When compounding occurs more frequently than once a year (e.g., quarterly), interest is earned on interest more often, making the Effective Annual Rate (EAR) higher than the stated Nominal Rate.

A key assumption of NPV is that cash flows generated during the project life are reinvested at the firm's Cost of Capital (Required Rate of Return), which is considered more realistic than the IRR assumption.

Interest payments reduce the taxable income of the company, effectively lowering the cost of debt by the tax rate [Kd = I(1-t)]. Equity dividends are paid out of post-tax profits and offer no tax shield.

MM Proposition I (No Tax) states that in a perfect market, how a firm finances its operations (Debt vs Equity) is irrelevant to its total value. Value is determined by its earning power and risk of assets, not funding mix.

Operating Cycle = Inventory Period + Accounts Receivable Period. It is the duration from buying raw materials to collecting cash from customers.

Rule of 72 formula: Years to Double ˜ 72 / Interest Rate. Here, 72 / 8 = 9 years.

IRR is defined as the discount rate at which NPV is zero. If NPV calculated at the cost of capital is zero, then the IRR must be exactly equal to that cost of capital.

In Method I, MPBF = 0.75 * (Total Current Assets - Current Liabilities). This implies the borrower finances 25% of the Working Capital Gap (CA-CL) from long-term sources.

Gordon's Formula: P = D1 / (Ke - g). It values a stock based on the next expected dividend (D1), the cost of equity (Ke), and the constant growth rate (g).

If ROI > Cost of Debt, using debt magnifies the Earnings Per Share (EPS) for shareholders (Trading on Equity). If ROI < Cost of Debt, leverage destroys value.

Perpetuity is a stream of constant cash flows that continues indefinitely. PV of Perpetuity = Annual Cash Flow / Discount Rate.

Payback period only focuses on how quickly the initial investment is recovered. It ignores profitability (total cash flows) and the Time Value of Money (unless discounted payback is used).

Beta indicates how volatile a stock is compared to the overall market. Beta > 1 means higher volatility than the market; Beta < 1 means lower volatility.

Profit maximization is vague, short-term, and ignores risk/timing. Wealth maximization (maximizing stock price/NPV) accounts for timing, cash flows, and risk, serving the long-term interest of shareholders.

Gross Working Capital is Total Current Assets. Net Working Capital is the difference between Current Assets and Current Liabilities, representing the liquidity cushion.

In an Ordinary Annuity, cash flows occur at the end of the period (e.g., bond interest). In Annuity Due, cash flows occur at the beginning (e.g., rent, insurance premium).

Because future cash flows are discounted (reduced in value), it takes more time (more years) to recover the initial investment in present value terms compared to nominal terms.

DOL measures how much Operating Profit (EBIT) changes for a 1% change in Sales. It reflects business risk arising from fixed operating costs. (DFL measures EPS sensitivity to EBIT).

If r > k, the firm can earn more on the money than the shareholders can earn elsewhere. Therefore, to maximize value, the firm should retain all earnings and reinvest them.

Retained earnings involve an opportunity cost. Shareholders forgo dividends to let the firm reinvest. They expect a return equal to what they would demand on equity shares (Ke).

Spontaneous sources arise naturally from day-to-day business operations (like buying goods on credit creates accounts payable). They expand automatically as sales expand.

YTM is the Internal Rate of Return (IRR) of the bond. It discounts all future coupon payments and principal repayment to the current market price of the bond.

At the indifference point, the firm is indifferent between choosing Debt plan or Equity plan because the EPS remains identical. Below this EBIT level, equity is better; above it, debt is better.

PI = PV of Cash Inflows / Initial Investment. If PI > 1, it means the project generates more value than it costs (NPV is positive), so it should be accepted.

Combined Leverage = Degree of Operating Leverage × Degree of Financial Leverage. It measures the sensitivity of EPS to changes in Sales.

Net Working Capital = CA - CL. If CA = CL, Net Working Capital is zero. This implies no long-term funds are used to finance current assets.

This theory views dividends as a passive residual. Priority is given to reinvesting in profitable projects. Only if funds remain, dividend is paid.

Marginal cost is the incremental cost of new capital. It is the relevant rate for evaluating new investment proposals.

If you need ?10 Lakhs after 5 years to repay a bond, the Sinking Fund factor helps you calculate how much you need to save annually to reach that target.

Macaulay Duration is a measure of a bond's interest rate sensitivity. It represents the weighted average time to receive the bond's cash flows.

Firms prefer internal funds (Retained Earnings) first because they are cheapest and safest. Next is Debt. External Equity is the last resort due to high costs and dilution.

Sensitivity Analysis helps identify which variables (like sales price or raw material cost) the project is most sensitive to, indicating where the risk lies.

CPs are used by highly rated corporates to meet short-term working capital requirements at rates typically lower than bank interest rates.

Buyback returns excess cash to shareholders, similar to a dividend. However, it provides tax advantages (Capital Gains tax vs Dividend Tax) and signals management confidence.

More frequent compounding results in interest being earned on interest sooner, leading to a higher final amount. Daily > Quarterly > Annual.

NPV is preferred because it measures the absolute addition to shareholder wealth and uses a realistic reinvestment rate (Cost of Capital), whereas IRR assumes reinvestment at the IRR itself, which may be unrealistic.

Market values reflect the current economic value of the capital employed. Using market value weights aligns the WACC with the actual cost of raising new capital in the market today.

The goal is to find the cheapest mix of funds. Lower WACC means higher Net Present Value of future cash flows, thus maximizing firm value.

Method II ensures that the borrower finances 25% of Total Current Assets from long-term sources, resulting in a Current Ratio of 1.33:1.

If the bond pays less interest (Coupon) than the market expects (YTM), its price must fall below face value to offer a competitive yield to the investor.

Discounting is the reverse of compounding. It determines what a future amount is worth today, given a specific interest rate.

NOI theory suggests that the benefits of cheaper debt are exactly offset by the increasing cost of equity (higher risk), leaving the overall WACC (Ko) and Firm Value unchanged.

Bonus shares convert free reserves into share capital. The total Net Worth (Capital + Reserves) remains the same; only the composition changes.

There is an inverse relationship. A higher discount rate means money loses value faster over time, so the current worth of a future sum is lower.

Gross Operating Cycle = Inventory Period + Receivables Period = 60 + 45 = 105 Days. (Note: Net Operating Cycle would be 105 - 30 = 75 days. Usually "Operating Cycle" implies Gross unless specified).

Firms take on debt to get tax shields (benefit), but only up to a point where the risk of bankruptcy (financial distress cost) starts outweighing the tax benefit.

Ke = Risk Free Rate + [Beta * (Market Return - Risk Free Rate)]. This adds a risk premium to the safe rate based on the stock's volatility.

Unlike other methods (NPV, IRR, Payback) which use Cash Flows, ARR uses Accounting Profit from the P&L account.

Since there are no interim coupon payments, the entire cash flow occurs at maturity. Thus, the weighted average time to receive cash flow is exactly the maturity period.

Companies maintain stable dividends to signal consistency and reliability to investors, avoiding sharp drops even when profits dip temporarily.

High operating leverage means high fixed costs. High financial leverage means high debt/interest. A small drop in sales can lead to massive losses or bankruptcy.

It is a forecasting tool that estimates cash inflows and outflows, ensuring the firm has enough liquidity to meet obligations.

Formula: EAR = (1 + r/n)^n - 1. Here r=0.12, n=12. EAR = (1 + 0.01)^12 - 1 = 1.1268 - 1 = 0.1268 or 12.68%.

NPV gives an absolute value which favors larger projects. PI (Benefit-Cost Ratio) gives a relative measure (Value per rupee invested), making it better for ranking projects of different sizes.

Preference dividends are not tax-deductible, so no tax adjustment is made. Cost = Dp / NP.

If the bond pays more interest than the market demands, investors will pay more than the face value to acquire it.

These costs offset the tax benefits of debt in the Trade-off Theory, suggesting an optimal level of debt exists.

MM argue that in a perfect world without taxes or transaction costs, dividend policy does not affect share price; investors can create their own dividends by selling shares.

While a high ratio shows safety, too high means cash is not being invested or inventory is not being sold, indicating poor asset management.

To find the present value, we divide the future value by the compounding factor (1+r)^n.

As a firm takes on more debt (higher D/E ratio), the financial risk to shareholders increases. Shareholders demand a higher return (Ke) to compensate for this added risk.

Standard IRR assumes cash flows are reinvested at the IRR rate (often unrealistic). MIRR assumes reinvestment at the Cost of Capital (WACC), providing a more accurate picture of profitability.

Rule of 69 Formula: Doubling Period = 0.35 + (69 / Interest Rate). Here, 0.35 + (69/10) = 0.35 + 6.9 = 7.25 years. This is more accurate for continuous compounding.

The Chore Committee reinforced the adoption of Tandon Method II: MPBF = (Total Current Assets * 0.75) - Current Liabilities (excluding bank borrowings). This ensures a higher current ratio.

Stock split increases the number of shares and reduces the face value per share proportionately. It does not change the total capital or reserves, unlike a Bonus Issue which capitalizes reserves.

Floatation costs (issue expenses) reduce the "Net Proceeds" the company receives from the issue. Since the denominator (Net Proceeds) decreases, the calculated Cost of Capital increases.

When interest rates rise, existing bonds with lower coupon rates become less attractive, so their price falls. Conversely, when rates fall, bond prices rise.

Under RADR, a higher discount rate (Risk-Free Rate + Risk Premium) is used for riskier projects, which lowers the Present Value of future inflows, making the acceptance criteria stricter.

This indicates a liquidity crisis where short-term obligations exceed short-term assets. However, in some sectors like retail (supermarkets), this might be a strategy (using supplier credit to fund inventory).

Financial Break-even Point is the level of EBIT at which EPS is zero. It is the point where operating profit is just enough to cover fixed financial charges (Interest + Preference Dividend).

A loan is a lump sum received today (PV), which is repaid in installments (Annuity). To equate the loan amount to the stream of EMIs, we use PVIFA.

Excessive debt increases the probability of bankruptcy. Lenders compensate for this increased credit risk by charging higher interest rates.

Factoring allows a firm to sell its accounts receivable (invoices) to a Factor for immediate cash (up to 80-90%), improving liquidity.

Current yield measures the return based on the current market price, ignoring capital gains/losses upon maturity.

This policy gives shareholders a reliable steady income while allowing the firm to share prosperity in boom years without committing to a permanently high dividend.

Traditional NPV ignores future flexibility. Real Options approach values the ability to change course (e.g., abandoning a failing project early), adding value to the investment.

CAPM assumes "Homogeneous Expectations" - that all investors have the same expectations regarding expected returns, variances, and correlations.

The Baumol Model balances the "Ordering Cost" (Transaction cost of selling securities) against the "Carrying Cost" (Opportunity cost of holding cash) to find the optimal cash balance, just like EOQ.

The indifference point is specifically calculated to find the EBIT level where the EPS outcome is identical regardless of the financing option chosen.

In the early years, the outstanding principal is high, so interest is high. As principal is repaid, interest drops, allowing a larger portion of the fixed EMI to go towards principal repayment.

Instead of adjusting the rate (RADR), CE adjusts the numerator (Cash Flows) by multiplying uncertain flows with a CE coefficient (0 to 1) to get certain flows, then discounts them at the risk-free rate.

Carrying costs are the costs of holding inventory in the warehouse. Ordering costs are associated with placing orders. Stockout costs arise when inventory is exhausted.

Retained earnings lead to share price appreciation (Capital Gains). If capital gains are taxed at a lower rate than dividend income (or deferred), investors prefer retention over payout.

A perpetual bond has no maturity. Its value is simply the annual interest divided by the yield (discount rate), based on the perpetuity formula.

Cheaper debt reduces WACC, but increased financial risk raises Ke. MM II argues these exactly cancel out, keeping overall WACC constant.

JIT is a lean manufacturing strategy. By eliminating idle stock, it minimizes storage, insurance, and obsolescence costs, though it increases the risk of stockouts.

Explicit costs involve cash outflow (interest). Implicit costs are Opportunity Costs. The cost of retained earnings is the return shareholders could have earned if the money was distributed.

SIP involves a series of equal payments at regular intervals. We want to know the total value at the end (Future), so FV of Annuity is used.

Decision making focuses on "what changes". Only the extra cash inflow or cost saving generated by the new machine over the old one is relevant.

DFL measures the impact of interest (fixed financial cost). It is Operating Profit (EBIT) divided by Profit Before Tax (EBT). DFL = EBIT / (EBIT - Interest).

Unlike MM theory, the Traditional View argues that judicious use of debt initially lowers the WACC (Ko) up to a point. Beyond this point, rising financial risk causes Ke and Kd to rise, increasing WACC. The lowest point of the U-shaped WACC curve is the optimal structure.

Decision trees map out sequential decisions and uncertain outcomes (with probabilities), allowing managers to evaluate complex, multi-stage investment proposals.

Duration assumes a straight line relationship, which is inaccurate for large rate changes. Convexity measures the curvature, showing that bond prices rise more when rates fall than they drop when rates rise.

Based on a working capital cycle of 3 months (25% of year), the requirement is 25% of turnover. The promoter brings 5%, and the bank provides 20% as a minimum limit.

Cost of Debt depends on interest, tax shield, and redemption terms (discount/premium). Dividend Payout Ratio is relevant for Cost of Equity, not Debt.

While r = R + i is a common approximation, the precise relationship accounts for the cross-product of real rate and inflation: r = R + i + (R*i). Thus, (1+r) is the product of (1+R) and (1+i).

Proposed by Gordon and Lintner, this theory argues that dividends are less risky than future capital appreciation. Therefore, a higher dividend payout reduces the cost of equity and increases share price.

DFL = EBIT / (EBIT - Interest). DFL = 1,00,000 / (1,00,000 - 20,000) = 1,00,000 / 80,000 = 1.25. Tax rate is irrelevant for DFL calculation (unless Preference Dividend exists).

When the direction of cash flows changes more than once (e.g., heavy maintenance cost in year 5 causing a net outflow), the IRR equation can have multiple mathematical solutions, making IRR unreliable.

An LC (especially Usance LC) allows the buyer to receive goods now and pay later. This creates "Sundry Creditors," which is a source of spontaneous working capital financing.

The P/E ratio indicates how much the market is willing to pay for every rupee of earnings generated by the company. A high P/E suggests high growth expectations.

Managers might pursue personal goals (like expensive jets) over shareholder wealth (Agency cost of equity). Shareholders might take high risks to shift loss to debt-holders (Agency cost of debt).

This point is called the "Break Point". Once retained earnings are used up, the firm must issue new shares (incurring floatation costs), which raises the WACC.

Example: A pension plan where you invest now, but the annuity payments (pension) start only after you retire (say, after 10 years).

Firms attract a specific clientele based on their payout policy. Changing the policy might alienate the existing shareholder base and affect the stock price.

Under Capital Rationing, the firm must select the combination of projects that maximizes total NPV within the budget constraint (often using Profitability Index).

CCC measures the time between paying for raw materials and receiving cash from sales. A shorter cycle is better for liquidity.

If the firm earns less on its assets (ROI) than the interest it pays on debt, using debt reduces the return to shareholders (Negative Leverage).

Book Value represents the net worth attributable to equity shareholders based on the historical accounting figures, not market value.

With taxes, debt provides a tax shield. The value of the firm increases by the Present Value of the Tax Shield, which is Debt * Tax Rate (Dt). So Vl = Vu + Dt.

If a stock is above the SML, it is offering a higher expected return than what CAPM predicts for its level of risk. Hence, it is attractive/undervalued and should be bought.

Sunk costs are past costs that have already been incurred and cannot be recovered (e.g., money spent on market research last year). They should not affect the decision to accept/reject a project today.

T-Bills are short-term sovereign debt instruments issued by the Central Government (via RBI) to meet short-term liquidity mismatches. They are risk-free.

Companies Act allows declaring dividend out of reserves if current profits are insufficient, provided conditions regarding rate of dividend and withdrawal amount are met.

Formula: PV = CF1 / (k - g). This is used when cash flows grow forever at a constant rate (e.g., valuation of a stock with constant dividend growth).

Lower coupon bonds have higher Duration (more of their value comes from the distant principal repayment). Higher duration means higher price volatility when rates change.

DOL = Contribution / EBIT. If Fixed Cost is 0, then Contribution = EBIT. So, DOL = Contribution / Contribution = 1. This implies no operating leverage (1% change in sales = 1% change in EBIT).

Over-capitalization doesn't mean too much money. It means the capital base is too large relative to the earnings, leading to low dividend rates and falling share prices.

A conservative policy minimizes risk by using safe long-term funds for everything, even temporary needs. This increases safety (high liquidity) but reduces profitability (higher cost of long-term funds).

Post-Audit provides feedback, helps identify why forecasts went wrong, and improves future decision-making. It is a control mechanism.