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FM Formulas

This document contains a list of formulas related to capital structure theory, valuation, and financial management. It includes formulas to calculate: 1. The value of equity, debt, and the firm using capital structure theories. 2. The weighted average cost of capital and opportunity cost of capital for valuation. 3. Dividend policy models like the Walter and Gordon models. 4. The valuation of securities including bonds, preferred shares, and common stock using approaches like discounted cash flow valuation and multiples models. 4. Capital budgeting techniques like NPV, IRR, payback period, and accounting rates of return. 5. The cost of capital including the cost of debt, preferred

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118 views

FM Formulas

This document contains a list of formulas related to capital structure theory, valuation, and financial management. It includes formulas to calculate: 1. The value of equity, debt, and the firm using capital structure theories. 2. The weighted average cost of capital and opportunity cost of capital for valuation. 3. Dividend policy models like the Walter and Gordon models. 4. The valuation of securities including bonds, preferred shares, and common stock using approaches like discounted cash flow valuation and multiples models. 4. Capital budgeting techniques like NPV, IRR, payback period, and accounting rates of return. 5. The cost of capital including the cost of debt, preferred

Uploaded by

rafishogun
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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LIST OF FORMULAS

NAME

FORMULAS

EXPLANATORY NOTES

Capital Structure Theory & Policy


Value of Equity

Value of Debt

Value of the firm


Firms Cost of Capital
Or
WACC

Ve

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

Value of equity means Discounted value of Net Income

Firms Cost of Capital


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

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

Value of debt means Discounted value of Interest

D.
V

Valuation & Financing


Asset Beta

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


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

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

Opportunity cost of
capital

Opportunity cost of capital = RF + ( RM RF)


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

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

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

Valuation of firm

Vf = Free Cash Flow (FCF)


WACC

FCF = EBT(1-t) Dep NWC Capex

Vf =

CCF= FCF + ITS


ITS = Int * Tax Rate

Capital Cash Flow (CCF)


Opportunity Cost of Capital (K0)

WACC= KeWe + Kd(1-t) Wd


Favorable when debt ratio is fixed

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

APV = All equity NPV Value of Financing Effects


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

Dividend Policy
Walter Model

r = opportunity cost of capital


K = cost of capital

Div + r (EPS Div.) /K


K
K

or

Dividend decision depends on Type of organization

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


K
Gordon Model

Growth organization r > K Go for 0% Payout


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

EPS (1- b)
K - br

Derivatives

Future Price

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

NAME
Return on Share

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

Portfolio

Compound Annual Rate


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

EXPLANATORY NOTES
Dividend = Par Value x Dividend Rate

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


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

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

Standard Deviation of
Portfolio

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


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

If cor = 1

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

If cor = -1

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

If cor = 0

2p = x2.wx2 + y2.wy2

Minimum variance
portfolio

wx =

y2 - covxy .
x2 + y2 - 2covxy

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

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

Time Value of Money


NAME
Lumpsum

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

PV = FV .
(1+i)n

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

PV = FV x PVF
PVA = FVx PVFA

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

or

PVA =

FV / A .

[(1+i)n-1]
i

EXPLANATORY NOTES

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

Annuity
(Annuity Due)

FVA = PV x CVFA(i,n)

PVA = FVx PVFA

or

or

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

](1+i)

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

](1+i)

Valuation of Securities
1. Value of Bonds

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


Present Value of Maturity Value
VB =

C
+
(1+r)t
(Annuity)

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

Int = C = Annual Coupon Payment


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

* We can use above formula only when discounting rate


+

Int
(1+Kd) t
(Annuity)

Bn .
(1+Kd) n
(Lumpsum)

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

or
VB = Int * PVFA + MV * PVF

Yield to Maturity

YTM=

C+

M-P
n

.4M +.6P

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

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

Valuation of Preference
Shares

RV= MV = Redemption Values

or
Vp = Div * PVFA + RV * PVF

Valuation of Equity Shares


NAME

FORMULAS

Single Period Valuation

Po = Div1 + P1
(1+r)

No growth Model

P0 = Div1
ke

Constant Growth Model

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

Two Stage Growth

P0 = Div1

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

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

1 n
1+r

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

Div1 = Dividend expected a year hence


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

Growth = Retention Ratio* Return on Equity


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

Price-Earning Approach

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

or

= (b x EPS1) (ROE ke)


ke (ke-g)

Capital Budgeting
Payback Period

Payback Period = Initial Investment


Annual Cash Flow

NPV

NPV = Present Value of Inflow Present value of Outflow

Average Rate of Return

Average Rate of Return (ARR) =

Average Profit
Average Investment

If there is no Scrap Value, than,


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

Initial Investment Scrap Value


2

+ Scrap Value

Cost of Capital
Cost of Debt
Irredeemable
Cost of Debt
Redeemable

B0 = Sales Price of Bond

Kd = Interest / Bo
B0 =

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

MV = Repayment of Debt on Maturity

t=1

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


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

Cost of Irredeemable
Preference Shares

kp = PDIV
P0

Cost of Redeemable
Preference Shares

P0 =

Normal Growth

Supernormal Growth

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

t=1

b= Retained Earning Ratio

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

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

t=1

Ke = Div.
P0
or
Zero Growth

= EPS(1-b)
P0
= EPS
Po

CAPM Approach

[ as b= 0]

Risk free + Risk premium


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

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

kd = Rf + (Rm Rf) d

kd = Cost of Debt

OTHERS
Real Rate
Nominal Rate

Real Rate = 1 + Nominal Rate - 1


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

Rate to be denominated in decimals.

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