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Profitability ratios

Profitability ratios measure the company's use of its assets and control of its expenses to
generate an acceptable rate of return

Gross margin, Gross profit margin or Gross Profit Rate[7][8]


Operating margin, Operating Income Margin, Operating profit margin or Return on

sales (ROS)[8][9]

Note: Operating income is the difference between operating revenues and operating
expenses, but it is also sometimes used as a synonym for EBIT and operating profit.
This is true if the firm has no non-operating income. (Earnings before interest and
taxes / Sales[11][12])
Profit margin, net margin or net profit margin[13][14]

Return on equity (ROE) [14]

Return on investment (ROI ratio or Du Pont Ratio)[6]

Return on assets (ROA)[15]

Return on assets Du Pont (ROA Du Pont)[16]

Return on Equity Du Pont (ROE Du Pont)

Return on net assets (RONA)

Return on capital (ROC)

Risk adjusted return on capital (RAROC)


Return on capital employed (ROCE)

Note: this is somewhat similar to (ROI), which calculates Net Income per Owner's Equity
Cash flow return on investment (CFROI)

Efficiency ratio

Net gearing

Basic Earnings Power Ratio[17]

Current ratio (Working Capital Ratio)[18]

Acid-test ratio (Quick ratio)[18]

Cash ratio[18]
Operation cash flow.
Average collection period[3]

Degree of Operating Leverage (DOL)

DSO Ratio[19]

Average payment period[3]

Asset turnover[20]

Stock turnover ratio[21][22]

Receivables Turnover Ratio[23]

Inventory conversion ratio[4]

Inventory conversion period (essentially same thing as above)

Receivables conversion period

Payables conversion period

Cash Conversion Cycle
Inventory Conversion Period + Receivables Conversion Period - Payables
Conversion Period
[edit]Debt ratio
Debt ratios measure
debt. Debt ratios mea

Debt ratio[24]

Debt to equity ratio[25]

Long-term Debt to equity (LT Debt to Equity)[25]

Times interest-earned ratio / Interest Coverage Ratio[25]


Debt service coverage ratio

The primary market is that part of the capital markets that deals with the issue of new securities.
Companies, governments or public sector institutions can obtain funding through the sale of a
new stock or bond issue. This is typically done through a syndicate of securities dealers. The
process of selling new issues to investors is called underwriting. In the case of a new stock issue,
this sale is an initial public offering (IPO). Dealers earn a commission that is built into the price of
the security offering, though it can be found in the prospectus. Primary markets creates long term
instruments through which corporate entities borrow from capital market.

Features of primary markets are:

 This is the market for new long term equity capital. The primary market is the market
where the securities are sold for the first time. Therefore it is also called the new issue market
 In a primary issue, the securities are issued by the company directly to investors.
 The company receives the money and issues new security certificates to the investors.
 Primary issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business.
 The primary market performs the crucial function of facilitating capital formation in the
 The new issue market does not include certain other sources of new long term external
finance, such as loans from financial institutions. Borrowers in the new issue market may be
raising capital for converting private capital into public capital; this is known as "going public."

The secondary market, also known as the aftermarket, is the financial market where
previously issuedsecurities and financial instruments such as stock, bonds, options,
and futures are bought and sold.

A stock exchange is an entity which provides "trading" facilities for stock

brokers and traders, to trade stocks and other securities. Stock exchanges also provide
facilities for the issue and redemption of securities as well as other financial instruments
and capital events including the payment of income and dividends

The role of stock exchanges

Stock exchanges have multiple roles in the economy. This may include the following:[1]

[edit]Raising capital for businesses

The Stock Exchange provide companies with the facility to raise capital for expansion through
selling shares to the investing public.[2]

[edit]Mobilizing savings for investment

When people draw their savings and invest in shares, it leads to a more rational allocation of
resources because funds, which could have been consumed, or kept in idle deposits with banks,
are mobilized and redirected to promote business activity with benefits for several economic
sectors such as agriculture, commerce and industry, resulting in stronger economic growth and
higher productivity levels of firms.

[edit]Facilitating company growth

Companies view acquisitions as an opportunity to expand product lines, increase distribution
channels, hedge against volatility, increase itsmarket share, or acquire other necessary
business assets. A takeover bid or a merger agreement through the stock market is one of the
simplest and most common ways for a company to grow by acquisition or fusion.

[edit]Profit sharing
Both casual and professional stock investors, through dividends and stock price increases that
may result in capital gains, will share in the wealth of profitable businesses.

[edit]Corporate governance
By having a wide and varied scope of owners, companies generally tend to improve on
their management standards and efficiency in order to satisfy the demands of these shareholders
and the more stringent rules for public corporations imposed by public stock exchanges and the
government. Consequently, it is alleged that public companies (companies that are owned by
shareholders who are members of the general public and trade shares on public exchanges) tend
to have better management records than privately held companies (those companies where
shares are not publicly traded, often owned by the company founders and/or their families and
heirs, or otherwise by a small group of investors).

Despite this claim, some well-documented cases are known where it is alleged that there has
been considerable slippage in corporate governance on the part of some public companies.
The dot-com bubble in the late 1990's, and the subprime mortgage crisis in 2007-08, are classical
examples of corporate mismanagement. Companies like (2000), Enron
Corporation (2001), One.Tel (2001), Sunbeam(2001), Webvan (2001), Adelphia (2002), MCI
WorldCom (2002), Parmalat (2003), American International Group (2008), Bear
Stearns (2008),Lehman Brothers (2008), General Motors (2009) and Satyam Computer
Services (2009) were among the most widely scrutinized by the media.
However, when poor financial, ethical or managerial records are known by the stock investors,
the stock and the company tend to lose value. In the stock exchanges, shareholders of
underperforming firms are often penalized by significant share price decline, and they tend as
well to dismiss incompetent management teams.

[edit]Creating investment opportunities for small investors

As opposed to other businesses that require huge capital outlay, investing in shares is open to
both the large and small stock investorsbecause a person buys the number of shares they can
afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares
of the same companies as large investors.

[edit]Government capital-raising for development projects

Governments at various levels may decide to borrow money in order to finance infrastructure
projects such as sewage and water treatment works or housing estates by selling another
category of securities known as bonds. These bonds can be raised through the Stock Exchange
whereby members of the public buy them, thus loaning money to the government. The issuance
of such bonds can obviate the need to directly tax the citizens in order to finance development,
although by securing such bonds with the full faith and credit of the government instead of with
collateral, the result is that the government must tax the citizens or otherwise raise additional
funds to make any regular coupon payments and refund the principal when the bonds mature.

[edit]Barometer of the economy

At the stock exchange, share prices rise and fall depending, largely, on market forces. Share
prices tend to rise or remain stable when companies and the economy in general show signs of
stability and growth. An economic recession, depression, or financial crisis could eventually lead
to a stock market crash. Therefore the movement of share prices and in general of the stock
indexes can be an indicator of the general trend in the economy.

The money market is a component of the financial markets for assets involved in short-
term borrowing and lending with original maturities of one year or shorter time

Common money market instruments

 Certificate of deposit - Time deposits, commonly offered to consumers by banks, thrift
institutions, and credit unions.
 Repurchase agreements - Short-term loans—normally for less than two weeks and
frequently for one day—arranged by selling securities to an investor with an agreement to
repurchase them at a fixed price on a fixed date.
 Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270
days; usually sold at a discount from face value.
 Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located
outside the United States.
 Federal agency short-term securities - (in the U.S.). Short-term securities issued
by government sponsored enterprises such as the Farm Credit System, the Federal Home
Loan Banks and the Federal National Mortgage Association.
 Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other
depository institutions at the Federal Reserve; these are immediately available funds that
institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds
 Municipal notes - (in the U.S.). Short-term notes issued by municipalities in anticipation of
tax receipts or other revenues.
 Treasury bills - Short-term debt obligations of a national government that are issued to
mature in three to twelve months. For the U.S., see Treasury bills.
 Money funds - Pooled short maturity, high quality investments which buy money market
securities on behalf of retail or institutional investors.
 Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal
of the exchange of currencies at a predetermined time in the future.
 Short-lived mortgage- and asset-backed securities

In economics, a financial market is a mechanism that allows people to buy and sell (trade)
financialsecurities (such as stocks and bonds), commodities (such as precious metals or
agricultural goods), and other fungible items of value at low transaction costs and at prices that
reflect the efficient-market hypothesis.
Earnings per share (EPS)[26]

Payout ratio[26][27]


Dividend cover (the inverse of Payout Ratio)

P/E ratio

Dividend yield

Cash flow ratio or Price/cash flow ratio[28]

Price to book value ratio (P/B or PBV)[28]

Price/sales ratio

PEG ratio

In finance, valuation is the process of estimating the potential market value of a

financial assetor liability.
We can calculate cost of equity capital with following ways:

1. Dividend yield method or Dividend Price ratio method

According to dividend yield method or dividend price ratio method, “Cost of equity capital is
minimum rate which will be equal to the present value of future dividend per share with
current price of a share.

Cost of equity =

Dividend per equity share/ Market price or net proceed of per share


A company issues 1000 shares of Rs. 100 each at a premium of 10%. The company has been
paying 20% dividend to equity shareholders for the past five years and expects to maintain
the same in the future also. Compute the cost of equity capital. Will it make any difference if
the market price of equity share is Rs. 160?



= 20/110 X 100

= 18.18%

If the market price of equity share is Rs. 160.

=20/160 X 100 = 12.5%

At increasing of market price, value of cost of equity capital will decrease.

2. Dividend yield plus growth in dividend method

Dividend yield plus growth in dividend method is based on the assumption that company is
growing and its shares market value is also increasing. In that situation, shareholders want
more than simple dividend, so company can provide some more profit according to growth.
So, we will add it in previous calculated cost of equity capital.

Cost of Equity Capital = DPS/ MPPS or NPPS + Rate of growth in dividends

Ke = DPS/ MPPS or NPPS + G%

A company plans to issue 1000 new equity shares of Rs. 100 each at par. The floatation costs
are expected to be 5% of the share price. The company pays a dividend of Rs. 10 per share
initially and the growth in dividends is expected to be 5%. Compute the cost of new issue of
equity shares.

= 10/100-5 + 5% = 15.53%

If the current market price of equity share is Rs. 150, calculate the cost of existing
equity share capital.

=10/150 +5% = 11.67%

3. Earning yield method

According to this method, cost of equity capital is minimum rate which we have to earn on
market price of a share. Its formula is

Ke = Earning per share / Net proceed or Market price per share


A firm is considering an expenditure of Rs. 60 lakhs for expanding its operations. The relevant
information is as follows:

Number of existing equity shares = 10 Lakhs

Market value of existing share= Rs. 60

Net Earning = Rs. 90 Lakh

Compute the cost of existing equity share capital and of new equity capital assuming that new
shares will be issued at a price of Rs. 52 per share and the costs of new issue will be Rs. 2 per

Earning per share = earning / total number of shares = 90/10

= Rs. 9

Ke = 9/60 X 100

Ke = 15%

Cost of new equity capital

Ke = 9/52-2 X 100 = 18%

4. Realised yield method

One of major limitation of dividend yield method or earning yield method that both methods
are based on estimation of future dividend or earning. There are large numbers of factors
which are uncontrollable and uncertain. And if any financial risk will happen, we can not use it
in future planning or we also can not take any decision related to estimation of return on
investment. So, realised yield method is best method for calculating the cost of equity share

This method is based on actual earning earned on all amount of investment. After this, we try
to know, how much money is financed from equity share capital and reserve amount of past
profits and after this we calculate cost of equity share capital.

Ke = Actual earning per Share / Market price per share X 100

Cost of pref. share capital’s formula is given below.

Cost of Pref. Share capital (Kp) = amount of preference dividend/ Preference share

Kp = D/P

If we have obtained this preference share capital after some adjustments like premium or
discount or pay some cost of floatation, at that time, it is our duty to deduct discount
andcost of floatation or add premium in par value of pref. share capital.

In adjustment case cost of pref. share capital will change and we can calculate it with
following way:-

Kp = D/ NP

D = Annual pref. dividend,

NP = Net proceed = Par value of Pref. share capital – discount – cost of floatation

Or NP = Par value of pref. share capital + Premium

There will no adjustment of tax rates because, dividend on pref. share capital is payable on
net profit after tax adjustment, so need not to do adjustment of tax for comparing it with cost
of debt or cost of equity share capital .

Some, time we issue redeemable preference shares whose amount is payable after some
At the time of maturity, we need to calculate cost of pref. share capital with following

Cost of redeemable pref. share capital =

D = Annual dividend

MV = Maturity value of pref. shares

NP = Net proceeds of pref. shares

N= number of years

This formula is little different from cost of non redeemable pref. share capital because, we
have to add, the benefit which we have given to pref. share capital at the time of maturity.

Suppose, we have to pay Rs. 10, 00,000 but at the time of issue of pref. share, we had paid
Rs. 2 per issue of pref. share. So, net proceed is Rs. 9,80,000 but if this amount is payable
after 10 years at 10% premium, this will also benefit to pref. share capital and total cost of
pref. share capital will increase. Rate of dividend is 10%.

Cost of pref. share capital

= D + (MV – NP )/n / ½(MV +NP) X 100

= 100,000 + ( 10,50,000- 9,80,000 )/ ½ ( 10,50,000 + 9,80,000) x 100

= 100,000 + 7,000/ 10, 15,000 X 100

= 10.54%

If we compare it with simple cost of pref. share capital with following way
Kp = D/P X 100 = 100000 / 10, 00,000 X 100 = 10% it is same as dividend rate but Kpr is
more than Kp. So, Kpr will give you correct result.
Weighted Average Cost Of Capital - WACC

What Does Weighted Average Cost Of Capital - WACC Mean?

A calculation of a firm's cost of capital in which each category of capital is proportionately
weighted. All capital sources - common stock, preferred stock, bonds and any other long-term
debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the
beta and rate of return on equity increases, as an increase in WACC notes a decrease in
valuation and a higher risk.

The WACC equation is the cost of each capital component multiplied by its proportional weight
and then summing:

Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a
project, using the formula:

NPV = Present Value (PV) of the Cash Flows discounted at WACC.

In finance, the cost of equity is the minimum rate of return a firm must offer shareholders to
compensate for waiting for their returns, and for bearing some risk.

The cost of equity capital for a particular company is the rate of return on investment that is
required by the company's ordinary shareholders. The return consists both of dividend and capital
gains, e.g. increases in the share price. The returns are expected future returns, not historical
returns, and so the returns on equity can be expressed as the anticipated dividends on the shares
every year in perpetuity. The cost of equity is then the cost of capital which will equate the current
market price of the share with the discounted value of all future dividends in perpetuity.

The cost of equity reflects the opportunity cost of investment for individual shareholders. It will
vary from company to company because of the differences in the business risk and financial or
gearing risk of different companies.

The cost of equity is calculated by the following formula:

The formula above calculates the cost of equity based on a firm's current rate of return. If one
assumes a perfect market, industry-specific costs of equity reflect the riskiness of particular
industries. A high cost of equity would then indicate a higher-risk industry that should command a
higher return to compensate for the higher risk.

However, there are also a variety of other ways to estimate the cost of equity. For example, using
the CAPM model, the cost of equity is the product of the Market Risk Premium and the
equity's beta plus the risk-free interest rate.

[edit]See also

Other Market R