FM Brahmastra

CA Intermediate (New Syllabus)

INDEX
Chp
Chapter Name Page No.
No.

3 Ratio Analysis 3.1 – 3.6

4 Cost Of Capital 4.1 – 4.3

5 Capital Structure 5.1 – 5.4

6 Financing Decisions - Leverages 6.1

7 Investment Decisions 7.1 – 7.7

8 Divident Decisions 8.1 – 8.3

9 Working Capital Management 9.1 – 9.8

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FM Brahmastra CA Inter New Syllabus
CHAPTER 3 – RATIO ANALYSIS

Liquidity Ratios Long-term Solvency Ratios / Leverage Ratios

Capital Structure Ratios

Current Ratio Current Assets
Current Liabilities Equity
Equity Ratio
Total Funds
Quick Ratio or Quick Assets Quick assets = CA – inventory
Acid Test Ratio Current Liabilities – prepaid exp Total Debt Long Term Debt
Debt Ratio OR
Total Funds Total Funds
Cash & Bank Bal + Marketable Securities
Cash Ratio / Current Liabilities Preference Share Capital
Preference Ratio
Absolute Or, Capital Employed
Liquidity Ratio
Cash & Bank Bal + Current Investments LTD Total Debt
Debt to Equity OR
Current Liabilities Equity
Ratio Sh. Fund

Cash & Bank Bal + Net Receivables + Marketable Securities Owned funds → Proprietary Ratio
Basic Defense Total Assets → Financed by
Interval Daily Operating Expenses / No. of Days [FA + CA] Borrowed funds → Debt to Total
or Assets Ratio
Interval Measure Current Assets – Inventories – Prepaid Expenses
Debt to Total Total Outside Liabilities Total Debt
Daily Operating Expenses OR
Assets Ratio Total Assets Total Assets
Proprietary Fund
Daily Operating Cost of Goods Sold + Selling, Admin & Other General Exp Proprietary Ratio
- Depreciation & Non Cash Exp Total Assets
Expenses
No. of Days in a year Fixed Cost Bearing Funds
Capital Gearing Non-Fixed Cost Bearing Funds
Net Working Ratio PSC + LTD
Current Assets – Current Liabilities =
Capital Ratio
ESC + R&S

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FM Brahmastra CA Inter New Syllabus
CHAPTER 3 – RATIO ANALYSIS

Capital Structure Income Statement

Equity Share Capital Particulars Amt

+ Reserves & Surplus Sales xxx
- Fictitious Assets Less Variable Cost xxx
- P&L Dr. Bal [Acc. Losses]
Contribution xxx
Equity
Less Fixed Cost ( excluding dep & int) xxx
+ Preference Share Capital
Earnings Before Interest, Tax, Depreciation & Amortization [EBITDA] or
Shareholders’ Fund or xxx
[PBITDA]
Net Assets or
Net Worth or Less Depreciation & Amortization xxx
Proprietary Fund
Earnings Before Interest & Tax [EBIT] or [PBIT] [Operating Profit] xxx
+ Long Term Debt Notes:_____________________________________________________________________
Less Interest
___________________________________________________________________________ xxx
Capital Employed
[Total Funds invested in business] ___________________________________________________________________________
Earnings Before Tax [EBT] or [PBT] xxx
___________________________________________________________________________
Less Tax xxx
Alternative Formula
___________________________________________________________________________
Net Assets Total Total Earnings After Tax
= - xxx
Or Net Worth Assets Liabilities __________________________________________________________________________
[EAT] or [PAT] or [Net Profit]
= [FA + CA] - [LTD + CL] Less Preference Dividend xxx
Capital =
FA + [ CA – CL ] Earnings for Equity Shareholders [EFES] xxx
Employed
= FA + WC Less Dividend for Equity Holders xxx
Note: When LTD = 0, Retained Earnings xxx
Capital Employed = Proprietary Fund = Sh. Fund

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FM Brahmastra CA Inter New Syllabus
CHAPTER 3 – RATIO ANALYSIS

Fixed Assets Sales Cost of Goods Sold

Long-term Solvency Ratios / Leverage Ratios OR
Turnover Ratio Fixed Assets Fixed Assets
Coverage Ratios Sales Cost of Goods Sold
Capital Turnover OR
Debt-Service Earnings available for debt services Ratio Capital Employed
Capital Employed
Coverage Ratio Interest + Instalments Current Assets Sales Cost of Goods Sold
(DSCR) OR
OR Turnover Ratio Current Assets Current Assets
EBITDA Sales
Working Capital OR Cost of Goods Sold
Interest + Instalments Turnover Ratio Working Capital Working Capital
Where, Sales Cost of Goods Sold
OR
Net Operating Income or EADS Inventory/ Stock Average Inventory Average Inventory
= PBIT → [PAT + Tax + Int] Turnover Ratio Op. Stock + Cl. Stock
Where, Average Inventory =
(+) Loss on sale of F.A. & other Adjustments [Non operating exp] 2
(+) Non Cash Exp [ Dep & Amortization]
Inventory Holding Average Inventory
12 mts/365 days/52 weeks OR
Interest Coverage Earnings before interest and taxes (EBIT) period Or Daily/Monthly/weekly COGS
Inventory T/O ratio
Inventory Velocity
Ratio Interest
Raw Material R.M Consumption
Preference Net Profit after taxes (PAT) Inventory T/o
Ratio Average R.M. Stock
Dividend
Preference dividend liability
Coverage Ratio Receivables Credit Sales
EBIT + Fixed Charges (Debtors) T/o Average Accounts Receivable
Fixed Charges Ratio
Coverage Ratio Interest + Fixed Charges
Average Accounts Receivable 12 months/52 weeks/360 day
OR
Activity / Efficiency / Performance / Turnover Ratios Receivables Average Daily Credit Sales Receivable Turnover Ratio
(Debtors’) Velocity Credit Sales
Total Assets Sales OR
Cost of Goods Sold Average Daily Credit Sales =
Turnover Ratio No. of days in year (say360)
Total Assets Total Assets

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FM Brahmastra CA Inter New Syllabus
CHAPTER 3 – RATIO ANALYSIS

Activity / Efficiency / Performance / Turnover Ratios d) Expenses Ratio

Payables Cost of
Annual Net Credit Purchase COGS
(Creditors) Goods Sold x 100
Average Accounts Payables Sales
Turnover Ratio (COGS) Ratio
Operating Administrative exp. + Selling &
Payable
12 months/52 weeks/360 day Expenses Distribution OH
Velocity/ Average Accounts Payable x 100
OR Ratio
Average Sales
Average Daily Credit Purchases Payables Turnover Ratio
payment period Operating COGS + Operating Exp. x 100
Ratio Sales
Profitability Ratios
Financial Financial Exp x 100
Profitability Ratios Related to Sales Exp Sales
Ratio
a) Gross Profit Financial Exp = Interest + Equity & Pref Dividend
Gross Profit
x 100
Ratio Sales
Operating Profit
b) Net Profit Net Profit Earnings after taxes (EAT)
x 100 OR x 100
Ratio Sales Sales Sales Sales Sales Gross Profit Net profit
(-) COGS (-) [COGS (-) Op. cost (-) Op.Exp (-) Non
Pre-tax Profit Earnings before taxes (EBT) (-) Operating Operating
x 100 + Operating
Ratio Sales Exp Exp] income
(+) Non
Op Exp
Earnings before
c) Operating Operating Profitx x 100
100 OR interest & taxes (EBIT)
Profit Ratio Sales COGS Ratio + GP Ratio = 100%
Sales Op. cost ratio + Op. profit ratio = 100%

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FM Brahmastra CA Inter New Syllabus
CHAPTER 3 – RATIO ANALYSIS

Profitability Ratios Related to Overall Return on Assets/ As Assets are also financed by lenders, hence ROA can be
Investments calculated as-
Return / Profit / Earnings Net Profit after taxes + Interest
a) Return on x 100
Investment ROA =
Investment Average Total Assets or Average Tangible Assets or
OR
(ROI) Average Fixed Assets
Profitability Ratio x Investment Turnover Ratio ii) Return on
Assets (ROA) EBIT (1-t)
Return on Total Assets (ROTA) =
The concept of investment varies and accordingly there are Average Total Assets
three broad categories of ROI
ROCE (Pre-tax) = EBIT x 100 EBIT (1-t)
Capital Employed Return on Net Assets (RONA) =
Average Net Assets
i) Return on
ROCE (Post-tax) = EBIT (1-t)
Capital x 100
Employed Capital Employed iii) Return on Net Profit after taxes − Preference dividend (if any) x 100
(ROCE) Equity (ROE)
Equity
ROCE (Post-tax) = PAT + Interest (1-t) x 100
Capital Employed As per Du Pont Model → ROE has three components

Net Profit after taxes

Average Total Assets

ii) Return on Net Profit after taxes

OR
Assets (ROA) Average Tangible Assets
Return on Total Net Profit after taxes
Net Profit after taxes Shareholders = x 100
OR Fund Total Shareholders Fund (incl. Pref Capital)
Average Fixed Assets

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FM Brahmastra CA Inter New Syllabus
CHAPTER 3 – RATIO ANALYSIS
Profitability Ratios Required for Analysis from Owner’s Point
of View Profitability Ratios related to market/ valuation/ Investors

a) Earnings per Net profit available to equity shareholders Market Price per Share (MPS)
a) Price- Earnings
Share (EPS) Number of equity shares outstanding Ratio (P/E Ratio) Earning per Share (EPS)

b) Dividend per Total Equity Dividend Dividend ± Change in share price

x 100
Share (DPS) Number of equity shares outstanding Initial Share Price
b) Dividend and OR
c) Dividend Pay- Dividend per equity share (DPS) Earning Yield
Dividend per Share (DPS)
out Ratio (DPR) x 100
Earning per Share (EPS)
Market Price per Share (MPS)

Other Ratios related to DPS Earnings Yield or Earning per Share (EPS)
x 100
Earnings Price (EP)
Market Price per Share (MPS)
Retained Earning Retained Earning Ratio
per Share (REPS) Number of equity shares
Profitability Ratios related to market/ valuation/ Investors
EPS DPS + REPS
c) Market Value Average share price Closing Share Price
OR
Dividend Pay-out Total Eq. Dividend DPS /Book Value per Equity ÷ No. of equity
OR Equity ÷ No. of equity shares
Ratio (DPR) Share (MVBV) shares
Earning per Eq Share EPS
Total Eq. Dividend DPS Market Value of equity and liabilities
Dividend Rate OR
FVPS d) Q Ratio Estimated replacement cost of assets
FV of ESC
OR
Retention ratio Retained Earnings REPS Market Value of a Company
OR
[b] EFES EPS Assets’ Replacement Cost

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FM Brahmastra CA Inter New Syllabus
CHAPTER 4 – Cost Of Capital
Cost of Long Term Debt (Kd)
Cost of Convertible Debentures

Cost of Redeemable Debt → Holders of convertible debentures

Cost of Irredeemable Debt
have an option on maturity to either

Kd = Interest x (1-t)
NP Approximation Method YTM or IRR Method
Receive Cash Or Receive Specified
Calculate NPV of relevant cash no. of equity
➢ Net proceeds mean flows at 2 discount rates, such shares
issue price less issue (RV – NP) that
expenses. I (1-t) + NPV @ higher rate = -ve
n NPV @ lower rate = +ve → Calculation of cost of convertible
Kd =
➢ If current market price debentures is same as that of
is given in question, (RV + NP) Year Cash flows redeemable debentures
then Issue Price = CMP 1) Approximation method or,
2 0 NP or CMP 2) YTM/IRR Method
➢ If issue expenses are
not given then 1 to n Interest net of tax [I(1-t)] However difference lies in calculation of
assume, IE = 0 Redemption Value.
n Redemption value (RV)

Lower NPVL Higher - Lower

IRR = +
Rate Rate Rate
NPVL - NPVH
Amortisation of Bond
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FM Brahmastra CA Inter New Syllabus
CHAPTER 4 – Cost Of Capital
COST OF EQUITY SHARE CAPITAL Realised Yield approach
(Ke) 2 ways to calculate Ke as per above method

Growth If ques mentions If ques mentions

Dividend Price Earnings Price Capital Asset opening price & opening & closing
Approach or
Approach Approach pricing model closing price (at price of every year
Gordon’s Model
maturity) & along with
dividend dividend
= D1 1 D1 payments every payments every
Ke EPS Ke = Ke = Rf + β (Rm – Rf)
or + g year year
P0 PE 0 1 2 3 0
P0 1 2 3
P0 Ratio

➢ D1 = Expected Dividend Rm – Rf = Po D1 D2 D3 Po P1 P2 P3
➢ Po = Current Market Price (Ex Dividend) Market Risk Premium
➢ Ex Div Price = Cum Div Price (-) DPS D1 = D2 =
β (Rm – Rf) =
➢ If Floatation Cost is given, then subtract Security Risk Premium
it in denominator→ [ P0 – FC ] Calculate Ke by i) Calculate returns
➢ g = b (x) r using “YTM/IRR” of each year →
method
[Illus 10] (1 + r1) = P1+D1
Generally, Ke = Cost of Retained Earnings (Kr)
However, difference comes when floatation cost & personal tax exists Po
(1 + r2) = P2+D2
➢ If personal tax [tp] is given in ques P1
Kr = Ke (1-FC) (1-tp)

➢ If we have to calculate both Ke & Kr & Ques mentions → issue price, FC, & CMP {illu. 13} n (1+r1) x (1+r2)…….x (1+rn) - 1
Ke =
▪ For Ke (assuming new issue of equity shares) → Po = Issue Price – F.C
▪ For Kr → Po = C.M.P

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FM Brahmastra CA Inter New Syllabus
CHAPTER 4 – Cost Of Capital

Cost Of Preference Share Capital (Kp) Floatation Cost

Floatation cost is the cost which a company incurs while

issuing a security [ shares, deb etc]
Cost of Irredeemable Preference Cost of Redeemable Preference Shares They are aka. Issue Expenses.
Shares E.g. Legal Fees, Registration fees, Commission, listing exp, etc.

Annual Pref Div (Pd) (RV – NP) Treatment of Floatation Cost

Kp =
Pd +
Net Proceeds n ✓ If F.C. id given in “%” form → then logically F.C. should be
Kp =
calculated on Issue Price.
[But, if issue price is not given & C.M.P. is given →
(RV + NP)
➢ Net proceeds mean issue then use CMP as IP ]
price less issue expenses.
2 ✓ However if Ques specifically mentions to calculate F.C. on
➢ If current market price is FACE VALUE → then do so
given in question, then Where,
✓ If new issue of Deb/share → N.P. = Issue Price (-) F.C.
Issue Price = CMP ➢ if R.V. is not given in Ques, then
✓ If existing Deb/share → N.P. = Market Price (-) F.C.
assume FV = RV
➢ If issue expenses are not ➢ YTM/IRR method can also be used. (If Choice of weights
given then assume, IE = 0 ques mentions to do so)

WEIGHTED AVERAGE COST OF CAPITAL (WACC) Market value

Book value
Proportion / Cost of ▪ No separate MV of R&S
Sources of Finance Amount Wi x Ki
Weights (Wi) Captial (Ki) ▪ Thus, MV of equity shares is
to be divided as per
Equity Share Capital xxx We Ke We x Ke
to
Retained Earnings xxx Wr Kr Wr x Kr
Pref Share Captial xxx Wp Kp Wp x Kp MV of ESC MV of R&S

Long Term Debt xxx Wd Kd Wd x Kd BV of ESC BV of ESC

MV of x MV of x
xxx WACC Equity BV of ESC (+) BV of R&S Equity BV of ESC (+) BV of R&S

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FM Brahmastra CA Inter New Syllabus
CHAPTER 5 – Capital Structure

Value of the firm Note :

1) In this chapter we will mainly study about “capital structure theories”, where
we assume, that a firm has only
Before Tax After Tax Two sources of finance

NOI NOI (1-t) Equity Debt

Ko Ko
2) In this chapter, EBIT = Net operating Income = NOI

OR When tax exists No taxes

Vf = Mkt Value of Equity + Mkt Value of Debt NOI NOI
(-) Interest (-) Interest
= Net income + Interest
Ke Kd EBT Net Income [EBT = EAT = EFES]
(-) Tax
Value of Firm (Vf) = S + D
Net Income [EAT = EFES] NI = NOI - Interest

Cost of Capital Or

Ko = (Cost of debt x weight of debt) NI = (NOI – Interest) (1-t)

+ (Cost of equity x weight of equity)
Ko = [{Kd x D/ (D+S)} + {Ke x S/(D+S)}]
______________________________________________
Notes:
Ko = [{Kd x Wd} + {Ke x We }] __________________________________________________
OR __________________________________________________
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Overall cost of capital =
𝑬𝑩𝑰𝑻
𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝒕𝒉𝒆 𝒇𝒊𝒓𝒎
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FM Brahmastra CA Inter New Syllabus
CHAPTER 5 – Capital Structure

Net The increase in debt in the capital

Capital Structure Theories
Operating structure leads to increase in Ke such
Income that Ko remains constant.
Net
NI Approach suggests, a firm should have maximum (NOI) Thus, Vf does not change by the amount
Income
debt in its capital structure → for minimizing Ko & Irrelevan Approach of debt in total capital.
(NI)
thereby maximizing Vf ce Theory
Approach Propositions of MM Approach (without
tax)
A firm should increase leverage (debt) only upto (capital 1) Vf [Levered or unlevered] = NOI/Ko
Traditional
Optimum point, where Ko is minimum & Vf is structure Modigliani-
Approach
maximum is Miller Value of Lev Co. = Value of Unlev Co.
irrelevan (MM)
t to the Approach- 2) Ke of Levered Co [KeL] > Ke of
As per this approach, VL > VUL value of Unlevered Co [Keul]
Relevance 1958
the firm) (Without
Theory VL = VUL + Tax Advantage …OR
Tax) KeL = Ko + [Ko-Kd] D/S
VL = VUL + [Debt x Tax Rate]
(capital
structure 3) Capital Structure does NOT affect
Steps to solve Ques of MM Approach (with tax)
decision is Ko or value of firm
relevant Modigliani NOI (1-t)
to the Step 1 VuL = Arbitrage
- Miller
value of KouL
(MM) Case I: When Value of Levered > Value of Unlevered
the firm) Approach- • Step 1: Sell (assuming we have 10% equity) Shares of Levered
1958 (With Step 2 VL = VuL + Tax Advantage [Debt x t] Co. & receive cash
Tax) • Step 2: Personally Borrow an amount equal to 10% of (Debt of
Levered Co.) at the same interest rate of levered cos. debt.
NOI (1-t)
Step 3 Ko of levered co. =
• Step 3: Buy 10% Equity of Unlevered Co.
VL
✓ Now balance cash left will be →
NI (NOI – Int) (1-t) (Amt recd from shares + Debt Taken) – Value of Unlev Co. 10% sh.
Step 4 Ko of levered co. = =
S VL - D • Step 4: Calculate Return due to arbitrage (which will be “0”) &
you will be left with balance cash

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FM Brahmastra CA Inter New Syllabus
CHAPTER 5 – Capital Structure
Alternatively from step 3, we can also do the following (when que asks to calculate Pecking Order Theory
INCREASE in return due to arbitrage) This theory suggests that capital structure decisions are
• Step 3: Buy Equity of Unlevered Co. of the WHOLE AMOUNT→ (Amt recd from affected by manager’s choice of source of capital.
shares + Debt Taken) A Manager will always prefer to give priority to those sources
✓ Now balance cash left will be → 0 which reveal least amount of info to others.
• Step 4: Calculate Return due to arbitrage (which will now have some positive A co. issues –
value) ▪ Debt → when it is positive about future earnings.
Case II: When Value of Unlevered > Value of Levered ▪ Equity → [External equity / New equity shares] → issued
• Step 1: Sell (assuming we have 10% equity) Shares of Unlevered Co. & receive when a company is doubtful about future earnings &
cash Retained earnings [internal equity] is insufficient.
• Step 2: Buy 10% Equity & Debt of Levered Co.
✓ Now balance cash left will be → ▪ Thus, managers will raise funds in following ORDER-
(Amt recd from shares + Debt Taken) – Value of Unlev Co. 10% shares i. Internal Finance → Retained Earnings
ii. Debt
• Step 3: Calculate Return due to arbitrage (which will be “0”) & you will be iii. Equity share → Last option
left with balance cash
Alternatively from step 2, we can also do the following (when que asks to calculate Optimal Capital Structure
INCREASE in return due to arbitrage)
EBIT-EPS-MPS Analysis
• Step 2: Buy Equity & Debt of Levered Co. of the WHOLE AMOUNT→ value should
In these type of questions, a company would require funds for
in proportion to Debt to Equity Ratio of Levered co.
a project. Further ques will mention about Expected EBIT &
✓ Now balance cash left will be → 0
alternative options of financing the required amount.
• Step 3: Calculate Return due to arbitrage (which will now have some positive First we will calculate “EPS” of each alternative.
value)

If PE Ratio is not given If PE Ratio is given

Trade-Off Theory

VL = VuL + Tax Advantage - Cost of Financial Choose the alternative ▪ MPS = EPS x PE Ratio
Distress with highest EPS ▪ Calculate for each
alternative
As per trade off theory, as leverage (amt of debt) increases, there will be a trade- ▪ Choose the alternative
off between - Tax shield on interest [Tax adv] & Cost of Financial Distress with highest MPS

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FM Brahmastra CA Inter New Syllabus
CHAPTER 5 – Capital Structure

If question does NOT give value of “Expected EBIT” after Financial Break-Even Point [BEP]
additional investment, then –
1) First calculate “Existing ROCE” = Existing EBIT
It is the minimum level of EBIT needed to satisfy all the fixed financial charges,
Existing Cap. Employed. i.e. interest & pre. Dividend
2) Then assuming ROCE will remain same,
It is the Amount of EBIT where, EPS = 0 of a particular alternative of financing.
New EBIT = (New Cap Emp) x ROCE
(EBIT – Int) (1-t) - PD
Indifference point = 0
No. of Eq. shares

▪ AKA. EPS Equivalency Point

▪ It I the amount of EBIT where, value of EPS is equal in two PD
F.BEP wala EBIT = + Interest
alternative options of financing. (1-t)

(EBIT1-Int)(1-t) - PD (EBIT2-Int)(1-t) - PD
=
No. of Equity shares No. of Equity shares Sales BEP Financial BEP
At what level (amt) of sales At what level (amt) of EBIT
▪ If amount of ESC is same under two financial plans
(alternative), then

EBIT = 0 EPS = 0
No Indifference Or Many (infinite)
Point Indifference points

Sales (EBIT – Int) (1-t) - PD

(-) VC = EPS = 0
If after tax cost of source If after tax cost of source Contribution No. of Eq. shares
[other than ESC] is NOT [other than ESC] is SAME (-) FC
SAME under both plans under both plans EBIT 0
We find out this EBIT, where EPS = o

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FM Brahmastra CA Inter New Syllabus
CHAPTER 6 – Financing Decisions - Leverages

Formula of Leverages Alternative Formula Margin of Safety and Operating Leverage

OR
When Pref Div does not exist When PD exists Sales - BEP Sales
Degree of MOS = x 100
Operating Sales
% ∆ EBIT Contribution Contribution
Leverage DOL = DOL = DOL =
% ∆ Sales EBIT EBIT Sales-BEP Sales PV Ratio
MOS = x
Sales PV Ratio

Degree of EBIT EBIT

% ∆ EPS EBIT DFL = MOS =
Financial DFL = DFL =
Contribution
Leverage % ∆ EBIT EBT EBT – PD
1-t 1
Degree of =
Operating leverage Margin of
safety (in %)
Degree of % ∆ EPS Contribution
Combined DCL = Contribution DCL =
DCL = EBT – PD
Leverage % ∆ Sales
EBT
1-t

Formula of BEP Sales Formula of MOS Sales Combined Analysis of DOL & DFL
DOL DFL Comments

In Units In Amount In % In Units In Amount In % Moderate Total Risk. → Best

Combination
Fixed Cost Fixed Cost EBIT EBIT EBIT 1 Low DOL → Low F.C → High EBIT
Fixed Cost Low High
Or High DFL → Can take Adv. Of T.O.E
Contribution PV Ratio Contribution Contribution PV Ratio Contribution DOL High Financial risk is balanced by
per unit per unit lower operating Risk.

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FM Brahmastra CA Inter New Syllabus
CHAPTER 7 – Investment Decisions

Capital Budgeting Process Traditional OR Non-Discounting Techniques

Initial Investment
Payback
Planning → Evaluation [NPV] → Selection → Implementation → Control period Annual C.I

Review
Payback Average annual cash in flow
Reciprocal
Purpose of Capital Budgeting Initial investment

1) Substantial Expenditure Average annual net income

2) Irreversible Decision
3) Long time period → Affects long term profitability Average or initial Investment
4) Complex Decision → Multiple factors are involved Where, Average Investment = Avg funds which
remain blocked during the lifetime of the project.
Capital Budgeting Techniques = Value of Int @ Beginning (+) Value of Invt @ End

2
Traditional OR Non-Discounting Time Adjusted OR Discounting Accounting
Techniques Or
Techniques rate of
return = 1
1) Payback Period
1) Net Present Value (NPV)
(ARR)
( Initial Invt. – Salvage Value) + Salvage
method 2 Value (SV)
2) Profitability Index (PI) Or
2) Payback Reciprocal
3) Internal Rate of return (IRR)
method
3) Accounting Rate of return = 1 Working
4) Modified IRR ( Initial Invt. – SV) + +
(ARR) SV Capital
5) Discounted Payback period 2
(if any)
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FM Brahmastra CA Inter New Syllabus
CHAPTER 7 – Investment Decisions
Time Adjusted OR Discounting Techniques Time Adjusted OR Discounting Techniques

Sum of PV of cash inflow discounted @ WACC[Ko] - initial Sum of PV of C.I discounted @ Ko

investment
Initial investment
Or
C1 C2 Cn
= + +……..+ (-) Initial
(1+Ko) 1
(1+Ko) 2 (1+Ko)n Investment
Sum of Initial Sum of Sum of
> > Initial > Initial
PV of CI Invt PV of CI Invt PV of CI Invt
Year Particulars Or Cf Df Dcf

How to take decision as per NPV Method? NPV > 0 NPV = 0 NPV < 0
Net [+ve] [-ve]
Present NPV > 0 NPV = 0 NPV < 0 Profitability
Value
Index (PI)
(NPV)
Accept Accept/ Reject Reject
method P.I. > 1 P.I. = 1 P.I. < 1

NPV = Profit
Accept Accept / Reject Reject
1) When NPV is +ve → It means that the project is able to the the project the
generate return more than our project project
expectation [Ko]

1) When NPV is -ve → It means that the project is not able

to generate returns as per our
expectation [Ko]

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FM Brahmastra CA Inter New Syllabus
CHAPTER 7 – Investment Decisions

Time Adjusted OR Discounting Techniques Time Adjusted OR Discounting Techniques

IRR is the discounting rate at which ▪ Steps of solving MIRR Questions

Sum of PV of cF @ IRR = Initial Investment Step 1: All cashflows [except initial investment] are to be
re-invested till the end [terminal year] of the project,using
i.e, when IRR is discounting rate, then NPV = 0 WACC as compounding rate.

This will result in a single cashflow at the end of the

NPVLR project, i.e, “Terminal Cf”.
Lower Rate + (HR – LR)
NPVLR - NPVHR Step 2: MIRR is the rate at which

Here, we calculate NPV at 2 discounting rates, such that Modified Terminal Cf

= Initial Investment
NPVLR → +ve
IRR (1 + MIRR) n
Internal
Rate of & NPVHR → -ve
return Then, calculate MIRR by using “Dirty Power” method on
(IRR) ➢ How to take decision as per IRR method ? calculator
method
➢ How to take decision as per MIRR ?
IRR > Ko IRR = Ko IRR < Ko MIRR > Ko MIRR = Ko MIRR < Ko

Accept the Accept / Reject Reject the

Accept Accept / Reject Reject
project the project project
the the project the
project project “Discounted Payback Period” is the time taken to recover
Discounted the initial investment of the project in discounted
Join Telegram Channel of MVSIR- @camvsir Payback cashflow terms
Instagram Channel of MVSIR- @ca_mohnishvora period ➢ How to take decisions as per DPP ?
Buy books & classes of MVSIR- www.mvsir.in Projects having Lower DPP shall be selected.
Enroll in FM/SM classes from- www.ultimateca.com

CA Mohnish Vora (MVSIR) mvsir.in 7.3

FM Brahmastra CA Inter New Syllabus
CHAPTER 7 – Investment Decisions
Cash Inflow Vs. Cash Outflow Treatment of Various Amounts

▪ When we actually receive money, due to purchase of Working WC Required (At Yr=0) → Cash Outflow
asset. Capital WC Released (At last year) → Cash Inflow

Opportunity Cost of next best alternative foregone.

Cash ▪ When due to purchase of an asset → an expenditure
Cost Considered as Cash Outflow
Inflow which was happening earlier, is now saved. This is
also considered cash inflow. Sunk Cost Irrelevant for decision making. NOT an outflow

[Eg → Tax saving due to Depn, Rent saved due to Allocated

Irrelevant for decision making. NOT an outflow
Purchase of a factory] Overheads

▪ When we actually pay money, due to purchase of

Block of Assets
asset.

▪ When due to purchase of an asset → an income which ➢ Case 1:

Cash ▪ Ek hi asset tha. [No other asset is block] Profit → STCG
Outflow we used to receive, will now b NOT received.
▪ Usse hi hamne seel kar diya. Block will cease to exist. Or
[Jo income mil rahi thi, vo ab nahi mil rahi, new aseet ▪ Jis year sell karte hain machine → uss year mei dep.
ke wajah se calculate Nahi karte. Loss → STCL
Eg → Hospital - Commission]
➢ Case 2:
▪ More than one asset in the block.
Treatment of Various Amounts
▪ Usme sirf 1 asset sell kar diya. Block will still continue.
Depreciation is NON-CASH Exp. So NOT an outflow
Depreciation
But, Tax Saving on Dep is INFLOW
Sale value of WDV of WDV of
Sale value
>
1 machine Block <
Opportunity Cost of next best alternative foregone. Block
Cost Considered as Cash Outflow
• No STCL
Sunk Cost Irrelevant for decision making. NOT an outflow • We will calculate • STCG
depreciation on balance • Additional Tax due
Allocated to STCG will be
Irrelevant for decision making. NOT an outflow WDV. Further, the tax saving
Overheads outflow
on Dep. will be cash inflow.

CA Mohnish Vora (MVSIR) mvsir.in 7.4

FM Brahmastra CA Inter New Syllabus
CHAPTER 7 – Investment Decisions
Special cases in capital budgeting
a) Capital Rationing b) Projects with unequal life
Sometimes while evaluating mutually – exclusive projects, problem arises
Sometimes due to resourse [capital] constraints [rationing], a company in comparing NPV of projects having UNEQUAL LIFE.
may have to select some projects amount various projects, all having Such situations can be dealt with -
positive NPV

Replacement chain Equivalent Annualised

Independent or Divisible Non-Divisible method criterion [EAC]
projects projects
▪ AKA common life method
▪ Projects where either ▪ Projects which can be ▪ Illustration 14 ▪ Step 1 : Compute NPV of all
→ Whole project or accepted or rejected wholly, projects.
i.e, part project cannot be ▪ Project A
→ Part project can be selected
accepted 0 1 2 3 4 5 ▪ Step 2 : Compute PVAF of
projects as per the respective
life.
▪ If only a part of project is ▪ Ranking is done on the basis
of “Absolute NPV” (40L) 8L 14L 13L 12L 11L
selected, then both initial
▪ Step 3 : Compute
investment & NPV are reduced ▪ Project B
pro-rata. ▪ We will make combinations NPV
of projects as per Capital 0 1 2 3 4 5 EAC =
▪ Projects are ranked as per NPV available & select the PVAF
per rupee Invested = NPV combination with highest & compare the same
(20L) 7L 13L 12L
Initial NPV 7L 13L
(20L)
investment
0 1 2 3 4 5 EAC net inflows EAC net outflows
▪ Amount will be invested as per (NPV) (NPV)
above ranking, until all funds
are used.
(10L) 3L 9L Choose the Choose the
(10L) 3L 9L project with project with
(10L) 3L 9L Higher EAC Lower EAC

CA Mohnish Vora (MVSIR) mvsir.in 7.5

FM Brahmastra CA Inter New Syllabus
CHAPTER 7 – Investment Decisions
ADJUSTED PRESENT VALUE [APV]
• APV is calculated to show separately, the advantage of financing a Old M/C 0 10
project using DEBT. (purch 3 yrs ago)

Adjusted PV = Base case NPV + PV of tax shield on Int. (-) Issue cost
0 10
NEW M/C
(total life 10 yrs)
ADJUSTED DISCOUNT RATE [ADR]

Annual C. I. where APV = 0

ADR = Incremental Approach
Total funds Raised as DEBT Total Approach
(follow this in exams)
Separately calculate NPV Agar new m/c leke old wale ko
REPLACEMENT OF MACHINERY of old & new M/C replace kar diya toh
STEP 1 : Calculation of initial cash outflow Old M/C → NPV 
(if new m/c is Purch & old is sold ) New M/C → NPV Incr. CI (-) Incr. C.O. = Incr. NPV
STEP 2 : Calculation of incremental Base for Depreciation. 
STEP 3 : Calculation of Incremental PBDT Then compare, If incr. NPV is positive, then
STEP 4 : Calculation of Incremental NPV If NPV of NPV of purchase new M/C
New M/C old M/C

Incr. Incr. Incr. Incr. Incr.
Yr. Df DCF Purch new m/c
PBDT Depr. PBT PAT CFAT
(3) (4) (5)
(1) (2)
= (1)-(2) = (3) x (1-t) = (2)+(4) If old m/c is the only machine If old m/c is part of block of
Sum of PV of Incremental CF in block of asset assets having other m/c also
(+) P. V. of Incremental Salvage value [illu 18 & complier 66] [pp – 11]
(-) Initial Cash outflow  Then  then
Incremental NPV The value of new m/c will not The value of new m/c will be
be added to the WDV of old added to the WDV of old m/c.
Replace old m/c, if Incremental NPV is +ve m/c

CA Mohnish Vora (MVSIR) mvsir.in 7.6

FM Formulas CA Inter New Syllabus
CHAPTER 7 – Investment Decisions

Kya tax calculate karna hain loss pe ?

ICAI SM PP 9 Q40 of FM Q32 of FM

compiler compiler

Ques mentions ki Ques me CG/CL ko Ques mentions

loss can be set-off ignore karne NAHI → use SLM method
from profits of bola hain → Loss cannot be c/f
subsequent years

Use WDV method Ignore tax saving

for depreciation due to loss

Jis year ka Subsequent

Ques 62 of FM
loss hain, us ye ke profit MC ke last year me Compiler
year tax mei adjust SV – op. WDV = STCG/STCL
saving NAHI karna loss
nikalna pichle saal ➢ Ques silent
ka about loss c/f
STCG STCL ➢ Existing profit
For correct
making co.
amt of tax of
subsequent
year. Additional Tax Toh ab jab loss
tax saving aaega, toh uss hi
lagega = STCL x year me, tax savings
tax rate consider karna Join Telegram Channel of MVSIR- @camvsir
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Tax saving = loss x Buy books & classes of MVSIR- www.mvsir.in
tax rate Enroll in FM/SM classes from- www.ultimateca.com

CA Mohnish Vora (MVSIR) mvsir.in 7.7

FM Brahmastra CA Inter New Syllabus
CHAPTER 8 – Dividend Decisions
THEORIES OF DIVIDEND [ Balanced additional fund to be raised by issuing → new (n1) eqn sh.
@ price P1 ]
RELEVANCE THEORY TRADITIONAL THEORY
IRRELEVANCE THEORY iii. No. of equity shares to be issued for valance funds required [n1]
Dividend decisions are • Linter’s Model
• Dividend decisions relevant. • Graham & Dodd Bal funds read. for investment
are irrelevant. n1 =
Model P1
• Whether a co. pays MPS will change
dividend or not → according to the
value of MPS remains amount of dividend paid iv. Calculation of value of firm
SAME [No charge]
 (n + n1) P1 + E - I
Walter’s Gordon’s Vf =
M. M. Approach Model Model (1 + Ke)

STEPS FOR SOLVING M. M. APPROACH QUESTION RELATED TO DIVIDEND

DECISION
Calculate the following 4 things, in two case : ❖ Formula of theoretical MPS [walter’s model]
CASE I : Dividend are not paid
D + (E – D) (r/Ue)
CASE II : Dividend are paid MPS =
Ue
i. Calculation of price at the end of 1st year [P.]
P1 = P0 (1 + Ke ) – D1
ii. Calculation of funds required for investment ❖ Proposition of Walter

Particular Amount Correction

Situation Type of co. Optimum DPR between size of
Earning Xx dividend & MPS
Less : Dividend (xx)
r > Ke Growth co. 0% Negative
Retained earnings xx
Total amount required for investment xx r < Ke Declining co. 100% Positive

Balance (Additional) funds required for invt. xx r = Ke Constant co. 0 – 100% No co-relation

CA Mohnish Vora (MVSIR) mvsir.in 8.1

FM Brahmastra CA Inter New Syllabus
CHAPTER 8 – Dividend Decisions
Proposition of Gordon IMPORTANT POINTS
• r > Ke → share price will increase → DPR decrease
REPS Ret Earnings
Or 1) Retention ratio [b] = or
• r < Ke → share price will decrease → DPR increase EPS EFES
Situation Type of co. Optimum DPR = 100% - DPR
r > Ke Growth co. 0%
2) When “ke” is not given in Question directly, But PE ratio is given, then
r < Ke Declining co. 100%
1 EPS
r = Ke Normal co. 0 – 100% Ke = = [Earnings price approach]
PER MPS

a. Zero growth 3)
• Current dividend • Expected to pay div.
D1 • Last year dividend D0 • Div at end of 1st year D1
Theoretical MPS = P0 = • Had paid dividend • Next year div.
Ke
❑ Expected to pay dividend → assuming dividends are expected to grow
b. Constant Growth Model [Gordon] by ___% → then consider DPS it “D0”

D0 (1+g) D1 E1 (1-b)
P0 = or or
Ke -g Ke - g Ke – b.r Traditional Theories of Dividend

When data of EPS [E] & retention ratio [b] is given in question, then
a) Graham & Dodd Model b) Linter’s model
prefer formula (3)
P0 = m DPS + EPS D1 = D0 + [(EPS × target DPR)-Do] × Af
c. Variable Growth model [not part of Gordon]
3
D1 D2 Dn Sv Note: Note:
Intrinsic value = + +………+ + Value of multiplier “m” will be Value of Adjustment factor [Af]
(1+Ke)1 (1+Ke)2 (1+Ke) n (1+Ke)n given in Question will be given in Question

CA Mohnish Vora (MVSIR) mvsir.in 8.2

FM Brahmastra CA Inter New Syllabus
CHAPTER 8 – Dividend Decisions
Dividend Discount Model

Zero Growth Constant Variable

Growth Growth

D1 D1 D1 D2 RVn
Po = Po = Po = + +…+
Ke Ke - g n
1 + Ke (1 + Ke) 2 (1 + Ke)

Dividend

Dividend Rate DPS DPR

% ₹ per share %

Total Per share Total

wala data FVPS x Div EPS x DPR
wala data Equity Div
use karke rate
use karke
No. of
equity
shares
Equity Div DPS
Face value of FVPS
equity shares Join Telegram Channel of MVSIR- @camvsir
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DPS Buy books & classes of MVSIR- www.mvsir.in
Total Equity Div [ 100% - b ]
EPS Enroll in FM/SM classes from- www.ultimateca.com
EFES
CA Mohnish Vora (MVSIR) mvsir.in 8.3
FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – WORKING CAPITAL MANAGEMENT

Chp 9 – Unit 1
Approaches of WC Investment
➢ Working capital is the amount (capital) which is used by a
business organization to meet its current (short – term)
obligations. CONSERVATIVE
AGGRESSIVE MODERATE
➢ In other words, it is the amount used for carrying out day to • In between these • WC → high level
day operations of the organization. • WC is kept at two approaches • Adv. → higher sales
minimum level due to liberal credit
➢ The concept of working capital can be explained through two • Adv. → lower • Balance between policies, increase in
angles. financial cost risk & return, goodwill among
• Disadv. → stock due to efficient suppliers.
out situation use of funds. • Disadv. → cost of
ON BASIS OF VALUE ON BASIS OF TIME  Capital , Bad debt ,
High risk & poor Inventory obsolete,
liquidity Shortage of liquidity
 in long run.
Gross WC Net WC Higher 
  Return on total Low risk
Current Current (-) Current assets &
assets Assets liabilities Greater liquidity
(in short. term)

Lower return on
Total Assets
Permanent WC Fluctuation WC
• Aka. Base WC • Aka. Temporary WC
• Min. amount invested • Arises due to
in CA at all times fluctuation in
• Can be financed using sales, in order to
long – term sources of meet seasonal
finance demand.

CA Mohnish Vora (MVSIR) mvsir.in 9.1

FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – WORKING CAPITAL MANAGEMENT
ESTIMATION OF WORKING CAPITAL NEEDS Receivables = Estimated Cr. Sales (×) Estimated cost (×) Avg Rec.
(Debtors) 12 mts / 365d/ 52w of sales P. V. Collection period

1) CURRENT ASSET 2) RATIO OF SALES 3) RATIO OF FIXED

HOLDING PERIOD INVESTMENTS If cash cost Basis If Ques mentions to calculate
Here, it is assumed
1stpref. → Cash cost of sales debtors value on selling price,
This method is based on that investment in Here, WC is calculated
operating cycle concept. CA changes with as a percentage of 2nd pref. → Cash COGS then do so [pp 14]
 charges in sales fixed investment
Will use it in this chapter. [WC → % of sales] [WC → % of FA]
Effect of Double Shift on working capital
Net WC cycle = R + W + F + D (-) C
Due to working on double shift quantity of
➢ Production → double
NOTE :
➢ RM stock → double (p.u. value may change due to discount)
Calculated ➢ FG stock → double
RM stock RM consumed
➢ WIP stock → remains same
On ➢ Debtors balance → double (if selling price remains same)
Calculated
Creditors Credit → RM purchase NOTE :
On VC total value charges.
RM consumed = RM Purchase + Opening RM – Closing RM
When production VC is constant PER UNIT
➢ Number of operating cycles in a year (in times) charges
FC is constant in total
No. of days / Months / weeks in year
FC P. U. value charges.
Net WC cycle

Annual op. cost

Amount of WC reqd. =
No. of op. cycles in a year

CA Mohnish Vora (MVSIR) mvsir.in 9.2

FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – WORKING CAPITAL MANAGEMENT

❖ Calculation of WC on cash – cost basis NOTE :

1) In some questions, ICAI has considered
→ When nothing is mentioned in Question separately, it is always logical Admin OH → related to Production → PP7 …………..& in other que,
to calculate WC on “ cash – cost Basis” Admin OH → General (not related to prod.) → Illu 4 & PP4
Here, Debtors are valued at cash cost of sales & not total sales also,
depreciation & other Non-cash Exp are ignored. 2) When question mentions, it is “newly commenced business” it means
opening balance will be “O”

❖ Statement of cost (Required for FM question) ESTIMATION OF WORKING CAPITAL REQUIREMENT

Particulars Working Amount (Rs.)
A) Current Assets
Particulars Amount (Rs.)
R. M. Stock
Direct material WIP Stock
(+) direct labour (wages) FG Stock
(+) direct Exp. (MFG Exp.) Debtors / Bills Rec.
Prepaid Exp.
Prime cost
Cash Bank Balance
(+) op. WIP
(-) CS WIP Total CA / Gross WC
Factory cost B) Current Liabilities
(+) admin overheads (related to production) Creditors / Bills Pay.
Outstanding Wages
Cost of production
Outstanding Overheads
(+) op. FG stock
Tax Payable
(-) CS FG stock
Total CL
Cost of goods sold
(+) Selling & Distribution OH C) Excess of CA over CL [A - B]
(+) Admin overheads (General) D) Add : Safety margin
[only if given in Question ]
Cost of sales
E) Net WC Required [C + D]

CA Mohnish Vora (MVSIR) mvsir.in 9.3

FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – WORKING CAPITAL MANAGEMENT
IMP POINTS WHILE SOLVING QUESTIONS If you ……………. Then ……… EFFECT ON WC CYCLE
1. Admin Exp Ko “ Not related to prod “ hi You release cash from the
Collect receivable (debtors) faster Decrease
lete hai If que is silent. Lekin jaise cycle
PP – 7, isko related to production liya
Your receivables soak up
hai, kyuki, Collect receivables (debtors) slower Increase
cash.
Sales – GP = COGS (ye amt. mei admin Exp
included tha) Get better credit (in terms of duration or You increase your cash
Decrease
amount) from suppliers. resources.
2. Debtors ki value (Jab Ques silent ho)
Shift inventory (stocks) faster You free up cash Decrease
Sales pe le sakte hai → lekin generally cash
cost basis follow karna zyada logical hota Move inventory (stocks) slower You consume more cash. Increase
hai
❖ Cash Budget Chp 9 – Unit 2
Toh, for debtors It is used to plan & control cash receipts & payments. It represents cash requirements of business
1st preference : cost of sales during the budget period.
Agar que mei Admin Exp & selling Exp diya Cash budget [format]
hai, toh cost of sales pe hi lena chahiye
debtors ko. Particulars Month 1 Month 2 Month 3
2nd preference : COGS a) Opening cash Bal.
If Qn → Admin & selling exp → NAHI diya b) Receipts
then COGS pe le lo Debtors ko. • Cash sales
• Collection from decisions [on credit sales ]
3rd preference : sales • Other Receipts
PP 3 → mei bal sheet banana bola, our WC
nikalne bola uske hisab se Total receipts
Now, bal sheet mei debitors ki value toh,
c) Payments
“sales” pe hi hoti hai isliye is que mei
• Payment to creditors
humne sales pe hi liya debtors ko.
• Wages
Also so if que mentions to calculate • Overheads
debitors on selling price or sales → then do • Interest / dividend
so. • Tax
• Other payments

CA Mohnish Vora (MVSIR) mvsir.in 9.4

FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – WORKING CAPITAL MANAGEMENT

Total payments • When cash balance touches lower limit [zero]

Transfer from marketable securities account to cash account is made.
d) Excess of receipts over payments [a + b - c]
[sell securities]
e) Surplus to be invested deficit to be borrowed
• When cash balance stay between (h, z) or (z, o), i.e. high & low limits
f) Closing balance [d - e] No transaction between cash & marketable securities is made

❖ Cash Management Models

I) William J. Baumois EOQ Model

2×𝑈×𝑃
Optimum cash balance  C = → Miller orr Model is more realistic since it allows variations in cash
𝑆
balance within lower & upper limits.
Where, The finance manager can set limits according to firms liquidity
C = optimum cash Balance requirements.
U = Annual (or monthly) cash Disbursement [Requirement]
P = Fixed cost per transaction I. Economic order Quantity (EOQ)
S = opportunity cost per rupee per annum [or per month]
Chp 9 – Unit 3

2×𝐴×𝑂
II) Miller – orr cash management Model [1966] EOQ =
→ According to this model, net cash outflow is completely stochastic. 𝐶
[having random probability or pattern that may be analysed Where,
statistically but may not be predicted precisely] A = annual requirements of raw materials [or monthly]
C = carrying cost p. u. p. a.
→ When changes in cash balance occur randomly the application of O = ordering cost per order
control theory [like miller – orr model] serves useful purpose
→ In this model, control limits are set for cash balances these limits are II. Lead Time
“h” → upper limit i “z” → Return point, The no. of days / months it takes between when a purchase order is
zero → lower limit placed to replenish products & when the order is received in
Wherehouse.
• When cash balance reaches upper limit [h] III. Lead time consumption
Transfer of cash equal to “h - z” is invested in metastable securities 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒
account. [Buy securities] LTC = Annual Requirement ×
365𝑑𝑎𝑦𝑠/𝑤𝑒𝑒𝑘𝑠/12𝑚𝑜𝑛𝑡ℎs

CA Mohnish Vora (MVSIR) mvsir.in 9.5

FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – WORKING CAPITAL MANAGEMENT
IV. Re order stock level (ROL) g) Expected profit after Tax [e - f]
The level at which fresh order should be placed for replenishment of
stock. B) Opportunity cost of Invt. In
Receivables
ROL = lead time consumption (+) minimum stock level (if any) C) Net benefits [A - b]

Minimum stock level is the level of stock which is to be maintained at

all times. It is aka. Safety stock. Advice : The policy _______ should be adopted since the net benefits are
highest
V. Average stock level
NOTE :
1
ASL = minimum stock level (+) × 𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑞𝑡𝑦
2
→ Fixed cost = [avg. cost (-) variable cost ] (×) no. of units in present
❖ Evaluation of credit policies Chp 9 – Unit 4 policy
[when Qn is silent → use total approach, use incremental approach, total cost of 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑟𝑎𝑡𝑒 𝑖𝑓 𝑟𝑒𝑡𝑢𝑟𝑛
→ opportunity cost = (×) (×)
only if Qn specifically asks] credit sales 365 𝑑𝑎𝑦𝑠 100

Present Proposed Proposed

Particulars
policy policy I policy II ➢ There is one more method to evaluate credit
policies → Expected rate of return method [use this only if Question
A) Expected profit mentions]
a) Credit sales
b) Total cost 𝑖𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡
Expect rate of return = (×) 100
Other than bad debits 𝑖𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙 𝑖𝑛𝑣𝑡 𝑖𝑛 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
i) Variable cost
ii) Fixed cost → Above method can be used only after making table of incremental
approach.
c) Bad debts → Here, policy with highest exp rate is selected.
d) Cash discounts
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e) Expected net profit before tax
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[a – b- c- d]
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CA Mohnish Vora (MVSIR) mvsir.in 9.6

FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – WORKING CAPITAL MANAGEMENT
Factoring of receivables
iii) Evaluation of Factoring Proposal
MV foods ltd. Transfer the right to collect factoring agency
Particulars Amt. (Rs.)
receivables to factor
A) Savings due to factoring
Admin cost 1,40,000
• Credit sales = Rs. 360 lac • Commission = 1% Bad debts [360L × 2%] 7,20,000
• Avg collection period = 30 days • Advance against receivables
• Bad debt loss = 2% @ interest 15% P. a. & after Total saving 8,60,000
• Debtors admin cost = ₹1,40,000 with holding reserve of 10%
(annual) B) Costs due to factoring
Factoring commission
360
[360L × 1% ] or [30,000 × 30 ] 3,60,000
𝟑𝟎
i. Avg level of receivables = 360L × = Rs. 30L 360 4,00,500
𝟑𝟔𝟎 Interest charge [33,375 × 30
]
ii. Calculation of net amount of Advance
Total cost 7,60,500
Particulars Amt. (Rs.) C) Net Benefits to firm [A - B] 99,500
Factoring commission [30L × 1%] 30,000 Since net benefits due to factoring are positive [savings cost] factoring
Reserve [30L × 10%] 3,00,000 proposal should be accepted.
Total (a) 3,30,000
❖ Rate of effective cost of factoring
Thus, amt. available for advance 𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑓𝑎𝑐𝑡𝑜𝑟𝑖𝑛𝑔 𝒏𝒆𝒕 𝒂𝒏𝒏𝒖𝒂𝒍 𝒄𝒐𝒔𝒕 𝒐𝒇 𝒇𝒂𝒄𝒕𝒐𝒓𝒊𝒏𝒈
Avg level of receivables 30,00,000 × 100 or × 100
𝑎𝑚𝑡 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑎𝑑𝑣𝑎𝑛𝑐𝑒 (𝑔𝑟𝑜𝑠𝑠) 𝒂𝒅𝒗𝒂𝒏𝒄𝒆 𝒕𝒐 𝒃𝒆 𝒑𝒂𝒊𝒅 (𝒏𝒆𝒕)
Less : total (a) from above (3,30,000)
Where,
Amt. available for advance 26,70,000 Advance to be paid (net amt of adv)
Less : int on advance @ 15% pa for 30 days = amount available for advance (-) interest deducted by factor
30
(26,70,000 × 15% × 360) (33,375) • Company should avail factoring services,
When,
Net amt. of advance (Adv to be paid) 26,36,625 Effective cost of factoring } lower than } existing cost of borrowings

CA Mohnish Vora (MVSIR) mvsir.in 9.7

FM Brahmastra CA Inter New Syllabus
CHAPTER 9 – Working Capital Management

Cost of not taking Discount [CNTD] Chp 9 – Unit 6

Working capital finance may be classified into -
Chp 9 – Unit 5
1. Simple interest method
d 365 Spontaneous Source Negotiable Source
CNTD = x X 100
100-d t Naturally arise in the They have to specifically negotiated
course of business with lenders
2. Compound interest method a) Trade credit a) Inter-Corporate loans & deposits
b) Bill Payable b) Commercial papers
100 365 c) Accrued Expenses c) Public Deposits
CNTD = t -1 d) Factoring
100-d
e) Bank credit [loans]
Cash credit , Bank overdraft, Bill
Where, d = amt of discount Discounting ,Bill Acceptance,
t = Gap period = Total credit period (-) Discount period Line of credit, Letter of credit,
Bank Guarantee
Note: If question does not mention anything about the type of interest
Maximum Permissible Bank Finance [MPBF] By Tandon Committee
[simple or compounding] → then use SIMPLE Interest method only.
Lending Norms
▪ When,
Return on alternative Reject the discount
> CNTD →
investment (opp. Cost) given by creditor
1st Method 2nd Method 3rd Method

Or Current Assets
Current Assets Current Assets
▪ When, (-) Core Current Assets
(-) Current Liab (-) 25% from long
Return on alternative Accept the discount Soft core C.A
< CNTD → WC Gap term sources
investment (opp. Cost) given by creditor (-) 25% from long
(-) 25% from long Bal C.A
term sources
term sources (-) Current Liab
Bal C.A
MPBF MPBF
(-) Current Liab
MPBF

CA Mohnish Vora (MVSIR) mvsir.in 9.8