹𝐴𝑇)

PBP = Completed Years + 𝐶𝐹𝐴𝑇 𝑜𝑓 𝑁𝑒𝑥𝑡 𝑌𝑒𝑎𝑟
X 1 year or 12 months

(10,00,000 − 9,00,000)
PBP = 3 + 4,00,000
x 1 or 12 months
​ = 3.25 years or 3 years 3 months

Method 3: Discounted Payback Period

This method is same as payback period but we use Discounted CFAT

Example: Initial Investment = ₹ 10,00,000

Year 1 2 3 4 5 6
CFAT 4,00,000 3,00,000 2,00,000 4,00,000 6,00,000 4,00,000
Discounting Rate = 10%. Calculate Discounted PBP

Solution
(i) Initial Investment = ₹ 10,00,000
Year Cash Flow (A) PV Factor 10% (B) PV (A X B) Cumulative CF
1 4,00,000 0.909 363600 363600
2 3,00,000 0.826 247800 611400
3 2,00,000 0.751 150200 761600
4 4,00,000 0.683 293200 10,34,800
5 6,00,000 0.621
6 4,00,000 0.564
(10,00,000 − 761600)
Discounted PBP = 3 + 293200
x 1 ​ = 3.873 years
Payback Period < Discounted PBP

Method 4 : NPV (Net Present Value)

1.​ It is one of the most used method
2.​ While calculating NPV, we actually calculate

​ ​ Present Value of Cash Inflows​ PVCI

-​ Present value of Cash Outflow​ PVCO
Net Present Value​ ​ ​ NPV

3. While calculating NPV, we should

●​ Ignore Sunk Cost - Already Incurred . Ex Research Cost

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●​ Ignore Irrelevant Cost - A cost which will not change in different situation whether we accept
Proposal or not.
●​ Ignore Apportionable Expenses - Headoffice expenses are anyhow going to be incurred. So if these
expenses are apportioned on proposes they should be ignored
Ex- General O/H apportioned on Project (should be ignored)

4. PV Kya Hoti hai????

When we bring back future cash flows to today’s date, it is called discounting.
1
​ PV = FV X 𝑛
(1+𝑖)
5. Format for NPV
Particulars Year PV factor 10% Amount PV
Outflow:
Purchase of machine 0 1
-​ Sale of Old Machine 0 1
-Subsidy/Grant 0/1 1/0.909 (x) ✔
Working Capital invested 0 1 * *
Present Value of Cash Outflow PVCO (A)
Inflows
Annual CFAT 1 0.909 𝐶𝐹𝐴𝑇1 ✔
2 0.826 𝐶𝐹𝐴𝑇2 ✔
3 0.751 𝐶𝐹𝐴𝑇3 ✔
4 0.683 𝐶𝐹𝐴𝑇4 ✔
Scrap Sle of Asset 4 0.683 Net Salvage Value ✔
Working capital recovered 4 0.683 WC* ✔
Present Value of Cash Inflow PVCI (B)
Net Present Value (PVCI -PVCO) = (B-A) = ✔

Decision Rule
1. Single Project Question
If NPV ≥ 0 , Accept Proposal
If NPV< 0 , Reject Proposal

2. Multi Project Question

Select Project with highest possible NPV.

6. Working Capital
We assume that working capital is recovered back at end of life of project.

7. Basic Notes:
When we buy new asset, we reduce its cost by sale of old asset and subsidies recovered.

8. Golden Rules:
a.​ Money saved is money earned.
b.​ Money forgone is money expensed.

Method 5: PI (Profitability Index) Desirability Index.

𝑃𝑉𝐶𝐼 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑎𝑠ℎ 𝐼𝑛𝑓𝑙𝑜𝑤
PI = 𝑃𝑉𝐶𝑂
= 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝑎𝑠ℎ 𝑂𝑢𝑡𝑓𝑙𝑜𝑤

●​ It is often used for ranking projects.

●​ PI - The Ratio between PVCI and PVCO

Decision Rule :
1. Single Project

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If PI ≥ 1 , Accept Proposal
If PI < 1 , Reject Proposal

2. Multi Project
Select Project with higher PI

Method 6: NPV Index

𝑁𝑃𝑉 𝑃𝑉𝐶𝐼 − 𝑃𝑉𝐶𝑂
NPV Index = 𝑃𝑉𝐶𝑂
= 𝑃𝑉𝐶𝑂

NPV Index = PI - 1

Method 7: IRR (Internal Rate of Return)

It means rate at which NPV = 0
At 5% At 10%
PV Factor PV PV Factor PV

+100 -60

𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑟𝑎𝑡𝑒𝑠
IRR = Lower rate + Lower rate NPV × 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑁𝑃𝑉

★​ If first rate has (+) NPV, then increase rate to find (-)NPV.
★​ If first rate has (-) NPV, then decrease rate to find (+) NPV.

Explain NPV vs IRR Conflict

Example : Project A Project B
NPV ₹ 10,000 ₹ 12,000
IRR 11% 9%

NPV vs IRR conflict arises when one project has higher NPV but other project has higher IRR.

Decision: Select proposal having higher NPV.

(because it provides more cash inflow as per wealth maximisation principle.)

Concept : Unequal Life Projects

➔​ Divides by cumulative PV factor and find equivalent annual PVCO or NPV and then take decision.

Concept : Format for only Outflow Question

Particulars Year PV Factor Amount PV
1.​ Initial Investment (Purchase of Plant) 0
+​ Cash expenses [Amount (1-t)]
(Maintenance/fuel /Repairs) 2,00,000 (1-30%) 1-5 3.179
-​ Tax saving on Depreciation
(Dep ×Tax rate) 1-5 3.179 *
PVCO

Concept : Tax exp or saving on sale of asset at end. Or capital gain or capital loss.
ex : Purchase = 1,00,000 Life of Asset = 5 Yrs
+​Installation cost = 50,000 Scrap Value = 50,000

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Total Asset Cost = 1,50,000

Sale < WDV Sale = WDV Sale > WDV

Cost = 1,50,000 Cost = 1,50,000 Cost = 1,50,000
-​ Dep = - . -​ Dep = - . -​ Dep = - .
WDV = 50,000 WDV = 50,000 WDV = 50,000

Sale of Asset = 40,000 Sale of Asset = 50,000 Sale of Asset = 80,000

Sale = 40,000 Sale = 50,000 Sale price = 80,000

-​ WDV = -50,000 -​ WDV = -50,000 -​ WDV = -50,000
Capital Loss = 10,000 CG = 0 CG = 30,000

Tax saving on capital loss(40%) = 4000 Tax on CG (30,000×40%) = 12,000

Sale Value = 40,000 Sale Value = 50,000 Sale Value = 80,000

+​ Tax Saving = 4,000 -​ Tax Saving = - . -​ Tax = -12,000
Cash flow = 44,000 Cash flow = 50,000 Cash flow = 68,000

Alternative way:
Sale of Asset at end xxx
-​ Tax amount on capital gains (-)
Or
+​ Tax saving on capital loss (+)
Net cash Inflow from sale of asset *

Concept :
Independent Proposal Mutually Exclusive Proposals

If one event’s occurance doesn’t influence other event, If one event occurs, the other event cannot occur.
then they are called Independent proposals.
Ex: If you select project A, then you cannot select
Select Proposal having higher (+) NPV. project B at same time.

Concept : Block of Asset Method Vs Normal Dep Method

Block of Asset Normal Dep Method
Here all assets belonging to same rate (and same Here each asset is depreciated separately.
nature) are combined in a block.

Opening value of Block *

+​ Purchase of new asset +
-​ Sale of old asset (-)
Depreciable Amount of Block *.
For our Exam Question
Dep = ( 𝑛 )
𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑜𝑓 𝑛𝑒𝑤 𝑚𝑎𝑐ℎ𝑖𝑛𝑒− 𝑆𝑎𝑙𝑒 𝑜𝑓 𝑜𝑙𝑑 𝑒𝑥𝑖𝑠𝑡𝑖𝑛𝑔 𝑚𝑎𝑐ℎ𝑖𝑛𝑒
(
𝑜𝑟 rate Dep=
𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑜𝑓 𝑛𝑒𝑤 𝑚𝑎𝑐ℎ𝑖𝑛𝑒−𝑓𝑢𝑡𝑢𝑟𝑒 𝑠𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑛𝑒𝑤 𝑚𝑎𝑐ℎ𝑖𝑛𝑒
𝑛 )
Method 8: MIRR (Modified Internal rate of return)

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Terminal Value:
4
1 = CFAT1(1 + 𝑟)
3
2 = CFAT2(1 + 𝑟)
2
3 = CFAT3(1 + 𝑟)
1
4 = CFAT4(1 + 𝑟)
0
5 = CFAT5(1 + 𝑟)

1
Initial Investment = Terminal Value × 5
(1+𝑀𝐼𝑅𝑅)

Step 1: We will reinvest all cash flows (during the life) to terminal date.
𝑅𝑒𝑚𝑎𝑖𝑛𝑖𝑛𝑔 𝑙𝑖𝑓𝑒
CFAT1 , (1 + 𝑟) = *
𝑅𝑒𝑚𝑎𝑖𝑛𝑖𝑛𝑔 𝑙𝑖𝑓𝑒
+​ CFAT2 , (1 + 𝑟) = *
+​ = *
+​ = *
Terminal Value

Step 2: MIRR is that discounting rate, at which Terminal Value discounted = Initial Investment
1
Initial Investment = Terminal Value × 𝑛
(1+𝑀𝐼𝑅𝑅)

Method 9: Payback Reciprocal

●​ It is the reciprocal of Payback period.
●​ It is calculated in %
●​ It is used as a proxy for IRR (estimation of IRR) (Tukka for IRR)

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑛𝑛𝑢𝑎𝑙 𝐼𝑛𝑓𝑙𝑜𝑤

Payback Reciprocal = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

Ex : Initial Investment = ₹ 20,000

Annual Cash Inflow = ₹ 4,000

𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 ₹20,000

PBP = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝐼𝑛𝑓𝑙𝑜𝑤
= ₹4,000
= 5 years.

𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 4,000

Payback Reciprocal = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
= 20,000
× 100
Payback Reciprocal = 20%

Concept : Capital Rationing

It is a process by which we try to optimise utilization of total capital available for Investment.
We try to use funds in most profitable manner.

We have limited funds, so we cannot invest in all proposals , therefore we have to choose best earning
projects.

Type of Questions
Divisible Projects Indivisible Projects
Step 1. Calculate NPV Step 1. Calculate NPV
Step 2. Calculate PI and ranking as per PI (or NPV Index) Step 2. Calculate PI and rank as per PI (or NPV Index)
Step 3. Start investing funds from rank 1, onwards. Step 3. Make Various Combinations.
Step 4. If at end a proposal cannot be purchased full, (try to use high rank projects)
then we will invest our remaining capital in it and (try to maintain high NPV and use maximum
earn proportioned NPV. funds.)
𝐴𝑚𝑜𝑢𝑛𝑡 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑏𝑦 𝑢𝑠
Total NPV of that project× 𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 Step 4. Select Highest NPV option combination.

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Working Capital Management

Topic 1: Operating Cycle
Time taken for cash to return back to cash in a business.

Calculation of Operating Cycle

Particulars Days
RM holding period =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑀
× 365 *
𝑅𝑀 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑊𝐼𝑃
WIP Conversion period = (100% 𝑅𝑀 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑑 + 50% 𝐿𝑎𝑏𝑜𝑢𝑟 𝑎𝑛𝑑 𝑂𝐻) 𝑜𝑟 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛
× 365 *
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐹𝐺
FG Holding Period (Stock Velocity)= 𝐶𝑂𝐺𝑆
× 365
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑒𝑏𝑡𝑜𝑟𝑠 *
Debtors Collection Period(ACP)(Debtors Velocity)= 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 × 365 *
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
-​ Creditors Payment Period(Creditors Velocity)= 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 × 365 (-)
Operating Cycle Period Days

Concept 2:
365
1.​ Number of operating cycles in a year (or Cash Cycle Turnover) = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐶𝑦𝑐𝑙𝑒 𝑃𝑒𝑟𝑖𝑜𝑑
Times
𝐶𝑎𝑠ℎ 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑒𝑥𝑝 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
2.​ Working Capital estimation = 365
× 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
Total Operating Expenses xxx
-​ Depreciation / Amortization (Non Cash Exp) xxx
Cash Operating Expenses xxx

Topic 2: Estimation of WC Requirement

Concept 1: Total Basis Vs Cash Cost Basis
Total Basis Cash cost Basis
●​ Here we include Depreciation and Profit in ●​ Here we exclude Depreciation and Profit in
calculation of WC. calculation of WC.

Note : Total Basis

-​ Depreciation (Non Cash Exp)
Cash Basis
-​ Profit .
Cash Cost Basis

Concept 2: Format of Cost Sheet. (Long Format)

Particulars Amount (₹)
Raw Material Purchased xxx
+​ Operating Stock of RM
-​ Closing Stock of RM
Raw Material Consumed xxx
+​ Direct Labour +
+​ Direct Expenses +
Prime Cost *
+​ Factory O/H +
(works O/H / Production O/H / Manufacturing O/H)
Gross Works Cost / Factory Cost *
+​ Op WIP +
-​ Cl WIP -
Net Factory Cost xxx
+​ Quality Control
+​ Research & Development
+​ Admin (Production Related)
+​ Primary Packing
-​ Scrap Sale

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Cost of Production *
+​ Opening FG
-​ Closing FG
COGS *
+​ Selling & Distribution O/H
+​ Admin (General)
Cost of Sales
+​ Profit
Sales **
Used in case of new company question. [Opening stock will be Zero, closing stocks will not be Zero]

Cost Sheet (Short Format)

RM Consumed / Purchased *
+​ Direct Labour +
+​ Direct Expenses
Prime Cost *
+​ Factory O/H
Factory Cost / Works Cost *
+​ Admin (Production nature) +
Cost of Production / exp *
+​ Selling & Distribution O/H
+​ Admin (General)
Cost of Sales *
+​ Profit
Sales *
Used in case of existing /Old company Question
We assume Op stock = Cl stock . So, they get cancelled, thus we don’t show them in Cost Sheet.

Note -
Old Company New Company
Short Cost Sheet Long Cost Sheet
Op Stock = Cl Stock Op Stock ≠ Cl Stock
Op Stock = 0
Cl Stock ≠ 0
RM Consumed = RM Purchased RM Consumed ≠ RM Purchased

Estimation of WC
Particulars Amount (₹)
Current Assets
𝑛
●​ Raw Material = RM Consumed × 12/52/365
𝑛 𝑛
●​ WIP = (RM×100% + Labour & OH × 50%) × 12/52/365
OR (Factory Cost)× 12/52/365
𝑛
●​ FG Stock = cost of production× 12/52/365
𝑛
●​ Debtors = (Total Basis Question) = Credit Sales× 12/52/365
𝑛
(Cash Cost Basis Question) = Cash cost of Sales × 12/52/365
●​ Advance to Suppliers
●​ Cash / Bank Balance (Mentioned in question)
Total Current Asset (A) (A)
Current Liabilities
𝑛
●​ Creditors = RM Purchased × 12/52/365
𝑛
●​ O/S Wages = Annual Wages × 12/52/365
𝑛
●​ O/S Expenses = Cash Expenses × 12/52/365
Total Current Liabilities (B) (B)
Excess of CA over CL (A-B)

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+​ Safety Margin for contingency

Net WC required

General Knowledge Note:

Conversion Cost → Labour Cost + Overhead Cost

Topic 3: Management of Receivables

Debtors Management
Option 1. Liberalise Credit Policy (Increase Credit Period)
Benefits Costs
1.​ Increased sales and contribution. 1.​ Increased Bad Debt.
2.​ Interest Cost on Debtors Cost.
3.​ Increased Collection Cost.
4.​ Increase Admin Cost.

Option 2. Strict Credit Policy (Reduce Credit Period)

Benefit Costs
1.​ Reduced Bad Debt 1.​ Reduced contribution & Sales.
2.​ Reduced Interest lost on Debtors Cost
3.​ Reduced Collection Cost

Note: Solution Method

●​ Total Approach (easy)
●​ Incremental Approach (lengthy)

[Link] Approach
Statement for evaluation of Credit Policy
Particulars Present Proposal (I) Proposal (II)
30 days 60 days 90 days
Credit Sales
Less Variable Cost
Less Fixed Cost
Less Bad Debt
Less Collection Cost
Less Discount (Cash)
Estimated PBT
-​ Tax (if given)
(A)​Estimated Profit (PAT)
(B)​
Opportunity cost of investment in
Debtors (Int on Debtors Cost)
Net Benefit (A - B)
Advice: Select highest Net Benefit Option.
Note :
𝐴𝐶𝑃
1.(B) Int on Debtors Cost =(VC +FC)Cost of Sales × 12/52/365
× 𝐼𝑛𝑡 𝑅𝑎𝑡𝑒
2. If FC is not given, we can calculate Interest only on VC.
3. If Tax rate is given
➔​ Profit should be Profit after Tax
➔​ Int rate should be after Tax [I(1-t)]

If Tax rate is missing

➔​ Profit should be before Tax
➔​ Int rate should be before Tax rate.

[Link] Approach.
Ex: Present Policy A(30 days) Proposal (I) Policy (B)(60 days) Proposal (II) Policy (c)(90 days)
Total Amount (A) (B) (C)

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 Chapter 7 - WCM Brahmastra Revision – One shot, full Revision

Incremental Amount - (B - A) (C - A)
(We will have to calculate incremental value for each item.)

Statement for evaluation of Credit policy

Particulars Proposal (I) Proposal (II)
Incremental Sales (B) - (A) (C) - (A)
Less: Incremental VC
Less: Incremental FC
Less: Incremental Bad Debt
Less: Incremental Collection Cost
Less: Incremental Cash Discount
Incremental Expected Profits * *
-​ Tax - -
(A)​Incremental Expected Profits
(B)​Incremental Int Cost on Debtors Cost (-) (-)
Net Benefit (A) - (B) * *
Extra Note : 2/15 net 45
If customer pays within 15 days he gets 2% discount else , he has to pay in 45 days.

Topic 4. Treasury & Cash Management

Concept . Cash Budget
1.​ It is a statement for cash projections (future)
2.​ It has estimated figures.
3.​ It shows transactions of both revenue and capital nature.
4.​ If we receive cash or pay cash it should be recorded in cash budget, even if it belongs to any specific
period.
5.​ If we have to maintain a closing cash fixed figure. (EX: ₹20,000)
➔​ Any excess cash will be invested in short term securities.
➔​ Deficit (a) Sell short term securities. Or (b) Borrow short term funds.
6.​ Depreciation / Amortization will be ignored. (as it is non cash)

Cash Budget
Particulars Jan Feb March
Opening Balance xxx 20,000 20,000
Receipts
●​ Cash sales xxx xxx xxx
●​ Collection from debtors xxx xxx xxx
●​ Sale of asset xxx
●​ Issue of share / Debenture xxx
●​ Income Tax refund xxx
●​ Miscellaneous receipts xxx xxx
Total Cash Available (A)
Payments
●​ Cash Purchases
●​ Payment to Creditors
●​ Purchase of Asset
●​ Redemption of Debentures
●​ Dividend paid
●​ Income Tax Paid
●​ Miscellaneous Payment
Total Payments (B)
Closing Cash (A) - (B) 28,000 15,000 13,000
Less: Investment in short term securities -​ 8,000
Add : Sell short term securities +​ 5,000 +​ 3,000
Add : Short term borrowing +​ 4,000
Net Closing Cash 20,000 20,000 20,000

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 Chapter 7 - WCM Brahmastra Revision – One shot, full Revision

Topic 5. Management of Payables

365

1.​ Cost of lost Cash Discount = ( 100

100−𝑑 ) 𝑡
−1
d= Discount amount (calculated on 100%)
t = Reduction in time period (kitne din jaldi paise dene se discount mil sakta hai)
2.​ Nominal Cost (on annual basis)
( 𝑑
Rate = 100−𝑑 × 𝑡 )
365

Topic 6: Financing of WC
Concept 1: Factoring
Factor
➔​ May collect amount from debtors
➔​ May perform invoicing for client
➔​ Non recourse factors bear bad debt losses also.
Factor
Recourse Non Recourse
●​ Factor will not bear bad debt. ●​ Factor will bear bad debt.

WORKING NOTE (i)

Debtors = Annual Credit Sales (A) × ACP /365 or 12 or 52 = xxx(B)
𝑅𝑎𝑡𝑒
Less Commission = (B) × 100 = (-) (C)
Less Reserves = (B) × Reserves % = (-) (D)
Amount available for Advance = E = (B-C-D)
𝑅𝑎𝑡𝑒 𝑛
Less Interest on advance = (E)× 100 × 12
= (-) (F)
Net Advance Amount = (G)

Statement for evaluation of factoring Proposal.

Particulars Amount(₹)
Benefits
Saving in collection cost (Admin Cost)
Saving in Bad debt (in case of non recourse factoring)
Interest saved on reduced ACP
(𝑂𝑙𝑑 𝐴𝐶𝑃 − 𝑁𝑒𝑤 𝐴𝐶𝑃)
Cost of Sales× 365 𝑜𝑟 360
× 𝑅𝑎𝑡𝑒 𝑜𝑓 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
Total Benefits
Costs
12 𝑜𝑟 52 𝑜𝑟 365
Commission (Annual) = (C) × 𝐴𝐶𝑃
12/52/365
Interest (Annual) = (F) × 𝐴𝐶𝑃
Total Cost
Net Benefit (X) - (Y) or Net Cost (Y) - (X)
X>Y If Y > X

Decision Making :
Case 1: If we have Net Benefit (X - Y)(+) : Accept Factoring
Case 2: If we have Net Cost (Y - X), then calculate effective Interest on advance(effective factoring rate)
𝑁𝑒𝑡 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑓𝑎𝑐𝑡𝑜𝑟𝑖𝑛𝑔 𝑁𝑒𝑡 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐹𝑎𝑐𝑡𝑜𝑟𝑖𝑛𝑔
Effective Rate = 𝑁𝑒𝑡 𝐴𝑑𝑣𝑎𝑛𝑐𝑒 𝐴𝑚𝑜𝑢𝑛𝑡 or 𝐴𝑚𝑜𝑢𝑛𝑡 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝐴𝑑𝑣𝑎𝑛𝑐𝑒
𝑌 −𝑋 𝑌−𝑋
= (𝐺)
or (𝐹)
=x%
If X% > Market Int Rate, Reject Factoring , If X% < Market Int Rate, Accept Factoring.

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