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LIST OF FORMULAS

NAME

FORMULAS

EXPLANATORY NOTES

Capital Structure Theory & Policy


Value of Equity

Value of Debt

Value of the firm


Firms Cost of Capital
Or
WACC

Ve

= Net Income
Cost of Equity
= NI
Ke
Vd
= Interest
Cost of Debt
= Interest
Kd
Value of the firm = Value of Equity + Value of Debt
V F = V e + Vd

Value of equity means Discounted value of Net Income

Firms Cost of Capital


= Net Operating Income
Value of the firm
= NOI
VF
= Ke x E
+ Kd x
V

Decision making
If ROI > Interest Charges Go with that source.
Also the Cost of Debt < Cost of Returns Go with that source.

Value of debt means Discounted value of Interest

D.
V

Valuation & Financing


Asset Beta

Asset Beta = B1W1 + B2W2 + . . . . . . . . BnWn


or
a = e x E + d x D
V
V
e = a + (a- d) D
E

W = weight
E = value of equity
D = value of debt
V = value of firm

Opportunity cost of
capital

Opportunity cost of capital = RF + ( RM RF)


Kd = RF + RP d
Ke = RF + RP e
Ko = RF + RP a

Kd = Cost of debt
Ke = Cost of equity
Ko = overall cost of capital

Ko = Ke E + K d D
V
V
or
Ko = KeWe+ Kd Wd
Ke = Risk Free + Business Risk + Financial Risk
= RF + RPa + RP (Ba B d) D
E
Valuation of firm

Valuation of firm

Vf = Free Cash Flow (FCF)


WACC

FCF = EBT(1-t) Dep NWC Capex

Vf =

CCF= FCF + ITS


ITS = Int * Tax Rate

Capital Cash Flow (CCF)


Opportunity Cost of Capital (K0)

WACC= KeWe + Kd(1-t) Wd


Favorable when debt ratio is fixed

Ko = KeWe + KdWd
Favorable when debt quantity is fixed
Adjusted Present Value

APV = All equity NPV Value of Financing Effects


APV = PVI PVo Value of Financing Effects
= PVI PVo + PV of ITS + PV of Int Subsidy Issue cost

Dividend Policy
Walter Model

r = opportunity cost of capital


K = cost of capital

Div + r (EPS Div.) /K


K
K

or

Dividend decision depends on Type of organization

Div. + (r/K) (EPS - Div )


K
Gordon Model

Growth organization r > K Go for 0% Payout


Decline organization r < K Go for 100% Payout
Normal organization r = K Hardly Matters
b = Retention Ratio = 100- Payout ratio
br = b x ROE = Growth = g

EPS (1- b)
K - br

Derivatives

Future Price

Future Price = Spot Price ( 1 + Rv) - Dividend Foregone

NAME
Return on Share

FORMULAS
Return on Share = Dividend Yield + Capital Gain Yield
= Div. + P1 P0
P0
P0

Portfolio

Compound Annual Rate


of Return (CRR)
Expected Return of a
security
Expected Return of a
portfolio

EXPLANATORY NOTES
Dividend = Par Value x Dividend Rate

= n (1 + r1) x (1 + r2) x .....................x (1 + rn) 1


E (R) = R1P1 + R2P2 + ...............+ RnPn
E (R)p = E (R)x Wx + E (R)y Wy

P = probability
R = return
(R)x = Expected Return on x security
(R)y = Expected Return on y security

Standard Deviation of
Portfolio

2p = x2.wx2 + y2.wy2 + 2.wx.wy.covxy


or
2p = x2.wx2 + y2.wy2 + 2.wx.wy.x.y.corxy

If cor = 1

2p = ( x.wx + y.wy)2

If cor = -1

2p = ( x.wx - y.wy)2

If cor = 0

2p = x2.wx2 + y2.wy2

Minimum variance
portfolio

wx =

y2 - covxy .
x2 + y2 - 2covxy

cov = Covariance
cor = Correlation
covxy = x.y.corxy
p = 2p

w y = 1 - wx
wx = Weight of X security
wy = Weight of Y security

Time Value of Money


NAME
Lumpsum

FORMULAS
Future Value (FV)
Present Value (PV)
FV = PV(1+i)n

PV = FV .
(1+i)n

or
or
FV = PV x CVF
Annuity
(Regular Annuity)

PV = FV x PVF
PVA = FVx PVFA

FVA = PV x CVFA(i,n)
or
FVA = A / PV [ (1+i)n-1
i

or

PVA =

FV / A .

[(1+i)n-1]
i

EXPLANATORY NOTES

r = i (is in decimal)
n = t = time period
Regular annuity = annuity at the end of the year
Annuity Due = annuity at the beginning of the year

Annuity
(Annuity Due)

FVA = PV x CVFA(i,n)

PVA = FVx PVFA

or

or

FVA = A [ (1+i)n-1
i

](1+i)

PVA = A [ (1+i)n-1
i (1+i)n

](1+i)

Valuation of Securities
1. Value of Bonds

Value of Bonds = Present Value of Annuity (Coupon) +


Present Value of Maturity Value
VB =

C
+
(1+r)t
(Annuity)

MV
.
(1+r)n
(Lumpsum)
or

Int = C = Annual Coupon Payment


Kd = r = Required Rate
Bn = MV = Maturity Value at Bond at the nth year
t = Time when payment is received
n = No. of years to maturity

* We can use above formula only when discounting rate


+

Int
(1+Kd) t
(Annuity)

Bn .
(1+Kd) n
(Lumpsum)

i.e. cost of debt (Kd) is given.

or
VB = Int * PVFA + MV * PVF

Yield to Maturity

YTM=

C+

M-P
n

.4M +.6P

M = Maturity Value
P = Present Value
Int = Face Value x Coupon Rate

Or
Amount of Interest
Current Value of Bond
Vp =
Div
+
Redemption Value
(1+r)t
(1+r)n
(Annuity)
(Lumpsum)
.

Valuation of Preference
Shares

RV= MV = Redemption Values

or
Vp = Div * PVFA + RV * PVF

Valuation of Equity Shares


NAME

FORMULAS

Single Period Valuation

Po = Div1 + P1
(1+r)

No growth Model

P0 = Div1
ke

Constant Growth Model

P0 = Div1
ke- g
or
P0 = EPS (1-b)
ke- g

Two Stage Growth

P0 = Div1

1-(1+g1)n
1+r
r-g1

D1(1+g1)n-1(1+g2) x
r-g2

1 n
1+r

EXPLANATORY NOTES
Po = Current Price
Div1 = Dividend expected a year hence
P1 = Price of share expected after a year i.e P1 = P0(1+g )
r = Rate of Return

Div1 = Dividend expected a year hence


ke = Required rate of return / Cost of Equity
g = Growth rate = br = b x ROE
b = Retention Ratio = (1- Payout Ratio)

Growth = Retention Ratio* Return on Equity


g = b x ROE
g1 = b x ROE1
g2 = b x ROE2
refer to page No 174 equation no 12 of IM Pandey

Price-Earning Approach

P0 = EPS + Vg
ke
Vg = NPV1
ke-g

or

= (b x EPS1) (ROE ke)


ke (ke-g)

Capital Budgeting
Payback Period

Payback Period = Initial Investment


Annual Cash Flow

NPV

NPV = Present Value of Inflow Present value of Outflow

Average Rate of Return

Average Rate of Return (ARR) =

Average Profit
Average Investment

If there is no Scrap Value, than,


Average Investment = Initial Investment
2
If there is Scrap Value, than,
Average Investment
=

Initial Investment Scrap Value


2

+ Scrap Value

Cost of Capital
Cost of Debt
Irredeemable
Cost of Debt
Redeemable

B0 = Sales Price of Bond

Kd = Interest / Bo
B0 =

INT + MV
(1+ kd) t (1+ kd) n

MV = Repayment of Debt on Maturity

t=1

Kd = Lower Rate + Higher - Lower rate * Difference of


Present Value of Bonds at Lower rate Bo / Difference of
Present Value of Bonds at Higher Rate Present Value of
Bonds at Lower rate
kd after tax = kd before tax (1-Tax rate)

Cost of Irredeemable
Preference Shares

kp = PDIV
P0

Cost of Redeemable
Preference Shares

P0 =

Normal Growth

Supernormal Growth

PDIV + Pn
(1+kp)t (1+ kp)n
.

t=1

b= Retained Earning Ratio

kp = Div + g
P0
or
= EPS (1-b) + g
P0
P0 =

Div0(1+gs)t + Pn
(1+ke)t
(1+ ke)n
.

t=1

Ke = Div.
P0
or
Zero Growth

= EPS(1-b)
P0
= EPS
Po

CAPM Approach

[ as b= 0]

Risk free + Risk premium


ke = Rf + (Rm Rf) e
kp = Rf + (Rm Rf) p

ke = Cost of Equity
Rf = Risk free rate
(Rm Rf) = Risk Premium
kp = Cost of Preference Shares

kd = Rf + (Rm Rf) d

kd = Cost of Debt

OTHERS
Real Rate
Nominal Rate

Real Rate = 1 + Nominal Rate - 1


1+ Inflation Rate
Nominal Rate = ( 1 + Real Rate ) x ( 1 + Inflation )

Rate to be denominated in decimals.

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