FORMULA GUIDE BUSINESS FINANCE DECISIONS

FORMULA GUIDE BUSINESS FINANCE DECISIONS

TABLE OF CONTENTS
No. Name Page No. Name Page
1. Return on capital employed (ROCE) 1 20. Profit margin 4
2. Return on shareholder capital (ROSC) 1 21. Current ratio 5
3. Basic earnings per share (EPS) 1 22. Quick ratio 5
4. Accounting rate of return (ARR) 1 23. Gearing ratio 5
5. Payback period (for an investment with 1 24. Debt to equity ratio 5
constant cashflows)
6. Discount factor 2 25. Interest cover 5
7. Changing discount rates 2 26. Receivables turnover 5
8. Equivalent periodic rate (EPR) 2 27. Payables turnover 5
9. Present value annuity factor 2 28. Inventory turnover 5
10. Future value annuity factor 2 29. Theoretical ex-rights price (TERP) 5
11. Perpetuity factor 2 30. Dividend valuation model (without growth) 6
12. IRR interpolation formula 3 31. Dividend valuation model (with growth) 6
13 Modified internal rate of return (MIRR) 3 32. Gordon’s growth model 6
14. Fisher equation (Link between money cost, 3 33. Geometric mean growth rate 6
real cost and inflation)
15. Profitability Index (PI) 3 34. Capital asset pricing model (CAPM) 7
16. DuPont analysis / method 3 35. Market premium 7
17. Expected value 4 36. Beta factor 7
18. Equivalent annual cost 4 37. Alpha (α) 8
19. Sensitivity 4 38. Country risk premium (CRP) 8

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 FORMULA GUIDE BUSINESS FINANCE DECISIONS

TABLE OF CONTENTS
No. Name Page No. Name Page
39. CAPM adjusted for country risk premium 8 54. Modigliani and Miller’s propositions 13
(with taxation)
40. Arbitrage pricing model 8 55. Asset beta, equity beta and debt beta 14
41. Sharpe ratio 8 56. Price/Earnings ratio method 14
42. Treynor index (ratio) 9 57. Earnings yield method 14
43. MV of irredeemable fixed rate debt 9 58. Earnings growth model 15
44. Weighted average cost of capital (WACC) 9 59. Dividend yield method 15
45. Total market value of a company (Subject to 10 60. Purchasing power parity 15
certain conditions)
46. Variance 10 61. Interest rate parity 15
47. Standard deviation 10 62. Leverage 16
48. Co-variance of returns of A & B 10 63. Operating leverage 16
49. Expected return from a two-asset portfolio 11 64. Financial leverage 16
50. Standard deviation of return for a 11 65. Combined leverage 16
two-asset portfolio
51. Expected return from a three-asset portfolio 12 66. Hedge efficiency 16
52. Standard deviation of return for a 12 67. Basis 16
three-asset portfolio
53. Modigliani and Miller’s propositions 13
(no taxation)

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FORMULA GUIDE BUSINESS FINANCE DECISIONS

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Profit before interest and taxation

× 100
(Share capital and reserves + long term debt capital + preference share capital)
Return on capital
1. OR
employed (ROCE)
Profit before interest and tax
× 100
Average capital employed during the year

Profit after taxation and preference dividend

× 100
Share capital and reserves
Return on
2. shareholder capital OR
(ROSC)
Profit after taxation and preference dividend
× 100
Average value of shareholder capital

Basic earnings per Net profit (or loss) attributable to ordinary shareholders during a period
3.
share (EPS) Weighted average number of shares in issue during the period

Accounting rate of Average annual net profit after tax

4. × 100
return (ARR) Average/Initial investment

Payback period (for Initial investment(s)

5. an investment with Annual cash inflows
constant cashflows)

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1 r = the period interest rate (cost of capital)
6. Discount factor (1 + r)n where:
n = number of periods

rx = discount rate over x periods

Changing discount 1 1 nx = number of periods for which rx is the discount rate

7. × where:
rates (1 + rx) nx (1 + ry)ny ry = discount rate over y periods
ny = number of periods for which ry is the discount rate

a = annual rate
(1 + a) = (1 + er)en
Equivalent periodic er = equivalent periodic rate (half yearly/ quarterly/ monthly)
8. OR where:
rate (EPR)
(1 + er)en − 1 = a en = no. of equivalent periods in one year (e.g. '4' in case of
quarterly rate)

Present value
1 1 1 − (1 + r)−n r = discount rate, as a proportion
9. (1 − ) OR ( ) where:
annuity factor r (1 + r)n r
n = number of time periods

Future value (1 + r)n − 1 r = discount rate, as a proportion

10. ( ) where:
annuity factor r
n = number of time periods
1
11. Perpetuity factor where: r = the cost of capital
r

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IRR interpolation NPVA NPVA = NPV at A%

12. A% + ( ) × (B − A)% where:
formula NPVA − NPVB NPVB = NPV at B%

n = the project life in years

nA A = the end-of-year investment returns during the recovery phase of the
√ −1 where:
B project

Modified internal B = the present value of the capital investment in the investment phase
13. rate of return
OR
(MIRR)
PVR = the PV of the return phase
n PVR
√ × (1 × re ) − 1 where: PVI = the PV of the investment phase
PVI
re = the cost of capital

Fisher equation m = money cost of capital

(Link between
14. 1 + m = (1 + r)(1 + i) where: r = real cost of capital
money cost, real
cost and inflation) i = inflation rate

Profitability Index NPV

15.
(PI) Initial investment
DuPont analysis / Net profit Sales Assets
16. ROE = × ×
method Sales Assets Equity

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∑ px p = the probability of each outcome

17. Expected value where:
x = the value of each outcome

Equivalent annual PV of costs over one replacement cycle of length n

18.
cost Annuity factor (1 to n)
NPV of project NPV of project
Sales price = Variable cost =
PV of revenue PV of variable cost
NPV of project NPV of project
Fixed cost = Volume =
PV of fixed cost PV of total contribution
NPV of project NPV of project
Initial cost = Tax rate =
Initial outlay PV of annual tax expense
19. Sensitivity Estimated projet life – Discounted payback period
Life of the project =
Estimated project life
IRR of Project − Discount rate
Sensitivity of discount rate =
Discount rate
Desired change in NPV of project
% change required in variable =
PV of all cashflows of the variable
Note: Where the tax is involved all the present values above indicated need to be after tax.
Profit
20. Profit margin × 100
Sales

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Current assets
21. Current ratio
Current liabilities
Current assets excluding inventory
22. Quick ratio
Current liabilities
Long term debt
23. Gearing ratio × 100
Share capital + reserves + long term debt

Long term debt

24. Debt to equity ratio × 100
Share capital + reserves

Profit before interest and tax

25. Interest cover
Interest charges in the year

Receivables Credit sales

26. times
turnover Average trade receivables

Credit purchases
27. Payables turnover times
Average trade payables

Cost of sales
28. Inventory turnover times
Average inventory

Theoretical ex-rights (Number of existing shares × Price per share) + (Number of new shares × Rights issue price)
29.
price (TERP) Total number of shares after the rights issue

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MV = the share price ex-dividend

Dividend valuation d
30. model (without MV = where: d = the expected constant future annual dividend
growth) re
re = the shareholders’ required rate of return (cost of equity)

MV = the share price ex-dividend

do = the annual dividend for the year that has just ended
Dividend valuation do (1 + g)
31. MV = where: re = the cost of equity
model (with growth) re − g
g = the expected annual growth rate

Therefore, do(1 + g) = expected annual dividend next year or d1

g = annual growth rate in dividends in perpetuity

Gordon’s growth
32. g = br where: b = proportion of earnings retained (for reinvestment in the business)
model
r = rate of return that the company will make on its investments

Geometric mean n value at end of period of n years n = number of terms in the series (e.g. years of
33. √ −1 where:
growth rate value of start growth)

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RE = the cost of equity for a company’s shares

R RF = the risk-free rate of return: this is the return that
Capital asset investors receive on risk-free investments such as
34. pricing model R E = R RF + β(R M − R RF ) where: government bonds
(CAPM) R M = the average return on market investments as a
whole, excluding risk-free investments
β = the beta factor for the company’s equity shares

35. Market premium R M − R RF

βS =
σS βS = beta factor of security S
σM
where: σS = systematic risk of security S
σM = systematic risk of the market as a whole
Covariance of a share with the market
or βS =
Variance of the market
36. Beta factor ρShM σSh σM ρShM = Correlation coefficient of a share’s returns with
or βS =
those of the market
σM 2
ρShM σSh σSh = Standard deviation of a share’s returns
or βS =
where:
σM
σM 2 = Variance of the market
σM = Standard deviation of the market

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37. Alpha (α) Actual expected return − CAPM return

Annualised standard deviation of equity index of developing country

Sovereign yield spread ×
Annualised standard deviation of sovereign bond market in terms
Country risk of the developed market currency
38.
premium (CRP)
Where the sovereign yield spread is the difference between the yields of government bonds in the
developing country and treasury bonds of similar maturities

CAPM adjusted
39. for country risk R E = R RF + β(R M − R RF + CRP)
premium

R E = R RF + β1 (R1 − R RF ) + β2 (R 2 − R RF ) + β3 (R 3 − R RF ) (and so on)

RE = the cost of equity for a company’s shares

40. Arbitrage pricing
β 1, 2, 3 = the beta for factors 1, 2, 3 (i.e. a measure of the risk associated with the
model where:
factor)

R1,2,3 – RRF = the risk-premium associated with factor 1, 2 or 3

RP = return on the portfolio

R P − R RF
41. Sharpe ratio where: R RF = the risk-free rate of return
σp
σp = the risk of the portfolio

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RP = return on the portfolio

Treynor index R P − R RF
42. where: R RF = the risk-free rate of return
(ratio) βp
βp = the beta factor of the portfolio

rd = the cost of the debt capital

Pre-tax cost i
MV = where: i = the annual interest payable
of debt rd
MV of irredeemable t = rate of tax on company profits
43.
fixed rate debt
MV = Ex interest market value of the debt
Post tax cost i(1 − t)
MV = Note that calculations are usually performed on a
of debt Post tax rd
nominal amount of 100 or 1,000

Ke = cost of equity

E × Ke + D × Kd Kd = cost of debt (after tax)

where:
E+D E = market value of equity
Weighted average
44. cost of capital D = market value of debt
(WACC)
In case where there is more than one source of debt finance, then WACC can be calculated as follows:
E × K e + D1 × K d1 + D2 × K d2 + D3 × K d3 + ⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅
E + D1 + D2 + D3 + ⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅⋅

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Total market value

of a company Earnings(1 − t)
45. where: t = rate of tax on company profits
(Subject to certain WACC
conditions)

p = the probability of a given return on the investment

̅ )2 R = the % of that return

46. Variance ∑ p (R − R where:
̅ =
R the average expected return on the investment. This is the
expected value (EV) of the return

p = the probability of a given return on the investment

R = the % of that return
47. Standard deviation ̅)2
√∑ p (R − R where:
̅ =
R the average expected return on the investment. This is the
expected value (EV) of the return

p = the probability of a given return on the

investment

̅̅̅̅ ̅̅̅̅ R A = the % of return on investment A

48. cCo-variance of CoVAB = ∑ p(R A − R A )(R B − R B ) where:

A = the average expected return on investment A

creturns of A & B ̅̅̅̅
R
R B = the % of return on investment B

R B = the average expected return on investment B

̅̅̅̅

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RP = the expected return from the two-asset portfolio

RA = the expected return from investment A

Expected return
49. from a two-asset R P = R A x + R B (1 − x) where: RB = the expected return from investment B
portfolio
x = the proportion of investment A in the portfolio

(1 – x) = the proportion of investment B in the portfolio

σp = √σA 2 x 2 + σB 2 (1 − x)2 + 2x(1 − x)ρAB σA σB

where:

σp = the standard deviation of returns of the portfolio

σA = the standard deviation of returns of investment A

Standard deviation
50. of return for a σB = the standard deviation of returns of investment B
two-asset portfolio
x = the proportion of the portfolio consisting of investment A

(1 – x) = the proportion of the portfolio consisting of investment B

ρAB = the correlation coefficient of the returns of investment A and investment B

ρAB σA σB = the covariance of the returns for investment A and investment B

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̅ A XA + R
RP = R ̅ B XB + R
̅ C XC

where:
Expected return
51. from a three-asset RP = expected return of the portfolio
portfolio
̅ A, R
R ̅ C = are expected returns of assets/ securities A, B and C respectively
̅ B and R

XA , XB and XC = are weightages of assets/securities A, B and C respectively in the portfolio

σp = √σA 2 XA 2 + σB 2 XB 2 + σC 2 X C 2 + 2XA XB ρAB σA σB + 2XA XC ρAC σA σC + 2XB XC ρBC σB σC

where:

σp = the standard deviation of returns of the portfolio

Standard deviation σA , σB , σC = the standard deviation of returns of investment A, B or C

52. of return for a
three-asset portfolio XA , XB , X C = the proportion of the portfolio consisting of investment A, B or C
(where XA + XB + XC = 1)

ρAB , ρAC , ρBC = the correlation coefficient in returns between pairs of assets
(A and B, A and C, B and C)

ρAB σA σB , ρAC σA σC , ρBC σB σC = the covariance of returns between pairs of assets (A and B,
A and C, B and C)

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WACCG = WACCU
MVG (E + D) = MVU (in proportion to PBIT)
D
K EG = K EU + (K − K D )
E EU
where:

Modigliani and WACCG = weighted average cost of capital of a geared company

53. Miller’s propositions
WACCU = weighted average cost of capital of an ungeared company
(no taxation)
E = market value of equity of the geared company
D = market value of debt
KEU = cost of equity of an ungeared company
KEG = cost of equity of a geared company
KD = cost of debt
Dt
WACCG = WACCU [1 − ]
(D + E)
Modigliani and
54. Miller’s propositions MVG (E + D) = MVU (in proportion to PBIT) + Dt
(with taxation)
D
K EG = K EU + (K EU − K D ) (1 − t)
E

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E D(1 − t)
βA = βEG × + βD ×
E + D(1 − t) E + D(1 − t)
where:
Asset beta, equity βA = the company’s asset beta: this is the same as the equity beta for an ungeared (all-equity)
55.
beta and debt beta company
βEG = the beta factor of equity in the company: if the company has debt capital, this ‘equity beta’
is the ‘geared beta’ for the company’s equity capital
βD = the beta factor for the debt capital in the company
t = rate of tax on company profits

Market value per share

P/E ratio = × 100
Price/Earnings Earnings per share
56.
ratio method
Market value per share = Earnings per share × P/E ratio

Earnings per share

Earnings yield = × 100
Current market price per share
Earnings yield
57.
method Earnings per share
Current market price per share =
Earnings yield

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r = discount rate
Earnings growth Earnigs at time 1
58. MV = where: g = the expected annual growth rate
model r−g
MV = the market value of the company

Dividend per share

Dividend yield = × 100
Dividend yield Current market price per share
59.
method Dividend per share
Current market price per share =
Dividend yield
1 + id 1 + if
If quotes are direct: ST = S0 × If quotes are indirect: ST = S0 ×
1 + if 1 + id
Purchasing power where:
60.
parity
ST = estimated spot rate at end of period S0 = current spot rate
if = period inflation rate in foreign currency id = period inflation rate in domestic currency
1 + id 1 + if
If quotes are direct: F = S × If quotes are indirect: F=S×
1 + if 1 + id

61. Interest rate parity where:

F = forward rate S = current spot rate
if = period interest rate in foreign currency id = period interest rate in domestic currency

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% change in dependent variable

62. Leverage
% change in independent variable

Contribution margin
63. Operating leverage
PBIT (Operating profit)

PBIT
64. Financial leverage
Profit after interest but before tax (PBT)

Contribution margin
65. Combined leverage
Profit after interest but before tax (PBT)

Gain or loss in futures

66. Hedge efficiency
Gain or loss in spot market

67. Basis Future price − Spot price

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