CORPORATE FINANCE

Introduction
weightage average capital (WACC) is a fundamental concept for determining the
financial health and investment of a company . it is the rate that a company expected
to pay on average to all its security holder to finance its assets and the capital that
company procures is derived from various sources .

Steps for calculating WACC

1) First ,the specific cost of each source of capital is calculated separately or
determining the cost of all individual factors .

2) In second step ,the specific cost of each source of capital is multiplied by its
relative shred in capital structure.

3) The weighted cost of all sources thus obtained are then added together and
weighted average is calculated.

The weighted cost of capital ( WACC)

WACC= (weight of equity * cost of equity ) + ( weight of debt * cost of debt )

Concept and application –

Calculating the weighted average cost of capital for M/s Antara Limited
Market value of equity
Market value of equity = share price * number of shares outstanding
Since the price of the shares at the start of the year was Rs 50 and at the end it was
Rs 55 we can take up an average figure of Rs 52.5.

Number of shares outstanding = book value of share capital + retained earnings

= Rs 50,00,000 + 2,50,000 = 52,50,000

Market value of equity = 52.5 * 52,50,000 = RS 27,56,25,000

Market value of debt
Market value = face value * ( 1 – tax rate )
Since the tax rate in India is 30% the value of debt can be calculated by
Market value = Rs 15,00,000 * ( 1 – 0.3 ) = Rs 10,50,000

Total capital
Total capital = market value of equity + market value of debt
Total capital = Rs 27,56,25,000 + 10,50,000 = Rs 27,66,75,000
Weight of each component in the capital structure

Weight of equity
Weight of equity = market value of equity / total capital
Weight of equity = 27,56,25,000 / 27,66,75,000 = 0.9962

weight of debt
weight of debt = market value of debt / total capital
weight of debt = 10,50,000 / 27,66,75,000 = 0.0038

cost of equity
cost of equity = risk-free rate + beta * market risk premium
the risk free rate in India is around 4% and the market risk premium is estimated to
be around 5 %.
So cost of equity = 4% + 0.6 * 5% = 7%

Cost of debt
Cost of debt = interest rate
The interest rate on the debenture is 8%. The typical rate of interest on loans is 9%.
So cost of debt = ( 8 + 9 ) / 2 = 8.5%
the average weighted cost of capital
WACC = ( weight of equity * cost of equity ) + ( weight of debt * cost of debt )
WACC = ( 0.9962 * 7% ) + ( 0.0038 * 8.5% )

= 7.0057%

Interpretation
So from the above analysis we can conclude that M/s Antara Limited needs to earn
at least 7.0057% on its investments to cover the cost of its capital.

Question 2

Gross Operating cycle refers to the time taken by the firm in processing the raw
material into finished goods or its investment in raw materials and other resources
into finished goods for earning sales revenue . operation cycle can be defined as the
time taken by the company to turn its inventories into cash
Or
Gross operating cycle refers to as 1 company takes time to buy good, 2 convert or
transform its inventories into finish goods, 3 after transformation of inventories
through sale of finished goods receive cash.
In other words it’s how long it takes a company to turn its inventories into cash
Drawing .
The operating cycle includes day to day operations and expenses of a business
enterprises of and nature of size and involves various steps in cyclical form .it is a
broader concept and considers the company’s external financial interactions with
suppliers .
Gross operating cycle period = 𝑛1 + 𝑛2 + 𝑛3 + 𝑛4
Net operating cycle or cash cycle = 𝑛1 + 𝑛2 + 𝑛3 + 𝑛4 − 𝑛5
It is a measurement of the time it takes for a company to convert its investment in
inventory into cash through sales and the collection of accounts receivable . it is also
can refers as the time between the cash payment or cash collections .

Concept and application –

Calculation of net operating cycles and cash cycle
(A) Calculation of the stocking period of raw materials
It refers to the time taken by firm to conversion of raw material into semi-
finished goods or work in progress –

𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑟𝑒𝑟𝑖𝑎𝑙

Raw material storage period =𝑎𝑣𝑒𝑟𝑎𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙

250000
= 8611

= 29 days

𝑜𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘+𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘

Average stock of raw material = 2
200000+300000
== = = 250000
2

Annual consumption of raw material = opening stock of raw material + annual

purchase – closing stock of raw material

= ( 200000 + 3200000 – 300000 )

= 3100000

𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙

Average daily consumption = 360

3100000
= 360

=8611 days

(B) Calculation of conversion period of raw material into finished goods =

 It is the time of conversion process of raw material to finished goods taken by
the firm

𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑊𝐼𝑃
Conversion period = =
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛

62500
10125

= 6 days

𝑜𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑊𝐼𝑃+𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑊𝐼𝑃

Average WIP =
2

60000+65000
= 2
= 62500
𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛
Average cost of production = 360

3645000
= 360

= 10125 days

Annual cost of production =(opening stock of WIP +consumption of raw material +

other manufacturing costs – closing WIP)

( 60000+ 3100000+ 550000 – 65000)

3645000)

(C) Calculation of storage period of finished goods— it refers the time period of
converting finished goods to sales required by the firm .
 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠
Storage period = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠

662500
= = 62.44 days
10611

Average stock of finished

𝑜𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠+𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 𝑜𝑓 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠
goods= 2

600000+725000
= =662500
2

𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠

Average daily cost of sales=
360

3820000
= 360

= 10611 days

Annual cost of sales = opening stock of finished goods + cost of production + excise
duty + selling and distribution expenses + general administration costs – closing
stock of finished goods

( 600000+3645000+300000 -725000)
=4545000-725000
=3820000

(D) Calculation of average collection period

The time taken by the debtors of the firm for payment against credit sales

𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑢𝑛𝑑𝑟𝑦 𝑑𝑒𝑏𝑡𝑜𝑟𝑠

Average collection period= 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠

232500
12444.444

=18.68 days
 𝑜𝑝𝑒𝑛𝑖𝑛𝑔 𝑑𝑒𝑏𝑡𝑜𝑟𝑠+𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑑𝑒𝑏𝑡𝑜𝑟𝑠
Average debtors = 2

250000+215000
= 2

= 232500
Annual credit sales = 4480000

𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠

Average daily credit sales = 360

4480000
= 360
= 12444.444
(E) Calculation of average payment period of the firm
it refers to the time taken by the firm for payment to creditors against credit
sales .

𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝑠𝑢𝑛𝑑𝑟𝑦 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠

• Average payment period = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒

562500
= 8888.88

= 63 days

𝑜𝑝𝑒𝑛𝑖𝑛𝑔 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠+𝑐𝑙𝑜𝑠𝑖𝑛𝑔 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠

• Average balance of sundry creditors = 2

550000+575000
= 2

1125000
= 2

= 562500
• Annual credit purchase = 3200000 ( given ).

𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒

• Average daily credit purchase = 360
 3200000
= 360

= 8888,88
=8888.89

• Formula for gross operating cycle period = 𝑛1 + 𝑛2 + 𝑛3 + 𝑛4 . The

operating cycle period is = 29 +6 +62.44 + 18.68 = 116.12 .

• Formula for Cash cycle or Net operating cycle = 𝑛1 + 𝑛2 + 𝑛3 + 𝑛4 −

𝑛5 . Thus the net operating cycle period is (29+6+62.44+18.68 -63)
=53.12

360
= 53.12

= 6.777

=7 times per annum.

So the operating cycle will repeat itself , on an average , seven times a year

Interpretation
The analysis of Vishal & co. Ltd. Sheds lights on to operational efficiency. The above
analysis shows that collection period of payments is less than payment period which
means that firms collection are efficient and is able to have the advantage to use the
money for some time.
3(a)
Introduction –
perpetuity can be defined as a series of payments that have a specified data of start
but not maturity as they continue forever . it is a financial concept that represent a
series of cash flows that continuous indefinity into the future and cab be constant
fixed . perpetuity can be change on fixed amount or a fixed percentage basis.

Concept and application

1. Formula for calculating perpetuity is following

𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝐴
• Present value of perpetuity= =
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 𝑖

𝐼𝑁𝑅 200000 𝐼𝑁𝑅 200000

= PV of perpetuity = = =
8% 0.08

= PV of perpetuity =2500000

Thus the investor should invest INR 2500000 at an interest rate of 8% to get
INR 200000 each year in perpetuity.

2. In context of first point if we incorporate the growth rate 3% is expected then

the present value of perpetuity will be following

𝐴(1+𝑔)
• PV of growing perpetuity = 𝑖−𝑔

𝐴 𝐼𝑁𝑅 200000 200000

= PV of perpetuity = 𝑖−𝑔 = = = 4000000
0.08−0.03 0.05
 For receiving INR 200000 annum with a growth rate of 3% per annum the
investor should invest 4000000

3. to receive 400000 per annum in perpetuity at an interest rate of 5%

the calculation will be

𝐴 400000
PV of perpetuity = = = 8000000
𝑖 0.05

So 80,00,000 should be invested by investor to receive 400000 per annum in

Interpretation
From the above analysis we are able to conclude that to get a perpetuity of inr 2
lakhs at an interest rate of 8 %, an amount with present value of inr 25 lakhs should
be invested. Similarly to get perpetuity of inr 2 lakhs with a growth rate of 3% then
amount with present value of inr 40 lakhs is to be invested.
If the amount of perpetuity is inr 4 lakhs with an interest rate of 5 % then the amount
with present value of inr 80 lakhs is to be invested.

B) introduction
1 Current ratio – it is referring to as a measurement of a company’s financial ability to
meet its short-term financial obligation by using company’s current assets and
liabilities . current ration compares the short-term liabilities with short term assets .
and if the current ratio finds higher it shows better liquidity position of the firm or
company . the ideal accepted current ratio is 2:1

Formula –
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
Current ratio= 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
2 acid ratio- the acid ratio or quick ratio measures a company’s financial ability to
meet its short-term financial obligation without relaying the sale of inventory or how
well a company can satisfy its short-term financial obligations excluding the sale of
inventory.
Formula
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑠𝑡𝑠−𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Acid ratio = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Concept and application

𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 1 100000

Current ratio = = =5.5
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 200000

𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑡𝑠−𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 1100000−400000 700000

Acid ratio = = = = 3.5
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 200000 200000

Here current assets are = debtors + cash in bank + inventory

= 500000+200000+400000
= 1100000

Current liabilities = trade payables + bank overdraft (OD)

= 150000+ 50000
= 200000

Interpretation
After calculation of company’s current and acid ratio we can conclude that the
current ratio is 5:5 and acid ratio is 3:5 . its indicate the company is in strong
position and can meet its short-term financial obligations because these both are key
ratio indicators of the credit position or liquidity of the firm .
An acid ratio of 1 is company has enough liquid assets to satisfy its current liabilities
but here the acid ratio is 3:5 which is good to meet the short-term financial
obligations .
A current ratio of 2:1 is ideal for the cover company obligations but here the current
ratio is 5:5 which is better to meet the short-term financial obligations .