The major differences between compounding and discounting techniques in time value of money are as follows −Compounding techniqueIt is a process of calculating future value using present investment.It determines money gained by an investment.It is also called as present value.Compound interest rate.Uses future value/compounding factor.Its formula is Fv= Pv(1+r)^nAmount increases in this method.Right side to left (time line).If the rate is low then, future value will decrease and if the rate is high then, future value will increase.Discounting techniqueIt calculates future cash flows using present value.It determines the amount to be invested to get maximum future gains.It is also called ... Read More

Time value of money tells, what would be the worth of value of your present money in future. In other words, it tells about the worth of today’s money in future. Money potential increases with time.If you invest your today’s money, for which you will get interest, it will automatically increase the value of money. Factors like inflation and purchasing power are to be considered, while investing the money because both can erode the value.Time value of money helps investors to take decisions about where to invest, when to invest. It also helps us to understand about interest, inflation, risk ... Read More

SolutionThe solution is explained below −Future value = to be calculatedPresent value =Rs. 2500/-Interest rate = 10%Time = 2 years          Fv = Pv * [1 + (i/n)] ^ (n*t)         Fv = 2500 *[1+ (10%/1)] ^ (1*2) Fv = 2500 * [1 + 0.1] ^2 Fv = 2500 * [1.1] ^2 Fv = 2500 * 1.21 Fv = 3025/-

Following are cash flow for P1 and P2Year12345Project 1 (P1)40004600580072003500Project (P2)40004800360054003500Year 1Year 2Year 3Year 4Year 50.9250.8920.7490.6710.602Present value Rs.1/- @10% (discounted factor) using present value tableSolutionThe solution is stated below −For Project 1 (P1) −Initial investment = Rs. 35000/- YearDiscounted factorReturnsNet present value10.9254000370020.89246004103.230.74958004344.240.67172004831.250.602350021072510019085.6 Present value = Rs.19085.6/- Return on investment = (25100-19085.6)/35000 => 0.17184 => 17.184% For Project 2 (P2) −  Initial investment = Rs. 23000/- YearDiscounted factorReturnsNet present value10.9254000370020.89248004281.630.74936002696.440.67154003623.450.602350021072130016408.4 Present value = Rs.19085.6/- Return on investment = (21300-16408.4)/23000 => 0.21268 => 21.268% Hence, from the above calculations: Return on investments for P2 is more than P1 So, project P2 is selected.

Assets (Rs.)Liabilities (Rs.)Owners’ equity (Rs.)5000022000XXX11600XXX560010000055000XXX50000XXX290004500016000XXX41300XXX36500SolutionThe solution is explained below −We know accounting equation => Assets = Liabilities + Owner’s equityAssets (Rs.)=Liabilities (Rs.)+Owners’ equity (Rs.)50000=22000+2800011600=6000+5600100000=55000+4500050000=21000+2900045000=16000+2900041300=4800+36500

SolutionThe solution is explained below −We need to calculate preferred dividends, net interest expense before calculating financial breakeven pointPreferred dividends = preferred stock * 6% = 150*6% => $9 millionNet interest expense = total interest expenses – interest income= 150*6% => $9 millionNet interest expense = total interest expenses – interest income= 15 million – 2 million => 13 millionFinancial breakeven = (PD/1-TR)+ NIE= (9/ (1-28%)) + 13= 12.5 + 13= $ 25.5 million(Here, PD = preferred dividends, TR = Tax rate and NIE = Net Interest Expense).

The major differences between accounting breakeven point and financial breakeven point are given below −Accounting breakeven pointIt is the number of units sold to cover costs.It is an easy method.Cost per unit, fixed cost and variables cost are required to calculate the breakeven point.Accounting breakeven point = (TFC/PPU)-VC (Where TFC= Total fixed cost, PPU = price per unit, VC = variable costZero operating margin is calculated.Financial breakeven point −It is the number of units sold to cover costs.It is an easy method.Cost per unit, fixed cost and variables cost are required to calculate the breakeven point.Accounting breakeven point = (TFC/PPU)-VC ... Read More

Number of outstanding shares2500000Price of each shareRs. 48/-Market value for bondsRs. 30000000/-Risk free rate ( 10 year treasury)2.75%Cost of rate of return on company bonds (cost of return)5.90%Corporate tax22.25%Investor risk premium5.60%Company stock beta1.25SolutionThe solution is mentioned below −Market value (A) = no.of shares * price => 2500000 * 48 => Rs. 120000000/-Determine company debt = 30000000Cost of equity = 2.75% +5.60*1.25 => 0.0975Cost of debt = 5.90*(1-22.25%) => 0.046Weight of cost of capital = (R/V*Ke)+(D/V)*Kd*(1-tax rate)=(120000000/150000000)*0.0975 + (30000000/150000000)*0.046= 0.078+0.0092= 0.0872= 8.72 %

Weighted average cost of capital (WACC) is the computation of company’s cost of capital of each category of capital corresponds to weight. It includes common stock, preferred stocks, bonds and other long term debts. In other words, WACC is the average rate of a company pay to its investors.Increase in WACC means increase in risk. WACC uses by security analysts to assess the value of investment and to determine the pursue. It is also essential to calculate economic value added (EVA). Investors may use WACC to make decisions whether to invest or not. WACC tells about cost of new projects ... Read More

Plan APlan BCommon stockRs. 2000000Rs.500000Preferred stockRs.150000Rs.90000Long term debtRs.250000Rs.8000000Using EBIT-EPS approach, calculate EBIT.SolutionThe solution is given below −            (EBIT – In(a)) (1-T) – Pd(a) / OSa = (EBIT – In(b)) (1-T) – Pd(b)) / OSbL.H.S.EBIT = Earnings before interest and tax,In(a) = 250000 * 9% = 22500T = 28%Pd(a) = 150000 * 12% = 18000OSa = 2000000/10 = 200000R.H.S.EBIT = Earnings before interest and tax,In(b) = 8000000 * 9% = 720000T = 28%Pd(b) = 90000 * 12% = 10800OSb = 500000/10 = 50000         (EBIT – In(a)) (1-T) – Pd(a) / OSa = (EBIT – In(b)) (1-T) – Pd(b)) / OSb       (EBIT – 22500)(1-0.28) – 18000 / 200000 = (EBIT – 720000) (1-0.28) – 10800 /50000          (EBIT – 22500)*0.72 -18000 = 4{(EBIT -720000)*0.72 – 10800}             0.72EBIT – 34200 = 2.88EBIT – 518400                   2.16EBIT = 484200                   EBIT = 224166.67/-