AFM CHARTS CA.

DINESH JAIN

ADVANCED FINANCIAL
MANAGEMENT

SUMMARY CHARTS (TO BE USED

ALONG WITH CONCEPT BOOK–ANY
REFERENCE OF CONCEPT BOOK IS OF
THIRD EDITION)

BY CA. DINESH JAIN

DEDICATED TO MY LOVABLE FATHER

[RAMESH JAIN]

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TABLE OF CONTENTS
Chapter 2 – Risk Management .................................................................................. 3
Chapter 3 – Advanced Capital Budgeting Decisions ............................................ 4
Chapter 4 – Security Analysis .................................................................................. 14
Chapter 5 – Security Valuation................................................................................ 17
Chapter 6 – Portfolio Management ......................................................................... 28
Chapter 8 – Mutual Funds ........................................................................................ 40
Chapter 14 – Mergers, Acquisitions & Corporate Restructuring ...................... 47

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Chapter 2 – Risk Management

Value at Risk - Maximum Possible loss in worst case scenario

VAR = Amount invested x Daily SD x No of days x Multiple

Amount SD of Number of days Multiple for

invested Security of VAR confidence level

95% - 1.65 99% - 2.33

Concept 1 – Value at Risk

Conversion of Daily SD into Monthly SD (Let us assume one month has 20

trading days)

Correct Approach Wrong Approach

Monthly SD = Daily SD x 20 Monthly SD = Daily SD x 20

Concept 2 – Daily SD vs Monthly SD vs Annual SD

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Chapter 3 – Advanced Capital Budgeting Decisions

Techniques of Capital
Budgeting

Discounted
Payback Profitability
Payback NPV ARR IRR
Method Index
Method
Introduction to Capital Budgeting
Format for computation of various techniques

Technique Year CF Cum CF PVF DCF CDCF Depreciation PAT

Payback        
Disc Payback        
NPV        
PI        
ARR        
IRR        

Payback Method - Unrecovered CF of Base Year

Payback = Base year +
Time taken to recover CF of Next Year
the initial investment
ignoring the time
value of money Lower the better

Concept 1 – Payback Method

Discounted Payback Unrecovered DCF of Base Year

Method - Time taken Disc Payback = Base year +
DCF of Next Year
to recover the initial
investment
considering the time
value of money Lower the better

Concept 2 – Discounted Payback Method

NPV and PI

NPV = PV of inflows - PV of PV of inflows

PI =
outflows PV of outflows

Higher Positive NPV is

PI > 1 is better
better

Concept 3 and 4 – NPV and Profitability index (or) Benefit cost Ratio (or) Present value Index Method
(or) Desirability Factor

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Accounting Rate of
Return (only technique
based on Profits)

On Initial On Average
Investment Investment

Average PAT Average PAT

Initial Investment Average Investment

Note:
Opening investment + Closing investment
Average investment = ; Closing investment = Salvage value
2
Concept 5 – Accounting Rate of Return

IRR (Rate of return earned by the company) -

This is the discount rate at which NPV of the
cash flows is zero

NPV Positive NPV = 0 NPV Negative

IRR > DR IRR = DR IRR < DR

Concept 6 - IRR
Initial guess rate
Start with an initial
= 2/3 of ARR on
guest rate and
average
compute NPV
investment

Increase DR if NPV is
Steps in positive and reduce
Computation of DR if NPV is negative
IRR
Compute IRR
once one Positive NPV at L1
NPV and L1 + x L2 − L1
NPV at L1 − NPV at L2
Negative NPV is
Computed

Concept 6 - IRR

Cost of capital Specific to the project and not overall cost of

capital of company
Discount rate
Cost of capital can increase or decrease depending on change
in risk of the project. PVF needs to be computed in the same
manner as that of forward rates in bond valuation
Concept 7 – What discount rate to be used for Project Evaluation?

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Depreciation (Non-
cash Item)

Relevant Irrelevant

If the company has tax exemptions or

Because of tax benefit
taxes to be ignored

Concept 8 – Rules for computation of Cash flows

Opportunity cost (Cost of benefit
foregone) - Relevant item

Considered in PBT computation Considered in PAT computation

If given item is pre-tax If given item is post-tax

Concept 8 – Rules for computation of Cash flows

Sunk cost (or) Historical Cost - Irrelevant

Cost of an item which has already Example: Market survey expense, R&D
been incurred (whether paid or not) Costs

Concept 8 – Rules for computation of Cash flows

Overhead cost

Apportioned/ General/
Specific/ Incremental OH
Corporate OH

Irrelevant Relevant

Concept 8 – Rules for computation of Cash flows

Working capital (Money

required for smooth
functioning of operations)

Initial working Decrease in Final recapture

Increase in WC
capital WC of WC

Outflow in Outflow in in- Inflow in in- Inflow in last

year 0 between years between years year
Concept 8 – Rules for computation of Cash flows

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Reward Exclusion Principle (ignore reward paid for

providers of capital)

Capital is contributed by equith shareholder, Ignore interest, Preference

preference shareholders and debt holders Dividend and Equity Dividend

Concept 8 – Rules for computation of Cash flows

Outflow at start of Capital expenditure
Initial outflow
project and working capital

Steps in In-between Cash Inflows during life CFAT during

computation of cash flows of project project
flows
NSV of machine
One-time inflow on
Terminal Flow and recapture of
project completion
WC
Concept 9 – Steps for computation of Cash flows
Formats:
Step 1: Initial Outflow
Particulars Amount
Capital expenditure (XXX)
Working capital (XXX)
Total outflow (XXX)

Step 2: In-between cash flows:

Particulars Amount
Incremental Revenues XXX
Incremental cost savings XXX
Less: All costs other than depreciation (XXX)
Profit before depreciation and tax (PBDT) XXX
Less: Depreciation (XXX)
Profit before Tax (PBT) XXX
Less: Tax (XXX)
Profit after Tax (PAT) XXX
Add: Depreciation XXX
Cash flow after tax (CFAT) XXX
Add/Less: Increase/decrease in Working capital XXX
Less: Purchase of additional machinery / payment for original machine (XXX)
Revised CFAT XXX

Step 3: Terminal flow:

Particulars Amount
Net salvage value of capital expenditure XXX
Recapture of working capital XXX
Total terminal flow XXX

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Different from salvage value (Sale value of

machine)

Net salvage value of Machine

NSV = Sale value + Tax saved on capital loss -

Tax paid on capital gain

Concept 9 – Steps for computation of Cash flows

No capital gain/loss on sale of machine unless the

block is exhausted
Block Assets Method (Method
followed in Income Tax)
Depreciation on incremental value of block = Purchase
price of new machine - sale value of old machine

Concept 9 – Steps for computation of Cash flows

Any asset purchased at the beginning of the year will

be treated as acquired at the end of the prior year for
Investment decision assumes CF computation
cash flows to happen at end of
year
For example: Asset purchase at beginning of year 5
will be considered as Year 4 outflow
Concept 10 – Asset Purchase at beginning of year
Existing Profit-making Immediate tax saving in the year of
company loss

Treatment of Carry forward loss and set-off in

Loss carry forward
Losses future - less tax payment in future

No carry forward and no No tax saving as loss cannot be

details of existing profit carried forward nor set-off now
Concept 11 – Impact of Losses

Other
concepts

Tax exemption for specific Expenses not paid in the

% of Profits year of incurrence

Take effective tax rate Deduct expenses as Add Back: Amount which was not
= Normal tax rate x (1 per accrual concept to be deducted and deduct amount
- Exemption %) for tax comption which was already paid

Concept 12 and 13 – Tax Exemption for Specific % of Profits and Expenses not paid in the year of
incurrence

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Adjust with the cost of Asset

Capital Subsidy
(assumption based)
Not to adjust with cost of asset
Subsidy/Grant
Taxable
Revenue Subsidy
Exempt
Concept 14 – Treatment of Subsidy/Government Grant
Utility value (Attach utility value to every cash flow earned
by the company)

Compute expected utility value for the project = Weighted average of utility
values with probability being the assigned weight

Select the project with higher expected utility value

Concept 15 – Utility Value

Sell today and compute cash

Compute Cash flow today
flows of machine
Abandonment Decision
(When to sell an existing
machine)
Compute PV of all cash
Continue with machine and
inflows by using the
sell machine at end of life
machine
Note:
• NPV = PV of continuation option – PV of selling today
• If NPV is positive, continue using the machine and If NPV is negative, sell the machine today.
Concept 19 – Abandonment Decision

How to decide on replacement

Compute NPV of replacement decision based on cash flows of replacement decision

Step 1 Outflow = Initial Step 3 Terminal flow =

Step 2 inflow = CFAT of
outflow of new machine - Terminal flow of new
new machine - CFAT of
inflow from sale of old machine - Terminal flow of
old machine
machine today old machine

Concept 20 – Replacement Decision

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Type 1 - Deciding whether to

replace an existing machine Follow concept 20
(one-time exercise)

Type 2 - Deciding on optimum Example: Deciding of

Types of Replacement
life of regulary used asset optimum life of Car by a
Decision
(acquired or to be acquired) taxi driver

Type 3 - Deciding the timing of

replacement decision

Concept 21 – Types of Replacement Decision

Type 2 Problem

Let us assume Compute cash flows, NPV/PV of Select the optimum

an asset (car) has outflow and EAB/EAC if machine life as the one which
life of 3 years is purchased and sold in 1 year, 2 has highest EAB or
year and 3 years lowest EAC

Concept 21 – Types of Replacement Decision

Type 3 Problem

Let us assume an Compute cash flows, NPV/PV of outflow Select the

existing asset has and EAB/EAC if machine is replaced alternative with
balance life of 2 years today, a year later or after two years highest EAB or
lowest EAC
Concept 21 – Types of Replacement Decision
NPV
Projects which generate EAB =
returns PVAF r, life
EAB/EAC (Concept is
used to compare
alternatives which have
different lives) PV of outflow
Projects which has only EAC =
costs PVAF r, life

Concept 18 – Equated Annual Benefit (EAB) or Equated Annual Cost (EAC)

Long-term
Ignore cash flow
funds
between company and Discount at Get Project
approach
equity share-holder, cost of NPV and
(FCFF) -
preference share-holder capital Project IRR
Preferred
Project and debentureholders
Approach
evaluation
approach
Equity
Ignore cash flow Discount at Get equity
shareholders
between company and cost of NPV and
approach
equity-shareholder equity equity IRR
(FCFE)

Concept 16 – FCFF vs FCFE Approach

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APV Approach

Compute base NPV of Final NPV = Base

Compute PV of debt Compute PV of
a project assuming it is NPV + PV of debt
financing benefit issue cost
100% equity funded financing benefit
- Issue cost
PV of tax PV of interest saving (lower Discount two as
saving on interest payment as compared pre-tax cost of
interest to normal rate) debt
Concept 17 – Adjusted Present Value Approach

Inflation in capital
budgeting

Types of cash Flows Types of Discount rate

Nominal Real Nominal or Money

Real DR (excludes
(includes (excludes DR (includes
inflation)
inflation) inflation) inflation)

Concept 22 – Inflation in Capital Budgeting

Approach to Inflation
in Capital Budgeting

Real CF to be discounted at
How to adjust
Real DR and Money CF to be How to adjust CF
DR
discounted at Money DR

Nominal cash flows (1 + MDR) = (1 + RDR) x (1 +

= Real cash flows x ሺ1
+ Inflation rateሻn Inflation Rate)

Concept 22 – Inflation in Capital Budgeting

Expected Value, Standard Deviation

and CV

Risk ሺSDሻ
Expected value = Weighted SD = Deviation from CV =
Return ሺNPVሻ
average of various possible expected value - Computed
CF/NPV with Probabiltiy using format 1 of Porfolio
being assigned weight Management

Concept 23 – Expected Value, Standard Deviation and CV

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Dependent CF (Cash flow

Compute SD of every
of succeeding period is Sum of DSD is final
year cash flow and
dependent on previous SD
discount them
period CF) - High Risk
Standard
Deviation
Independent CF (Cash flow
Compute SD of every
of succeeding period is ∑ 𝑑𝑠𝑑 2
year cash flow and 𝑆𝐷 =
independent of previous
discount them
period CF) - Low Risk

Note: Probability of NPV

• Probability of Dependent cash flow NPV = Probability of the cash flow in year 1
• Probability of independent cash flow NPV = ሺProbability of the cash flow in year 1ሻn
Concept 24 – SD for dependent and independent cash flows
Format for Concept 24
DSD
Year SD PVF (SD x PVF) 𝐃𝐒𝐃𝟐

RADR

Not to use Different discount

same cost of RADR = Risk-
rate for different RADR = Rf + Risk
capital for free rate +
projects based on risk Index (Normal DR - Rf)
discounting Risk-Premium
of Project
all projects

Concept 25 – Risk-Adjusted Discount Rate

Certain cash flow
CEF =
Uncertain Cash flow

CEF (How certain/confident are we in Convert uncertain CF into certain

earning a cash flow given in question) - CF using CEF
Certainty will decline with time and
risk of cash flows Discount these cash flows at risk-
free rate and get NPV

RADR and CEF - Low CEF would indicate higher

risk and hence will have higher RADR
Concept 26 – Certainty Equivalent Factor

Impact on NPV due to

change in one factor (SP or
Sensitivity Analysis
cost or life or outflow or
discount rate)
Sensitivity Analysis vs
Scenario Analysis
Impact on NPV due to
Scenario Analysis
changes in multiple factors

Concept 27 – Sensitivity Analysis and Scenario Analysis

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Approaches of
sensitivity Analysis

Approach 1 - Impact on NPV for Approach 2 - Find out what percentage change
uniform % change in variable in variable will make the NPV as zero

Factor with maximum fall in NPV is Variable with smallest change making
the most sensitive factor NPV 0 is the most sensitive factor

Fall in NPV Change

% Change in NPV = x 100 % fall in variable = x 100
Old NPV Base

Concept 27 – Sensitivity Analysis

Starts with decision
Value is highest of branches
node (Rectangle)

Chance node (circle) Value is weighted average of

Decision Tree can come in between various branches
(Diagrammatic
representation of a problem
which requires sequential Drawn from left to
decision making) right and valued
from right to left

Use concept of joint Prob of event 1 x Prob of even

probability t2
Concept 28 – Decision Tree

Simulation (Useful for complex project which has lot of uncertainty - Simulate NPV
computation million times and find out the expected performance and deviation)

Find Based on Discount rate

parameters Create RN Random number to be used is Final NPV =
(no change) table for tables, find value risk-free rate Average of
and variables of various the various
variables using variables for If question gives experiments
(which can probability multiple something else,
change) experiments then we follow the
other rate
Concept 29 – Simulation
Compute NPV of base
project without the option

Option in capital budgeting Do valuation of the option

(Give a choice to company either with only the cash flows of
to expand or abandon the project the option
- Similar to call and put option - Final NPV = Base NPV +
Increases NPV of project) Value of option
Do a project even if base
Decision based on final
NPV is negative but
NPV on project
final NPV is positive

Concept 30 – Option in Capital Budgeting

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Chapter 4 – Security Analysis

Fundamental Analysis No practical Problems

Security Moving average, Breadth Index,

Technical Analysis
Analysis Confidence Index and Relative Strength

Efficient Market
Run Test and Correlation Test
Hypothesis
Introduction

Economy Analysis
Value of share = Intrinsic
Fundamental value = PV of future
Industry Analysis
Analysis dividends = Buy under-
valued and sell over-valued
Company Analysis

Concept 1 – Fundamental Analysis (EIC Analysis)

Purchase or sell History will repeat

Study historical
Technical Analysis decision based on and take buy/sell
price movements
price trends decision
Concept 2 – Technical Analysis

SMA (Average data of the

most recent observations)

5-day SMA is 10-day SMA is Equal weightage is

average of last 5 average of last 10 given to all observations
days prices days prices in SMA
Concept 3 – Simple Moving Averages (SMA)
2
Exponent =
Value of n+1
exponent will be
EMA (Give extra given in question N = Number of
weights to recent days EMA
observations and
less weights to New EMA = [(Previous day EMA x (1 -
earlier observations) Exponent)] + (Latest value x Exponent]
Formula EMA Adjustment =
New EMA =
Exponent x (Today
Previous EMA +/-
value - Previous EMA
EMA Adjustment
value)
Concept 4 – Exponential Moving Averages (EMA)
Format for computation of EMA:
EMA New
Change Adjustment EMA
EMA of (Col 2 - Col (Col 3 x 30-day (Col 3 +
Date Sensex previous day 3) exponent) Col 5)
6 14,522 15,000.00 -478 -29.64 14,970.36
7 14,925 14,970.36 -45.36 -2.81 14,967.55

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Breadth Index

Index that covers No of securities Advanced − No of securities declined

all securities Total Securities traded
traded
Concept 5 – Breadth Index

Confidence Index

How willing are the Yield on high grade bond

investors to take chance in CI =
Yield on low grade bond
the market
Concept 6 – Confidence Index

RSI Index (Relative Strength Index)

Average gain 100

How strong a company is RS = RSI = 100 −
compared to others in market Average loss 1 + RS

Rise more in bull Fall less in bear

market market
Concept 7 – RSI Index
Sign of technical strength = Supports
movement of Dow Jones averages
Breadth Index
Sign of technical weknesses = Does not
Support movement of Dow Jones averages

Rising CI = Bull Market

Confidence
Interpretation
Index
Falling CI = Bear Market

RSI Above 70 = Correction in price

RSI Index
RSI below 30 = Increase in price

Concept 5 to 7 – Interpretation
Efficient Market - Cannot be predicted what
will happen in future
Inefficient market - Can be predicted based
Types of Market Run Test
on past trends

Tests to check market efficiency Serial Correlation Test

Filter rules test

Efficient Market vs Inefficient Market

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Run Test

Step 1 Step 2 Step 3 - Compute Compute

Take Mention number of runs tolerable limit
past price
price change Run is Runs within Runs outside
data coninuous Any sign tolerable limit tolerable limit
every
increase/ in price
day as +
decrease in change is a
or - Efficient Inefficient
price new run
market (weak market
form of
efficiency)
Tolerable Limit Computation: • Upper limit = Mean + (SD x t-value)
𝟐𝒏𝟏𝒏𝟐 • Lower Limit = Mean - (SD x t-value)
𝐂𝐨𝐦𝐩𝐮𝐭𝐞 𝐌𝐞𝐚𝐧 µ𝐫 = +𝟏
𝒏𝟏 + 𝒏𝟐 • t-value is to be computed for given significance level
𝐂𝐨𝐦𝐩𝐮𝐭𝐞 𝐒𝐃 𝛔𝐫
and (n-1) degrees of freedom
ሺ𝑴𝒆𝒂𝒏 − 𝟏ሻሺ𝑴𝒆𝒂𝒏 − 𝟐ሻ
= √
𝒏−𝟏
Concept 8 – Run Test
Data 1 = Jan 2025
Prices
Identify two data for which
correlation is to be tested
Data 2 = Jan 2024
Prices

Auto correlation test

- Absolute change
Correlation Data Measure changes in data
Serial Correlation
test = % change

Correlation closer to
+1 or -1 = Inefficient
market
Calculate correlation coefficient
between two data change
Correlation closer to
0 = Weak form of
efficiency
Concept 9 – Correlation Test

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Chapter 5 – Security Valuation

Security Valuation

Rights Money
Equity Bond Convertible Enterprise
issue and Market
Valuation Valuation Instruments Valuation
Buyback Instruments
Introduction

Walter Model - Price is sum of

Dividend (due to paid out Capital Appreciation (due to

earnings retained earnings)
⬚
⬚
⬚
r
D K e ሺE − Dሻ
Ke Ke

Concept 1 - How to Compute Price under Walter’s Model?

Terms Used

D = Dividend R = Return on E = Earnings per Ke = Cost of

per share equity share equity
Total Dividend EAES Investor required
R = IRR
No of shares No of shares return
Opportunity
R = Return on ROE x
EPS x PR cost of capital
retained earnings BVPS
Rate of
Dividend R = Return on capitalization
rate x FV investment
Cost of capital
EAES EPS (100% equity
ሺORሻ company)
Equity BVPS
Equity capitalization
rate
Concept 1 - How to Compute Price under Walter’s Model?

R> Ke (Growing) 0%

Optimum Payout Ratio R = Ke (Normal) Any ratio

R < Ke (Decline) 100%

Concept 15 – Appropriate Dividend Payout Ratio

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Compute at a payout ratio

Minimum Possible value per
Limiting value which is opposite of optimum
share
payout ratio

Concept 17 – Limiting Value

Gordon's Model (Growing

Perpetuity)

D1 D0 x ሺ1 + Gሻ E1 x Payout Ratio
P= P= P=
Ke − G Ke − G Ke − G

Concept 2 - How to value under Gordon’s Model?

Paid out (or) Will pay now
Current year dividend (D0)
(or) Paid last year

Dividend Given (Is Will pay next year (or) end

Next year dividend (D1)
it D0 or D1) of CY

No clarity Assumption to be taken

Concept 2 - How to value under Gordon’s Model?

How to compute Growth Rate

Based on Past Dividends

Based on Earning Ability; History
ROE x Retention ratio

Take First Dividend = PV

EAES Take Last Dividend = FV
ROE =
Amount of equity

FV = PV x FVF r, n
Retained earnings (OR)
RR =
Total Earnings PV = FV x PVF r, n

Concept 6 – How to Compute Growth Rate

Preference given to this as
Past EPS Data EPS reflects real growth of
company
Basis of Growth Rate

Used only if EPS data not

Past DPS Data
there

Concept 7 – Growth Rate Based on EPS vs DPS

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Future value FV = PV x 1 + r n
(Compounding)

Present value FV
PV =
(Discounting) 1+r n

Future value
AA x FVAF (r,n)
Time Value of Money (Annuity)
(Most important concept
of FM) Present value
AA x PVAF (r,n)
(Annuity)

Perpetuity (normal CF1

and growing) Discount rate − Growth Rate

Loan Amount
Loan instalment
Amount PVAF r, n

Concept 8 – Time Value of Money

EAES
Amount of equity

Return on Equity
EPS SC + Reserves − Fictitious Assets
BVPS =
BVPS No of shares

Concept 9 and 10 – How to Compute Return on Equity

Cost of Equity (What equity shareholder
wants) = Required return on equity

Dividend Non-Dividend Based on PE

Paying Paying Company
Company
1
Ke =
K e = R f + Beta x ሺR m − R f ሻ 𝑃𝐸
D1
Ke = +G
P0 − F
Rf = Risk Free Useful if there is
Rate 100% Payout
D1 = Dividend
of Next year
Rm = Market
Return
Po = Issue
price (or CMP
Rm - Rf = Risk
Premium of
F = Floatation market
cost

G = Growth
Rate
Concept 11, 12 and 14 – Computation of Cost of Equity
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Favourable Project Share price will increase by

(Positive NPV) NPV per share
Impact on new Project on
Share price
Adverse Project (Negative Share price will decrease
NPV) by NPV per share

Concept 31 – Impact of New Project on Share Price

Purchase Under-valued AMP < FMP

Decision on
Purchase/Sell
Sell Over-valued AMP > FMP

Concept 32 – Under-valued vs Over-valued Security

How to move from Price on one year to another
year (Can be used for bond valuation/ equity
valuation or any asset valuation) - Modigilani
Miller Approach

P1 = P0 x 1 + K e − D1 P2 = P1 x 1 + K e − D2

Concept 3 – Computation of Price of Different Years (MM Approach of CA Inter)

Company pays Dividend income meets

Dividend Investing
dividend committment
(People want regular
income from shares for
meeting their Do partial sale of shares till
Company stops paying
commitments) company starts paying
dividend
dividend again
Concept 27 – Maintenance of Dividend Income

Holding Period Return (Return

earned by holding shares)

Capital Appreciation P1 − P0 + Dividend ሺD1 ሻ

Return = x 100
Opening price ሺP0 ሻ

Concept 4 – Holding Period Return

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Real value of security
Ex-dividend values without accrued
dividend
Ex-dividend (vs) cum-
dividend values
Ex-dividend values +
Always use ex- Cum-dividend values
Dividend Income
dividend values in
any formula
Price falls by the amount of
Relationship DPS post share becoming ex-
dividend
Concept 5– Ex-Dividend vs Cum-Dividend Price
Required Return of any
security

Risk-Free Rate Risk Premium

Real-rate of return on
Inflation
risk-free security
Note:
• Real-return of any security = Normal return of security – Inflation rate
• Inflation premium forms part of Risk-free Rate and hence any increase in inflation premium
will increase the Risk-free Rate
Concept 33 and 34 – Component of Required Return and Inflation Premium
Step 1 - PV of Compute DPS till
Dividend Growth stability

Value of Share = PV of
Step 2 - Compute price at beginning of
Dividend + PV of sale proceeds
stabilization using Gordon's Formula
of share price on sales

Step 3 - Discount step 1 and step 2 at Ke (or) investor

required return and compute share price
Concept 18 – Step-up Growth Model
DPS of future years
No change in = DPS of earlier
Payout ratio years + Growth
rate
Dividend Estimation
for future period
Estimate EPS of
Change in future years = EPS Future DPS = Future
Payout Ratio of earlier years + EPS x Payout Ratio
Growth rate
Concept 20 – Estimation of Future Dividends

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Linear Fall in Growth Higher rate − Lower rate

Number of years of Annual fall in GR =
Rate (Growth rate Number of years of fall
fall given
will stabilitze from
higher number
(example 20%) to
Number of years of Take 1% fall every
lower number
fall not given year
(example 10%)

Concept 19 – Linear Fall in Growth Rate

H Model - Price is sum of

Dividend at normal growth Extra price for higher growth

rate
⬚
⬚
⬚
Transition Period
D0 x ሺ1 + Normal GRሻ D0 x High GR − Normal GR x 2
K e − Normal GR K e − Normal GR

Concept 26 – H Model valuation

Fair Price = EPS x PE Multiple

PE Multiple can be given in question Not Given

100% Payout BPVS = MPS

1 1
PE = PE =
Ke ROE
Concept 28 – PE Multiple Approach

Earning Growth Model Consider CMP as FMP and

substitute in Gordon Formula

E1
D0 x ሺ1 + Gሻ
Ke − G P1 =
Ke − G
Concept 29 – Earning Growth Model Concept 21 – Implied Growth Rate by CMP
Share price = PV of
Dividend + Sale price of
Bonus issue (one share will shares
become 1.2 or 1.5 shares on
last date) Sale proceeds = Higher
Sale price of shares = Sale
number of shares x Selling
proceeds - Transaction cost
Price
Concept 24 – Impact on Bonus on Terminal value

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Max Purchase Price = Fair

No Transaction cost
value per share

Maximum Purchase Price

Fair value
Incurrence of Transaction Max PP =
cost on sale 1 + TC%

Concept 25 – Impact of Transaction Cost on Maximum Purchase Price

US investors are Infosys deposits

Infosys India wants
ready to invest but some 10,000 shares
to raise money from 10 shares = 1 GDR
want to invest in with a custodian
US investors
USD Bank

GDR are issued on Investor invests money Instrument is same

the security of through GDR - Gets regular as equity and cost of
shares and issued in dividend income when GDR = Cost of
USD Infosys declares dividends equity

Formula:
D1
Cost of GDR = +G
P0 − F
Concept 16 – GDR
Step 1: Take the
Direct formula of
Cost of equity with CMP as outflow of Step 2: Compute
concept 11 cannot
multiple growth the investor dividends till the
be used as Growth
rates assuming we buy it stabilization phase
changes
today

Step 5: Increase DR
Step 3: Take Step 6: Compute
Step 4: Discount if we get positive
terminal value IRR. IRR of investor
above and compute NPV and Decrease
based on perpetuity = Cost of equity of
NPV DR if we get
valuation company
Negative NPV
Concept 13 – Computation of Cost of Equity (Dividend Paying Company with Multiple Growth
Rates)
Compute Price without
growth. Take EPS as DPS.
100% Payout ratio
PVGO (Extra Premium paid by company
due to growth in company)
PVGO = CMP - Price
computed above

Concept 22 – Present Value of Growth Opportunities

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Free Cash Flow Approach

FCFE1 FCFE = Free cash FCFE = PAT -

P0 = flow of equity Equity funding for net
Ke − G Equity funding capex and working capital
shareholder of next for net capex
year = (Net capex and working
and working capital requirement) x
capital (100% - Debt ratio%)

Concept 30 – Free Cash Flow Approach

Particulars Amount
Sales XXX
Less: Cost of Goods Sold (XXX)
Gross Profit XXX
Less: Operating expenses (Selling and admin expenses) XXX
Operating Profit/EBIT XXX
Less: Interest expenses (Note 1) (XXX)
EBT XXX
Less: Tax (XXX)
EAT XXX
Less: Preference Dividend [Preference capital x Coupon %] (XXX)
Earnings available to equity shareholders XXX
No of equity shares XXX
EPS [EAES/No of equity shares] XXX

Sum of (Respective debt

Problem is silent x Respective interest
rate)
How interest to be
computed?
Problem gives effective Total Debt x Effective
interest rate interest rate %

Concept 35 – Format of Income Statement

Liquidity Ratios/Short term solvency Ratios
Capital Structure/ Long term Solvency Ratios
Profitability ratios related to sales
Types of Ratios
Coverage Ratios
Profitability ratios related to return on assets/ investments
Profitability ratios from owners point of view
Turnover Ratios
Concept 36 – Important Ratios

CA
Current Ratio CL
Liquidity Ratios (Ability to
repay short-term liabilities) QA
Quick Ratio (or) QA = CA - stock -
Acid Test Ratio CL Prepaid expenses

Concept 36 – Liquidity Ratios

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Debt
Debt Ratio Capital Employed

Equity or Networth
Equity Ratio Capital Employed

Debt
Capital Structure (Ability to
Debt to Equity Ratio Equity
repay Long-term Liabilities)

Debt + Preference
Capital Gearing Ratio Equity

Equity
Proprietary Ratio Total Assets

Concept 36 – Capital Structure Ratio/Long Term Solvency Ratio

What is Capital Employed?

Assets Side Liabilities Side

Route Route

CE = Total Assets - CE = ESC + Reserves + PSC +

Fictitious Assets - Long-term debt - Fictitious assets
Current liabilities
Concept 36 – Capital Structure Ratio/Long-Term Solvency

Interest Coverage EBIT

Ratio Interest

Source of payment PAT

Preference Dividend
Coverage Ratio What are we paying Preference Dividend
Coverage Ratio

EAES
Equity Dividend
Coverage Ratio Equity Dividend

Concept 36 – Coverage Ratio

Gross Profit
GP Ratio Sales
COGS
COGS Ratio Sales
Profitability Ratio
Net Profit
Net Profit Ratio Sales
EBIT
Operating Profit Ratio Sales
Concept 36 – Profitability Ratios related to Sales

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Sales
Relevant item
Sales based
Ratios Relevant item can be Total Assets, Fixed Assets,
Current Assets, Working Capital and Capital
Employed

Debtors Turnover Credit Sales

Ratio Debtors
Turnover
Ratios Ratios based Credit Purchases
Creditors
on other Creditors
Turnover Ratio
items

Inventory Turnover COGS

Ratio Stock

Conversion 365
Debtor days =
into days Debtors Turnover Ratio

Concept 36 - Turnover Ratios used to assess effectiveness of usage of resources

EBIT
Pre-tax CE
ROI (or)
ROCE EBIT x 1 − T
Profitability Ratios What is earned
related to Return on Post-tax CE
What is invested
Assets/Investments
EAES
ROE Equity

Concept 36 – Profitability Ratios related to Return on Assets/Investments

DPS
Dividend Yield x 100
MPS
EPS
Earning Yield x 100
MPS
EAES
Profitability Ratio EPS No of equity shares
related to owners
Equity Dividend
DPS No of equity shares

DPS
Payout Ratio EPS

Concept 36 – Profitability Ratios related to Owners Point of View

Ability to repay the

Fixed Interest and Fixed Dividend fixed interest and fixed PAT + Interest
Coverage Ratio dividends (Preference Interest + Dividend
Dividends)
Concept 37 – Fixed Interest and Fixed Dividend Coverage Ratio

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Our ratio is better than Required return of our

Industry company will decline
Impact of Ratios on required return
of our company with help of proxy
company data
Our ratio is weaker Required return of our
than Industry company will increase
Concept 38 – Impact of Adverse/Favourable Ratios on Required Yield

Stock Lending - Lender temporarily lends

the shares of a particular stock to borrower

Borrrower (He does short-sell

Lender (Owner who
and hence wants shares for
has shares and lends it)
delivery

Lending Dividend Guarantee

Profit or loss Lending fees
fees Income charges
on short sell (Income)
(Income) (Income) (expense)
Concept 57 – Stock Lending

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Chapter 6 – Portfolio Management

Concept of Risk
and Return

Return Risk

Possibility of earning Possibility of

money losing money

SBI Equity = 14.00% SBI Equity = 22.07%

SBI FD = 7.00% SBI FD = 1 to 2%
Concept 1 and 2 – Return of Security and Risk of Security
Formats for Portfolio
Management

Format 1 Format 2 Format 3

Format 1
Probability Return Product Deviation 𝐏𝐝𝟐

Format 2:
Security A Security B
Prob Return Product Deviation 𝑷𝒅𝟐 Return Product Deviation 𝐏𝐝𝟐 𝐏𝐝𝐚 𝐝𝐛

Format 3:
Return of security (X) Return of market (Y) XY 𝐘𝟐

Computation of Risk and

Return

P1 − P0 + D1 P1 − P0
Return = Return = + DY Risk = pd2
P0 P0

Concept 1 and 2 – Return of Security and Risk of Security

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Co-variance of A
and A is called
variance
COVAB = ∑𝐏𝐝𝐀 𝐝𝐁
Co-variance of A and B =
Co-variance and Beta of A x Beta of B x
Correlation Variance of Market
coefficient
COVAB
Correlation can
COR AB = SD range between -
A SDB
1 to +1
Concept 3 – Computation of Correlation coefficient and Covariance

Healthy eating habits -

Health and organic fooods
will do well and fast food
Fast food chains vs chains will struggle
health and organic
foods brands If there is no shift - Fast
food chains will do well
Diversification or and healthy foods will
Portfolio Creation struggle

Online Retailers vs
Performance will have
Brick and Mortar
negative correlation
Stores
Benefit of Diversification:

Business 1 Business 2 Combined performance

40 -10 15

30 0 15

10 10 10

-10 20 5

-15 40 12.5
Average Return = 11% Average Return = 12% Average Return = 11.50%

SD (Risk) = 21.54% SD (Risk) = 17.20% SD (Risk) = 3.74%

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Portfolio Return and

Risk

Portfolio Return = Portfolio Risk = Not weighted average

Weighted average of due to Corrrelation coefficient
individual returns

Two Securities
= 𝑆𝐷1 𝑊1 2 + 𝑆𝐷2 𝑊2 2 + 2𝑆𝐷1 𝑊1 𝑆𝐷2 𝑊2 𝐶𝑂𝑅12

Concept 4 – Portfolio Return and Portolio Risk

Notion of Dominance -
Security dominates
other security if

Higher return with Higher return with Same return with

lower risk same risk lower risk

A = 10% Ret and A = 10% Ret and A = 10% Ret and

5% Risk 5% Risk 5% Risk
B = 12% Ret and B = 12% Ret and B = 10% Ret and
4% Risk 5% Risk 4% Risk
Concept 5 – Notion of Dominance

Compensation for risk - Extra

return generated due to risk
being taken

Diversified Portfolio (Beta based) Undiversified Portfolio (SD based)

Treynor Ratio Sharpe Ratio

Act Return − Risk Free Return Act Return − Risk free rate
TR = SR =
Beta SD

Concept 6 – Compensation for Risk

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Types of Risk

Systematic Risk (or) Unsystematic Risk

Non-diversifiable risk (or) Diversifiable risk

Risk inherent to the market and Risk specific to company and

will impact all companies in the will not impact everyone in the
market industry

GDP Growth/Interest Poor management decision/

Rates/Inflation/Wars Frauds/ Lawsuits/ Competition

Cannot be eliminated Can be eliminated by

by diversification diversification

Measure of Risk

Standard Deviation
Beta (Systematic Risk)
(Total Risk)

How does security

How much does security return
react to fluctuations in
deviate from its average return?
market?

Considered for undiversified Considered for diversified

portfolio portfolio

Concept 11 – Beta vs Standard Deviation

How to we
measure Beta?

Probability information Probabiity Approx formula

not given information given (not prefered)

Use Format 3 Beta

Use Format 2 Change in Security
=
F3 Change in Market
∑XY − n Mean of X Mean of Y F2
= SDs
∑Y 2 − n Mean of Y Mean of Y = x COR SM
SDm
COVSM
F1 =
VAR M

Concept 9 - Beta

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Risk-free Rate (Return on Government

Security)

Interest in Rs.
Multiple Risk-free Rf = Hidden Rf in question
Rates value per Bond

Aggressive Approach = Rf = Security return with 0

Higher Number Beta

Conservative Approach = Rf =
Lower Number

Moderate Approach = Rf =
Average
Concept 7 – Risk-Free Rate

Risk Premium of Market

Extra return generated Rm − Rf

by market for risk taken

Positive if market return is higher

than risk-free rate

Negative if market return is lower

than Risk-free Rate
Concept 8 – Risk Premium of Market

Portfolio Beta

Weighted average of the Can be altered by Can also be altered with

Beta of individual securities adding/removing borrowing/investment in
securities risk-free security

Concept 15 and 16 – Portfolio Beta and Weights for Target Portfolio Beta
Format for computing Portfolio Beta and weights of Portfolio for target Beta
Security Beta Weight Product

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Return
Beta

Fair Fair Beta /Equilibrium Actual

Return/Equilibrium Actual Return Beta Beta
Return
What Beta should a Calculated
What return should What return a security security have for the using
a security give? is actually giving? return it is giving? F1/F2/F3
Act Return
= R f + Fair Beta x R M − R f
Fair Return = R f + Actual Beta x R m − R f

Concept 12 – Concept of Fair/Equilibrium Return and Fair/Equilibrium Beta

Risk of Portfolio Relative to Market

Optimum Risk High Risk Low Risk

Actual Beta = Actual Beta > Fair

Fair Beta Actual beta <
Beta Fair Beta

Concept 13 – Risk of Portfolio Relative to Market

Decison on Purchase/sell

Purchase Sell

Under-valued Over-valued

Act Return > Fair Return Act Return < Fair Return

Act Price < Fair Price Act Price > Fair Price

Act Beta < Fair Beta Act Beta > Fair Beta
Concept 14 – Decision on Purchase/Sale of Security

Risk-taking ability of the investor

Bull Markets Bear Markets

Markets will go up Markets will go down

Invest in high Beta Stocks Invest in low Beta Stocks

Higher Positive Return Lower Negative Return

Concept 10 – Beta (Bullish vs Bearish Market)
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Numerator of F2 of Beta
Systematic Risk
Computation
Systematic Risk and
Unsystematic Risk
(Computation) Unsystematic
risk/Specific SD/ Total Risk - Systematic
Residual Risk/ Random Risk
error

Concept 17 – Systematic Risk and Unsystematic Risk

Formulae
Particulars Variance Approach SD Approach
Total Risk Variance of security SD of security
ሺBeta of security x SD of marketሻ2 Beta of security x SD of market
(or) (or)
Systematic Risk ሺSD of security x COR sm ሻ2 SD of security x COR sm
Unsystematic Risk Total risk - Systematic risk Total risk - Systematic risk

Portfolio Risk

Markowitz Approach Sharpe Approach (Co-movement of

(Correlation based) security with index)

2 Total Risk (Variance) = Systematic

a+b formula Risk + Unsystematic Risk

Sys Risk of Portfolio = Same

as concept 17 Formula

Unsys Risk of Portfolio = weighted

average of individual USR with W2
being assigned weights
Concept 18 – Portfolio Risk through Markowitz/Sharpe Approach

Co-efficient of Determination

Variance Approach ሺr 2 ሻ SD Approach (r) = This is equal to

correlation coefficient

Sys risk as per variance approach Sys risk as per SD approach

r2 = r=
Total Variance SD

Concept 19 – Co-efficient of Determination

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Investment with margin of 60%

Investment in risky portfolio = Borrowing = 60% at risk-free

160% rate
Concept 20 – Investment with margin of XX

Fully Diversified Portfolio

Carries no unsytematic risk

SD = Systematic Risk of Portfolio

Concept 21 – Fully Diversified Portfolio

Components of Return

Return due to Return due to sheer skill of

Return due to extra risk taken
market risk manager

CAPM return for given

Rm - Rf beta - CAPM return for 1 Actual Return -
Beta CAPM Return

Concept 21 – Components of Return

Stock Specifc
Characteristic Line
CL = Alpha + Beta x (Return
of Market)

Common for all companies

Characteristic Line, Security Market Line
CML and SML (SML) - CAPM
R f + Beta x R m − R f

Common for all Companies

Capital Market Line
(CML) SDsecurity
Rf + x Rm − Rf
SDmarket

Concept 22 – Characteristic Line, CML and SML

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Return earned in excess of

the required return. This is
also know as return due to
sheer skill of portfolio CAPM
manager Approach
How is (Diversified
Alpha Alpha = Actual Return - required
CML Approach
Required Return return
(Undiversified)
calculated
Positive Alpha is strong Characteristc
performance and Line
Negative Alpha indicates
underperformance

Concept 23 – Alpha

Rf and Rm Computation through

two securities SML

Form 2 SML equations

Solve equations to get Risk-
with Beta and return
free rate and Market return
given in question

Concept 24 – Computation of Rm and Rf using two SML Equations

CAPM is single
factor model and Rf + [Factor 1 x Risk (or) Return
APT is multi-factor premium of Factor 1] + [Factor 2 x Risk
Return model (or) Return premium of Factor 2] +
[Factor 3 x Risk (or) Return Premium of
under APT Factor 3]
Two formulae for
return
computation Rf + [(Expected value – Actual Value of
Factor 1) x beta of Factor 1] + [(Expected
value – Actual value of Factor 2) x Beta of
Factor 2] + [(Expected value – Actual
value of Factor 3) x Beta of Factor 3]

Concept 25 – Arbitrage Pricing Theory

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Weighted average of the Beta

Asset side of various assets
Beta (or)
Unlevered Asset Beta of our company =
Beta Asset Beta of Proxy =
Beta (Asset side
Liability Beta of Proxy
Beta = Liability
Side Beta) Weighted average of the Beta
of various liabilities
Liability Side
Beta
Weights for debt would be
taken as Debt x (1 - Tax Rate)
Concept 26 – Beta and Leverages

Asset beta (or)

Used to compute cost
unlevered beta (or)
of capital (WACC)
overall beta
Beta Classification
Equity Beta (or)
Used to compute cost
Levered Beta (or)
of equity
Stock Beta

Concept 26 – Beta and Leverages

Portfolio Strategies

Buy and Constant Constant Proportion

Hold Mix Policy Portfolio Insurnace
Policy (CPPI)
Rebalancing at every Rebalancing is
No event (Fixed done at every
rebalancing period/Fixed change) event
done
Investment in Floor value =
equity = Total investment -
Multiplier x Maximum % fall
(Total value - in Nifty
Floor value)
Concept 27 – Portfolio Strategies

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Var2 − COV12
W1 =
Var1 + Var2 − 2COV12
Two Securities
W2 = 1 − W1

Minimum Risk
Portfolio Three Securities Critical Line Approach

More than Three Sharpe's Optimal Portfolio

Securities Approach

Concept 28 – Minimum Risk Portfolio

Critical Line
Approach (Three
Securities)

Find two portfolios Fit an equation Use the equation and

which are on which links weights find the weights for the
minimum risk of two securities third portfolio with
minimum risk

Weight of Security 1 = a
+ b (weight of security 2)

Concept 28 – Critical Line Approach

More than
3 Securities

Step 1 - Step 4 - Step 5 -

Step 2 - Step 3 - Maximum cut-
Rank Compute Z
Rearrange Compute off is taken as
securities value and final
in the cut-off final cut-off.
in the weights in
order of point Security with
order of proportion of Z
ranking TR > cut-off
Treynor value
Ratio forms part of
final portfolio

Concept 28 – More than 3 Securities

Format for Computation of Cut-off Point:
Sec TR Beta USR SR SR SR SR SR SR Cur-off
TR x ( ) ∑TR x ሺ ሻ ∑( ) 1 +∑( )
USR USR USR USR USR

Note:
• TR = Treynor Ratio
• USR = Unsystematic Risk

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• SR = Systematic Risk = Beta x Beta x Variance of Market
• Cut-off Point =Column 8/Column 10
Z- value computation
Beta
Z value = Excess cutoff x ( )
USR
• Excess cutoff = Treynor Ratio - Cutoff point
Based on credit side of Value of Property = Area
P&L - Sales comparison x Adjusted SP per square
appproach feet

Based on debit side of Area x Construction cost

P&L - Cost Approach per square feet
Real Estate
Valuation Perpetual Income
Based on income (Credit - Value =
Debit) Capitalization rate

PV of cash flows
Based on Cash Flows discounted at required
return
Concep 29 – Real Estate Valuation

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Chapter 8 – Mutual Funds

MF Introduction (Financial
Doctor for Managing Investor
Money)

Sponsor Trustee (Ensures AMC (Manages Investors/

(entity that MF operates in the fund
establishes investments) unit-holders
the best interest
MF and of investors)
gives initial Incurs expenses and
capital) recovers it as part of
Expense ratio
Mutual Fund Introduction
MF Return vs Individual Return (Return to
be earned by MF to give same return which
an investor would get on his own)

Without With Opportunity

Opportunity Cost Cost

Individual Return Do cost benefit analysis

MF Return = + AER
1 − IER to check which is better

Concept 1 and 2 – MF Return vs Individual Return

Return is function of Dividend and Capital
Appreciation for an investor

What I get back − What I give

Return =
What I Give

ሺNAV1 − NAV0 + D1 + CG1 ሻ

Return =
NAV0

Holding Period Return Annual Return

Same Above formula

Formula multipled with (12/m)
as above
Concept 3 – Holding Period Return vs Annual Return

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Period of Holding through Holding period

Return and Annual Return

HPR
Period of Holding = x 365 days or 12 Months
Annual Return

Concept 7 – Period of Holding

Question specifies Do return

that a year consist of computation on
Days or Months 360/365 days number of days
Calculation for Annual
Return
Do computation
No such information
on months basis

Concept 5 – Return Computation – Days vs Months

Note:
• Number of days = Redemption date – Investment date [Consider date of redemption in days
calculation and ignore date of investment in computation]

Dividend Declared by MF
[Dividend Rate x Face value]

Dividend Payout Dividend

Plan Reinvestment Plan

Dividend is re-invested and

Paid in Cash
given extra units

Return computed Closing value − Opening value

using formula of HPR = x 100
Opening value
Concept 3
Concept 8 – Dividend Payout Plan and Dividend Re-investment Plan
Concept 9 – Computation of Closing Units
Dividend Reinvestment Plan:
Dividend
Unit Amount (B) New Total
held (A x Face value x Reinvestment NAV units units
Date (A) % Dividend %) (C) (D= B/C) (A+ D)

Bonus Plan:
Bonus
units
Unit (B = A x Total
held Bonus Bonus units
Date (A) ratio Ratio) (A + B)

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Types of MF Schemes

Open-ended Scheme (Entry Close-ended scheme (entry

and exit at any time) and exit at specified time)

Return computed using Listed in stock market (to

formula of Concept 3 facilitate purchase and sale)

Purchase and sale cannot

happen at NAV

Replace NAV 1 and NAV 0

with adjusted price in formula
Concept 4 – Return for Close-ended Schemes

Taxation Impact

Cost of Acquisition of bonus units STT is not tax deductible expense for
is 0 computing capital gain

Concept 10 – Taxation Impact

Effective Yield

Return computed as Annual Compute return as IRR of the

return through formula ignores investor
Time value of Money and hence
not fully accurate
Day 0 - Outflow of Maturity - Inflow
investor of Investor

Concept 11 – Effective Yield

Collected extra
Front-end Public offer price − NAV
on entry and
Load (or) NAV
hence increases
Entry Load
Load purchase price
in MF Collected on
exit and hence NAV − Redemption Price
Back-end Load
decreases NAV
(or) exit load
redemption
price

Concept 12 – Front-end Load and Back-end Load

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Asset and Liabilties

Formula 1
details available
NAV (Fair value per
unit of MF)
Asset and Liabilites
Formula 2
details not available

Concept 14 and 15 – NAV

Market value of assets − Value of liabilities
Formula 1 NAV =
Number of units
Opening Networth + Items increasing networth − Items reducing networth
Formula 2 NAV =
Opening units + New units issued − Redemptions

Impact of events on NAV

Fresh Purchase/ Redemption Dividend Declaration

No impact as Numerator and NAV falls by the amount of

denominator is impacted Dividend per unit
Concept 16 and 17
Total yield of Investor (Applicable
when an investor is investing in
multiple MF)

Capital Gain of All MF + Dividend of All MF

x 100
Amount invested in all MF

Concept 6 – Total Yield of Investor

No exit Load Exit Immediately

Exit strategy of
under-performing
MF Check proportionate %
loss in return as
Exit Load exist
compared to exit load
and decide
Concept 13 – Exit Load vs Lower Return from MF

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Record cash as an
asset if given for
Not possible
NAV computation -
Tracking of cash else ignore it
inflows and
outflows Prepare Cash book
and compute
Possible
closing cash and
consider in NAV
Concept 18 – Cash Balance Computation to Value NAV

Applicable and
Original Shares
will be received
Dividend income
of MF on its
Will not be applicable
investments
Rights in case dividend
shares/Bonus declared before
shares allotment of
bonus/rights shares
Concept 21 – Dividend Income on Equity Shares

No need to do
Yes dividend equalization
adjustment

MF reports daily Purchase NAV =

NAV Opening NAV + Entry
Load + Dividend
No (Practical equalization per unit
world this option
is not there) Redemption NAV =
Opening NAV - Exit Load
+ Dividend Equalization
per unit
Concept 21 – Impact of Dividend Equalization
Note:
Total income earned
Dividend equalization per unit =
Number of units
Income Let us assume there are three months in the calculation period
Available for
distribution is
computed to Total income
identify the Income per unit =
amount of Number of units of that month
dividends
which can be Income available for distribution = (Month 1 income per unit
distributed + Month 2 income per unit + Month 3 income per unit) x
Closing units
Concept 24 – Income Available for Distribution

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Dividends out of realized earnings

Dividends distributed = Realized earnings x Specific %

Realized earnings = Dividend/interest income of MF +

Realized capital gain
Concept 20 – Dividends out of realized earnings

Valuation of Assets

Equity shares Bonds

Closing index value Interest in Rs.

Amount invested x
Index on date of investment Current Yield in %
Concept 19 – Valuation of shares and bonds for NAV computation
Amount incurred by MF such as office expenses, rent, fund management
expenses etc
Expense Ratio
Annual Expense per unit
Expense ratio = x 100
Opening NAV or Closing NAV or Average NAV

Concept 25 – Expense Ratio

Sharpe Ratio (or)
Undiversified MF Reward to Variability
Ratio
Treynor Ratio (or)
MF Performance
Diversified MF Reward to Volatility
Evaluation
Ratio

Either of them Jensen Alpha

Concept 26, 27, 28 and 29

Formulae
Expected return − Risk free Higher the
Sharpe Ratio =
Standard Deviation better Values can be negative if MF
Expected return − Risk free Higher the return is lower than risk-free
Treynor Ratio =
Beta better return
Alpha = Actual return – Required return as Higher Positive
per CAPM Alpha is Better

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Will decline by
Cash component
expense per unit
Break-up of NAV
Will increase or
Equity Component decrease based on
market change

Concept 22 – MF NAV computation – Cash and Equity Component

Note:
• Closing NAV = Cash Component + Equity Component
• Equity Component = Opening Value +/- % change;
• % Change = Beta of Portoflio x Change in Market

Applicable for MF which Computes the amount

Tracking tracks any index. of variation in
error performance as
Example: Nifty Index MF compared to the index
Concept 30 – Tracking error

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Chapter 14 – Mergers, Acquisitions & Corporate Restructuring

Economies of scale,
Operating Synergies
improved market
(Improvement in cash
reach, lower
flow/PAT)
competition
Merger of company with
Financial Synergies
surplus cash with another
Why Merger? (Improvement in Cost of
company having high-
capital/ PE Multiple)
return projects

Empire Building,
Managerial self-interest Stronger
Management Team

Introduction
Concept 1 – Format for doing Merger Analysis
Particulars AC TC Merged company
PAT/EAES XXX XXX XXX
No of equity shares XXX XXX XXX
EPS [PAT/ No of shares] XXX XXX XXX
PE Multiple XXX XXX XXX
MPS [PAT x PE Multiple] XXX XXX XXX
No of equity shares XXX XXX XXX
Market value of firm [MPS x No of shares] XXX XXX XXX
Note:
• AC = Acquiring Company; TC = Target Company
• Market value of firm (real formula) = PAT x PE Multiple

Cash flow/PAT of
merger firm > Sum
of individual
Gain from Merger = companies)
Value of Merged
Arises due to the
Firm - (Pre-merger
following Post-merger
value of AC + Pre-
merger value of TC) PE/Cost of capital is
better than weighted
average of AC and
TC
Concept 2 – Gain from Merger
Cost of Merger (Consideration Paid
to TC)

Net Cost or
Gross Cost
True Cost

Stock offer Cash offer Gross cost - Pre-merger

value of TC
No of shares issued x Cash paid per share x Pre-
Post merger MPS merger No of shares

Concept 3 – Cost of Merger

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Relevant Post-Merger EPS/MPS

For AC For TC

Normal number without Equivalent number = Post merger (EPS or MPS)

adjustment x Exchange Ratio

Concept 9 – Equivalent EPS/MPS

Find out basis of ER

(EPS/MPS/BVPS)

How exchange Adjust base values in case

Write base value as
ratio is company wants to consider
AC:TC
determined? some premium in base value

Switching is not be done in case

Switch those values
basis is on adverse factors such
and take it as ER
as NPA, cost ratio
Concept 7 – How Exchange Ratio is Determined?

Can be (Post-merger MPS - Pre-

Gain/Loss computed at For AC merger MPS) x Pre-merger no
Computation EPS or MPS of shares
for AC and TC level (Do both (Post-merger equivalent MPS -
Shareholders if problem is For TC Pre-merger MPS) x Pre-merger
silent) no of shares

Concept 10 – Gain/loss per share (or) Impact of merger on EPS/MPS

To maintain ER based on Only if no PAT
EPS EPS synergy

ER for
To maintain ER based on Only if no PAT and
maintenance
MPS MPS PE Multiple Synergy
of parameter

To maintain ER based on Only if no

BVPS BVPS revaluation gain

Concept 11 – ER to maintain EPS/MPS/BVPS

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Problem is Equal to pre-merger PE Multiple

silent of AC

Weighted PAT of AC x PE of AC + PAT of TC x PE of TC

PE Multiple
average PE PAT of AC + PAT of TC
Post Merger
Multiple
Minimum PE Pre − merger value of AC + TC
Multiple to Post merger PAT
justify merger

Concept 8 – PE Multiple

Value of merged firm

Approach 1 (commonly used) Approach 2

Pre-merger value of AC + Pre-

Post merger PAT x PE Multiple merger value of TC + Valuation
gain from merger
Concept 8 – Value of Merged Firm
ER at which
Minimum ER (from TC consideration paid is
point of view) equal to pre-merger
value of TC
Exchange Ratio (if
basis not given)
ER at which
Maximum ER (from consideration paid =
AC Point of view) Post-merged value -
Premerger value of AC

Concept 8 – Value of Merged Firm

EG > Cost of
Calculate earning capital =
Opportunity Continue
yield and compare
cost of capital
with Opportunity EG < Cost of
given
cost capital = Sell
Decision on Shares
sale of shares Gain at MPS
Compare pre- level =
Opportunity merger MPS with Continue
cost not given post-merger Loss at MPS
equivalent MPS level = Sell
shares
Concept 27 – Decision on Sale of Shares

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Value of Original Shareholders

Post-merger value of AC and TC shareholders

assuming no gain in merger

Value of AC Shareholders Value of TC shareholders

Note 1 Note 1

Concept 13 – Value of Original Shareholders

Note 1
Pre merger value of AC + TC
Value of AC shareholders = ( ) x Shares held by AC shareholders
Pre merger shares of AC + Shares issued to TC
Pre merger value of AC + TC
Value of TC shareholders = ( ) x Shares issued to TC shareholders
Pre merger shares of AC + Shares issued to TC
Overall Gain = Post-merger value -
(Pre-merger value of AC and TC)

True cost of merger (or) net cost of NPV of merger (or) Gain of AC
merger (or) Gain of TC Shareholders shareholders

Gross Cost - Pre-merger value of AC Total gain - Net cost of merger

Concept 4 – Gain from Merger

Post -merger EPS

Stock Offer Cash Offer (no shares issued to TC)

Post merger PAT PATof AC + PAT of TC − after − tax Interest cost

Shares of AC + Shares issued to TC Shares of AC

Concept 5 and 6 – Post-Merger EPS

Book value per share (Value of Networth divided by

Number of equity shares)

Liabilities Side Assets Side

SC + Reserves − Fictitious assets Total assets − Fictitious assets − CL − Debt − Preference

No of shares No of shares

Concept 16 – Book value per share

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Free Float Market Capitalization (Shareholding by non-promoters (or)

Shareholding by Public)

Free-float market capitalization = Overall market capitalization x %

shareholding by non-promoters

Concept 14 – Free Float Market Capitalization

Impact of bonus issue/Split

Increase in no of shares and Overall Market Capitalization will

EPS/MPS/BVPS will go down remain same

Concept 17 – Impact of bonus/Split

Compute existing cost
of capital as
𝐎𝐯𝐞𝐫𝐚𝐥𝐥 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬
+𝐆
Value of TC business 𝐄𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐯𝐚𝐥𝐮𝐞
Impact of Revision in
will increase in case
Growth rate of Firm Compute revised value
growth rate increases
of business as
𝐎𝐯𝐞𝐫𝐚𝐥𝐥 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬
𝐄𝐱𝐢𝐬𝐭𝐢𝐧𝐠 𝐊 𝟎 − 𝐍𝐞𝐰 𝐆

Concept 19 – Impact of Revision in Growth rate of Firm

ROE
EPS (ROE x
BVPS)
Price (EPS x PE
BVPS
Multiple)
PE Multiple

Concept 15 – Components of Price

Closer to lower
limit if TC is
Stronger company is one stronger
Final ER
with better PE, Growth,
(Negotiation)
Brand, Cost of capital, ROE Closer to upper
limit if AC is
stronger

Concept 18 – How is final exchange ratio decided in negotiation

Taken as equal to
Real value of
Intrinsic value MPS in absence of
company
information

Concept 20 – Intrinsic value

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Adverse parameters are

We should take ER as
Exchange ratio those which an
equal to base values and
based on adverse organization wants to
no switching should be
parameters minimize such as NPA,
done in these cases
Expense Ratio, COGS Ratio

Concept 22 – Exchange Ratio based on adverse parameters

Ratios related to Bank Merger

GNPA in Rupees Networth

GNPA % = x 100 CAR % = x 100
Advances Risk Weighted Assets

Concept 23 – Ratios related to Bank Merger

Normal Approach
[(PAT of AC of year 0 +
PAT of TC of Year 0) x (1 +
Post-merger growth of
merged firm)] + Synergy
Post Merger PAT of Gain
Next year Retained earnings are
already re-invested Post merger PAT of
Year 2 = [Post-merger
[PAT of AC of year 0 + AC PAT of year 1] x (1 +
Growth Rate] + [PAT of TC Merged company
of year 0 + TC Growth Growth Rate)
Rate] + Synergy Gain

Concept 28 – Post-merger PAT if retained earnings have already been re-invested

Post bonus Number of shares

Promoter Shares held by Promoters
=
shareholding is Desired Promoter shareholding %
reduced to comply
with SEBI Norms and
this is done by giving Number of bonus
Bonus ratio = New shares
free shares only to shares allotted = (Post
allotted to Minority:
minority shareholders bonus number of
Existing shares held by
shares) - Existing
minority
shares

Concept 25 – Bonus issue to reduce Promoter Holding

Fund available for Merger in

case of Cash Consideration

Maximum Debt Maximum New debt Available Total Fund =

Post Merger = = Total debt - cash and Maximum New
Networth x Existing debt of AC cash debt + Cash and
(Debt/Equity) and TC equivalents cash Equivalents

Concept 30 – Fund Available for Merger

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Post merger shareholding

Existing shares in AC + Existing shares in TC x ER

Post − merger overall shares

Concept 31 – Post-merger shareholding of a shareholding who has shares both in AC and

TC

Distribution of shares to TC shareholders in case of partly

paid shares

Convert partly ER = Shares Allot shares based on

paid shares into alloted: Total this to fully paid and
equivalent fully Fully paid partly paid
paid shares shares shareholders

Concept 29 – Distribution of shares in case of Partly Paid Shares

Value of debt of Individual debt values

merged firm = Value of is weighted average of
debt of AC + Value of various values at
debt of TC different scenarios
Valuation of debt and
equity of Merged firm Individual Equity
Value of equity of
values is weighted
merged firm = Value of
average of various
equity of AC + Value
values at different
of equity of TC
scenarios

Concept 32 – Valuation of Debt and Equity (Not a Logical Item)

EAES or PAT
ROE =
Amount of equity

ROE = NP Margin x Asset Turnover x

Equity Multiplier

PAT Asset Turnover Assets

NP Margin = Sales Equity Multiplier =
Sales = Equity
Assets

Assets = Debt + Equity

if no information
Concept 24 – ROE as per Dupont Framework

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CR = Items increasing
Compute capital
NW - Items decreasing
Reserve
NW
Internal
Reconstruction
Prepare revised
Balance sheet post
reconstruction giving
effect to changes

Concept 19 of Business Valuation Chapter – Internal Reconstruction

Promoters can enjoy allied benefits such as higher

remuneration due to majority shareholding. Hence they
Minimum need to be compensated for the same
consideration for
promoters Value of allied benefits
Minimum Price = Existing MPS +
No of shares held by promoters

Concept 26 – Minimum Consideration for promoters to relinquish Promoter Holding

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