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TIME

V A L U E

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Time Value of Money Time value of money acts as a base for financial management. The value of

money decrease day by day and year after year. To take decision for future and

present time value of money become important.

The time value of money is the value of money figuring a given amount of

interest earned over a given amount of time.

Two important tools of time, value of money are

Time Value of Money

For calculation: - 2 important situations are arisen

Single cash flow :- when there is one investment in a single year

Multiple cash flow: - when there is inflow or outflow in each

period. Multiple cash flow further divided into two category

1. Even cash flow:- Same amount of money is deposited

every year.

2. Uneven cash flow: - Different amount of money is

deposited every year.

The time value of money is calculated using 4 tables.

1) Present value of lump sum

2) Present value of annuity

3) Future value of lump sum

4) Future value of annuity

Present value of “Future inflows”

(Discounting)

‘

Future value of “Present outflows”

(Compounding)

Example: - need Rs. 50000

after 3 year what is its value

as of today?

Example: investing Rs. 50000

after 3 year how much it will

grow?

Formula, PV = FV

(1+r)n

Formula, FV = PV (1 + r)n

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Present Value: The current worth of a future sum of money or stream of cash

flows given a specified rate of return.

Future Value: It is the value of an asset or cash at a specified date in the future

that is equivalent in value to a specified sum today.

Formula

Present value of a future sum

The present value (PV) formula has four variables, each of which can be solved

for:

PV = FV

(1+r)n

1. PV is the value at time=0

2. FV is the value at time=n

3. „I‟ is the rate at which the amount will be compounded each period

4. „n‟ is the number of periods (not necessarily an integer)

The problem can also be solved without using the table. The formula for the

same is:

PV = 1/ (1+r) n

Future value of a present sum

The future value (FV) formula is similar and uses the same variables.

FV = PV (1 + r)n

Numerical questions:-

Q1. An investor wants to invest Rs. 28000 in FD OF PUNJAB BANK at

10.5 % p.a. for the period of 5 year. Find the value at the end of 5 year

Solution: - FV = PV (1 + r)n

=28000 (1 + 0.105)5

= 28000(1.105)5

= 28000 X 1.648

FV = 46128

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Q2. A cash certificate scheme of SBI has a maturity value of 15000 after 6

year at 9% p.a. find the price of the certificate.

Solution:- PV = FV

(1+r)n

= 15000

(1 + 0.09)6

=15000 = 15000

(1.09)6 1.689

=8929

Problem based on using table

Q3. A business man considering a project value will generate a cash

inflows of 15000, 25000, 30000 45000 for 4 year. Rate of interest 10% .find

PV

Solution:-

Year cash inflow interest@ 10% PV

1 15000 X 0.909 13635

2 25000 X 0.826 20650

3 30000 X 0.751 22530

4 45000 X 0.683 30735

If we do not have a table then w use formula 1/ (1 + r)n

Q4. Businessman investing Rs. 100000 and generate 20000, 35000, 25000,

45000 rate of interest 11%. Advise the business to go for the project or not.

Solution:-

Year FV interest PV

1 20000 X 0.901 =18020

2 35000 X 0.812 =28420

3 25000 X 0.731 =18275

4 45000 X 0.659 =29655

= 94370

It should not invest in this project at present value of inflow is less then

initial investment.

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Q4. Person invests 3000,2500,4500,6000 for 4 year, rate of interest 10%.

How much it grows.

Solution:-

Year PV interest FV

4 3000 X 1.464 4392

3 2500 X 1.331 3327.5

2 4500 X 1.210 5445

1 6000 X 1.100 6600

19764.5 or 19765

Q5. Investor capacity inflow of Rs. 10000 each year foe 5 year @ 9% p.a.

what is the PV (annuity for PV).

Solution: - 10000 X 3.890 = 38900

Financial Statement Analysis

Financial analysis involves analyzing financial statements prepared in

accordance with generally accepted accounting principles to ascertain

information concerning the magnitude, timing, and riskness of future cash

flows. The objective of the financial analysis imbedded in the quarter project is

to evaluate a company as an investment opportunity

I. Past performance record and future expectations

II. How much risk is inherent in the current capital structure

III. What is the performance of the firm compared to the industry and/or

specific competitors

Following are the method of financial statement analysis:-

1. Ratio Analysis

2. Trend Analysis

3. Cash flow Analysis

4. Fund flow Analysis

5. Common size Analysis

6. Comparative Analysis

7. DuPont Analysis

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Ratio Analysis

Ratio analysis is the process of computing, determining and presenting the

relationship of items or group of items of financial statement .it also involve the

comparison and interpretation of those ratios and the use of them for future

projections. A ratio is a mathematical relationship between two relative item

expressed in quantitative from. This quantitative relationship may be expressed

in either of the following way:-

1. In proportion

2. In rate or time or coefficient

3. In percentage

Classification of Ratios

Ratios can be classified into four broad groups:-

i. Liquidity ratios

ii. Profitability ratios

iii. Turnover ratios

iv. Solvency ratios

Liquidity ratios: - it is the ability of a firm to satisfy its short term

obligations as they become due. Liquidity is inversely proportional to

profitability. If liquidity is “0” then profitably is 100%.

Current Ratio = Current Assets

Current Liabilities

If the CR is between 2:1 to 1.33:1 then liquidity is good and satisfactory.

If the CR is below 1.33:1 then the liquidity is bad. Business have no

sufficient fund

If the CR is above 2:1 then the liquidity is not under control. Too much

ideal fund lying in the business. The ideal fund must be reduced & should

be invested in long term investment/fixed assets.

Acid Test Ratio (Quick Assets Ratio) = Liquid Assets

Current Liabilities

Liquid Asset = Current Assets – (Closing Stock +Pre paid expenses)

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Liquid Liability = Current Liability – (bank overdraft)

Liquid assets are assets that can be converted into cash in no time (10-15 days)

List of current assets and current liability are

Current Assets Current Liability

Cash in hand bank overdraft

Cash at bank short term loans

Marketable security creditor

Short term investment bills payable

Debtor outstanding expenses

Bills receivable

Stock/inventory

Prepaid expenses

Q1:- from the following detail compute liquid ratio and give your inference:-

Cash in hand....................................45000

Bank overdraft.................................15000

Cash at bank.....................................50000

Furniture & fixture.........................100000

Marketable security..........................25000

Creditor............................................50000

Plant and machine..........................250000

Bills payable.....................................35000

Debtor...............................................50000

Bills receivable.................................40000

Stock/inventory.................................65000

Prepaid expenses...............................10000

Solution:-

Current Assets Current Liability

Cash in hand 45000 bank overdraft 15000

Cash at bank 50000 bills payable 35000

Marketable security 25000 creditor 50000

Prepaid expenses 10000 100000

Debtor 50000

Bills receivable 40000

Stock/inventory 65000

285000

Current Ratio = Current Assets = 285000 = 2.85 : 1

Current Liabilities 100000

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Inference: - so, the liquidity is not under control.

Acid Test Ratio= Current Assets – (Closing Stock +Pre paid expenses)

Current Liabilities

= 285000 – 65000- 10000

100000

= 2:1

Profitability ratios:-

Gross Profit Ratio= Gross Profit X 100

Sales

Higher the ratio is better the position of the firm which means that the firm

earns greater profits out of the sales and vice versa.

Net Profit Ratio= Net Profit X 100

Sales

Higher the ratio is better the operating efficiency of the firm which means

that the firms earns greater volume of both operating as well as non

operating profit out of sales and Vice versa

Operating ratio = operating cost X 100

Net sales

Operating cost = Cost of goods sold + Operating expenses X 100

Net sales

Expenses ratio = particular expenses X 100

Net sales

Operating expenses ratio = operating expense X 100

Net sales

Turnover ratio: inventory and stock both are same

Stock turnover ratio= Cost of Goods Sold or Sales

Average stock closing stock

Higher the ratio is better the firm in converting the stock into sales and vice

Versa

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Cost of goods sold = sales – gross profit

Cost of goods sold = opening stock +purchases+ wages+ direct exp – cl. stock

If Cost of goods sold is not given in problem the used below formula:-

Stock turnover ratio = net sales

Average stock

Average stock = opening stock + closing stock

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Inventory conversion period = 365 days /52 weeks /12 months

Stock turnover ratio

Lower the duration is better the position of the firm in converting the stock

Into sales and vice versa

Debtors turnover ratio = Net Credit Sales OR Net Credit Sales

Average Debtors Debtor + Bills Receivable

Higher the ratio is better the position of the firm in collecting the overdue

Means the effectiveness of the collection department and vice versa

Net credit sales = total sales – cash sales

Average trade debtor = op Dr + cl Dr

op B/R + cl B/R

op a/c rec + cl a/c rec

2

Creditors Turnover ratio = net Credit Purchase or Credit Purchase

Average creditors payable + Sundry Cr

Lesser the ratio is better the position of the firm in liquidity management

Means enjoying more credit period from the creditors and vice versa

Average trade debtor = op Cr + cl Cr

op B/P + cl B/P

op a/c payable + cl a/c payable

2

Net credit sales = total sales – credit sales

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Solvency ratio

Debt –Equity Ratio = Debt or outsides fund or external equity

Equity Share holder‟s fund internal equity

The ideal norm is that 1:2 which means that every one rupee of debt

finance is covered by the 2 rupees of shareholders’ fund

List of Debt list of Equity

Debenture Equity Share Capital

Mortgage Preference Share Capital

Loans Capital Reserve

Bonds Reserve Capital

Bills Other Kind Of Reserve

Other Liability Contingency Reserve

Sinking Fund Reserve

Proprietary Ratio = Owner‟s Funds or Equity or Share Holder‟s Funds

Total Assets

Fixed Assets Ratio= Share Holders‟ Funds + Outsiders‟ Funds

Net Fixed Assets

Earnings per share (EPS) = net income

No. Of equity share

Interest Coverage Ratio = Earnings before Interest & Tax

Total interest expenses

Return on equity = net income X 100

Share holder fund

Dividend per share = dividend / share

P/E Ratio = Marketing Price of the Share

EPS

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Trend analysis

Trend analysis is a form of comparative analysis that is often employed to

identify current and future movements of an investment or group of

investments. The process may involve comparing past and current financial

ratios as they related to various institutions in order to project how long the

current trend will continue. This type of information is extremely helpful to

investors who wish to make the most from their investments.

Sales:-

2001 Jan 100000

2002 Feb 120000

2003 Mar 110000

2004 Apr 90000

2005 May 130000

Funds Flow Statement

Fund flow statement takes cash + near cash assets.

The term „flow‟ means movement and includes both „inflow‟ and „outflow‟.

The term „flow of funds‟ means transfer of economic values from one asset

of equity to another

Flow of funds is said to have taken place when any transaction makes

changes in the amount of funds available before happening of the transaction

0

20000

40000

60000

80000

100000

120000

140000

Jan Feb Mar Apr May

Trend Analysis

Revenve

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Cash Flow Statement

Inflow and outflow of cash are found.

Analyses are in three different categories:-

Investing activity:- purchase and sale of fixed assets

Operating activity:- regular activity of the business, like raw material &

sales. Generally short term periods

Financing activity: - issue and repayment of share, debenture and loans.

Generally long term periods

Common Size Financial Statements

Common size financial statement is also known as percentage analysis. Profit

and loss account and balance sheet is considered. Common size ratios are used

to compare financial statements of different-size companies or of the same

company over different periods. By expressing the items in proportion to some

size-related measure, standardized financial statements can be created, revealing

trends and providing insight into how the different companies compare. A sale

is always 100% taken.

The common size ratio for each line on the financial statement is calculated as

follows:

Common Size Ratio = Item of Interest

Reference Item

For example, if the item of interest is inventory and it is referenced to total

assets (as it normally would be), the common size ratio would be:

Common Size Ratio for Inventory = Inventory

Total Assets

The ratios often are expressed as percentages of the reference amount. Common

size statements usually are prepared for the income statement and balance sheet,

expressing information as follows:

Income statement items - expressed as a percentage of total revenue

Balance sheet items - expressed as a percentage of total assets

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The following example income statement shows both the dollar amounts and

the common size ratios:

Common Size Income Statement

Income Statement Common-Size

Income Statement

Revenue 70,134 100%

Cost of Goods Sold 44,221 63.1%

Gross Profit 25,913 36.9%

SG&A Expense 13,531 19.3%

Operating Income 12,382 17.7%

Interest Expense 2,862 4.1%

Provision for Taxes 3,766 5.4%

Net Income 5,754 8.2%

Risk & Return

Nobody knows what the future holds. So, whenever we talk about future

returns, we should be humble. Always there is an element of uncertainty or risk.

Perhaps the returns won't materialize; perhaps they will exceed our

expectations. We can't be sure.

Risk

Risk is the variability of actual return from the expected return associated with a

given asset. The greater variability, the riskier the security is said to be. The

more certain the return from an assets, the less the variability and, therefore the

less the risk. Risk is often understood as the possibility of loss. But risk, in

financial terms, is really a way to talk about a range of possibilities -- the

variability of returns. In short, risk is a way to describe degrees of uncertainty.

Returns

The return of assets and investment for a given period say a year, is the annual

income received plus any change in market price, usually expressed as a per

cent of the opening market price .symbolically the one period actual (expected)

return „R‟

R =Dt + (Pt-Pt-1)

Pt-1

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Where, Dt = annual income/cash dividend at the end of the period, t

Pt = security price at time period, t (closing/ending security price)

Pt-1 = security price at time period, t-1 (opening/beginning security price)

Portfolio

In finance, a portfolio is an appropriate mix or collection of investments or

security. Holding a portfolio is part of an investment and risk-limiting strategy

called diversification. By owning several assets, certain types of risk (in

particular specific risk) can be reduced. The assets in the portfolio could include

stocks, bonds, options, warrants, gold certificates, real estate, futures contracts,

production facilities, or any other item that is expected to retain its value. In

building up an investment portfolio a financial institution will typically conduct

its own investment analysis, whilst a private individual may make use of the

services of a financial advisor or a financial institution which offers portfolio

management services.