IES’s Management College and Research Centre

Mumbai

STUDY MATERIAL

Program : PGDM Term : II

Course : Corporate Finance
Batch : 2020-22
Course Instructor : Dr. Gazia Sayed

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CONTENTS

CHAPTER 1 ...................................................................................................................................... 2
CASH FLOW ANALYSIS ............................................................................................................ 2
CHAPTER 2 ....................................................................................................................................... 11
RATIO ANALYS IS ...................................................................................................................... 11
CHAPTER 3 .................................................................................................................................... 35
WORKING CAPITAL MANA GEMENT ................................................................................ 35
CHAPTER 4 .................................................................................................................................... 39
RECEIVABLES MANAGEME NT ............................................................................................ 39
CHAPTER 5 .................................................................................................................................... 43
CAPITAL BUDGETING DE C IS IONS .................................................................................... 43
CHAPTER 5 .................................................................................................................................... 54
CAPITAL BUDGETING DE C IS IONS - FORECASTING CASH FLO W ..................... 54
CHAPTER 6 .................................................................................................................................... 57
COST OF CAPITAL ..................................................................................................................... 57

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CHAPTER 1

CASH FLOW ANALYSIS

In the last term, we have seen the preparation of two financial statements viz., the Balance Sheet
and the Statement of Profit and Loss. In this term, we will learn the third statement i.e. the Cash
Flow Statement (CFS). Before going into the details about this statement, let us understand the need
or the importance of preparing this statement.

Need (Purpose) for preparing Cash Flow Statement:

Balance sheet is also called as the statement of financial position of the company as it discloses the
worth or position of the company. Balance sheet is true on the day it is prepared i.e. the balance
sheet shows the position of a particular day and does not show the information for a period as
compared to the statement of profit and loss, which shows the result of the company’s performance
for a period. This is a limitation of balance sheet. Similarly, statement of profit and loss also suffers
a limitation. It focuses on the revenue and expenses of a period irrespective whether those revenues
and expenses are settled in cash or not. It is very much possible that a company may have strong
bottom line i.e. PAT (Net Profit) but it may be facing cash shortage problem. This is because as per
the accounting system, the statement of profit and loss and balance sheet are prepared on the basis
of accrual system and not on the basis of cash. That is, all the items are parked in these two
statements based on the period (which is normally a year) irrespective whether they are settled in
cash or not. A company may accrue accounting revenues but may not actually receive the cash. This
will lead to book profit and not cash profit. Let us take two examples to understand this
discrepancy, one of income and one of expense.

Example 1
In the income statement the revenue from operations, disclose the net sales of the company that
includes both cash as well as credit sales. If the cash sales of the company is Rs.5,00,000 and the
credit sales of the company is Rs.2,00,000, then the total income displayed by the income statement
is Rs.7,00,000 but actual cash realized is only five lacs and not seven lacs. So, in this case the book
profit will be high as compared to cash profit.

Example 2
Consider a company which is having a policy of making the payment of salary on the 5th of every
month and the amount of one month salary is Rs.1,00,000. Then in the income statement the
company will disclose the annual salary payment of Rs.12,00,000 (eleven lacs paid and one lac
outstanding) but actual payment made in cash is only Rs.11,00,000. So, in this case the cash profit
will be high as compared to book profit. There are many such items in income statement that will
lead to such differences. Therefore, it is utmost important to understand the flow of cash and to
determine the position or balance of cash and cash equivalents. For this purpose, a Cash Flow
Statement (CFS) is prepared. Cash flow statement shows the items that generate cash inflow, the
items that leads to cash outflow and the balance in hand. Analysis of Cash Flow (CF) of an
enterprise is very important from management as well as investors perspective. CF analysis helps in
identifying the liquidity of the company.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Preparation of Cash Flow Statement

Balance sheet and statement of profit and loss are prepared from the ledger account whereas the
cash flow statement is derived from these two statements. Before 2013, the presentation of cash
flow statement in the annual reports was optional but as per the Company Act 2013, the preparation
and presentation of cash flow statement along with statement of profit and loss and balance sheet in
the annual report is mandatory. Since the Companies Act, 2013 does not lay down any format of
preparing the cash flow statement; companies follow (Accounting Standard) AS 3 in this regard. As
per AS 3, cash flow statement should present the inflow and outflow of cash from three types of
activities viz. operating, investing and financing activities. Some of the definitions as per AS 3 are
as under:

Definitions

1. Cash comprises cash on hand and demand deposits with banks.

2. Cash equivalents are short term, highly liquid investments that are readily convertible into
known amounts of cash and which are subject to an insignificant risk of changes in value.
3. Cash flows are inflows and outflows of cash and cash equivalents.
4. Operating activities are the principal revenue-producing activities of the enterprise and
other activities that are not investing or financing activities.
5. Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.
6. Financing activities are activities that result in changes in the size and composition of the
owners’ capital (including preference share capital in the case of a company) and
borrowings of the enterprise

As per the definition, operating activities means activities related to core business of the
organization. Cash receipts from the sale of goods and rendering of services or collections from
debtors are the examples of cash inflow from operating activities. Similarly, payments to creditors
or employees are considered as cash outflow from operating activities.

Investing activities are related to investment of funds in the non-current assets of the organization.
The information on investing activities comes from the assets side of the balance sheet. E.g. sale of
fixed assets and investments will lead to cash inflow from investing activities while purchase of
fixed assets and investments will lead to cash outflow from investing activities.

Financing activities are related to raising of funds or money. The information on financing
activities comes from the liabilities side of the balance sheet. Issuing of shares and debentures,
raising of loans are considered as cash inflow from financing activities whereas redemption of
debentures, repaying loans are considered as cash outflow from financing activities.

The classification of activities will differ from organization to organization based on the business
model. For example, a manufacturing or a trading company will classify interest and dividend
received under investing activity whereas a financial enterprise (bank or NBFC) will classify the
interest and dividend under operating activity. This chapter will focus on cash flow statement of a
manufacturing or a trading company, so the activities will be classified accordingly.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Format of cash flow statement

As discussed earlier, cash flow statement consist of three parts.

A. Cash flow from operations (CFO) or operating activities
B. Cash flow from investing activities
C. Cash flow from financing activities

Calculation of cash flow from investing and financing activities is comparatively simple but
calculation of cash flow from operations or operating activities is somewhat complicated and
difficult because the items affecting CFO are reflected by statement of profit and loss as well as by
balance sheet. Therefore, there are different ways of determining CFO.

Calculation of CFO is actually reconciling the book profit (PAT) with cash profit by taking into
consideration all non-cash items of statement of profit and loss. In order to calculate the cash flow
from operations (CFO) we need to eliminate the effect of non-cash items from profit and loss
statement. There are two suggested methods of calculating CFO or cash flow from operating
activities:
a. Direct method
b. Indirect method
Under the Companies Act, 2013, non-listed companies have a choice of using direct or indirect
method under AS 3 to prepare the cash flow statement. However, due to the listing agreement
requirement, listed companies do not have the choice of selection of method. They are required to
follow the indirect method of calculation of CFO. Let us see both the methods with an illustration
using hypothetical statement of profit and loss and balance sheet and ignoring the Notes to
Accounts.

Illustration 1.1

Statement of Profit and Loss for the Year ended 31st March 2020
Particulars ` `
Income :
Sales
Cash 2,50,000
Credit 1,00,000 3,50,000
Less : Expenses
Purchases
Cash 50,000
Credit 1,25,000 1,75,000
Salaries 13,000
Wages 10,000
Add : outstanding +5,000 15,000
Insurance 28,000
Less : prepaid -8,000 20,000
Rent 25,000
Electricity 20,000
Depreciation 14,000 2,82,000
PAT 68,000

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Balance Sheet as on 31st March 2019 and 31st March 2020
Particulars 2019 ` 2020 `
Assets
Net Fixed Assets 3,00,000 2,86,000
Debtors 0 1,00,000
Prepaid Insurance 0 8,000
Cash Balance 20,000 124,000

3,20,000 5,18,000

Equities and Liabilities

Equity Share Capital 3,20,000 3,20,000
Other Equity (Retained Earnings) 0 68,000
Sundry Creditors 0 1,25,000
Outstanding Wages 0 5,000

3,20,000 5,18,000

For simplicity purpose, the amount of debtors, prepaid expenses, retained earnings, creditors and
outstanding wages for the 2019 are considered as zero.

a. Calculation of CFO using Direct Method

In direct method, the statement of profit and loss is prepared again but using cash basis and not
accrual basis. That means the statement of profit and loss is prepared considering only those items
that are settled in cash and ignoring all the non-cash items.

Particulars ` `
Income :
Sales 2,50,000
Less : Expenses
Purchases 50,000
Salaries 13,000
Wages 10,000
Insurance 28,000
Rent 25,000
Electricity 20,000 1,46,000
Cash from operations 1,04,000

From the above statement, it can been seen that:

1. Credit sales of Rs.1,00,000 are ignored as cash is not realized.
2. Credit purchases of Rs.125,000 are also ignored as cash is not paid.
3. Outstanding wages of Rs.5,000 are ignored as they are not paid.
4. Prepaid insurance of Rs.8,000 is considered as it is paid in cash.
5. Depreciation of Rs.14,000 is ignored because it is a notional (non-cash) expense.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
b. Calculation of CFO using Indirect Method

In the indirect method, the profit figures are adjusted with the non-cash items to calculate the CFO.
In this method, we start with book profit and add or subtract all the non-cash items to determine the
CFO. For example, depreciation is added in the profit, as it is a non-cash expense. While calculating
CFO using indirect method either statement of profit and loss or balance sheet can be taken as a
base, because all the non-cash items affecting profit are present in both the statements. However, if
balance sheet is considered as a base, then two balance sheets (opening and closing) are needed. For
example, the credit sales appears as sundry debtors under the heading of Trade Receivables in
balance sheet. Credit purchases appears as sundry creditors under the heading of Trade Payables in
balance sheet. Outstanding expenses, prepaid expenses, accrued income and income received in
advanced, all appears under current liabilities or under current assets in balance sheet. Depreciation
figures are also present in PPE note of balance sheet. Similarly, the profit figures are available from
the other equity note of balance sheet.

If statement of profit and loss is used as a base then the CFO calculation will as under:

Particulars `
PAT 68,000
Adjustment for Non-cash expenses/income
Less : Credit sales (1,00,000)
Add : Credit Purchases 1,25,000
Add : Outstanding wages 5,000
Less : Prepaid insurance (8,000)
Add : Depreciation 14,000
Cash from operations 1,04,000

If balance sheet is used as a base then the CFO calculation will as under:

Particulars ` `
Closing balance of Retained Earnings 68,000
Less : Opening balance of Retained Earnings 0
Profit for the period 68,000
Add : Non-cash expenses
Depreciation (300,000-286,000) 14,000
82,000
Add / Less : Adjustment for Working Capital Items
Less : Increase in Debtors (0-100,000) (100,000)
Less : Increase in Prepaid Insurance (0-8,000) (8,000)
Add : Increase in Creditors (0-125,000) 125,000
Add : Increase in Outstanding Wages (0-5,000) 5,000 22,000
1,04,000

It is clearly seen that the amount of CFO will remain same even if different methods are used. In
this course, we will be focusing on indirect method and will take balance sheet as a base to calculate
CFO. Therefore, let us take one more illustration with only balance sheet with more line items to get
better clarity.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Illustration 1.2

Balance sheets as on 31st March 2019 and 31st March 2020

Particulars 2019 ` 2020 `

Assets
Land and Building 1,75,000 1,85,000
Plant and Machinery 50,000 40,000
Furniture 1,50,000 2,00,000
Goodwill 10,000 5,000
Patents 18,000 14,000
Stock 78,000 85,000
Debtors 68,000 60,000
Prepaid expenses 6,000 10,000
Accrued commission 5,000 6,000
Cash and Bank 10,000 25,000

5,70,000 6,30,000
Equities and Liabilities
Equity Capital 3,20,000 3,80,000
Term Loan 40,000 30,000
Debentures 50,000 30,000
General Reserve 38,000 52,000
Profit and loss account 35,000 45,000
Creditors 36,000 40,000
Bills Payable 22,000 25,000
Outstanding expenses 14,000 10,000
Provision for tax 15,000 18,000

5,70,000 6,30,000

First step is to divide the balance sheet into three parts viz. investing, financing and operating.
1. Share capital and non-current borrowings will come under financing activities.
2. Other equity (Reserve and Surplus) will come under operating activities.
3. All the non-current assets (purchased or sold) will come under investing activities except the
depreciation component. Depreciation will be the part of operating activity.
4. All current assets and current liabilities (working capital items) except cash and cash
equivalent will come under operating activities.

Second step is to compare the opening and closing balance sheet and understand the inflow or out
flow of cash. For e.g. if the loan taken figure increases then it means loan is taken and it will lead to
cash inflow and if the loan taken figure reduces then it means loan is repaid and it leads to cash
outflow. Let us understand each row item of balance sheet.
1. Share capital and non-current borrowings if increases means cash inflow and if decreases
means cash out flow from financing activities.
2. Any reserves if increases, then it is to be considered as profit transferred to reserves.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 3. Profit and loss balance/Surplus balance/Retained Earnings balance increases means profit
earned during the year or if decreases then loss suffered during the year.
4. Non-current assets increases then it means it is purchase of assets and will lead to outflow of
cash from investing activity. If the non-current assets reduces, then the first priority for the
reduction is given to depreciation / amortization and then further decrease is to be
considered as sale of assets. E.g. If machine balance reduces from Rs.100,000 to Rs.60,000,
then Rs.40,000 should be considered as depreciation but if we know that the depreciation
charged is Rs.25,000 then the further reduction of Rs.15,000 should be considered as sale of
machine.
5. Current assets if increases it means blocking of cash in working capital, so it will lead to
cash outflow and if current assets reduces it means realization of working capital or cash
released from working capital so it will lead to cash inflow.
6. Opposite is the case for current liabilities. If current liabilities increases, it leads to cash
inflow and if current liabilities decreases, it leads to cash outflow.

Let’s understand the CA and CL calculation with the help of the illustration 1.2:
Stock or inventory : The opening stock would be sold during the year and will generate cash
inflow and the closing stock is purchase of inventory so it will lead to cash out flow. Therefore, in
order to bring the book profit to the level of cash profit we need to add opening stock to profit and
subtract closing stock from the profit. So in the above illustration Rs.78,000 is to be added and
Rs.85,000 is to deducted or in other words Rs.7,000 is to be subtracted.

Debtors : Rs.68,000 of opening debtors will be collected during the year and will lead to cash
inflow and Rs.60,000 of closing debtors is actually the credit sales and the credit sales have inflated
the book profit but actual cash is not realized, it will be realized in the next year so Rs.60,000 is to
be subtracted. So instead of adding 68,000 and subtracting 60,000 the net effect of Rs.8,000 is given
as Add: Decrease in Debtors – Rs.8,000

Same is the case with prepaid expenses and accrued commission. Rs.4,000 of prepaid expenses and
Rs.1,000 of accrued commission will be subtracted.

Coming to current liabilities, it will show opposite effect as compared to current assets.
Creditors : Creditors are generated from credit purchase of raw material therefore the opening
creditors have to be paid, thus leading to cash outflow and the closing creditors will be paid in the
next year thus deferring the payment of cash. Therefore, to bring the book profit to the level of cash
profit we need to subtract the opening balance of creditors from profit and add closing balance of
creditors to profit. So in the above illustration Rs.36,000 is to be subtracted and Rs.40,000 is to
added or in other words Rs.4,000 is to be added. Same logic is to be applied to all other current
liabilities items except provision for taxation. viz., bills payable and outstanding expenses.

In nutshell - Increase in current assets is be subtracted and Decrease in current assets is to be

added to profit and Increase in current liabilities is to be added and Decrease in current
liabilities is to be subtracted from the profit.

Provision for Taxation : The rule of current liability i.e. finding increase or decrease is not applied
to provision for income tax because the actual amount of tax paid may differ from the amount
provided for in the form of provision. Generally, the opening balance of provision for income tax is
paid in the current year and is shown as a separate item of cash outflow under operating activities

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
and the closing balance of provision of income tax is added in the profit in order to bring the book
profit to the level of cash profit. However, if some adjustment or additional information is provided
for the actual amount of tax paid, then it has to be considered accordingly.

The final step is to calculate the net cash flow during the year and to adjust it with opening balance
of cash and cash equivalent to determine the closing balance of cash and cash equivalent.

Solution of illustration 1.2

Cash Flow Statement for the year ended on 31st March 2020

Particulars ` `
Cash flow from operating activities
Closing balance of Profit and loss account 45,000
Less : Opening balance of Retained Earnings 35,000
Profit for the period 10,000
Add/Less : Non-cash items
1. Transfer to General Reserve (52,000 -38,000) 14,000
2. Provision for income tax created 18,000
3. Depreciation on Plant and Machinery (50,000-40,000) 10,000
4. Amortization of Goodwill (10,000-5,000) 5,000
5. Amortization of Patents (18,000-14,000) 4,000 51,000
Profit before working capital changes 61,000
Add / Less : Adjustment for working capital items
Less : Increase in stock (78,000-85,000) (7,000)
Less : Increase in prepaid expenses (6,000-10,000) (4,000)
Less : Increase in accrued commission (5,000-6,000) (1,000)
Add : Decrease in debtors (68,000-60,000) 8,000
Add : Increase in creditors (36,000-40,000) 4,000
Add : Increase in bills payable (22,000-25,000) 3,000
Less : Decrease in outstanding expenses (14,000-10,000) (4,000) (1,000)
Cash flow before payment of income tax 60,000
Less : Payment of Income Tax (2019) 15,000
Net cash flow from operating activities / CFO 45,000
(A)
Cash flow from investing activities
Purchase of land and building (175,000-185,000) (10,000)
Purchase of furniture (150,000-200,000) (50,000)
Net cash flow from investing activities (60,000)
(B)
Cash flow from financing activities
Issue of equity shares (320,000-380,000) 60,000
Repayment of term loan (40,000-30,000) (10,000)
Redemption of debentures (50,000-30,000) (20,000)
Net cash flow from financing activities 30,000
(C)
Net cash flow for the year 15,000

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Add : Cash balance at the beginning of the year 10,000
Cash balance at the end of the year 25,000

-----------------------------------------

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CHAPTER 2

RATIO ANALYSIS

BACKGROUND

Ratio analysis is an important and powerful technique or method, generally, used to examine the
health or the performance of the company. If a person is interested in investing money in the equity
of a company by purchasing its equity shares (stock), then he is required to do thorough analyses of
that company before purchasing the shares, so that he doesn’t suffer losses. There are two main
important methods of doing stock analysis. Both the methods are important and have its own
significance. We will look into both the methods but briefly as this is a finance specialization topic
and finance students will be learning these methods in detail in their specialization courses.

Fig 2.1 - Methods used for Stock Analysis

Stock
Analysis

Fundamental Technical
Analysis Analysis

Fundamental and technical analysis are two major methods for analysing and predicating future
share price. Both the methods are pole apart from each other w.r.t. approach, methodology and
usage. Fundamental analysis refers to the analysis of the fundaments of the company. In
fundamental analysis, all the macro-economic factors affecting the company alongwith the financial
statements viz. statement of profit and loss, balance sheet and cash flow statement are analysed.
Technical analysis refers to the analysis of share price movement in the stock market. It is done
with the help of charts and indicators. Thus, it is clearly seen that fundamental analysis is evaluating
the company’s performance whereas technical analysis is evaluating the performance of the share
price. Fundamental analysis is generally used by the genuine investors who want to invest the
money for a longer period of time and wants to create the wealth whereas technical analysis is used
by traders or speculators who want to make short term gain and want to take the advantage of time.
Technical analysis helps the trader to identify of the right time to enter and right time to exit the
stock market. Since ratio analysis is a part of fundamental analysis, let us briefly understand this
method and the two different approaches used under this method.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Fig 2.2 - Approaches used in Fundamental Analysis

Approaches for
Fundamental Analysis

Top Down Approach Bottom Up Approach

Top Down Approach : The top down approach is also called as E-I-C approach, where ‘E’ stands
for Economy, ‘I’ stands for Industry and ‘C’ stands for Company. In this approach first the macro
economic factors like political, economic, social, technological, environmental and legal (PESTEL)
are studied and analysed. After that, the industry specific factors are analysed and then the detailed
company analysis is done. E.g. if a person wants to do analysis of Dabur India Ltd., then he has to
first understand the Indian economy, then FMCG sector and then the company ‘Dabur India Ltd.’.
Under the company analysis, first the analyses of the non-financial parameters or qualitative
parameters are done i.e. understanding and analysing the business model, promotors and
management quality and corporate governance practices. Followed by financial statement analysis
(FSA), which consist of statement of profit and loss, balance sheet and cash flow statement. There
are main four tools and techniques to do FSA, as under:

1. Common size analysis

2. Comparative analysis
3. Trend analysis (Graphical representation)
4. Ratio analysis

From the above it can be concluded that ratio analysis is one of the tool or technique for doing FSA
of a company. Usually in the placement interviews, students are asked the question – ‘How will you
analysis a company?’ The normal answer given by the student is that ‘We will calculate the ratios.’
So please understand that ratio analysis or calculating financial ratios is the last step involved in
company analysis. Though, this step is very important but it is not the only step. The answer needs
to be - First we will do Economy analysis followed by Industry analysis and then Company analysis
and under company analysis, first we will study the business model of the company, then the
promotors and the management quality, then the corporate governance practices and then the
financial statements using ratios.

Bottom Up Approach : In this approach, instead of starting the analysis from the larger scale i.e.
economy the analysis of the individual stock is done. The rationale of this is that individual stocks
may perform much better than the overall industry or sector.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
The following diagram depicts the flowchart of stock analysis in nutshell.

Fig 2.3 – Stock Analysis

Stock Analysis

Technical Fundemental
Analysis Analysis

Top Down
Bottom Up
(EIC) Approach

Economy Industry Company

Non-financial Financial
Analysis Analysis

Promotors & Corporate Common

Business Comparative Trend Ratio
Management Govarance Size
Model Analysis Analysis Analysis
Quality Practices Analysis

MEANING AND RATIONAL

Ratio is a mathematical relationship between two items or variables. Financial ratio is a relationship
between one item (number) with another item (number) or group of items (number) from financial
statements. Financial ratio is used as an index for evaluating the financial performance of the
company. Analysis and interpretation of various ratios gives a better understanding of financial
condition and performance of the company than the perusal of financial statements. A single figure
by itself has no meaning but when expressed in terms of a related figure, it yields significant
inferences. For instance, if the profit of Company A is Rs.50,000 and of Company B is Rs.30,000,
we can’t conclude that Co A is better that Co B, just because 50,000 is greater than 30,000.
However, if we consider the profit in relation with sales then a better conclusion can be drawn.
Suppose the sales of Co A is Rs.1,25,000 and Co B is Rs.60,000, then definitely Co B’s
performance is better than Co A because Co B is able to earn a profit of 50% (30,000/60,000) and
Co A is able to earn a profit of 40% (50,000/125,000). From this example, two important points
have surfaced. First, the ratio needs to be expressed in some form. Here we have used percentage to
express the ratio. Second, the ratio need to be compared. Here we have compared the ratio of Co A
with Co B.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
FORMS OF EXPRESSING RATIOS

Ratio can be expressed in three forms:

1. Percentage
2. Simple or pure ratio
3. Rate

Percentage - Some ratios are expressed in terms of percentage. Normally the profit ratios are
expressed in percentage, say, net profit is 50 per cent of sales (assuming net profits of Rs.30,000
and sales of Rs.60,000).

Proportion or pure form - It gives a simple relationship between two figures. Instead of saying
profit is 50% of sales, it is said that the relationship between the profit and sales is 1 : 2. But,
whenever a ratio is expressed in proportion or pure form than the denominator should be always 1.
So here the ratio will be 0.5 : 1.

Rate – Rates means number of times. The sales is 2 times the profit.

A ratio can be expressed in any of the above form. There is no hard and fast rule, that a particular
ratio is to be expressed in a particular form. A ratio should be expressed in such a form, that it
becomes easy for the user to understand and interpret. For instance, 40% and 50% is easily
understandable as compared to 2:5 and 1:2. There are some general points to be kept in mind while
expressing a ratio. If the numerator is less than the denominator, i.e. the ratio is less than 1, then the
ratio is expressed in percentage. If the denominator is less than the numerator, i.e. the ratio is greater
than 1, then the ratio is expressed in times or rate. If both the numerator and denominator are
equally important than express the ratio in pure form. For instance, while understanding the
relationship of current assets with reference to current liabilities then both CA and CL are equally
important so the ratio of CA to CL will be expressed in pure form.

BASIS OF COMPARISON

As we have already seen that a single ratio is not meaningful. For proper interpretation and
understanding, ratios are to be compared. Comparison can be done as under:
1. Interfirm comparison
2. Intrafirm comparison
3. Comparison with standards or industry averages

Interfirm comparison – The ratios of one company are compared with the ratios of the other
company that is in the same line of business or is a peer group company. For example, ratios of
Dabur India Ltd. can be compared with HUL or Nestlé India Ltd., or Marico Ltd.

Intrafirm comparison – The present ratios are compared with the past ratios of the same company.
For example, the ratios of Dabur India Ltd. of 2020 can be compared with the ratios of Dabur India
Ltd. of previous years like ratios of 2019.

Comparison with standards or industry averages - Industry average ratio is a mean value of the
ratios for a particular sector or industry. It is calculated by aggregating the ratio of all the companies
of a particular sector or industry. Industry averages are normally considered as benchmark or

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
standards. For example the ratios of Dabur India Ltd. will be compared with the ratios of Fast
Moving Consumer Goods (FMCG) sector.

TYPES OF RATIOS

Several ratios can be grouped into various classes, according to the activity or function they
perform. Ratios can be classified according to the way they are constructed and their general
characteristics. Therefore, the ratios can be classified as:

1. Based on financial statement

2. Based on user
3. Based on function

1. Based on financial statement

The relationship between two items taken from financial statement i.e. statement of profit and loss,
balance sheet or both is expressed. The ratios can be grouped as follows.
a. Balance sheet ratio – The relationship between two items is expressed by taking figures
from balance sheet only. Actually, the relationship between the assets and liabilities is
calculated. Some of the ratios of this kind are current ratio, liquid ratio, proprietary ratio,
capital gearing ratio, debt/equity ratio and stock to working capital ratio.
b. Income statement ratio – The relationship between two items is expressed by taking
figures only from statement of profit and loss. Mostly, these ratios are the comparison of
profit with sales. For Example - gross profit ratio, cash operating profit ratio, operating
profit ratio, pretax profit ratio, net profit ratio, expenses ratios, stock turnover ratio,
interest coverage ratio and dividend coverage ratio.
c. Combined ratios – Under these category of ratios the relationship between two items is
expressed by taking one item from balance sheet and another from income statement. It
shows the relationship between the profits and investment of the firm. For e.g. Return on
Capital employed, Earning Per Share, Debtors Turnover Ratio, etc.

2. Based on users

The ratios are calculated from the perspective of the users of that information.
a. Ratios useful for shareholders and potential shareholders – Shareholders and/or investors
are interested in the safety of their funds and capital appreciation. It includes ratios like
net profit ratio, dividend payout ratio, return on shareholders fund, return on equity
capital and P/E ratio.
b. Ratios useful for short term creditors – Basically, creditors are interested in knowing the
firm’s ability to meet short term obligation. This includes current ratio, liquid ratio and
cash ratio.
c. Ratios useful for management - The management is interested in the efficiency of the
company. So the ratios calculated are all turnover ratios, return on capital employed and
all profit ratios.
d. Ratios useful for lenders – The lenders are the debt capital providers and they are
interested in companies’ ability to pay interest and repayment of the debts when it is due.
The ratios of this kind are debt/equity ratio, interest coverage ratio, DSCR ratio and
return on capital employed ratio.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 3. Based on functions:

Here the ratios are grouped by their relevance to different aspects of the business. The categories of
ratios are as under:
a. Liquidity or solvency ratios
b. Leverage or capital structure ratios
c. Profitability ratios
d. Activity or turnover ratios
e. Valuation ratios (will be covered in finance elective courses)

In this chapter, we will learn the ratios classified on the basis of functions.

Fig 2.4 – Types of Ratios based on Functions

Types of Ratios

Liquidity ratios Leverage ratios Profitability ratios Activity ratios

Profitability ratios Inventory turnover

Current ratio Debt-Equity ratio
based on sales ratio
Debt to total capital Profitability ratios Debtors turnover
Quick ratio
ratio based on assets ratio
Creditors turnover
Cash ratio Proprietary ratio
ratio
Defensive interval Assets turnover
Capital gearing ratio
ratio ratio
Interest coverage
ratio
Debt service
coverage ratio
Dividend coverage
ratio

LIQUIDITY RATIOS OR SOLVENCY RATIOS

Liquidity ratios are highly useful to creditors, banks and financial institutions that provide short-
term credit to companies. Short-term refers to a period not exceeding one year. Liquidity ratios
measure the company’s ability to meet current obligations, as and when they fall due. It also shows
how fast a company is able to convert its non-cash assets into cash. Companies should ensure that
they does not suffer from lack of liquidity as well as they do not have excess liquidity. In the
absence of adequate liquidity, the firm would not be able to pay creditors, who have supplied goods
and services, on the due date. Loss of creditworthiness may result in legal problems and also will
spoil the reputation of the company. If corrective measures are not taken then it may even lead to
the closure of business of a company. If the firm maintains more liquidity, it will not experience any
difficulty in making payments. More than required degree of liquidity is also bad because the cash
will be lying idle and company will loss on the opportunity of investing the money in non current
assets and will invite a problem of profitability in future. The firm’s funds will be, unnecessarily,
IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
tied up in liquid assets. Both inadequate and excess liquidity are not desirable. It is therefore
necessary for the firm to strike a proper balance between high liquidity and lack of liquidity.
Following ratios will help the analyst to understand the liquidity position of the company.

Note: Let us learn the calculation of the ratios and the meaning of each ratio with the help of the
balance sheet of Dabur India Ltd. The interpretation of the ratios and the comparison of the ratios
will done in the class.

Dabur India Limited

Balance Sheet as at 31st March, 2020
Particulars Rs. Crores
ASSETS
Property, Plant and Equipment 1,060.75
Capital work in progress 105.83
Investment property 48.38
Other intangible assets 25.15
Financial Assets
Investments 1084.16
Loans 16.78
Others 403.27
Other non-current assets 90.6
Inventories 809.14
Financial Asset
Investments 1382.67
Trade Receivables 379.63
Cash and cash equivalents 2.87
Others 533.2
Prepaid expenses 157.68
Total Assets 6,100.11
EQUITY AND LIABILITIES
Equity
Equity share capital 176.71
Other equity 4397.52
Financial Liabilities
Borrowings 24.68
Other financial liabilities 4.66
Provisions 54.69
Financial Liabilities
Borrowings 89.28
Trade payables 1169.74
Other current liabilities (Advances) 55.33
Provisions 122.8
Current tax liabilities 4.7
Total Equity and Liabilities 6100.11

1. Current Ratio

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Current ratio is defined as the relationship between current assets and current liabilities. It is also
known as working capital ratio. This ratio helps in identifying the short-term solvency position of
the company. The ratio is calculated by dividing total current assets by total current liabilities.
Current ratio is always expressed in pure form.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Current assets are those that can be realized within one operating cycle or a short period of time,
generally one year. Similarly, current liabilities are those that are due for payment within one
operating cycle or within a period of one year.

Current assets of Dabur India Ltd. are inventories, current investments, trade receivables, cash and
cash equivalents, other financial assets and prepaid expenses and current liabilities are borrowings,
trade payables, other current liabilities, provisions, current tax liabilities. The CA total is 3,265.19
and CL total is 1,441.85 so the current ratio is 2.26:1. This indicates that for the payment of Re.1 of
current liabilities, Dabur is having Rs.2.26 of current assets. Since the current assets are more than
the current liabilities, it indicates that the short-term solvency position of Dabur is sound.

2. Liquid / Quick / Acid Test Ratio / Near Money Ratio

Liquid or Quick ratio establishes the relationship between quick assets and quick liabilities. This
ratio judges the immediate solvency position of the company. This ratio is always expressed in pure
form and is calculated as:

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
𝐿𝑖𝑞𝑢𝑖𝑑 𝑅𝑎𝑡𝑖𝑜 =
𝑄𝑢𝑖𝑐𝑘 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

OR

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 − 𝑃𝑟𝑒𝑝𝑎𝑖𝑑 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠

𝐿𝑖𝑞𝑢𝑖𝑑 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 − 𝐵𝑎𝑛𝑘 𝑂𝑣𝑒𝑟𝑑𝑟𝑎𝑓𝑡 − 𝑃𝑟𝑒𝑟𝑒𝑐𝑖𝑣𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒

Quick or liquid assets are those that can be converted into cash, quickly, without loss of value. Cash
and bank balance are the most liquid assets. Other assets that are considered relatively liquid are
debtors, bills receivable and marketable securities (quoted investments purchased). Inventories and
prepaid expenses are excluded from this category. Inventories are considered less liquid or non
quick assets as they require time for realizing into cash and have a tendency to fluctuate in value at
the time of realization. Prepaid expenses or advances cannot be recovered in cash hence they are
excluded. Quick liabilities are those liabilities that have to be paid immediately. Creditors, bills
payable, outstanding expenses and provisions are the quick liabilities. Short term borrowings i.e.
Bank Over Draft and income received in advanced are the non quick liabilities.

Quick assets of Dabur India Ltd. are Rs.2,298.37 (3,265.19 - 809.14 - 157.68) and quick liabilities
are Rs.1,297.24 (1,441.85 - 89.28 - 55.33). Therefore, the quick ratio is 1.77:1. This indicates that
for the payment of Re.1 of quick liabilities, Dabur is having Re.1.77 of quick or near cash assets.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Since the quick assets are more than the quick liabilities, it indicates that the immediate solvency
position of Dabur is sound.

3. Cash Ratio / Absolute Liquid Ratio / Super Quick Ratio

Cash and cash equivalents are the most liquid asset. Although receivables (debtors and bills
receivables) are generally better realizable than inventories still there are doubts regarding their
realization. So, they are not considered immediately available for making payments and so excluded
for the calculation of cash ratio. Investments in securities, which are traded in secondary market are
considered par with cash and bank balance. Cash ratio calculates the availability of cash and cash
equivalents to pay the quick or current liabilities. This ratio is always expressed in pure form. The
ratio is calculated as under:

𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐵𝑎𝑛𝑘 + 𝑀𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠

𝐶𝑎𝑠ℎ 𝑅𝑎𝑡𝑖𝑜 =
𝑄𝑢𝑖𝑐𝑘 𝑜𝑟 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Dabur’s cash and cash equivalents are 2.87 and investments in marketable securities are 1084.16.
So, the ratio is 0.84:1 (1,087.03 / 1,297.24). This indicates that for the payment of Re.1 of quick
liabilities, Dabur is having Re.0.84 of cash assets.

From these three ratios it is clearly visible that current assets are equal to quick assets plus non
quick assets and quick assets are equal to super quick assets plus non super quick assets. Thus on
the basis of liquidity the assets can be classified as under:

Fig 2.5 – Classification of Assets based on Liquidity

Cash & Cash

Equivalents and
Marketable Securities

Debtors and
Bills Receivable

Inventories and
Prepaid Expenses

Fixed Assets

4. Defensive Interval Period Ratio

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
In the earlier ratios, the ability of the company to pay its current liabilities was analyzed. Apart from
paying current liabilities, the liquidity position of a firm should also be examined in relation to its
ability to meet projected daily cash expenses. The defensive interval ratio provides such a measure
of liquidity. It is a relationship between the quick / liquid assets and the projected daily cash
requirements. The projected cash operating expenditure is based on past expenditures and future
plans. It is calculated by adding cost of goods sold, administrative expenses, selling expenses and
other ordinary cash expenses. Depreciation and amortization expenses are excluded as they are non-
cash expenses. Defensive interval ratio is calculated in period i.e. in number of days / weeks or
month. The formula to calculate this ratio is as under:

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
𝐷𝑒𝑓𝑒𝑛𝑠𝑖𝑣𝑒 𝐼𝑛𝑡𝑒𝑟𝑣𝑎𝑙 𝑅𝑎𝑡𝑖𝑜 =
𝑃𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝐷𝑎𝑖𝑙𝑦 𝐶𝑎𝑠ℎ 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡
Where,
𝑃𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑐𝑎𝑠ℎ 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒
𝑃𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝐷𝑎𝑖𝑙𝑦 𝐶𝑎𝑠ℎ 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 (365)

Dabur’s cash operating expenses for 2020 is Rs.4,948.30. Assuming that the cash operating
expenses for the 2021 will also be the same, then the projected daily cash requirement will be
Rs.13.55. The quick assets of Dabur is Rs.2,298.37. So the defensive interval period is 169.6 ~ 170
days approx. This indicates that the liquid assets are sufficient to meet the operating cash
requirements for the next 170 days without resorting to future revenues.

-----------------------------------------

LEVERAGE RATIOS OR CAPITAL STRUCTURE RATIOS

The second category of financial ratios is Leverage or Capital structure ratios. Before understanding
this category of ratios, first let us understand the meaning of capital structure and different
terminologies used in this section. Capital structure comprises of long term sources of finance raised
by the company. Capital structure is sum total of own funds and borrowed funds. Own funds or own
capital is equal to equity plus other equity (reserves and surplus) and borrowed funds/capital is
equal to non-current borrowings like loans, debentures and bonds. The own capital is called as
Equity / Net Worth / Shareholders’ Funds whereas the borrowed capital is called as Debt capital.
Equity and Debt together comprises the capital structure of a company and it is called as Capital
Employed. Thus,

a. 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡

b. 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝐸𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 𝑎𝑛𝑑 𝑠𝑢𝑟𝑝𝑙𝑢𝑠
c. 𝐷𝑒𝑏𝑡 = 𝐷𝑒𝑏𝑒𝑛𝑡𝑢𝑟𝑒𝑠 + 𝐵𝑜𝑛𝑑𝑠 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑙𝑜𝑎𝑛

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Capital Employed

Debt
Equity

Capital structure ratios are important from the perspective of lenders of capital or debt capital
providers. Normally banks and other financial institutions (FIs) calculate these ratios before taking
the decision of lending money to a company. These ratios help in judging the soundness of a
company on the basis of its long-term financial strength, which is measured in terms of the
company’s ability to pay the interest amount regularly as well as to repay the instalment of the
principal on due dates or in one lump sum at the time of maturity. The long-term solvency position
of a company can be examined by using leverage or capital structure ratios. Important ratios
calculated under this category are

1. Debt/Equity (D/E) Ratio

This ratio shows the relationship between the borrowed capital and own capital i.e. the relationship
between Debt and Equity. This ratio is calculated to measure the relative claims of outsiders and
owners against the firm’s assets. Usually, only long-term loans are considered to calculate this ratio,
but sometimes instead of long-term loans, even the total loans (long-term loans plus short-term
loans) of the company are considered. Therefore the D/E ratio can be calculated using any of the
given formula :

𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

𝐷𝑒𝑏𝑡/𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 =
𝐸𝑞𝑢𝑖𝑡𝑦

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝐷𝑒𝑏𝑡/𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 =
𝐸𝑞𝑢𝑖𝑡𝑦

If the total capital employed of the company is Rs.100,000 comprising of equity of Rs.40,000 and
debt of Rs.60,000, then the D/E ratio will be (60,000 / 40,000) 3:2 or 1.5:1. This indicates that the
company has borrowed 1.5 times more or 50% more than its own capital. If the ratio is greater than
1, then it implies that a large share of financing is done by lenders and if the ratio is less than 1, then
it implies a smaller claim of lenders. Both high as well as low ratio has its own implications on the
financial health of the company. If the debt capital proportion is more than the equity capital, than
the company is a risky company to invest the money because the payment of interest as well as
principal amount is a compulsory obligation for the company and the company is required to earn
sufficient profits to satisfy the claims of lenders. Whereas if the equity proportion is high than the
company is considered as less risky company. But if a company is relying heavily on its own funds
and does not use its borrowing capacity to the fullest than the company will loose on the advantages
(leverage) achieved by debt capital. The leverage achieved from the debt financing are mainly of
two types, first in the form of tax shield enjoyed by the company on interest payment and second in
the form of high EPS. If we considered the balance sheet of Dabur India Ltd. from the earlier

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
section, it is seen that the D/E ratio is 0.01:1. This reveals that Dabur India Ltd. is not taking
advantage or leverage of debt capital.

2. Debt to Capital Employed Ratio / Debt to Total Capital Ratio

In this ratio, the relationship of borrowed capital with the total capital and not merely with the own
capital is calculated. Debt to total capital is actually one of the variant of D/E ratio. This ratio is
always expressed in percentage. The formula is as under:

𝐷𝑒𝑏𝑡
𝐷𝑒𝑏𝑡 𝑡𝑜 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 =
𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦

If we take the earlier example of D/E ratio of 1.5:1, then in this case the debt to capital employed
will be 60% (60,000 / 100,000 x 100). This indicates that out of the total capital, 60% of capital is
given by the lenders and the remaining 40% of the capital is provided by the owners. This also
indicates that 60% of the assets are financed by the borrowed capital.

3. Proprietary Ratio

Proprietary ratio is exactly opposite to debt to total capital. In the earlier ratio the proportion of
borrowed capital to total capital was calculated, here the proportion of own capital with total capital
is calculated. This ratio is also expressed in terms of percentage. It determines to what extent total
assets are financed by proprietors.

𝐸𝑞𝑢𝑖𝑡𝑦
𝑃𝑟𝑜𝑝𝑟𝑖𝑒𝑡𝑎𝑟𝑦 𝑟𝑎𝑡𝑖𝑜 =
𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦

If the debt to capital employed ratio is 60% then the proprietary ratio will be 40% (100 - 60).

4. Capital Gearing Ratio

Capital Gearing ratios explain the relationship between the Funds Bearing Fixed Rate of Return
(FBFRR) and Funds Not Bearing Fixed Rate of Return (FNBFRR). Funds bearing fixed rate of
returns are those funds, which carry a fixed amount of returns. The debt funds (debentures, bonds
and loans) and preference share capital are the FBFRR. On the debt capital there is a fixed return in
the form of interest and on preference share capital there is a fixed return in the form of preference
dividend. Funds not bearing fixed rate of return are equity share capital and reserve & surplus. If we
compare this ratio with the D/E ratio then it is seen that preference share capital is actually moved
from the denominator to the numerator. D/E ratio is calculated as (Debentures + Bonds + Loans) /
(Equity Share Capital + Preference Share Capital + Reserves and Surplus) whereas Capital gearing
ratio is calculated as (Debentures + Bonds + Loans + Preference Share Capital) / (Equity Share
Capital + Reserves and Surplus). This ratio is not expressed in any of the form learned earlier but it
is written as it is. E.g. in our earlier illustration where the total capital employed of the company is
Rs.100,000 comprising of equity of Rs.40,000 and debt of Rs.60,000, let us consider that the
preference share capital is Rs.10,000. Then FBFRR will be Rs.70,000 (60,000+10,000) and
FNBFRR will be Rs.30,000 (40,000-10,000). Therefore, the capital gearing ratio will be 2.33. If the
ratio is greater than 1, then it is interpreted that the company is in high gear and if the ratio is less
than 1, then the company is in low gear. High gear is preferred only when the company is a growing

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
company and is having sufficient profit to pay off the interest and preference dividend, as they are
the compulsory obligations of the company. Whereas if the company is in declining phase then it is
preferred to be in low gear that means, it is preferred to rely more on equity shared capital and
reserve & surplus.

𝐹𝑢𝑛𝑑𝑠 𝐵𝑒𝑎𝑟𝑖𝑛𝑔 𝐹𝑖𝑥𝑒𝑑 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛

𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑒𝑎𝑟𝑖𝑛𝑔 𝑟𝑎𝑡𝑖𝑜 =
𝐹𝑢𝑛𝑑𝑠 𝑁𝑜𝑡 𝐵𝑒𝑎𝑟𝑖𝑛𝑔 𝐹𝑖𝑥𝑒𝑑 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛

5. Coverage Ratios

We have seen in the earlier ratios that interest payment, preference dividend payment and the
repayment of debt and preference share capital is an obligation for the company. These obligations
are met from the profits of the company i.e. these amounts are paid from the profits of the company.
So a company is required to have sufficient profit for these kind of payments. The company as well
as the lenders are interested to know the proportion of profit available for these kind of payments or
in other words, company as well as the lenders are interested to know that how many times the
profit is able to cover these obligations. Therefore based on these three obligations, there are three
coverage ratios which are explained as under:

a. Interest Coverage Ratio

The interest coverage ratio is used to test the company’s ability of servicing the debt. The interest
coverage ratio shows the number of times the interest charges are covered by the operating profit of
the company. The operating profit is also called as EBIT (Earnings Before Interest and Taxes). The
detailed discussion of EBIT will be done in the next set of ratios i.e. profitability ratios. For time
being let us understand that, EBIT is calculated as Net sales minus all the expenses except finance
cost. Interest coverage ratio is always calculated in times and the formula is as under:

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑇𝑎𝑥

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑐𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑡𝑖𝑜 =
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑐ℎ𝑎𝑟𝑔𝑒𝑠

If the operating profit of the company is Rs.50,000 and the interest amount is Rs.10,000, then the
interest coverage ratio will be 5 times. (50,000 / 10,000). This indicates that the operating profit or
EBIT is 5 times the interest amount or it can be said that even if the profit falls down by 5 times, the
company will be able to pay the interest charges. It also indicates that the interest is covered 5 times
by the profit. From this example, it is very obvious that the lenders will prefer high interest
coverage ratio. Therefore, higher ratio is preferred.

b. Debt Service Coverage Ratio (DSCR)

Interest coverage ratio shows the relationship between the profit and the interest whereas the DSCR
shows the relationship between profit and interest plus installments of principal amount payable.
This ratio indicates the company’s ability to pay interest and principal amount on time. This ratio is
more useful for lender as it takes care of total repayment. This ratio is also expressed in times and
the formula is as under:

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑇𝑎𝑥

𝐷𝑒𝑏𝑡 𝑆𝑒𝑟𝑣𝑖𝑐𝑒 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜 =
𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 𝑑𝑢𝑒 𝑜𝑛 𝑙𝑜𝑎𝑛
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 +
(1 − 𝑡)

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 c. Dividend coverage ratio
This ratio talks about preference dividend and not equity dividend because preference dividend is a
fixed percentage and it is a compulsory obligation, whereas the equity dividend is paid based on the
profits earned by the company. Higher the profits, higher the equity dividend and lower the profits,
lower the equity dividend. Preference shareholders have the right to receive dividends. The
dividends of preference shares may be postponed but payment is compulsory and therefore they are
considered as a fixed liability. The preference shareholders like lenders are interested to known that
how many times the preference dividend payment is covered by the profit. Dividend coverage ratio
essentially calculates this relationship and indicates the capacity of the company to pay the
preference dividend. The ratio is calculated as under:

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥 (𝑃𝐴𝑇)

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜 =
𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑

-----------------------------------------

PROFITABILITY RATIOS

Profitability ratios are used to measure the operating efficiency of the company. Besides
management, lenders and owners of the company are also interested in the analysis of the
profitability of the firm. If profits are adequate, then the lenders can ensure easy recovery of interest
and principal amount. Owners invest their funds in the company in the expectation of good returns,
so if the profit of the company is high then the owners can get required rate of return on investment.
Similarly the management is interested in profitability ratios as these ratios evaluate the efficiency
of the company and measures the ability of the company to earn profit. Therefore, profit is
important to everyone associated with the firm. Profitability ratios can be determined on the basis of
sales and investments. So the ratios are:

A. Profitability ratios based on sales

B. Profitability ratios based on investment

A. Profitability ratios based on sales

Profit is a factor of sales. Profit is earned after meeting all expenses from sales. Profit can be
calculated as gross profit, cash operating profit, operating profit, pretax profit or net profit. All the
profitability ratios related to sales are expressed in percentage. Let us now see the calculation of
each type of profit. In order to calculate the different types or levels of profits the statement of profit
and loss is rewritten again by changing the headings. The following is the statement of profit and
loss of Dabur India Ltd for the year ended 31st March 2020

Statement of Profit and Loss for the years ended 31st March
(All amounts in crores)

31 March, 31 March,
Particulars
2020 2019
Income
Revenue from operations 6,309.80 6,273.19

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Other income 276.90 274.74
Total income 6,586.70 6,547.93
Expenses
Cost of materials consumed 2,449.37 2,262.51
Purchases of stock-in-trade 865.22 984.91
Changes in inventories of FG, SIT and WIP (69.89) 10.09
Employee benefits expense 578.26 572.33
Finance costs 19.27 29.80
Depreciation and amortization expense 129.93 108.83
Other expenses
Advertisement and publicity 514.26 490.75
Others 591.81 585.36
Total expenses 5,078.23 5,044.58
Profit before exceptional items and tax 1,508.47 1,503.35
Exceptional items 100.00 -
Profit before tax 1,408.47 1,503.35
Tax expense
Current tax 425.40 369.28
Deferred tax (187.28) (130.22)
Total tax expense 238.12 239.06
Net profit for the year 1,170.35 1,264.29

In other to calculate the different levels of profits, we will rewrite the above statement and will call
it as analytical profit and loss statement.

Analytical Profit and Loss Statement for the years ended 31st March
(All amounts in crores)

31 March, 31 March,
Particulars
2020 2019
Net Sales 6,309.80 6,273.19
Less : Cost of Goods Sold (COGS)
Cost of materials consumed 2,449.37 2,262.51
Purchases of stock-in-trade 865.22 984.91
Changes in inventories of FG, SIT and WIP (69.89) 10.09
Total (COGS) 3,244.70 3,257.51
Gross Profit 3,065.10 3,015.68
Less : Other Operating Expenses
Employee benefits expense 578.26 572.33
Other expenses 1106.07 1076.11
Earnings Before Interest, Taxes, Depreciation
and Amortization (EBITDA) 1,380.77 1,367.24
Less : Depreciation and Amortization 129.93 108.83
Earnings Before Interest and Taxes (EBIT) 1,250.84 1,258.41
Less : Interest (Finance costs) 19.27 29.8
Operating profit excluding other income 1,231.57 1,228.61

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Add : Other income 276.9 274.74
Profit before exceptional items and tax 1,508.47 1,503.35
Add / Less : Exceptional items (100) 0
Profit Before Tax (PBT) 1,408.47 1,503.35
Less : Tax expense 238.12 239.06
Net Profit After Tax (PAT) 1,170.35 1,264.29

Some of the formulae used in this section are as under:

1. Gross Profit = Net Sales – COGS

2. COGS = Opening Stock + Purchases – Closing Stock or
COGS = Cost of material consumed + Purchase of stock in trade + Changes in inventories
3. EBITDA = Net Sales – COGS – Other operating Expenses (excluding depreciation,
amortization and interest)
4. EBIT = Net Sales – COGS – Other operating expenses – Depreciation and amortization or
EBITDA – Interest
5. PBT = Total income – Total expenses
6. PAT = PBT – Provision for tax or PBT x (1-t), where t = tax rate

The profitability ratios related to sales are as below:

1. Gross Profit Ratio

The first ratio in relation to sales is gross profit ratio or gross margin ratio. The ratio is calculated by
dividing the gross profit by net sales. Net sales is calculated as gross sales minus return inward or
sales return. The formula is:

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝑋 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

Gross Profit Ratio reflects the efficiency with which a firm produces and sells its different products.
This ratio indicates the spread between the cost of goods sold and revenue. This ratio is very
important to judge the operating efficiency of the company. Higher ratio shows a good sign of
management.

Gross profit ratio reveals the relationship between selling prices, sales volume and cost of
production. In order to improve the ratio, the company needs to either increase the selling price or
sales volume or reduce the cost of production. Increasing the sales or reducing the cost of
production, which consist of uncontrollable expenses can’t happen overnight or in short run
therefore improving this ratio in a short span of time is difficult but in long run it is possible. This
ratio also indicates the extent to which the selling price can decline, without resulting in losses on
operations of a firm.

The gross profit ratio of Dabur for 2020 is 48.58%. This means that 51.42% is the proportion of
COGS to sales.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 2. EBITDA Margin

EBITDA margin is a relationship between the company's cash operating profit and net sales.
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. The ratio is
calculated as under:

𝐸𝐵𝐼𝑇𝐷𝐴
𝐸𝐵𝐼𝑇𝐷𝐴 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑋 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

The EBITDA margin of Dabur for 2020 is 21.88% and for 2019 is 21.79%.

3. EBIT Margin / Operating Profit Ratio

EBIT margin is a relationship between the company's operating profit and net sales. EBIT margin is
also called as operating profit ratio. EBIT stands for earnings before interest and taxes. The ratio is
calculated as under:

𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑋 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

The EBIT margin of Dabur for 2020 is 19.82% and for 2019 is 19.94%.

4. Pretax Profit Ratio

Pretax profit is also called as profit before taxes. This ratio indicates how much percentage of sales
is turned into profit. The ratio is calculated as:

𝑃𝐵𝑇
𝑃𝑟𝑒𝑡𝑎𝑥 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝑋 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

The PBT margin of Dabur for 2020 is 22.32% and for 2019 is 23.83%. The PBT ratio for both the
year is higher than the previous profit ratios because the other incomes are added. The PBT ratio of
2020 is declined as compared to 2019 because of exceptional expenses.

5. Net Profit Ratio / Net Profit Margin / Profit Ratio

Net profit is obtained after deducting all expenses from the revenue. Net profit includes both
operating as well as non-operating income and expenses. Net Profit ratio indicates the overall
efficiency of the management in manufacturing, administering and selling the products. The net
profit ratio is calculated as:

𝑃𝐴𝑇
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝑋 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

For a meaningful understanding both the ratios — gross profit ratio and net profit ratio — have to
be interpreted together. Gross profit is calculated after deducting COGS from sales and net profit is
calculated after deducting all other remaining expenses (overheads) from gross profit. COGS is a
uncontrollable expense whereas the overheads are controllable expenses. Therefore increasing gross

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
profit in short run is difficult whereas increasing the net profit is possible as the overheads are
controllable expenses.

The Net profit ratio of Dabur for 2020 is 18.55% and for 2019 is 20.04%.

Alongwith the profit ratios, the expenses ratios can also be calculated for better interpretation.
These ratios can be computed by dividing a particular expense by net sales. For example COGS
ratio can be calculated as COGS by Net Sales.

B. Profitability ratios based on investment

These ratios are also called as composite ratios. These ratios are calculated taking into consideration
both the financial statements statement i.e. profit and loss as well as balance sheet. These ratios are
useful to all the stakeholders to determine the returns on their investments. These ratios are
normally termed as Return on Investments (ROI). There are three different concepts of investments
in vogue in financial literature – Assets or Total Assets, Capital Employed and Equity. Based on
each of this concept of investments three ratios are calculated. They are (i) Return on Assets, (ii)
Return on Capital Employed and (iii) Return on Equity. These ratios are always expressed in
percentages. While calculating these ratios it is advisable to take the average of investments i.e.
average assets, average capital employed and average equity. Averages are calculated by taking
simple average of opening balance and closing balance. For example the average total assets for
2020 will be calculated as total assets of 2019 plus total assets of 2020 divided by 2. But if the
opening balance is not available than the closing balance is taken in place of average. The
computation of these ratios is explained in detailed as under:

1. Return on Assets (ROA) / Return on Total Assets (ROTA)

Here, the profitability ratio is measured in terms of the relationship between net profit and assets.
Net profit has a direct relationship with the total assets. If net profit is high, with no change in
assets, return on assets would be high. If there is fall in profits, return on assets would also go down.
ROA is also called as profit-to-asset ratio. There are various possible approaches to define net
profits and assets, according to the purpose and intent of the calculation of the ratio. Depending
upon how these two terms different variations of ROA are possible. The concept of net profit may
be (i) net profit after tax, (ii) operating profit or EBIT, (iii) profit after tax plus interest(1-t).
Similarly assets may be defined as (i) total assets, (ii) fixed assets, (iii) tangible assets (iv) fixed
assets plus working capital. Accordingly, the different formulae of the ROA are:
𝑃𝐴𝑇
a. 𝑅𝑂𝐴 = 𝑋 100
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑃𝐴𝑇
b. 𝑅𝑂𝐴 = 𝑋 100
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠+𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐸𝐵𝐼𝑇
c. 𝑅𝑂𝐴 = 𝑋 100
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠+𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

The (c) ratio is same as ROCE. The ROCE is calculated by taking liabilities side of balance sheet
into consideration but ROA is calculated by taking assets side into consideration.

2. Return on Capital Employed (ROCE)

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
This ratio measures the relationship between profit before interest and tax and the capital employed
to earn it. This ratio measures the relationship between the returns earned by the long term funds
employed. This ratio is calculated from the perspective of all stakeholders’ viz. lenders and
shareholders. This ratio will tell how much profit is available to pay the returns on debt capital as
well as own capital. The profit from which the interest, preference dividend and equity dividend are
paid is the operating profit (EBIT). Therefore this ratio is calculated by dividing EBIT with capital
employed. This ratio is expressed in percentage and the formula is as under:

𝐸𝐵𝐼𝑇
𝑅𝑂𝐶𝐸 = 𝑋 100
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

Capital Employed calculation is already seen in the earlier section. It is equal to equity plus debt.
Capital employed can also be calculated as non-current assets + working capital. Since the ratio
talks about the total funds invested, this ratio is also called as one version of ROI (Return on
Investment) ratio. Therefore, this ratio also gives clear index or utilization of assets earning
capacity.

3. Return On Equity (ROE)/ Net Worth (RONW)/ Proprietors Fund/ Shareholders Fund

ROE ratio measures the return available on proprietor funds or equity i.e. equity share capital plus
preference share capital plus reserves and surplus. ROCE ratio express the relation between the
returns and the funds supplied by the lenders and owners taken together while ROE express the
relation between the returns and the owners funds. The profit from which the preference dividend
and equity dividend are paid is the net profit after tax (PAT). Therefore this ratio is calculated by
dividing PAT with equity. Thus,

𝑃𝐴𝑇
𝑅𝑂𝐸 = 𝑋 100
𝐸𝑞𝑢𝑖𝑡𝑦 (𝑆ℎ𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 𝑎𝑛𝑑 𝑆𝑢𝑟𝑝𝑙𝑢𝑠)

Higher ratio signifies better utilization of shareholders’ funds. It also measures the overall
performance of a business in regards utilization of resources available.

4. Return on Equity Share Capital (ROEC)

This ratio measures the rate of earning on equity share capital. Though the preference shareholders
are also the owners of the company, the equity or ordinary shareholders are the real owners of the
company. Preference shareholders are entitled for fixed rate of return in the form of preference
dividend. But equity shareholders are not entitled for a fixed rate of returns. The equity dividend is
dependent on net profit available after satisfying all the claimants. Therefore, the equity
shareholders are interested in knowing the rate of return available on their capital. This ratio is
calculated by dividing the net profit available after tax and preference dividend by equity share
capital. The formula is as under:

𝑃𝐴𝑇 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑

𝑅𝑂𝐸𝐶 = 𝑋 100
𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
This ratio enables an investor to compare rate of earnings of one company with another company.
This ratio also enables the existing shareholders to decide whether to continue to hold the shares or
to dispose of such shares. Higher ratio signifies better utilization of equity share capital and higher
return on equity share capital.

5. Earnings Per Share (EPS)

EPS shows the availability of net earnings per equity share. It measures the net profit available to
the equity shareholders on a per share basis, that is, the maximum amount that they can get in the
form of dividend on every share held. It is calculated by dividing the net profits available to the
equity shareholders after taxes and preference dividend payment by the number of the outstanding
equity shares. Thus,
𝑃𝐴𝑇 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝐸𝑃𝑆 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠

If the EPS is Rs.100 per share than it shows that the equity shareholders can get maximum Rs.100
as equity dividend. But normally full EPS (Rs.100) is not given as dividend, the company will pay
only some amount of EPS as dividend say Rs.75 and the remaining amount will be retained by the
company in the form of reserves and surplus. Therefore, this will lead to calculation of further ratio
i.e. Dividend payout ratio and Retention ratio, which will tell how much part of EPS is paid as
dividend.

There are diffident variants of EPS (i) Basic EPS, (ii) Diluted EPS and (iii) Cash EPS. The basic
EPS is the same which is discussed above. Diluted EPS is calculated by dividing the net profit
available to equity shareholders by total number of equity shares that are issued plus the shares that
will be issued to the holders of convertible preference shares, convertible debentures and warrants,
if these holders exercise their rights to convert their present securities into equity shares on
maturity. Cash EPS is calculated by dividing the cash earnings with the number of equity shares.
Cash earning is calculated by adding noncash expenses, such as depreciation and amortization to the
net profit available to equity shareholders. Thus, cash earnings = Net profit available to equity
owners + Depreciation + Amortization

6. Dividend Payout Ratio (D/P)

Dividend Payout (D/P) Ratio is also known as Pay-Out ratio. It shows the relationship between the
actual dividend (DPS) paid to equity shareholders and the net income available to them or EPS.
This ratio indicates the percentage of the net profit after taxes and preference dividend paid as
equity dividend to the equity shareholders. It is calculated by dividing the total dividend paid by the
total earnings available or by dividing the DPS by the EPS. Thus,

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐷𝑃𝑆) 𝑜𝑟 𝑇𝑜𝑡𝑎𝑙 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑

𝐷/𝑃 𝑅𝑎𝑡𝑖𝑜 = 𝑋 100
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) 𝑜𝑟 𝑇𝑜𝑡𝑎𝑙 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠

If the D/P ratio is 75%, then it implies that 25% of the profits of the company are retained and 75%
are distributed as dividends. Therefore the 25% is called as retention ratio (RR). Retention ratio also
helps in understanding the future investment policy of the company. If the RR is higher than the
D/P, then it indicates that the company is on expansion mode and is retaining is profits to finance its

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
investment decisions. Higher ratio also indicates that the company is creating wealth for the equity
shareholders and may be in the future the equity shareholders can get bonus shares.

7. Price Earning Ratio (P/E Multiple)

Price Earning (P/E) Ratio or Multiple is very useful ratio for the equity shareholders as well as for
the prospective shareholders. This ratio indicates the relationship between market price of the share
and current earning per share.

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝑀𝑃𝑆)

𝑃/𝐸 𝑅𝑎𝑡𝑖𝑜 =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆)

If the shares of Dabur India Ltd. are traded at Rs.450 and its EPS is Rs.6.62, then the P/E (x) of
Dabur is 68. This means that MPS is 68 times more than EPS. It also means that if the shareholder
sells the share in the market than he can earn Rs.68 but if he holds the share then maximum
dividend which he can get from the company is Re.1.Therefore, this ratio also helps in determining
whether the shares are overvalued or undervalued. In this case, the shares are overvalued because
the market is giving 68 times high returns then the earnings. Hence this ratio is considered as one of
the indicator to purchase or sell the shares.

8. Earning Yield

Earning and Dividend Yield are closely related. P/E ratio is calculated by dividing MPS by EPS,
whereas earning yield is calculated by dividing EPS by MPS. Therefore this ratio is also called as
the reciprocal of P/E ratio. In this ratio the yield is expressed in terms of the market value per share.
Therefore this ratio is used as a ROI indicator and can be used to measure rate of return on shares.
Investors use earning yield ratio to compare the returns of different securities and accordingly take
the decision. The ratio is expressed in percentage and calculated as under

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆)

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑌𝑖𝑒𝑙𝑑 = 𝑋 100
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝑀𝑃𝑆)

9. Dividend Yield

Earning yield shows the relation between the earnings and market price whereas dividend yield
shows the relation between dividend and market price. This ratio indicates the current return which
investors can get as a percentage of current market value of shares. It also indicates dividend policy
of the company. This ratio is also expressed in percentage and calculated as under

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐷𝑃𝑆)

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑌𝑖𝑒𝑙𝑑 = 𝑋 100
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝑀𝑃𝑆)

-----------------------------------------

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 ACTIVITY OR TURNOVER RATIOS

Activity ratios measure the speed with which various assets of the company are converted into sales
or cash. These ratios measure the efficiency with which the assets are used or are converted into
sales, therefore these ratios are also called as turnover ratios. Activity or turnover ratios are another
way of examining the liquidity of the company. These ratios are to be studied alongwith the
liquidity or solvency ratios to get a better picture of the company’s liquidity position. The liquidity
ratios examine the liquidity of a firm as a whole whereas turnover ratios determine how quickly the
total assets and some of the important current assets like inventory and receivables get converted
into cash. If the turnover ratios are high then it shows that assets get converted into cash faster and
represents a good efficiency of the company. These ratios also help in determining the operating or
working capital cycle of the company. Operating cycle is actually the time lag between the
manufacturing of the products and collecting the cash by selling those products. The meaning and
computation of operating cycle will be discussed in detail in the next chapter. Some of the important
ratios under this category are as below:

1. Assets Turnover Ratio

It shows the relationship between net sales and total assets. The assets turnover ratio measures the
efficiency of a company in managing and utilizing its assets. Higher ratio signifies more efficient
management and utilization of the assets while low turnover ratio indicates underutilization of
available resources and presence of idle capacity. This ratio is expressed in rate (times).

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Net Sales of Dabur India ltd. for 2020 is Rs.6,309.80 and the total assets are Rs.6,100.11. Therefore
the asset turnover ratio is 1.03 times (6,309.80 / 6,100.11). This indicates that the sales are 1.03
times of the total assets.

2. Fixed Assets Turnover Ratio

Fixed asset turnover ratio is similar to assets turnover ratio but instead of taking total assets in this
ratio only fixed assets are considered. This ratio indicates the frequency of fix

ed assets utilization. Higher ratio indicates high degree of efficiency in utilization of fixed assets
and low degree signifies vice-versa.

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠

Net Sales of Dabur India ltd. for 2020 is Rs.6,309.80 and the fixed assets are Rs.1,240.11. Therefore
the fixed asset turnover ratio is 5.09 times (6,309.80 / 6,100.11)

3. Working Capital Turnover Ratio

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Like total assets and fixed assets turnover ratio this ratio also calculates relationship between the
sales or COGS and working capital. Since this ratio shows the efficiency of working capital it is
advisable to take COGS instead of sales. The ratio is calculated as under.

𝐶𝑂𝐺𝑆
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

4. Inventory (Stock) Turnover Ratio and Inventory Holding Period / Inventory Velocity

Inventory Turnover Ratio (ITR) indicates the speed with which the inventory is sold. A high ratio
signifies that inventory is sold fast and stays on the shelf or in the warehouse for a short period of
time and vice versa. Therefore a high ratio is good from the viewpoint of liquidity. ITR is calculated
by dividing cost of goods sold or sales by average stock. Here COGS will be considered to calculate
the ratio. Thus,

𝐶𝑂𝐺𝑆
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

From the ITR, the inventory holding period can be calculated. Inventory holding period represents
the time period for which the raw material, WIP and finished goods are hold in stock.

𝑁𝑜. 𝑜𝑓 𝐷𝑎𝑦𝑠/𝑊𝑒𝑒𝑘𝑠/𝑀𝑜𝑛𝑡ℎ𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝑃𝑒𝑟𝑖𝑜𝑑 =
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜

Alternatively, it can also be calculated as:

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐼𝐻𝑃 𝑜𝑟 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑉𝑒𝑙𝑜𝑐𝑖𝑡𝑦 = 𝑋 𝑁𝑜. 𝑜𝑓 𝐷/𝑊/𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
𝐶𝑂𝐺𝑆

The COGS of Dabur India Ltd. for 2020 is Rs.3,244.70 and the average inventory is Rs.771.02.
therefore the ITR is 4.20 times and the inventory holding period is 87 days.

5. Debtors (Accounts Receivable) Turnover Ratio and Debtors Collection Period /

Debtors Velocity

This ratio shows the relationship between net credit sales and average trade receivables. Net credit
sales consist of gross credit sales minus sales returns or return inward, if any, from customers.
Average trade receivable is the simple average of debtors (including bills receivable) at the
beginning and at the end of year. DTR ratio measures how rapidly receivables are collected. A high
ratio is indicative of shorter time lag between credit sales and cash collection. A high ratio shows
that the debt is collected fast from the customers. This ratio is calculated as:

𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠

𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
With the help of DTR the average debt collection period can be calculated which will indicate the
extent to which the debts have being collected in period or effectiveness of collection from debtors.
Debtors collection period also indicates the credit and collection policy of a company.

𝑁𝑜. 𝑜𝑓 𝐷𝑎𝑦𝑠/𝑊𝑒𝑒𝑘𝑠/𝑀𝑜𝑛𝑡ℎ𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 =
𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝑉𝑒𝑙𝑜𝑐𝑖𝑡𝑦 = 𝑋 𝑁𝑜. 𝑜𝑓 𝐷/𝑊/𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠

Debtors collection period or debtors velocity can alternatively be calculated by dividing the average
receivables by daily credit sales.

6. Creditors (Trade Payables) Turnover Ratio and Creditors Payment Period / Creditors
Velocity

This ratio shows the relationship between the net credit purchases and the average trade payables.
Net credit purchases is calculated by subtracting purchase returns / return outward from total credit
purchases. For calculating trade payables both creditors and bills payable are to be considered and
the average of the opening and closing amount is to be taken. If the details are not available then
only the closing balance may be considered. The creditors turnover ratio is an important tool of
analysis as a firm can reduce its requirement of current assets by relying more on supplier’s credit.

𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠

𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒

A high ratio indicates that the suppliers are to be paid rapidly whereas a low turnover ratio reflects a
liberal credit terms granted by supplier. Therefore a low creditors turnover ratio is preferred. The
extent to which creditors are willing to wait for payment can be calculated by creditors payment
period. Creditors payment period shows the relationship between number of days or months in a
year with the promptness in payment of credit purchases.

𝑁𝑜. 𝑜𝑓 𝐷𝑎𝑦𝑠/𝑊𝑒𝑒𝑘𝑠/𝑀𝑜𝑛𝑡ℎ𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑 =
𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠

𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑉𝑒𝑙𝑜𝑐𝑖𝑡𝑦 = 𝑋 𝑁𝑜. 𝑜𝑓 𝐷/𝑊/𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠

-----------------------------------------

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CHAPTER 3

WORKING CAPITAL MANAGEMENT

Every organization needs fixed or long term capital to purchase fixed assets viz. land and building,
plant and machinery, furniture, vehicles etc. In addition to long term capital an organisation also
needs additional capital for financing day to day activities. Such capital which is required for
financing day to day activities in the business is called Working Capital. Working capital is that part
of the funds of a business which is used for day to day operations. It is the money required to keep
the business running smoothly or for smooth conduct of business activities. Working capital is
considered as a life blood of an organisation. Therefore working capital management is a
continuous process and hence a part and parcel of the overall management of the business.

Concept and Definition of Working Capital

There are two concepts of working capital: gross working capital and net working capital

Gross Working Capital

Gross working capital is a sum total of current assets. It is identified with current assets
alone. It includes all current assets like stock of raw material, work in progress, finished
goods, spares and consumables, stores; sundry debtors, bills receivables, cash and bank
balances, prepaid expenses, accrued income, advance payments and short term investments.

Net Working Capital

Net working capital is another name for working capital. By definition, net working capital
or working capital is the amount by which current assets exceed current liabilities. Net
working capital is the excess of current assets over current liabilities i.e. current assets less
current liabilities. Net Working Capital = Total Current Assets (–) Total Current Liabilities.
In other words, total value of current assets is reduced by total current liabilities such as
sundry creditors, bills payable, bank overdraft, income received in advance and outstanding
liabilities.

Computation (Estimation) of Working Capital Requirement

As working capital denotes the requirement of funds needed for daily operations it is very important
to forecast the working capital requirement in advance. This will not only help the company in
maintaining its working capital but will also aid the company in managing its funds efficiently.

A most useful tool to determine working capital requirement is the operating cycle. Working capital
need is dependent on the operating cycle of the business. The operating cycle begins with the
acquisition or procurement of raw material and ends with the collection of cash from receivables or
debtors. Operating cycle consists of major current assets like stock, debtors cash balance and
prepaid expenses and major current liabilities such as creditors and outstanding expenses. If each
component of current assets and current liabilities are estimated then the working capital
requirement can be estimated accurately. While estimating working capital an assumption is made

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
that the production and sales is carried on evenly throughout the year and all costs are accrued
similarly.

Estimation of Current Assets : For estimating current assets; the stock of raw material, stock of
WIP, stock of finished goods, debtors, advances are estimated as under:

1. Estimation of Raw Materials Inventory

The investment in raw materials inventory is estimated as

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 X 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 (𝑝. 𝑢. ) X 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝑃𝑒𝑟𝑖𝑜𝑑
𝑁𝑜. 𝑜𝑓 𝐷/ 𝑊 / 𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

2. Estimation of WIP Inventory

The investment in WIP inventory is estimated as

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 X 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 (𝑝. 𝑢. ) X 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑖𝑚𝑒 𝑆𝑝𝑎𝑛 𝑜𝑓 𝑊𝐼𝑃

𝑁𝑜. 𝑜𝑓 𝐷/ 𝑊 / 𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

The cost of production is equal to cost of raw material plus conversion costs (labour and
manufacturing expenses). While calculating cost of production full unit cost of raw material and 50
per cent of conversion cost is considered.

3. Estimation of Finished Goods Inventory

The investment in finished goods inventory is estimated as

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 X 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 (𝑝. 𝑢. ) X 𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝐺𝑜𝑜𝑑𝑠 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝑃𝑒𝑟𝑖𝑜𝑑

𝑁𝑜. 𝑜𝑓 𝐷/ 𝑊 / 𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

4. Estimation of Debtors

The investment of working capital in debtors is estimated as

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 X 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 (𝑝. 𝑢. ) X 𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑

𝑁𝑜. 𝑜𝑓 𝐷/ 𝑊 / 𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

Estimation of Current Liabilities : For estimating current liabilities the important current
liabilities considered in this context are creditors, outstanding expenses (wages and overheads)

1. Estimation of Creditors

The amount of money a company owes to creditors or the trade credit enjoyed by a company by not
paying cash immediately for purchases is estimated as

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 X 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 (𝑝. 𝑢. ) X 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑃𝑒𝑟𝑖𝑜𝑑
𝑁𝑜. 𝑜𝑓 𝐷/ 𝑊 / 𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

2. Estimation of Accruals - Outstanding Wages

The amount of accrual is estimated as

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 X 𝐷𝑖𝑟𝑒𝑐𝑡 𝑊𝑎𝑔𝑒𝑠 𝐶𝑜𝑠𝑡 (𝑝. 𝑢. ) X 𝑇𝑖𝑚𝑒 𝐿𝑎𝑔 𝑖𝑛 𝑡ℎ𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑜𝑓 𝑊𝑎𝑔𝑒𝑠
𝑁𝑜. 𝑜𝑓 𝐷/ 𝑊 / 𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

3. Estimation of Accrual - Other Outstanding Expenses

The amount of accrual is estimated as

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 X 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐶𝑜𝑠𝑡 (𝑝. 𝑢. ) X 𝑇𝑖𝑚𝑒 𝐿𝑎𝑔 𝑖𝑛 𝑡ℎ𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑜𝑓 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑁𝑜. 𝑜𝑓 𝐷/ 𝑊 / 𝑀 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

Let us understand the estimation of different items of CA and CL with the help of following
example.

Illustration 3.1

The company’s policy regarding its current assets and current liabilities is as under:
a. Raw materials are kept in stock for 1 month.
b. Time span needed for WIP is 2 month.
c. Finished goods holding period is 1 and ½ month.
d. Credit allowed to customers is 2 months.
e. Credit allowed by suppliers is 3 months.
f. Lag in payment of wages is ½ month.
g. Lag in payment of other expenses is 1 month.

The cost of manufacturing one product is as under:

Particulars Rs. (p.u)
Raw material 60
Direct wages 30
Direct expenses 15
Overheads 90
Total 195

If the product is sold at Rs.240 per unit then the working capital required to produce 1,000 units will
be calculated as under:

Statement of Working Capital Requirement for 1,000 units

Particulars Rs.
Current Assets
1,000 X 60 X 1
Stock of Raw Material ( 12
) 5,000

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 1,000 X 82.5 X 2
Stock of WIP ( 12
)
13,750
Cost of Production (60+15+7.5) = 82.5
1,000 X 195 X 1.5
Stock of Finished Goods ( 12
) 24,375
1,000 X 240 X 2
Debtors ( 12
) 40,000
Total Current Assets (Gross Working Capital) 83,125
Less : Current Liabilities
1,000 X 60 X 3
Creditors ( ) 15,000
12
1,000 X 30 X 0.5
Outstanding Wages ( ) 1,250
12
1,000 X 15 X 1
Outstanding Direct Expenses ( ) 1,250
12
1,000 X 90 X 1
Outstanding Overheads ( 12
) 7,500
Total Current Liabilities 25,000
Net Working Capital 58,125

In the above illustration the total current assets are Rs.83,125 and total current liabilities are
Rs.25,000. This means that the entire current assets are not financed by the current liabilities. Only
Rs.25,000 is coming from current liabilities. The remaining part of the current assets which is not
financed by current liabilities is Rs.58,125, which is the amount of working capital requirement.
Now this amount (Rs.58,125) will be financed by the noncurrent liabilities, so the company needs to
work out on different sources to finance this part of current assets.

So the key important point learned here is that most businesses cannot finance its operating cycle
with short term financing alone. Consequently, working capital financing is needed. This shortfall is
covered by the net profits generated internally or raising money from external sources or by a
combination of the two.

-----------------------------------------

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CHAPTER 4

RECEIVABLES MANAGEMENT

The term receivable is defined as debt owed to the company by the customers arising from sale of
goods or services in the ordinary course of business. Receivables are one of the major components
of the current assets. It arises only due to credit sales to customers, hence, it is also known as
Account Receivables or Trade Receivables. Receivables include both debtors as well as bills
receivable.

Selling goods on credit basis is essential in order to promote sales and profit. Allowing credit period
to customers motivates customers to purchase the goods from the company but however, extension
of credit involves risk as well as cost. Therefore, company should weigh the benefits as well as cost
to determine the goal of receivables management. Receivables management is defined as the
process of making decision resulting to the investment of funds in these assets that will result in
maximizing the overall return on the investment of the company. The objective of receivable
management is to promote sales and profit.

Some of the important terms used in receivables management are as follows:

1. Credit Policy
Credit policy is the determination of credit standards and analysis. It may vary from
company to company or even some times product to product in the same company. Liberal
credit policy increases the sales volume and also increases the size of receivable. Stringent
credit policy reduces the size of the receivable.

2. Credit Terms
Credit terms specify the repayment terms required by the customer. Credit terms include
terms and conditions on which trade credit is made available. These terms are usually
written in abbreviations, for example, ‘3/15 net 60’. 3 signifies the rate of cash discount; 15
represents the time duration within which a customer must pay to be entitled to the discount;
60 means the maximum period for which credit is available. In other words, ‘3/15 net 60’
means that the customer is entitled to 3 per cent cash discount if he pays within 15 days of
sales. If, however, he does not want to take the advantage of the discount he may pay within
60 days and the maximum credit period available for payment is 60 days.

3. Credit Period
It is the time for which trade credit is extended to customer in the case of credit sales.
Normally it is expressed in terms of ‘Net days’.

4. Cash Discount
Cash discount is the incentive to the customers to make early payment of the due date. A
special discount will be provided to the customer for his payment before the due date.

While determining the credit terms the company is required to calculate the cost as well as the
benefits that will arise due to different credit terms. The company should adopt the credit terms that

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
will give maximum benefits to the company. The costs associated with the extension of credit to
customers and the benefits received are as follows:

Cost associated with the extension of credit:

1. Collection Cost
This cost is incurred in collecting the dues from the customers to whom credit sales have
been made. It includes administrative costs like additional expenses on the creation and
maintenance of a credit department, salaries to the staff kept for maintaining accounting
records relating to customers, cost of investigation, follow up cost, stationery, postage etc.

2. Default Cost
Default costs are the over dues that cannot be recovered. Business concern may not be able
to recover the over dues because of the inability of the customers to pay. Such debts are
treated as bad debts and have to be written off as they cannot be realized. Such costs are
known as default costs or bad debt costs

3. Capital or Investment Cost

There is a time lag between the sale of goods and payment received. Therefore, the
increased level of credit sales leads to blocking of funds or is called as an investment in
accounts receivable. The investment in accounts receivable involves a capital or servicing
cost, as funds have to be arranged by the company to finance them until customers make
payments. A capital cost is a cost on the use of additional capital to support credit sales that
alternatively could have been employed elsewhere. Higher the average accounts receivable
higher is the capital or carrying cost. The investment in receivables and the cost of financing
this investment are calculated as under:

Investment in receivables is equal to the cost of production of the units that are sold on
credit basis. It is calculated as No. of units sold on credit per annum x Cost of production per
unit x Credit period / No. of days in a year.

The money invested in the manufacturing the units will be recovered once the customers
will make the payment. However, till the time the payment is not received, the money is
blocked in receivables and this investment invites a cost, which is the cost of financing this
investment. If this money is borrowed from bank in the form of loan than the interest paid
on this loan will be considered as capital cost or cost of financing the investment in
receivables.

4. Additional Cost
Beside the above mentioned cost, there may be some additional cost incurred by the
company inform of cash discount offered to customers or additional working capital
invested to manufacture more units etc.

Benefit arising from the extension of credit:

By extending the credit period or by having a more liberal credit policy, customers are
motivated to purchase the products from the company thus leading to increased sales and
anticipated profits. The impact of a liberal trade credit policy either will increase the sales

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 from the existing customers or will attract new customers. As a result of increased sales, the
profits of the company will also increase.

Thus, it is clear that any investment in receivables involve both benefits as well as costs. The
extension of credit to customers has a major impact on sales, costs and profit of the organization.
The liberal policy will produce larger sales and the cost involved will also be higher with liberal or
relaxed policies than with more stringent policy. Therefore, companies should properly trade-off the
profit (benefit) and risk (cost) and manage its accounts receivable.

Illustration 4.1

The selling price of a product is Rs.10 per unit. The variable cost is Rs.4 per unit and the total cost
per unit, given a sales volume of 10,000 units, is Rs.6. Therefore, the total fixed cost is Rs.20,000. If
the average collection period is 30 days, then the annual sales (all credit) are 10,000 units.

If the credit period is relaxed from 30 days to 45 days then it will lead to 15 per cent increase in unit
sales. The increased sales will also lead to increase in the bad debt cost and collection cost. Bad
debt expenses will increase from the current level of 2 per cent to 4 per cent of sales. Similarly the
collection cost will increase from Rs.1,500 to Rs.2,500. The cost of finance is 15 per cent. Should
the credit standard be relaxed?

First, the calculation of benefit or profit that is earned at current level of sales and at increased level
of sales is to be done. Then the calculation of cost at both the level of sales is to be done. The last
step is to find the incremental or additional benefit and cost. If the incremental benefit is more than
the incremental cost then the company should relax its credit period or otherwise not.

Calculation of Benefit (Profit)

Particulars Current Policy New Policy
(30 Days) (45 Days)
Units sold 10,000 11,500
Sales (Rs.10) 1,00,000 1,15,000
Less : Variable Cost (Rs.4) 40,000 46,000
Less : Fixed Cost 20,000 20,000 *
Profit 40,000 49,000
* Fixed cost is same at all level of production

Calculation of Cost

1. Bad Debt Cost

At Current Policy (30 Days) At New Policy (45 Days)

Bad Debts = 2% of sales Bad Debts = 4% of sales
= 1,00,000 x 2% = 2,000 = 1,15,000 x 4% = 4,600
2. Collection Cost

At Current Policy (30 Days) At New Policy (45 Days)

Collection cost = 1,500 Collection cost = 2,500

3. Capital or Investment Cost

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
At Current Policy (30 Days) At New Policy (45 Days)
The investment = Variable cost + Fixed Cost The investment = Variable cost + Fixed Cost
= 40,000 + 20,000 = 60,000 = 46,000 + 20,000 = 66,000
60,000 is an investment in receivables for 1 year 66,000 is an investment in receivables for 1 year
(360 days). Therefore, the investment in receivables (360 days). Therefore, the investment in receivables
for 30 days will be Rs.5,000 for 45 days will be Rs.8,250
60,000 : 360 60,000 X 30 66,000 : 360 60,000 X 30
? : 30 ( ) ? : 45 ( )
360 360
Cost of Financing the Investment = 5,000 x 15% Cost of Financing the Investment = 8,250 x 15%
= Rs.750 = Rs.1,238

Calculation of incremental profit and cost

Particulars Rs.
Incremental Profit (49,000 – 40,000) (A) 9,000
Incremental Cost:
Bad Debt Cost (4,600 – 2,000) 2,600
Collection Cost (2,500 – 1,500) 1,000
Investment Cost (1,238 - 750) 488
Total Incremental Cost (B) 4,088
Net Benefit (A – B) 4,912

Since the benefit arising in the form of increased sales and increased profit (Rs.9,000) is higher than
the increased cost (Rs.4,088) under the 45 days credit policy, it is advisable that the company adopt
the 45 days policy instead of 30 days credit policy and get a net benefit of Rs.4,912.

-----------------------------------------

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CHAPTER 5

CAPITAL BUDGETING DECISIONS

Capital expenditure (CAPEX) budget or capital budgeting is a process of making decisions

regarding investments in fixed assets (non-current assets) which are not meant for sale such as land,
building, machinery or furniture. The word investment refers to the cost incurred in connection with
the acquisition and the development of long-term assets. The fixed / long-term assets are the assets
that are in operation and yield a return over a period of time, usually, exceeding one year. They,
therefore, involve a huge outlay or series of outlays of cash resources in anticipation of future
benefits. These benefits may be either in the form of increased revenues or reduced costs. Capital
budgeting refers to the process by which company evaluates and selects the investment proposals
that are worthwhile for investing available funds. Thus, capital budgeting includes addition,
disposition, modification and replacement of fixed assets in the light of overall objectives of the
company.

Type of Capital Investment / Expenditure

The examples of capital expenditure are:

 Purchase of fixed assets such as land and building, plant and machinery, etc.
 The expenditure relating to addition, expansion & diversification, improvement and
alteration to the fixed assets
 The replacement of fixed assets
 Research and development project
 Mandatory investments e.g. pollution control equipment's, medical dispensary, firefighting
equipment's, crèche in factory
 Strategic investment projects

Need and Importance of Capital Budgeting

Capital budgeting decisions are very crucial and it requires lots of analysis before taking such
decision. The reasons for the analysis are stated below. A candid or simple example to understand
the importance of capital budgeting decision is like making a decision to purchase a T-shirt and
making a decision to purchase a mobile phone. If people want to purchase a T-shirt, they just walk
to the store an order one and get it. But however before purchasing a mobile phone, people normally
do a survey, ask friends, compare the features of different mobile set, see the cost, and other terms
& conditions and then make a careful decision. Why is this so? Because, if the person don’t like the
t-shirt then he can discard it easily as the money involved is not very high, so the person can afford
to discard the t-shirt but not for the mobile phone, because the cost or investment is higher and
discarding the phone will have financial implications. Therefore, before making a decision to
purchase any capital asset the company is required to analysis the cost and the benefits arising from
such decision. The reasons of such analysis are:

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
  Huge investments: Capital budgeting requires huge investments of funds. There is heavy
substantial outlay of funds and the available funds are always limited, therefore the company
before investing in a project needs to plan its capital expenditure and allocate the funds
wisely to different projects.

 Long-term decision: Capital expenditure is incurred to purchase the fixed assets which are
having long life or are for long term. Therefore, financial risk involved in this type of
investment decision is more. Since the risks are higher it needs careful planning of capital
budgeting.

 Irreversible: The capital investment decisions are almost irreversible or cannot be changed.
Even if the decision is reversed or called back, it will involve huge cost. Once the decision is
made and the asset is purchased and if the company wants to reverse its decision by the
selling the assets, it will never get the price at which it was purchased thus leading to
substantial losses.

 Large anticipated benefits: Capital expenditures are incurred in anticipation of benefits

arising from such expenditures. The capital expenditure will help the company in directly
increasing the sales revenue or will help the company in reducing its operating cost, thus
leading to increase in profit. Secondly, the profit arising from such investments are spread
over a period of time, normally over the life of the assets. Therefore before making the
investment, it requires careful planning and analysis of the project thoroughly.

Types of Capital Budgeting Proposals

A company may have several investment proposals for its consideration. It may adopt the projects
after considering the merits and demerits of each one of them. For this purpose capital expenditure
proposals may be classified into:

 Independent investment proposals: These proposals are said be to economically

independent of each other. Any proposal can be accepted or rejected on the basis of
minimum return on investment required. Independent proposals do not depend upon each
other.

 Dependent or Contingent proposals: In this case, when the acceptance of one proposal is
contingent or dependent upon the acceptance of other proposals, it is called as dependent or
contingent proposals.

 Mutually exclusive proposals: Mutually exclusive proposals refer to the acceptance of one
proposal that results into the automatic rejection of the other proposal. If the acceptance of
one proposal leads to rejection of the other proposal, then the two investments are called as
mutually exclusive.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Methods of Evaluating Capital Investment Proposals

There are number of appraisal methods which may be recommended for evaluating the capital
investment proposals. The methods of evaluations are classified as follows:

1. Modern methods or Discounted Cash Flow methods

 Net Present Value
 Profitability Index
 Internal Rate of Return
 Discounted Pay Back Period

2. Traditional methods (or Non-discounted methods)

 Pay Back Period
 Accounting Rate of Return

1. Net Present Value (NPV) Method

The Net Present Value (NPV) method is a DCF technique that explicitly recognizes the time value
of money. This method states that cash flow arising at different time periods differ in value and can
be compared only when they are expressed in terms of a common denominator, that is, present
values. NPV is the summation of the present values of all the future cash inflows arising from the
project minus the summation of present values of the cash outflows (initial investment). Thus NPV
= PV of inflows – PV of outflows. The formula is:

𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹4 𝐶𝐹𝑛

𝑁𝑃𝑉 = [ + + + + ⋯ + ] − 𝐶𝐹0
(1 + 𝐾𝑜)1 (1 + 𝐾𝑜)2 (1 + 𝐾𝑜)3 (1 + 𝐾𝑜)4 (1 + 𝐾𝑜)𝑛
𝑛
𝐶𝐹𝑡
𝑁𝑃𝑉 = ∑ − 𝐶𝐹0
(1 + 𝐾𝑜)𝑡
𝑡=1

Where,
CF = Cash Flows
T = No. of years
Ko = Cost of Capital (Discounting Factor)

Acceptance and Rejection Rule: If the NPV is positive, the project is to be accepted and if the
NPV is negative, then the project is to be rejected. That is if NPV ≥ 0, accept the project; otherwise
reject the project. Let’s understand this through an example

Illustration 5.1

The company wants to make a decision to purchase a machine costing Rs.1,00,000. This machine
will help the company to increase the production of units and will lead to increase in cash inflows.
The life of the machine is excepted to be 5 years. The company will raise this Rs.1,00,000 through a

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
bank loan which is available at 10% interest. The net cash inflows by selling the products for the
next 5 years are as under:

Years 1 2 3 4 5 Total
Year-end Cash Inflows 10,000 20,000 20,000 50,000 30,000 1,30,000

In the above illustration the initial investment or CF0 is Rs.1,00,000. The cost of capital or Ko is
10%. The cash inflows from year 1 to year 5 are given in the table.

If we consider the cash outflow as Rs.1,00,000 and cash inflow as Rs.1,30,000, the project looks to
be a viable project as it is going to generate additional Rs.30,000 cash inflows on the investment of
Rs.1,00,000. But if we analysis it properly and take into consideration the time period then the
conclusion will differ because Rs.1,30,000 is not coming in the same year of investment it is
coming in phases. After the 1st year is over the cash recovered is 10,000 then after 2nd year the cash
inflow is 20,000 and so on and so forth. So the cash inflow are to be brought to a common
denominator that is the year 0, when the investment is made.

So when we bring the future cash inflows to the present value, it is called as discounting which is
completely opposite of compounding. The compounding formula is A = P (1+r) n where A is future
amount, P is present value of investment, r is rate of interest and n is number of years. On the same
grounds, the discounting formula is P = A / (1+r) n. In compounding, we find the future value of the
money based on the present value whereas in discounting the present value is calculated based on
the future value.

In the above illustration, as we are bringing the future cash inflows to present date we need to
discount the cash inflows. The discounting factor will be the cost of capital which is 10%.
Therefore, the discounted value of the cash inflows will be calculated as under:

10,000 20,000 20,000 50,000 30,000

[ + + + + ]
(1 + 10%)1 (1 + 10%) 2 (1 + 10%) 3 (1 + 10%) 4 (1 + 10%)5

Which is equal to Rs.93,410

Instead of doing the calculation this way, a simple method is adopted in which the present value of
Re.1 is calculated and then it is multiplied with the actual cash inflows.

Discounting Factor of
Year Cash Inflows 1 Present Value of Cash Inflows
Re.1 @ 10% [(1+10%)n ]
1 10,000 1/(1.1)1 = 0.909 10,000 x 0.909 = 9,090
2 20,000 1/(1.1)2 = 0.826 20,000 x 0.826 = 16,520
3 20,000 1/(1.1)3 = 0.751 20,000 x 0.751 = 15,020
4 50,000 1/(1.1)4 = 0.683 50,000 x 0.683 = 34,150
5 30,000 1/(1.1)5 = 0.621 30,000 x 0.621 = 18,630
Total Present Value of Cash Inflows 93,410

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
The present value of Rs.1,30,000 is just Rs.93,410 if it is discounted at 10%. So by investing
Rs.1,00,000 the company will get Rs.93,410 i.e. the company will lose Rs.6,590 which is the NPV
of the project. Thus,
NPV = Summation of cash inflows – Cash outflows
= 93,410 – 100,000 = Rs.(6,590)
Since the NPV is negative, the proposal should be rejected.

NPV method not only helps in accepting or rejecting a project, but also helps in ranking the projects
with positive NPV or for selecting mutually exclusive projects. Let take a second illustration to
understand this point.

Illustration 5.2

The company is contemplating an investment decision. It has to project proposals: Project A and
Project B. Both the project requires the same amount of investment i.e. Rs.2,00,000. The cash
inflows expected from the projects are as under:

Years 1 2 3 4 5 6 Total
Project A - Cash Inflows 80,000 70,000 50,000 30,000 40,000 40,000 3,10,000
Project B - Cash Inflows 40,000 40,000 30,000 50,000 70,000 80,000 3,10,000

Rank the projects using NPV method if the discounting rate is 12%.

In the above illustration the initial investment or CF0 for both the projects is same i.e. Rs.2,00,000
and the total cash inflows is also same for both the projects i.e. Rs.3,10,000. The discounting factor
or Ko is 12%.

The NPV for both the projects will be calculated as under:

Year Cash Inflows Cash Inflows DF of Re.1 PV of CF PV of CF

Project A Project B @ 12% Project A Project B
1 80,000 40,000 0.893 71,440 35,720
2 70,000 40,000 0.797 55,790 31,880
3 50,000 30,000 0.712 35,600 21,360
4 30,000 50,000 0.636 19,080 31,800
5 40,000 70,000 0.567 22,680 39,690
6 40,000 80,000 0.507 20,280 40,560
Total Present Value of Cash Inflows 2,24,870 2,01,010
NPV 24,870 1,010
Rank 1 2

The NPV of both the projects is positive, so the company can accept both the project proposals. But
if the company is having limited funds then it should invest its money in Project A as its NPV is
higher than Project B.

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 2. Profitability Index (PI) Method

Profitability Index (PI) method is also called as Benefit / Cost (B/C) ratio. PI method also uses DCF
technique. PI is a ratio of the present value of cash inflows to the initial investment or cash outflow.
Under the NPV method the initial investment was subtracted from the total present value of cash
inflows whereas under the PI method the total present value of cash inflow is divided by the initial
investment. The formula for calculating benefit-cost ratio or profitability index is as follows:

𝑛
𝐶𝐹𝑡
∑ 𝑡
𝑃𝑉 𝑜𝑓 𝐶𝑎𝑠ℎ 𝐼𝑛𝑓𝑙𝑜𝑤𝑠 𝑡=1(1+𝐾𝑜)
𝑃𝐼 = or 𝑃𝐼 =
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 𝐶𝐹0

Acceptance and Rejection Rule: If PI is greater than one (PI > 1), then accept the project. If PI is
less than one (PI < 1), then reject the project. The project with positive NPV will have PI greater
than one. PI less than one means that the project’s NPV is negative.

The PI value in the illustration 5.1 will be 0.93 (93,410 / 1,00,000). Since the NPV is negative, the
PI is also less than one. The project should be rejected.

The PI values in the illustration 5.2 will be : Project A = 1.12 (2,24,870 / 2,00,000) and Project B =
1.01 (2,01,010 / 2,00,000). On the basis of PI method also the project A is better that Project B as
the PI value of Project A higher than Project B.

3. Internal Rate of Return

Internal Rate of Return (IRR) method is also widely followed method. It also use discounted cash
flow technique and takes into account the timing of cash flows. IRR is the yield or rate of return on
the investment. IRR is the discount rate that equates the initial investment with the total present
value of cash inflows. This is a rate at which the NPV is zero.

While calculating NPV the discounting rate was the required rate of return on the investment and
was predetermined. The cost of capital is generally considered as the discounting rate. But in IRR
method the discount rate is not predetermined and it is calculated as a rate where the cash outflows
are equal to cash inflows. IRR is calculated using trial and error method. Under this method the cash
inflows are discounted using different rates based on trial and error basis, till the time a particular
rate is achieved that will make the total of present value of cash inflow equal to initial investment.
IRR is the value of ‘r’ in the following equation and it is determined by solving it .

𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹4 𝐶𝐹𝑛

𝐶𝐹0 = [ + + + + ⋯ + ]
(1 + 𝑟)1 (1 + 𝑟)2 (1 + 𝑟)3 (1 + 𝑟)4 (1 + 𝑟)𝑛
𝑛
𝐶𝐹𝑡
𝐶𝐹0 = ∑
(1 + 𝑟)𝑡
𝑡=1

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 𝑛
𝐶𝐹𝑡
𝐼𝑅𝑅 = ∑ − 𝐶𝐹0 = 0
(1 + 𝑟)𝑡
𝑡=1

Acceptance and Rejection Rule: If the IRR is greater than the cost of capital or required rate of
return or hurdle rate then the project should be accepted and if IRR is less than cost of capital then
the project should be rejected.

In illustration 5.1 the discounting rate was the cost of capital and was 10%. The cash inflows were
discounted at 10% to determine the NPV. The total present value of cash inflows is Rs.93,410
whereas the initial investment is Rs.1,00,000. So it can be inferred that if the cash inflows are
discounted at 10% the present value falls below the amount of initial investment. For IRR, we need
a rate that will equate the present value of cash inflow with the initial investment. So we have to
make the present value of the cash inflow as Rs.1,00,000 from Rs.93,410.Therefore, in order to
increase the present value of the cash inflows, we have to decrease the discounting rate. By trial and
error method, we will start calculating NPV at different rates like 9%, 8%, 7% ...... till we get the
NPV as zero.

Considering Discount Rate as 9%

Year Cash Inflows DF of Re.1 @ 9% Present Value of Cash Inflows
1 10,000 0.917 9,170
2 20,000 0.842 16,840
3 20,000 0.772 15,440
4 50,000 0.708 35,400
5 30,000 0.650 19,500
Total Present Value of Cash Inflows 96,350

At 9% discount rate the present value of cash inflows is Rs.96,350 which is higher than the present
value at 10% (Rs.93,410), but still it is lower than Rs.1,00,000. Now we will further reduce the rate
to 8% and will check the NPV whether it becomes zero or not

Considering Discount Rate as 8%

Year Cash Inflows DF of Re.1 @ 8% Present Value of Cash Inflows
1 10,000 0.926 9,260
2 20,000 0.857 17,140
3 20,000 0.794 15,880
4 50,000 0.735 36,750
5 30,000 0.681 20,430
Total Present Value of Cash Inflows 99,460

At 8% discount rate the present value of cash inflows is Rs.99,460 which is higher than the present
value at 9% (Rs.96,350), but still it is marginal lower than Rs.1,00,000. Now we will further reduce
the rate to 7% and will check the NPV whether it becomes zero or not

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Considering Discount Rate as 7%
Year Cash Inflows DF of Re.1 @ 7% Present Value of Cash Inflows
1 10,000 0.935 9,350
2 20,000 0.873 17,460
3 20,000 0.816 16,320
4 50,000 0.763 38,150
5 30,000 0.713 21,390
Total Present Value of Cash Inflows 102,670

At 7% discount rate the present value of cash inflows is Rs.102,670 which is higher than the present
value at 8% (Rs.99,460), but is also higher than the initial investment of Rs.1,00,000. This means
that IRR is between 7% and 8%. It is 7% and some decimal. To calculate the decimal value the
interpolation formula is used which is as under:

𝑃𝑉𝐿𝑅 − 𝐼. 𝐼
𝐿𝑅 + ( ) X ∆𝑟
𝑃𝑉𝐿𝑅 − 𝑃𝑉𝐻𝑅

Where, LR is Lower Rate

PVLR is Present Value of Cash Inflows at Lower Rate
I.I is Initial Investment
PVHR is Present Value of Cash Inflows at Higher Rate
Δr is Delta r which is the difference between the higher rate and the lower rate and it should always
be 1
Therefore the IRR = 7% + ((102,670 – 100,000) / (102,670 - 99,460) x 1) = 7.83%. IRR of 7.83%
means that if we discount the cash inflows at 7.83%, then the total present value of cash inflows
will be Rs.1,00,000 and the value of NPV will be zero. Since the IRR is less than cost of capital the
project should be rejected because the project will give a return of 7.83% whereas the rate of
financing the project is 10%. So if this project is undertaken, then it will incur losses.

4. Pay Back Period

The payback (PB) is one of the most popular and widely used traditional technique of evaluating
investment proposals. Payback period is the period required measured in number of years to recover
the original investment. If the project generates constant annual cash inflows, the payback period
can be computed by dividing cash outflow by the annual cash inflow. E.g. if the investment in a
project is Rs.50,000 and it yields annual cash inflow of Rs.10,000 for 7 years, then the payback
period for the project is 5 years (50,000 / 10,000). If the cash inflows are uneven (mixed cash flows)
like in the illustration 5.1 and 5.2, then the payback period can be calculated by adding up the cash
inflows until the initial investment is recovered.

Illustration 5.1
Year Cash Inflows Cumulative Cash Inflows
1 10,000 10,000
2 20,000 30,000
3 20,000 50,000
4 50,000 1,00,000
5 30,000

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Since the initial investment of Rs.1,00,000 is recovered in the 4th year the payback period is 4 years.

Illustration 5.2
Cash Inflows Cumulative Cash Cash Inflows Cumulative Cash
Year
Project A Inflows of Project A Project B Inflows of Project B
1 80,000 80,000 40,000 40,000
2 70,000 1,50,000 40,000 80,000
3 50,000 2,00,000 30,000 1,10,000
4 30,000 50,000 1,60,000
5 40,000 70,000 2,30,000
6 40,000 80,000

The payback period for Project A is 3 years as the entire initial investment of Rs.2,00,000 is
recovered in three years. But for the project B the payback period is between 4th and 5th year. It is 4
years and some months. Let calculate this number of months.
After 4 years the amount recovered is Rs.1,60,000
The amount yet to be recovered is Rs.40,000 (2,00,000 – 1,60,000)
The cash inflow of the 5th year is Rs.70,000. Assuming that the cash inflows occur evenly during
the year, the time required to recover Rs.40,000 will be 6.8 months. (Rs.70,000 is cash inflow for a
period of 12 months, therefore Rs.40,000 is for [40,0000 x 12 / 70,000] = 6.8 months). Therefore
the payback period for the Project B is 4 years and 6.8 months.

As the payback period of Project A less than project B, Project A will be ranked as 1 and Project B
as 2.

5. Discounted Pay Back Period

One of the limitations of payback period is that it does not consider the time value of money and
does not consider the discounted cash flows. This limitation is overcome by discounted payback
period. While calculating the discounted payback period first the cash flows are discounted and then
the payback is calculated. The discounted payback period is the period or number of years taken to
recover the initial investment on the present value basis. The calculation of discounted payback
period is similar to payback period but instead of considering the original cash inflows of the
project, the discounted cash flows are considered.

In the illustration 5.1, the discounted payback period cannot be determine as the total of discounted
cash inflow is Rs.93,410 which is less than the initial investment. This means that if the NPV of a
project is negative then the discounted payback period cannot be calculated. In illustration 5.2 the
discounted payback period of the projects will be calculated as under:

Illustration 5.2
PV of CF Cumulative PV of PV of CF Cumulative PV of
Year
Project A CF of Project A Project B CF of Project B
1 71,440 71,440 35,720 35,720
2 55,790 127,230 31,880 67,600
3 35,600 162,830 21,360 88,960
4 19,080 181,910 31,800 120,760

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 5 22,680 204,590 39,690 160,450
6 20,280 40,560 201,010

The discounted payback period for Project A is between 4th and 5th year.
After 4 years the amount recovered is Rs.1,81,910
The amount yet to be recovered is Rs.18,090 (2,00,000 – 1,81,910)
The discounted cash inflow of the 5th year is Rs.22,680. Assuming that the cash inflows occur
evenly during the year, the time required to recover Rs.18,090 will be 9.6 months. (Rs.22,680 is
cash inflow for a period of 12 months, therefore Rs.18,090 is for [18,090 x 12 / 22,680] = 9.6
months). Therefore the discounted payback period for the Project A is 4 years and 9.6 months.

The discounted payback period for Project B is between 5th and 6th year.
After 5 years the amount recovered is Rs.1,60,450
The amount yet to be recovered is Rs.39,550 (2,00,000 – 1,60,450)
The discounted cash inflow of the 6th year is Rs.40,560. Assuming that the cash inflows occur
evenly during the year, the time required to recover Rs.39,550 will be 11.7 months. (Rs.40,560 is
cash inflow for a period of 12 months, therefore Rs.39,550 is for [39,550 x 12 / 40,560] = 11.7
months). Therefore the discounted payback period for the Project B is 5 years and 11.7 months.

As the discounted payback period of Project A less than project B, Project A will be ranked as 1 and
Project B as 2.

6. Accounting Rate of Return / Average Rate of Return (ARR)

Accounting Rate of Return (ARR) is a traditional technique to evaluate a project. ARR uses
accounting profit as revealed by financial statements instead of cash inflows. ARR is the ratio of the
average after tax profit to average investment. The average investment is equal to half of the
original investment if it is depreciated constantly. The ARR is calculated in percentage and its
formula is as under:

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥𝑒𝑠

𝐴𝑅𝑅 = X 100
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

Average PAT is calculated by adding the profits generated over its life by the life of the project.
Average investment is calculated as total investment divided by 2 or alternatively the average
investment can also be calculated by dividing the total investment’s book values after depreciation
by the life of the project.

Illustration 5.3

Suppose the investment in a project is Rs.1,00,000 and its stream of Profit After Taxes (PAT) for
the five years is expected to be Rs.10,000, Rs.12,000, Rs.14,000, Rs.16,000 and Rs.20,000, what
will be the ARR of the project?

ARR = Average PAT / Average Investment

Average PAT = (10,000 + 12,000 + 14,000 + 16,000 + 20,000) / 5 = 14,400

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Average Investment = 1,00,000 / 2 = 50,000
Therefore ARR = 14,400 / 50,000 x 100 = 28.8%

ARR is having lots of limitations; therefore, this method is not widely used.

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IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CHAPTER 5

CAPITAL BUDGETING DECISIONS - FORECASTING CASH FLOW

Capital budgeting deals with the evaluation of long-term investment decisions that yield return over
a period of time in future. The data required for evaluating capital budgeting decision is cash flows,
both, outflows and inflows. Therefore, the foremost requirement for evaluation of any capital
investment proposal is to estimate the cash outflow in terms of initial investments and the series of
future cash inflows accruing from the investment proposal. After the estimation of cashflows the
proposal is evaluated using any technique of evaluation like NPV, IRR, payback period etc. The
estimation or forecasting of cashflow is explained as under:

Forecasting of Project Cost and Project Revenue of New Project

Cash Outflows [Beginning of the Period at Zero Year (t = 0)]

Particulars Year 0
Cost of assets (plant, land, equipment, furniture etc.) purchased ✓
Add: Installation cost of assets ✓
Add: Working capital requirements (if any) ✓
Total ✓

Cash Inflows [During the life of the project]

Year
Particulars Year 1 Year 2 Year 3 ………
Last (n)
Sales Revenues ✓ ✓ ✓ ✓ ✓
Less: Operating cost
(Raw Material, Labour charges, Overhead ✓ ✓ ✓ ✓ ✓
expenses)
EBITDA ✓ ✓ ✓ ✓ ✓
Less: Depreciation ✓ ✓ ✓ ✓ ✓
Profit Before Taxes (PBT) ✓ ✓ ✓ ✓ ✓
Less: Provision for Tax ✓ ✓ ✓ ✓ ✓
Profit After Tax / NOPAT ✓ ✓ ✓ ✓ ✓
Add: Depreciation ✓ ✓ ✓ ✓ ✓
Cash Flows After Tax (CFAT) ✓ ✓ ✓ ✓ ✓
Add: Terminal Value (in the last (n) Year)
1. Salvage value of assets (if any) ✓
2. Tax benefit (if any) ✓
3. Recovery of working capital (if any) ✓
Cash Inflows ✓ ✓ ✓ ✓ ✓

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 Illustration 5.4

An iron ore company is considering investing in a new processing facility. The company extracts
ore from an open pit mine. The company needs to refine the ore and remove the dirt, rocks and
other impurities before selling it. For extracting and then processing the ore, the company would
have to install equipments costing Rs.10 lakh. The equipment is subject to 20 per cent depreciation
per annum on reducing balance (WDV) basis/method. It is expected to have useful life of 5 years.
Additional working capital requirement is estimated at Rs.1 lakh. The management anticipates that
if it operates at 100 per cent capacity then it would be able to extract 50,000 tonnes of ore every
year. The company also estimates that its extraction cost will amount to Rs.80 per ton and it will
also incur a fixed cost of Rs.15 lakh every year. The proposed ore can be sold at Rs.160 per ton.
The company will utilize the capacity of its equipment as under :

Capacity utilization
Year 1 2 3 4 5
Capacity (Per cent) 50 60 80 100 100

Assuming the corporate tax rate of 35 per cent, calculate the cash flows from the project if the
expected salvage is Rs.2 lakh at the end of year 5.

Solution
(A) Calculation of Cash Outflow

Cost of equipment Rs.10,00,000

Add: Working capital needed Rs.1,00,000
Total initial investment Rs.11,00,000

(B) Calculation of Cash Inflows

Particulars 1 2 3 4 5
Capacity Utilization 50% 60% 80% 100% 100%
Units (ton) 25,000 30,000 40,000 50,000 50,000
Sales (SP - Rs.160) 4,000,000 4,800,000 6,400,000 8,000,000 8,000,000
Less: Processing Cost (Rs.80) 2,000,000 2,400,000 3,200,000 4,000,000 4,000,000
Less: Fixed Cost 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
EBITDA 500,000 900,000 1,700,000 2,500,000 2,500,000
Less: Depreciation 200,000 160,000 128,000 102,400 81,920
PBT 300,000 740,000 1,572,000 2,397,600 2,418,080
Less: Tax @ 35% 105,000 259,000 550,200 839,160 846,328
PAT 195,000 481,000 1,021,800 1,558,440 1,571,752
Add: Depreciation 200,000 160,000 128,000 102,400 81,920
CFAT 395,000 641,000 1,149,800 1,660,840 1,653,672
Add: Terminal Value
1. Salvage Value 200,000
2. Tax benefit on loss on sale 44,688
3. Working capital recovery 100,000
Final Cash Flows 395,000 641,000 1,149,800 1,660,840 1,998,360

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Working Note:

a. Calculation of Depreciation
Year 1 Year 2 Year 3 Year 4 Year 5
Opening Book value 1,000,000 800,000 640,000 512,000 409,600
Less: Depreciation @ 20% 200,000 160,000 128,000 102,400 81,920
Closing Book value 800,000 640,000 512,000 409,600 327,680

b. Calculation of loss on sale of equipment

Particulars Rs.
Closing Book value 327,680
Salvage value 200,000
Loss of sale of equipment 127,680
Tax benefit on loss of sale of equipment (127,680 x 35%) 44,688

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IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 CHAPTER 6

COST OF CAPITAL

Cost of capital is an integral part of investment decision as it is used to measure the worth of
investment proposal provided by the business concern. It is used as a discount rate in determining
the present value of future cash flows associated with capital projects. Cost of capital is also called
as cut-off rate, target rate, hurdle rate and required rate of return. Cost of capital also plays a vital
role in deciding the capital structure of the company. While raising the funds from the long-term
sources of finance the company should take careful decision with regard to the cost of capital
because it is closely associated with the value of the company and the earning capacity of the
company.

Whenever the shareholders and the lenders i.e. the providers of capital give money to the company,
they expect some returns on their money or investment. This return is called as required rate of
return from the perspective of providers of capital and the same rate of return is called as cost of
capital from the company’s perspective.

There are main four sources of long-term finance viz. equity shares, preference shares, debt
(debentures, loan and bonds) and reserves and surplus. Therefore, the cost of each source of finance
along with the overall or total cost of capital is to be studied. This chapter will briefly explain this
concept. The detailed discussion will be done in finance elective courses, as this is a chapter of
finance specialization stream.

Computation of Cost of Capital

Computation of cost of capital consists of two important parts:
1. Measurement of specific costs
2. Measurement of overall cost of capital

Measurement of Specific Cost of Capital

It refers to the cost of each specific source of finance like:
 Cost of debt (Kd)
 Cost of preference share capital (Kp)
 Cost of equity share capital (Ke)
 Cost of reserves and surplus (Kr)

Measurement of Overall Cost of Capital

It refers to the total or composite cost of finance
 Overall cost of capital (Ko)

Cost of debt (Kd)

Cost of debt is equal to the rate of return or yield expected by the lenders. While calculating cost of
debt, some of the important features of debt instruments like debenture or bond need to be
understood. Every debt instrument has a fixed rate of interest as well as fixed maturity period i.e.
years for maturity. Therefore the cost of debt is the rate that will equate the present value of the

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
debenture or bond with the present value of the contractual payments made by the issuer (company)
from the beginning till maturity plus the redemption value. Symbolically,

𝐼 (1 − 𝑡) 𝐼 (1 − 𝑡) 𝐼 (1 − 𝑡) 𝐼 (1 − 𝑡) 𝑀
𝑃=[ + + + + ⋯ + ]
(1 + 𝐾𝑑)1 (1 + 𝐾𝑑)2 (1 + 𝐾𝑑)3 (1 + 𝐾𝑑)4 (1 + 𝐾𝑑)𝑛

Or
𝑛
𝐼 (1 − 𝑡) 𝑀
𝑃=∑ 𝑡
+
(1 + 𝐾𝑑) (1 + 𝐾𝑑)𝑛
𝑡=1
Where,
P = Current Issue Price or Sales Proceeds
I = Interest payment
t = Tax rate
M = Maturity Value
n = Life of the debenture / bond

Illustration 6.1

Suppose a company has issued 12% debentures of Rs.1,000 each at 10% premium and it is
redeemable at par after five years and the company’s tax rate is 35%, then the cost of debt will be
calculated as under:

120 (0.65) 120 (0.65) 120 (0.65) 120 (0.65) 120 (0.65) 1000
1100 = [ + + + + + ]
(1 + 𝐾𝑑)1 (1 + 𝐾𝑑)2 (1 + 𝐾𝑑)3 (1 + 𝐾𝑑)4 (1 + 𝐾𝑑)5 (1 + 𝐾𝑑)5

Using trial and error method cost of debt (Kd) can be calculated as 5.46%. There is also a short cut
method to calculate the cost of debt. The following formula can also be used to calculate cost of
debt but the answer will differ a bit.

(𝑀 − 𝑃) (1000 − 1100)
𝐼 (1 − 𝑡) + 120 (0.65) +
𝐾𝑑 = 𝑛 𝑇ℎ𝑒𝑟𝑒𝑓𝑜𝑟𝑒: 𝐾𝑑 = 5 = 5.52%
(𝑀 + 𝑃) (1000 + 1100)
2 2

Cost of preference share capital (Kp)

Preference shares, like debentures and bonds, are usually subject to fixed rate of return/dividend and
fixed number of years for maturity. So the calculation of cost of preference capital is similar to cost
of debt with one difference that instead of interest (I) preference dividend (PD) is considered and as
preference dividend is not subject to tax deduction it is not multiplied by (1-t). The short cut method
formula of cost of preference capital is as follows:

(𝑀 − 𝑃)
𝑃𝐷 +
𝐾𝑝 = 𝑛
(𝑀 + 𝑃)
2

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Cost of equity share capital (Ke)
Equity shares do not carry fixed rate of return/dividend and also don’t have fixed maturity period
unlike preference shares, debentures and bonds. Therefore the cost of equity cannot be calculated as
per the earlier method. There are different models to calculate cost of equity. The main two widely
used models are (i) Constant Growth Dividend Discount Model (DDM) or Gordon Model and (ii)
Capital Asset Pricing Model (CAPM).

The formula of DDM is:

𝐷1
𝐾𝑒 = +𝑔
𝑃0
Where,
D1 is the equity dividend expected after year 1
P0 is the current market price of the equity share
G is the growth rate

The formula of CAPM is:

𝐾𝑒 = 𝑅𝑓 + 𝛽 (𝑅𝑚 − 𝑅𝑓)
Where,
Rf = Risk free rate of return
𝛽 = Beta
Rm = Return on market portfolio
(Rm-Rf) = Risk premium

Illustration 6.2

The shares of AB Ltd. are currently traded at Rs.500. The dividend expected per share a year hence
is Rs.25 and the Dividend Per Share (DPS) is expected to grow at a constant rate of 15% p.a. then
the cost of the equity as per DDM approach will be:

𝐷1 25
𝐾𝑒 = +𝑔 𝐾𝑒 = + 0.15 = 20%
𝑃0 500

Illustration 6.3

AB Ltd. has a beta of 0.5. If the current risk free rate is 9.5% and the expected return on the stock
market as a whole is 20%, using CAPM approach the cost of equity capital will be:

𝐾𝑒 = 𝑅𝑓 + 𝛽 (𝑅𝑚 − 𝑅𝑓) 𝐾𝑒 = 0.095 + 0.5 (0.20 − 0.095) = 14.75%

Cost of reserves and surplus (Kr)

Reserves and surplus are the accumulated profits of the company. Reserves and surplus unlike
shares and debentures are not raised from outside. It is the company’s own money. Apparently,
retained earnings may appear to carry no cost but it is not correct. On the contrary, they do involve
cost like any other source. It is true that a company is not obliged to pay a return (dividend or
interest) on reserves and surplus. But the reserves and surplus carry opportunity cost. The company
can invest the reserves and surplus money outside the organization in various investment
alternatives and earn handsome returns but the company foregoes all the alternatives and invests the

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
money inside the organization. Therefore the opportunity lost to earn the returns is called as
opportunity cost. Another way of looking at reserves and surplus is that reserves and surplus are the
equity shareholders money (claim). Instead of paying equity dividend the company accumulates the
profit in the form of reserves and surplus. If reserves and surplus were not retained then they would
have been paid out to the equity shareholders as dividends. In other words, retention of earnings
implies withholding of dividends from the equity shareholders therefore cost of reserves and surplus
(Kr) is equal to cost of equity (Ke).

Measurement of Overall Cost of Capital

It is also called as weighted average cost of capital (WACC) or composite cost of capital. Weighted
average cost of capital is the expected average future cost of funds over the long run found by
weighting the cost of each specific type of capital by its proportion in the firm’s capital structure.
Instead of book value of the capital even the market value of capital can be considered as weights. If
a company is having all the four sources of capital in its capital structure, then the overall cost of
capital (Ko) will be calculated as follows:

𝐾𝑜 = (𝐾𝑒 𝑋 𝑊𝑒) + (𝐾𝑟 𝑋 𝑊𝑟) + (𝐾𝑝 𝑋 𝑊𝑝) + (𝐾𝑑 𝑋 𝑊𝑑)

Illustration 6.4

The capital structure of AB ltd is as under:

Source of Capital Amount (Rs.)
Equity share capital 6,00,000
Retained earnings 4,00,000
Preference share capital 3,00,000
Debentures 2,00,000
Capital Employed 15,00,000

The after-tax cost of capital of the specific sources is as follows:

Cost of Equity Funds – 15%
Cost of Preference Share – 12%
Cost of Debt – 10%

The weighted average cost of capital (WACC) is equal to (Ke x We) + (Kr x Wr) + (Kp x Wp) +
(Kd x Wd) = (0.15 x 0.40) + (0.15 x 0.27) + (0.12 x 0.20) + (0.10 x 0.13) = 13.75%

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IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
Notes :
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IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
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IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed
 IES’s Management College and Research Centre

STUDY MATERIAL

(CORPORATE FINANCE)
(PGDM – I Year, Term : II)

By

(Dr. Gazia Sayed)

Academic Year (2020-21)

All rights with IES MCRC

No part of this course material can be reproduced without written permission of IES MCRC

IES MCRC PGDM-II Corporate Finance (Batch 20-22) Dr. Gazia Sayed