Ch-1

Finance- the science and art of using money

Two major sources of Finance:

Debt (loan)
Equity (share issue)

Nazia- debt (obligation, liability, no ownership dilution)

Samia- Equity (no interest payments, pay dividends, raise large sums of money)

Which one is more cost effective?

Debt (tax advantage, interest expense tax deductible)

Limited Liability (liability limited to investment in the company, personal assets cannot be
touched)
Unlimited liability

3 legal forms of businesses:

Sole proprietorship: Haque general store

Source of finance- own savings, loan from family & friends
Decision making- Self
Share of profit/loss- self
Continuity- dies with owner
Liability- unlimited

Partnership- partners bringing in money, loans from banks, partners

Corporation- registered company, raise money through issuance of share (SHAREHOLDERS),

Board of directors, limited liability

Shareholders v/s Stakeholders

Stakeholder (directly or indirectly impacted/ has interest in the company)

Suppliers, employees, customers, competitors, government, creditors, society

All shareholders are stakeholders in the company but not all stakeholders are shareholders in
the company.
What is the major goal of the business firm? MAXIMIZE shareholder wealth/ maximizing the
share price

Sales maximization
Profit maximization (timing of cash flow is important), higher profit might be achieved but
undertaking higher risk, risk component is a factor to be considered
Survival

A Sabiha
year 1 2 3 4 5
cashflow 20,000 30,000 10,000 30,000 10,000
$100,00
B Hridoy
year 1 2 3 4 5
cashflow 50,000 10,000 30,000 5,000 5,000
$100,000
C Rownak
year 1 2 3 4 5
cashflow 20,000 20,000 20,000 20,000 20,000
$100,000

Time value of money

Cashflow sooner than later is preferred

Accrual basis v/s cash basis of accounting

Accruals basis

Sales $100,000
Less: cost (80,000)

Net Profit = $20,000

Cash basis
Sales 0
Less: cost (80,000)

Net Loss= $80,000

Agency Cost: cost arising out of conflict of goals between managers and shareholders

REDUCE agency cost

Align manager performance with company performance (EPS acts as an indicator), Stock
options ,cash bonus

Ch-2
External sources of Finance:

Financial Institutions

Intermediaries between lender and borrower, net supplier of funds (business, government), net
demanders of funds (business, individuals and government)

Commercial Banks:
Investment Banks: assist/advise on investments, IPO (INITIAL PUBLIC OFFERING), MERGERS
(cement their position and secure industry future)

Financial Markets (stock markets, DSE, NYSE,LSE, TOKYO STOCK EXCHANGE)

Primary Market- issuance of NEW shares, IPO, ROBI, LARGETST IPO approval from BSEC, Tk
523.7 crores, Face value Tk 10, 52.37 crore shares issued. Employees – 13.6 crores shares. IDLC.
Walton.

Secondary market- pre-owned/ existing shares traded here

Money market- short term securities are traded. T-Bills (issued by govt. at the risk free rate),
commercial paper (issued by corporations), NCD, Negotiable certificate of deposit ( issued by
the banks)

Capital Market- Bonds (long term debt instrument from diverse group of investors), Common
stock (VOTING RIGHTS), Preferred stock ( GET PREFERENCE OVER PAYMENT OVER COMMON
STOCK)

Private Placement- Sale of a new security directly to a specific investor/ group of investors
Goldman Sach reached out to Warren Buffet to buy their 5% stakes

Broker- intermediary between buyer & seller, fees, responsible for buyers and sellers to meet,
CENTRALIZED TRADING FLOORS
Dealer- market maker, executes order on behalf of the seller, OTC (OVER THE COUNTER),
Commission, NASDAQ. BID-ASK SPREAD

Euro bond market- bonds issued by the govt/corporation denominated in US currency available
to foreign buyers outside USA
Foreign bond market- ISSUED BY FOREIGN CORPORATION/GOVERNEMNT

Taxable Income = $250,000

Tax = $22,250 + (250,000-100,000) * 39%.
= $80,750

Average tax rate= Total Tax/ Taxable Income

= (80,750/ 250,000) *100
=32.3%
Double taxation- taxed twice (corporate & personal tax on the same source of income). Cause-
Seperate Legal Entity

Capital Gain- appreciation of asset , gain by selling asset

Debt. Co No Debt. Co
EBIT 200,00 200,00
Less: interest expense (30,000) -
EBT 170,000 200,000
Less: Tax@40% (68,000) (80,000)
Net Income 102,000 120,000

ST2-1

a. Capital gain= 180,000-150,000= $30,000

b. Taxable Income= 280,000+30,000= $310,000
c. Tax= 22,250 + (310,000-100,000) *39%= $104,150
d. Marginal tax rate= 39%, Average Tax Rate= (104,150/310,000) *100= 33.59%
P2-4

a. Tax on Interest Received= 15,000*40%= $6,000

Tax on Dividend Income= 7,500*40%= $ 3,000
(25,000*30%= $7,500)
b. Net Income= Gross Profit – Operating expense= 520,000- 235,000= $ 285,000

Tax on Net Income 285,000*40%= $114,000

 Earnings available for common stockholders= (285,000-114,000)+ (15,000-6,000)+
(25,000-3,000)= $202,000
c. 25,000*40%= $10,000

TAXABLE INCOME= $250,000

Tax= 22,250+(250,000-100,000)*39%= $80,750
Average tax rate= Total tax / Taxable income= (80,750/250,000)*100= 32.3%

Debt Co. No Debt Co.

EBIT 200,000 200,00
Less: Interest Expense (30,000) -
EBT 170,000 200,000
Less: Tax @ 40% (68,000) (80,000)
Earnings after Tax 102,000 120,000

St2-1
a. Capital gain= 180,000-150,000= $30,000
b. Taxable Income= 280,000+30,000= $310,000
c. Total Tax= 22,250+ (310,000-100,000)*39%= $104,150
d. Marginal tax rate= 39%, Average tax rate=(104,150/310,000)*100= 33.59%

P2-4
a. Tax on Interest Income= 15,000*40%= $6,000
Tax on Dividend Income= 7,500*40%= $3,000
(25,000*30%= $7,500)
b. Net Income = Gross Profit – operating expense= 520,000-235,000= $285,000
Tax on net income = 285,000*40%= $114,000
Earnings Available to common stockholders= (285,000-114,000)+ (15,000-6,000)+
(25,000-3,000)= $202,000
c. 25,000*40%= $10,000

Chapter 3

Ratio Analysis- Analyze business performance through calculation of different ratios/ TOOL to
compare business or compare against industry standards

WHY?
Financial analyst
Current and prospective Shareholders/Investors
Managers
Competitors
Government
Suppliers

Liquidity
How quickly company can convert assets to cash but at its true value

Whether company will be able to meet its obligation as and when they fall due.

Current Ratio= Current Assets/ Current Liabilities= 1,223/620= 1.97 (for every 1 current
liability, 1.97 times current assets available to meet obligation/repay debt)

Benchmark= 2:1

Company A , CR=4:1 (cash remain idle in business)

 Buy non-current assets
 Go for expansion/growth/investment
Company B, CR=0.8:1 (will not be able to meet obligations)
 Sell of inefficient/idle non- current assets
 Take long term loan

Company C, CR= 2.5:1 (inventory = $100,000)

Company D, CR=1.1:1 (Inventory =$40,000)

Acid Test/Quick ratio= (Current assets- Inventory)/ Current Liability=(1,223-289)/620= 1.5

Benchmark =1:1

Company, CR 1.8:1, QR= 0.7:1

Activity Ratios:

Inventory Turnover= COGS/Inventory= 2,088/289= 7.2 times

Average age of Inventory= 365/Inventory Turnover=365/7.2 =51 days

Average collection period= Accounts Receivable/Avg. Sales per day=503/(3074/365)= 60 days

2088x 0.7= 1462
Average payment Period=Accounts Payable/ Avg. purchases per day= 382/ (1462/365) = 96
days

Total assets turnover= sales/ total assets (helps investors understand how efficiently assets are
being utilized to generate sales) = 3074/ 3597= 0.85 (For every $1 of asset, the company
generates 85 cents in sales)

A company has a very large asset base. It is expected that they would slowly turnover their
assets through sales
TAT Low- Sluggish sales, non-current assets not fully utilized, obsolete inventory

Debt ratio (Leverage ratio)= Total Liability/ Total assets=(1643/3597)*100= 45.7%

45.7% of the assets are being financed by debt

Debt Ratio >1 (L>A), Extremely leveraged, might be extremely risky to invest in, solvency of a
firm (Indicator), further loans might be difficult

Creditors look into debt ratio to help determine ability to repay

Times Interest Earned ratio= EBIT/ interest expense=418/93= 4.5 times (operate at a high safety
margin)

Profitability ratios:

Gross profit margin= gross profit/ sales *100= Sales- COGS/sales *100 = 986/3074 *100= 32%

Operating profit margin= operating profit/sales *100= 418/ 3074 *100= 14%

Net profit margin= Earnings available to common stockholders/ sales *100= 221/30174 *100=
7.2%

Earnings Per share= earnings available to common stockholders/ No. of common stock
outstanding= 221,000/ 76,262= $2.89 (indicator of company performance)

Return on Assets= earnings available to common stockholders/total assets= 221/3597 *100=

6.14%, how profitable a company is relative to its assets/ how efficiently assets are used to
generate earnings

Return on Equity= earnings available to common stockholders/Total common equity=

221/1754=12.6%
P/E ratio = 11.1 times ( a premium of 11.1 times greater than avg earnings)

P/E ratio is very high= investors expect high growth in the future, share prices are overpriced or
stock is overvalued

Return on Equity= earnings available to common stockholders/total common equity=

221/1754=13% how profitable a company is relative to equity. Indicator of future growth
estimate of stock and dividends

Du Pont analysis:

Net Profit Margin= Earnings available for common stockholders/ Sales

Total Assets Turnover= Sales/ Total Assets
Return on Assets= Earnings available for common stockholders/Total Assets

ROA= NPM X TAT

ROA= 0.072 X 0.85= 0.0612*100=6.12%
= (Earnings available for common stockholders/ Sales) X (Sales/ Total Assets)

ROA = Earnings available for common stockholders/ Total Assets

ROA (DELL) =4.3
ROA= NPM X TAT
ROA= 2.7 X 1.6

ROA (HOME DEPOT)= 6.5

ROA= NPM X TAT
ROA= 4 X 1.6

FLM = FINANCIAL LEVERAGE MULTIPLIER

ROE= ROA X FLM
=6.14% X (3,597/1,754)= 0.0614 X 2.05
= (Earnings available for common stockholders/Total Assets) X (Total assets/ Total common
Equity)
ROE (13%)= Earnings available for common stockholders/ Total common Equity

ROE (KROGER)= 1.4 (ROA X FLM)= 0.3 X FLM

ROE (WHOLE FOODS MARKET)= 14.5 =8 X FLM
Du Pont Analysis:

Return on Assets= Earnings available to common stockholders/ Total assets

Net Profit Margin= Earnings available to common stockholders/ Sales

Total Assets Turnover= Sales/ Total assets

ROA= NPM X TAT= 0.072 X 00.85= 0.0612*100=6.12%

ROA= (Earnings available to common stockholders/ Sales) X (Sales/ Total assets)
ROA= Earnings available to common stockholders/ Total assets

ROA(DELL)= 4.3
ROA(DELL)= NPM X TAT= 2.7 X 1.6= 4.3

ROA (HOME DEPOT)= 6.5

ROA= NPM X TAT= 4 X 1.6= 6.5

ROE= Earnings available to common stockholders/ total common equity

Financial Leverage Multiplier= Total Assets/ Total common equity= 3,597/ 1,754= 2.05
(BARLETTE)

ROE= ROA X FLM

ROE= (Earnings available to common stockholders/ Total assets) X (Total Assets/ Total common
equity)

ROE= Earnings available to common stockholders/ total common equity

ROE(KROGER)= 1.4
ROE (WHOLE FOODS)= 14.5

ROE(KROGER)= ROA X FLM = 0.3 X FLM

ROE(WHOLE FOODS) = 8 X FLM

Chapter 4

Types of cash flows:

Operating cash flow- day to day operations, directly sales and purchase

Investing cash flow- investment in non-current assets, investment in another company

Financing cashflows- investment in my own company, debt and equity

Baker Corporation

Cashflow statement

As at 20xx

Details $ $

Cashflow from operating

activities:

Net Income 180

Depreciation 100

Decrease in accounts 100

receivable

Decrease in inventories 300

Increase in accounts payable 200

Decrease in accruals (100)

Cash inflow from operating 780

activities

Cash flow from investing

activities:

Increase in non-current (300)

assets

Cash outflow from investing (300)

activities

Cash flow from financing

activities:

Decrease in notes payable (100)

 Increase in long term loan 200

Dividend payment (80)

Cash inflow from financing 20

activities

Increase in cash & 500

marketable securities

Opening cash 500

Closing cash 1,000

Net Income= Dividend+ Retained Earnings

180= Dividend + 100

Dividend= $80

Allied Food products

Gross fixed assets- depreciation= net fixed assets

GFA- 100= 130

CHANGE IN GFA= 130+100= 230

Net income= dividends+ retained earnings

117.5= dividends+ 60

Dividends= 117.5-60= 57.5

NOPAT= net operating profit after taxes= EBIT X (1-TAX)= 370 (1-0.4)= $222

OCF= operating cash flow= NOPAT + depreciation= 222+100= $322

FCF= free cash flow

FCF= OCF- CHANGE IN CURRENT ASSETS INVESTMENTS- CHANGE ON NON-CURRENTS ASSETS

INVSTMENTS

FCF= 322- 0- 300= $22

CHANGE IN CURRENT ASSETS INVESTMENTS= CHANGE IN CURRENT ASSETS- CHANGE IN
(ACCOUNTS PAYABLE + ACCRUALS)

CHANGE IN CURRENT ASSETS INVESTMENTS= 100- 100*= 0

*(700+100)- (500+200)= 100

CHANGE IN NON-CURRENTS ASSETS INVSTMENTS=2500-2200=300

Allied Food products

NOPAT= EBIT(1-TAX)= 283.8 (1-0.4)= $ 170.28

OCF= NOPAT + DEPRECIATION= 170.28 + 100= $270.28

FCF= OCF- CHANGE IN CURRENT ASSETS INVESTMENTS- CHANGE ON NON-CURRENTS ASSETS

INVSTMENTS

FCF= 270.28- 150- 230= $(109.72)

CHANGE IN CURRENT ASSETS INVESTMENTS= CHANGE IN CURRENT ASSETS- CHANGE IN

(ACCOUNTS PAYABLE + ACCRUALS)

190- 40= 150

CHANGE IN NON-CURRENTS ASSETS INVSTMENTS=130 +100= 230

Ch-5
A
year 1 2 3 4 5
cashflow 20,000 30,000 10,000 30,000 10,000
$100,000
B
year 1 2 3 4 5
cashflow 50,000 10,000 30,000 5,000 5,000
$100,000
C
year 1 2 3 4 5
cashflow 20,000 20,000 20,000 20,000 20,000

$100,000

Time value of money

Present value- current value of future cash flow (discounting the cashflows)

Future value-future expected value of current cash flow (compound the cash flows)

*If you invest $10,000 today, you will receive $15,000 in 5 years time. Should you go for the
investment at 10 % interest rate.

Year Cashflow

0 -10,000

1 3,000

2 2,000

3 7,000

4 1,000

5 2,000

Interest rate!

PV= FV/(1+R)^N= 3000/(1+0.1)^1 + 2000/ 1.1^2 + 7000/1.1^3 + 1000/1.1^4 + 2000/1.1^5= PV=

$11,564.2

*You invested $20,000 for 4 years earning an interest of 5 %. How much will you have in your
account after 4 years?

FV= PV (1+R)^N

FV= 20,000(1.05)^4

FV= $24,310

ANNUITY- same cashflow received every year

ORDINARY ANNUITY- cashflow received at the end of period

ANNUITY DUE- cashflow received at the beginning of each period

ANNUITY DUE> ORDINARY ANNUITY ( because of 1 extra compounding)

FV= PV(1+R)^N

FV=1000(1.07)^4 +1000(1.07)^3 + 1000(1.07)^2+1000(1.07)^1+1000

FV=$5,750

OR

FV(ORDINARY ANUITY)= CF X [{(1+R)^N}-1]/R

FV= 1000 X [{(1.07^5)-1}/0.07]

FV= 5,750

FV (ANNUITY DUE)= CF X [{(1+R)^N}-1]/R X (1+R)

FV= 5751 X (1.07)

FV= $6,153

PV= FV/(1+R)^N

PV= 700/(1.08)^1

PV ANUITY= CF/R X {1-1/(1+R)^N}

PV= 700/0.08 X {1-1/(1.08)^5}= $2794.9

PV (ANNUITY DUE)= 2794.4 (1.08)= $3018.49

E5-4

PV=FV/(1+R)^N

PV= 35000/1.09^1 + 50000/1.09^2 + 45000/1.09^3 + 25000/1.09^4 + 15000/1.05^5

PV= $136,402

PERPETUITY- ANNUITY FOR INFINITE TIME

PV= CF/R
I invest $5,000 today for 5 years at a rate of 10% compounded semi-annually. How much will
my investment be after 5 years?

FV= PV(1+R)^N

FV= 5000(1.05)^10

FV=$8,144.7

APR= NOMINAL/STATED RATE

EAR= ACTUAL

PV=FV/(1+R)^N

PV=700/(1.08)^1 +700/(1.08)^2 +…..

PV ANUITY= CF/R X {1-1/(1+R)^N}

CF= PVXR /{1-1/(1+R)^N}

CF= 6000X0.1 / [1-(1/1.1^4)]

CF= $1892.8

• Say you borrow $6,000 at 10 percent and agree to make equal annual end-of-year
payments over 4 years. To find the size of the payments, the lender determines the
amount of a 4-year annuity discounted at 10 percent that has a present value of $6,000.
LAON AMMORTIZATION SCHEDULE:

END OF BEG.YEAR LOAN INTEREST PRINCIPAL END OF YEAR

YEAR PRINCIPAL REPAYMENT PRINCIPAL

1 6000 1892.8 6000X10%=600 1892.8- 6000-

600=1292.8 1292.8=4707.2

2 4707.2 1892.8 4707.2X10%=470.72 1892.8- 4707.2-

470.72= 1422.28=
1422.28 3284.92

3 3284.92 1892.8 3284.92X10%=328.49 1892.8- 3284.92-

2 328.492= 1564.31=
1720.61
1564.31

4 1721 1892.8 1720.61X10%=172.06 1892.8- -

1 172.061=
1721

E5-6

ORDINARY ANNUTY FV=$150,000

RATE= 6%

CF=?

FV(ORDINARY ANUITY)= CF X [{(1+R)^N}-1]/R

150000= CF X {1-(1/1.06^18)}

CF= $150000/ {1-(1/1.06^18)}

CF= $4853.48
P5-9

PV=$200

RATE= 14%

A. FV= PV (1+R)^N

FV= 200 (1.14)^1

FV= $228

B. FV= 200 (1.14)^4

FV= $337.79
C. FV= 200 (1.14)^8
FV=$571.52

P5-14

1 30,000

FV= PV (1+R)^N
FV=30000(1.15)^4
FV= $52,470.19

210,000-52,40.19= $157,529.8 (FV)

PV=FV/ (1+R)^N
PV=157529.8/(1.15)^5
PV=$78,320.16
 P5-48

PV ANUITY= CF/R X {1-1/(1+R)^N}

CF= PVXR /{1-1/(1+R)^N}

CF= 15000X0.14 / {1-(1/1.14^3)}

CF= $6,460.97

END OF YEAR BEG.YEAR LOAN INTEREST PRINCIPAL END OF YEAR

PRINCIPAL REPAYMENT PRINCIPAL

1 15000 6,460.97 15000X14%

2 6,460.97

3 6,460.97

P5-17
18,000 (INVESTMENT)
30,000 (FV)
N=5 YEARS
RATE =10%
PV= FV/ (1+R)^N
PV= 30000 (1.1)^5
PV= $18,627

Chapter 6 Bonds

Bonds-Fixed income security, sell/issued by govt./ corporations (way of raising money)

Maturity-
Face value= $1,000 (least denomination)
Seller perspective (Borrower)- selling a bond Is a way of borrowing money
Buyer perspective (Lender)- is a form of investment, entitle the purchaser a guaranteed
repayment of principal (face value) as well as interest payments (coupon payments)

Factors that influence interest rates:

1. Inflation- persistent rise in the price level with subsequent fall in the value of money
2. Risk- credit risk, default risk
 3. Liquidity preference- long maturity (usually high interest rate) as a compensation for
undertaking higher interest rate risk, inflation risk for extended period

Real interest rate= interest rate without inflation

Risk free rate= real interest rate + inflation premium

Nominal interest rate= risk free rate + risk premium

Bonds can be repurchased- borrowers credit has improved, interest rates have declined; reissue
new bond at the lower interest rate/cost