Sales Guides: February 2016

Monday 29 February 2016

Cost of Redeemable Debt Formula

Cost of Redeemable Debt Formula

Cost of redeemable debt formula has been given below. Cost of redeemable debt has been explained with an example.

Cost of Redeemable Debt Formula = L +(NPV_L/NPV_H-NPV_L)x (H-L)

Where

R_L= Lower rate of Return

R_H= Higher Rate of Return

NPV_L= NPV with Lower rate of Return

NPV_H= NPV at higher rate of return

Cost of irredeemable debt process has been explained by example;

Cost of Redeemable Debt Formula Example

XYZ Quoted Rate	102
Coupon Rate	12%
Tax rate on companies	40%
Maturity	5 years

Solution

Particulars	Value	Dis. 5%	PV @ 5%	Dis. 10%	PV @ 10
Market Value	108	1	108	1	108
Interest	(7.2)	4.329	(31.172)	3.791	(27.29)
Redemption Value	(100)	.784	(78.40)	.621	(62.1)
			(1.57)		18.61

Formula = L +(Nl/Nh-Nl)x (H-L)

= 5% + (1.57/18.61)(7%)

=.05+.323(.05)

=5.59%

It is to be noted that interest rate is discounted by annuity factor, because it is a regular payment, while redemption value is discounted at straight discounting factor (at once), because it is onetime payment in five year.

Cost of irredeemable Debt

Cost of irredeemable debt formula has been given below. Cost of irredeemable debt formula has been explained with an easy example;

Cost of irredeemable Debt Formula = Io ( 1-T)/Po

Where,

Io= Interest rate

T= Tax Rate

Po= Market value of debt (Ex interest Price)

Cost of irredeemable Debt Formula Example

Interest Rate = 12%

Debt Value= 150

Prevailing Tax Rate =40%

Solution

Io ( 1-T)/Po

= [ 12(1-40%)]/150

=7.2/150

=4.8% (cost of Debt)

CAPM Formula

CAPM or capital asset pricing model Formula has been given below. CAPM formula has been explained with an easy example

CAPM = Rf + βe (Rm-Rf)

Rf= Risk Free Rate

Rm= Market Rate

βe = Equity Beta

Risk Free Rate

Risk Free rate is rate offered by the government on bonds. Bank offer rate in the country is also regarded as risk free rate. Risk free rate is lower than market rate due to lower risk.

Market Rate

Expected rate of return from the investment in the stock market is known as market rate or market rate of return. Market rate is expected to be higher than risk free return rate.

Application of CAPM

CAPM is used to calculate cost of equity, other important method of calculating the cost of equity is dividend valuation model. Cost of equity calculation has been explained below.

CAPM Formula Example

Stock Exchange Return Rate= 12%

Bank Risk Free Rate= 10%

Equity Beta= 1.6

Calculate Cost of equity?

Solution

= 10% + 1.6 ( 12%-10%)

=12%+1.6(2)%

=15.32%

CAPM Formula Learning Example

Market Rate of Return= 13%

Risk Free Return (Rate)= 8%

Equity Beta= 1.3

Calculate Cost of equity?

Solution

= 8% + 1.3 ( 13%-8%)

=8%+1.3(5)%

=8% + 6.5%

=14.5%

Advantage of Using CAPM

CAPM takes into account two important concept of investment i.e. time value of money and risk. Time value of money is represented by risk free rate, while risk is represented by risk premium (premium for risk). Thus CAPM is a preferred method for cost of equity calculation.

Risk Premium = ( Rm-Rf)

NCI Fair Value Formula

NCI can be calculated by two methods i.e. NCI net asset method and NCI fair value methods. In this article we would explain the NCI Fair value method.

NCI at Fair Value = Number of Share (NCI) x Market price

NCI Fair Value Method Example

A Company acquires 80% shares of another Company (Y)

Total Number of shares= 100,000

Market price of shares= 8

Net asset of Y = 500,000

What would be value of NCI?

Solution

NCI at Fair Value = Number of Share (NCI) x Market price

=20000 x 8

=160,000

NCI Net Asset Formula

NCI can be calculated in two ways i.e. NCI net asset method and NCI fair value method. In this article we would explain the NCI Net asset method.

NCI as proportion of net assets =Total net asset x NCI %

Where

NCI = Non controlling interest

NCI Net Asset Formula Example

A company (X) acquire 80% share of another company (Y)

Net asset of Y = 500,000

What would be value of NCI?

Solution

NCI as proportion of net assets =Total net asset x NCI %

= 500,000 x 20%

=100,000

Goodwill Formula

Goodwill formula has been given below. Goodwill formula has been explained with a simple an example

Goodwill = Cost of investment + Fair value of NCI- Fair value of net asset

NCI= Non controlling asset

NCI can be calculated in two ways i.e. market value of shares or % fair value of the net asset.

Goodwill Formula Example

80% Acquisition = 160,000

Fair value of Non controlling interest = 80,000

Net asset value of Company = 220,000

Solution

Goodwill = Cost of investment + Fair value of NCI- Fair value of net asset

= 160,000+44,000-200,000

=4,000 (Goodwill)

Machine Absorption Rate Formula

Machine Absorption Rate Formula = Production Overhead x 100

Budgeted Machine Hrs

Machine hour labour rate is calculated by dividing production overhead with budgeted machine hours.

Machine Absorption Rate Formula Example

Production Overheads= 450,000

Machine Hours= 15,000

Solution

= $ 450,000 (production overhead)/ 10,000 Total Machine Hours

= $ 150,000/ 1,000

= $ 10 (Machine Absorption Rate)

Labour Absorption Rate Formula

Labour Hour Absorption Rate Formula = Production Overhead x 100

Budgeted Labour Hrs

Labour absorption rate is calculated by dividing the production overhead with budgeted labour hours.

Labour Absorption Rate Formula Example

Overheads Expenditure = $300,000

Budgeted Labour Hours = 20,000

Calculated Labour absorption rate?

Solution

= $ 300,000 (production overhead)/ 10,000 Total Labour Hours

= $ 300,000/ 20,000

= $ 15 (labour absorption Rate)

Product Absorption Rate Formula

Product Absorption Rate Formula = Production Overhead x 100

Budgeted Production (units)

Product absorption rate is calculated by dividing production overhead with number of budgeted units.

Product Absorption Rate Formula Example

Overhead Expenditure = $ 400,000

Budgeted Production = 20,000

What would be product absorption rate?

Solution

Absorption Rate (Labour Hr) = Production overhead/Total units Produced

= $ 400,000 (production overhead)/ 20,000 Total Products

= $ 400,000/ 20,000

= $ 20 (product absorption Rate)

Over Absorption Formula

Over Absorption = Absorbed overhead – Actual Overheads

Over Absorption Formula Example

Machine Hour = 6000

Absorption Rate = $ 6

Production Overhead (Actual) = 25,000

Solution

Absorbed Overhead = Hr x Absorption Rate

= 6000 hr x 6 = 36,000

Over absorption = 36,000-25,000

=11,000 (Over absorption)

Reasons of Over Absorption

Over absorption result, because companies use predetermined absorption rate, while actual overhead may differ from the absorbed overheads.

Over and under absorption

When absorbed overhead are more than actual overhead, then this is over absorption situation, when absorbed overhead are less than actual overhead, then this is under absorption situation.

Absorbed Overheads > actual Overheads = over absorption overheads

Absorbed Overheads < actual Overheads = under absorption overheads

Wednesday 24 February 2016

Equal Annual Return Formula

Formula for Equal annual return has been given below. Equal annual return formula has been explained with an example.

Annual Return = = Present Cash flow

Annuity Factor

Equal Annual Return Formula Calculation

Equal return cash flows can be calculated by dividing the present cash outflow with annuity factor. It is important to remember that equal annual return is calculated with the help of annuity factor due to time value of money concept.

Equal Annual Return Formula Example

NPV or Present Value = 120,000

Period required for project = 5 Years

Rate of Return = 14%

Calculate equal return from project at required rate of return?

Solution

In first place we would calculate the annuity factor, and then with the help of that annuity factor, the annual equal return would be calculated.

Annuity Factor

= 1-(1.14)^-3

.14

=2.3216

Annual Return

Annual Return = = Present Cash Flow

Annuity Factor

= 120,000/2.3216

=51,688

Objective of Equal Annual Return

Primary objective of calculating equal annual return is to compare mutually exclusive project with different project life. Equal annual return makes this comparison possible, and project with a high equal annual return is selected.

Equal Annual Return Example

Project A Project B

NPV 160,000 220,000

Period 3 4

Discount 6% 8%

Solution

Project A Project B

NPV 160,000 220,000

Annuity Factor 2.678 3.312

Equal Annual Return 59,746 66,425

Project B will be selected, because it is offering high amount of equal annual return.

Future Value Growing Annuity Formula

Growing Annuity or future value of growing annuity can be calculated with following formula. It is important to note that for growing annuity future as well as present value may be calculated. In this article we have explained future value of Growing annuity.

Future Value Growing Annuity Concept

Growing annuity concept is very similar to the regular annuity due concept, however in case of growing annuity the amount of payment (contribution) in an investment plan is increasing with a constant rate. Growing annuity concept has been explained with an example

i= interest Rate

g=Growth rate

n= period

C=Deposited amount

Future Value Growing Annuity Formula Example

Deposited Amount = 5,000

Annual Growth in Deposit = 4%

Interest Rate = 10%

Period =5 Years

Solution

Annuity Factor =10,000x [(1+10%)⁵-(1+4%)⁵]

10%-4%

=5000 x [1.610 – 1.2166]/.1-.05

=5000 x 7.868

=39340

Growing Annuity

Future Value Annuity Due Formula

Future value of annuity due is calculated to determine the future value of the series of payment regularly made to a financial institution. This concept is widely used in insurance company.

Where;

C= Payment

i= Rate of interest

n= number of period (payment made)

Future Value of Annuity Due

Future value of annuity due is basically calculating the Final or future value of series of payment made in an investment scheme on annual bases. Future value of annuity due concept has been explained with an example.

Annuity Due Formula Example

Amount Deposited= 4000

Period = 4 Years

Interest Rate =12%

Solution

Annuity Factor =C x [(1+i)ⁿ-1] x (1+r)

= Cx [(1+12%)⁴-1] x (1+12%)

12%

= 4000x (4.7793 x 1.12)

=4000 x 5.353

=21410

Future Value of annuity may also be calculated by following table, but this is method is a time consuming exercise.

	Series of Payment	Interest	Future Value
1	4000	(1.12)⁴	6294
2	4000	(1.12)³	5619
3	4000	(1.12)²	5017
4	4000	(1.12)¹	4480
			21,410

Above example shows that person will receive an amount of 21,410 as result of series of payment he made in four years.