MACN 302 Own Notes

Contents
Questions:.......................................................................................................................................................................6
A. Course text Book:....................................................................................................................................................7
B. OWN RESEARCH TO DO STILL.................................................................................................................................8
C. TO SCAN IN/ DO STILL.............................................................................................................................................9
D. SPECIAL THINGS TO REMEMBER............................................................................................................................10
E. FORMULAS.............................................................................................................................................................11
EVALUATING A PROPOSED CREDIT POLICY : how to calc NPV of SWITCHING POLICIES.......................................11
The EOQ=economic order qty formula :................................................................................................................11
PV –FV annuities etc formulas :............................................................................................................................11
ANNUITY:...................................................................................................................................................................11
loan: periodic payment of a loan...............................................................................................................................12
Perpetuity:................................................................................................................................................................12
Other extra formulas.............................................................................................................................................12
SHARES.....................................................................................................................................................................13
MARKET VALUE OF A COMPANY:...............................................................................................................................14
market Value of Convertible debentures or preference shares.................................................................................14
2-TERMS:(vig ch 1+2)...................................................................................................................................................15
TABLE OF ALTERNATIVE TERMINOLOGY /USA /UK.................................................................................................15
CAPEX= capital expenditure ( eg buying PPE like land or machines)....................................................................15
the production point of indifference, :...................................................................................................................15
analysis of the companies cost structure:.............................................................................................................15
Capital structure....................................................................................................................................................15
annuity:.................................................................................................................................................................16
over-trading..........................................................................................................................................................16
Cost Objects:.............................................................................................................................................................16
Direct and Indirect Costs...........................................................................................................................................16
inventory valuation:(note).....................................................................................................................................16
DIRECT COSTS :.....................................................................................................................................................16
INDIRECT COSTS :.................................................................................................................................................16
Categories of manufacturing costs. – with direct/indirect costs.............................................................................16
DIRECT MATERIALS :..............................................................................................................................................17
INDIRECT MATERIALS :..........................................................................................................................................17
DIRECT LABOUR :..................................................................................................................................................17
INDIRECT LABOUR.................................................................................................................................................17
DIRECT EXPENSE :.................................................................................................................................................17
PRIME COST...........................................................................................................................................................17
MANUFACTURING OVERHEAD :..............................................................................................................................17
COST ALLOCATIONS :............................................................................................................................................17
TOTAL MANUFATURING COST :..............................................................................................................................17
Period and Product Costs.......................................................................................................................................17
PRODUCT COSTS :.................................................................................................................................................18
PERIOD COSTS :....................................................................................................................................................18
Relevant and Irrelevant Costs:..................................................................................................................................18
RELEVANT COSTS AND REVENUES :......................................................................................................................18
IRRELEVANT COSTS AND REVENUES:....................................................................................................................18
Avoidable or Unavoidable costs:...............................................................................................................................18
AVOIDABLE=.........................................................................................................................................................18
UNAVOIDABLE.......................................................................................................................................................18
Opportunity Costs:....................................................................................................................................................18
-Incremental /or Differential- and Marginal Costs......................................................................................................18
INCREMENTAL or DIFFERENTIAL COSTS :...............................................................................................................19
MARGINAL COSTS :................................................................................................................................................19
Job Costing and Process Costing systems:................................................................................................................19
JOB COSTING SYSTEMS:.........................................................................................................................................19
PROCESS COSTING SYSTEMS:...............................................................................................................................19
1 MACN 302 :CORPORATE FINANCE Own Notes

ABSORPTION COSTING AND VARIABLE COSTING:and STANDARD COSTING..............................................................19
inventory valuation:(note).....................................................................................................................................19
IAS 2 on INVENTORIES States the Following.:........................................................................................................19
Absorbtion costing :...............................................................................................................................................19
Cost Absorbtion Rate :...........................................................................................................................................20
Fully Integrated Absorbtion costing System ( or “full” absorb. costing system)....................................................20
Variable Costing (or Marginal or Direct Costing)....................................................................................................21
Direct Costing........................................................................................................................................................21
Marginal Costing....................................................................................................................................................21
Standard Costing:..................................................................................................................................................21
Sunk Costs:...............................................................................................................................................................21
SUNK COSTS :........................................................................................................................................................21
Responsibility Accounting :.......................................................................................................................................21
RESPONSIBILITY ACCOUNTING :............................................................................................................................21
PROFIT CENTRE :...................................................................................................................................................21
COST CENTRE:.......................................................................................................................................................21
INVESTMENT CENTRE:...........................................................................................................................................21
Maintaining a cost database:....................................................................................................................................22
Fixed and Variable Production Overheads : and Cost Behaviour of...........................................................................22
VARIABLE COSTS :.................................................................................................................................................22
FIXED PRODUCTION COSTS :.................................................................................................................................23
SEMI-FIXED (or STEP-FIXED COSTS) :.....................................................................................................................24
SEMI-VARIABLE (or MIXED COSTS) :......................................................................................................................24
Relevant Range.........................................................................................................................................................24
Relevant Range:....................................................................................................................................................24
Selling Costs..............................................................................................................................................................24
Selling Costs :........................................................................................................................................................24
Conversion Costs:.....................................................................................................................................................24
Conversion Costs :.................................................................................................................................................25
HIGH-LOW COST ANALYSIS:...................................................................................................................................25
contribution:..........................................................................................................................................................25
budget:..................................................................................................................................................................25
“Standard Hours Produced”:.................................................................................................................................25
“Standard PROFIT STATEMENT”:...........................................................................................................................25
STATIC BUDGET.....................................................................................................................................................25
FLEXED BUDGET....................................................................................................................................................26
BILL OF MATERIALS...............................................................................................................................................26
STANDARD COST CARD.........................................................................................................................................26
more definitions....................................................................................................................................................26
1) INTRODUCTION TO CORPORATE FINANCE ch1 textbook..........................................................................................27
DEFINITIONS:.............................................................................................................................................................27
what IS CORPORATE FINANCE:..................................................................................................................................27
ETHICS......................................................................................................................................................................27
THE FINANCIAL MANAGER.........................................................................................................................................27
CAPITAL BUDGETING.............................................................................................................................................28
CAPITAL STRUCTURE.............................................................................................................................................28
Working capital management...............................................................................................................................28
FORMS OF BUSINESS ORGANISATION.......................................................................................................................28
THE GOAL OF FINANCIAL MANAGEMENT...................................................................................................................29
THE AGENCY PROBLEM.............................................................................................................................................30
Financial markets ,FinaNcial institutions,..................................................................................................................30
CASH FLOWS TO / FROM THE FIRM........................................................................................................................30
MONEY VS CAPITAL MARKETS................................................................................................................................31
PRIMARY VS SECONDARY MARKETS......................................................................................................................31
FINANCIAL INSTITUTIONS......................................................................................................................................31
Environmental factors...............................................................................................................................................31
CHAPTER 2 TIME VALUE OF MONEY PRESENT & FUTURE VALUE OF MONEY.................................................................32
introduction:..............................................................................................................................................................32

future value:.............................................................................................................................................................32
Present value: (PV)....................................................................................................................................................32
APR AND EFF : EFFECTIVE ANNUAL RATE AND ANNUAL PERCENTAGE RATE.............................................................33
ANNUITY:...................................................................................................................................................................33
loan: periodic payment of a loan...............................................................................................................................34
Perpetuity: (or consol in UK)......................................................................................................................................35
AMORTISATION..........................................................................................................................................................35
PURE DISCOUNT LOANS............................................................................................................................................35
INTEREST ONLY LOANS..........................................................................................................................................35
AMORTISED LOANS................................................................................................................................................35
SHARES : PRESENT VALUE OF SHARES......................................................................................................................35
Return on Shares- return on investment:..................................................................................................................38
Debt : Present value of debt:....................................................................................................................................38
Market value of debentures......................................................................................................................................40
MARKET VALUE OF A COMPANY:...............................................................................................................................40
Issue costs................................................................................................................................................................40
How To Determine Growth Rate:...............................................................................................................................40
miller & Modigliani market value of company...........................................................................................................41
3)CASH FLOW : Financial Statements, Taxes & Cash Flow Ch 2 fundamentals corporate textbook..............................42
TABLE OF ALTERNATIVE TERMINOLOGY /USA /UK.....................................................................................................42
1-balance sheet:.......................................................................................................................................................42
NET WORKING CAPITAL.........................................................................................................................................42
3 MOST IMPORTANT THINGS ON A BALANCE SHEET..............................................................................................42
2-INCOME STATEMENT..............................................................................................................................................43
NOTE: 3 THINGS TO KEEP IN MIND WHEN LOOK AT INCOME STATEMENT :...........................................................43
3-MARGINAL vs AVERAGE TAX RATE.........................................................................................................................43
4-CASH FLOW statement...........................................................................................................................................43
FROM CORPORATE FINANCE BOOK- CHAPTER 3 ‘WORKING WITH FIN STATS’:.....................................................43
From MACN202 notes VIGGIO................................................................................................................................43
WORKING OUT THE CASH FLOW STATEMENT BACKWARDS (corp fin book)...........................................................44
ANALYSIS OF FIN STATS & RATIOS chapter3 fundamentals.txtbook.............................................................................46
CASH FLOW STATEMENT:(this chapters bit of extra info about cash flow stats etc)..................................................46
STANDARDISED FINANCIAL STATEMENTS (common size).........................................................................................46
RATIOS:.....................................................................................................................................................................47
Du Pont Identity:...................................................................................................................................................47
RATIOS..................................................................................................................................................................48
margin of safety:.......................................................................................................................................................50
key ratios for cvp......................................................................................................................................................50
1) (PV ratio) Profit Volume ratio: ( or also called ‘contribution RATIO or margin %’ ).............................................50
2) profit ratio.........................................................................................................................................................50
3) (B/E sales) break-even sales revenue:( not a ratio)...........................................................................................50
4) break-even sales volume:( not a ratio)..............................................................................................................50
5) margin of safety ratio........................................................................................................................................50
6) OTHER TYPES:...................................................................................................................................................51
Business Risk assesment..........................................................................................................................................51
business risk ratios (there are 8 of )..........................................................................................................................51
business risk ratios (there are 3 of )..........................................................................................................................51
Contribution : High – Low method to get it from the income statement................................................................51
OPERATING LEVERAGE: = CONTRIBUTION/EBIT (Earnings Before Interest and Tax) | =Decimal Answer |low=1,5
high=3 |................................................................................................................................................................51
(GP%) GROSS PROFIT Percentage % RATIO: = Gross Profit/TURNOVER | =% ANSWER |......................................51
return on operating assets: earnings before interest and tax/ Operating Assets *100/1 | = % answer...............52
net profit percentage % ratio= net profit after tax/turnover * 100/1 |%=answer|................................................52
Roe : return on equity = earnings after tax/total shareholders funds *100/1 |% =answer|...................................53
increase in Turnover or sales growth – as a ratio =new-old/old |=%answer |........................................................53
b/E point = fixed costs/pv ratio % (contribution margin) | =% answer |...............................................................53
debtor turnover.....................................................................................................................................................53
Stock turnover.......................................................................................................................................................53
For financial ratios note that the ratio for debt-equity: you do USE debt=ONLY long term debt + bank overdraft NOT
creditors at all!!!!!!!! in viggio book, but in other not sure........................................................................................53
CURRENT ASSET MANAGEMENT CH19..........................................................................................................................55

INTRODUCTION.........................................................................................................................................................55
reasons for holding cash...........................................................................................................................................55
FLOAT , CASH COLLECTION, AND CASH CONCENTRATION........................................................................................55
INVESTING IDLE CASH...............................................................................................................................................55
CREDIT & RECEIVABLES :..........................................................................................................................................56
credit POLICY............................................................................................................................................................56
1) TERMS OF SALE.................................................................................................................................................56
2) credit analysis.......................................................................................................................................................57
Analyzing Credit Policy..........................................................................................................................................57
CREDIT ANALYSIS:deciding whether to give a specific customer credit or not:.....................................................58
OPTIMAL CREDIT POLICY.......................................................................................................................................59
3) Collection policy....................................................................................................................................................60
-eoq : DETERMINING THE ECONOMIC ORDER QUANTITY:..........................................................................................60
TABULATION METHOD :.........................................................................................................................................61
GRAPHICAL METHOD:............................................................................................................................................61
FORMULA METHOD:...............................................................................................................................................62
MORE NOTES ON EOQ Model.................................................................................................................................63
INTERNATIONAL CORPORATE FINANCE CH20...............................................................................................................67
Definitions:................................................................................................................................................................67
Foreign exchange markets & exchange rates...........................................................................................................67
Exchange rate quotations:....................................................................................................................................67
Web sites for exchange rates:...............................................................................................................................67
Types of transaction:.............................................................................................................................................67
Purchasing power Parity............................................................................................................................................68
INTEREST RATES AND BOND VALUATION CH7..............................................................................................................69
1) bond CALCULATIONS:...........................................................................................................................................69
BOND FEATURES...................................................................................................................................................69
CALCULATIONS FOR BONDS..................................................................................................................................69
INTERST RATE RISK:..................................................................................................................................................70
GENERAL NOTES on BONDS......................................................................................................................................70
DIFFERENCE BETWEEN DEBT & EQUITY.................................................................................................................70
CLSSIFYING IT AS DEBT OR EQUITY?......................................................................................................................70
HOW BONDS WORK...............................................................................................................................................70
fisher effect:..............................................................................................................................................................71
fisher effect:

Questions:
1. What headings nust we use in the the cash flow stat. – same as acc or same as pg 35 txtbook
2.

A. Course text Book:

B. OWN RESEARCH TO DO STILL

C. TO SCAN IN/ DO STILL
1. Chapter 2 time value of money –see spreadsheet calc. of time value of money ALSO ch 3 all the annuities and
other stuff, check out all the spreadsheet methods
2. Check formulas for APR and EFF in textbook pg 164 – cannot get them to work and what is formula for APR?

A. SPECIAL THINGS TO REMEMBER

B. FORMULAS
EVALUATING A PROPOSED CREDIT POLICY : how to calc NPV of SWITCHING POLICIES.

a. NPV of Switching Policies:
i. FORMULA :
where:
The EOQ=economic order qty formula :
PV –FV annuities etc formulas :

1) Future Value FORMULA : FV= PV(1+i)n
a) Where FV= future value
b) PV= present value
c) I = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
d) n= number of years/periods
2) Present Value Formula : PV = FV/(1+i)n
ANNUITY:
1) Future Value FORMULA for ORDINARY/DEFERRED/REGULAR ANNUITY. : FVa = I x [ (1+i)n –

1 / i] (1+i)
a) I = Constant Amount invested each year
b) FVa = future value of the annuity.
c) i = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
2) Future Value FORMULA for ANNUITY DUE : FVa= I x [ {(1+i)n – 1 }/ i] (1+i)


3) Present Value FORMULA for Regular ANNUITY : PVa= I x [ {1 – 1/ (1+i)n } / i] DO
A SCAN)
b) PVa = present value of the annuity.
e) This is where the payments are at the end of the year.
4) Present Value FORMULA for ANNUITY DUE : PVa= I x [ ({1 – 1/ (1+i)n } / i) + 1 ] (

DO A SCAN)
e) This one is where payments are at the beginning of the year.-annuity due.
LOAN: PERIODIC PAYMENT OF A LOAN

1) CHANGING the Present Value FORMULA for Regular ANNUITY to MAKE I THE SUBJECT below:
a) PVa= I x [ {1 – 1/ (1+i)n } / i]
PVa
i) Becomes : I = / [ {1 – 1/ (1+i)n } / i]
PVa X i
ii) Or: I = / [ {1 – 1/ (1+i)n } / i] : this formula is easier to use than the one above
for manual calculations – the /I is just changed mathematicaly to go on top as “X PVa “
iii)Where:
(1) I = Constant Amount invested each year
(2) PVa = present value of the annuity.
(3) i = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
(4) n= number of years/periods
PERPETUITY:
1) A Perpetuity is a normal Annuity but with an infinite life.
2) You only work it out by using a special formula:
3) PRESENT VALUE of a PERPETUITY FORMULA : PVp= I/i
a) PVp = Present Value of a Perpetuity.
b) I = Constant Amount invested each year
d) This one is where payments are at the end of the year.- I think- it does not say in the book what it is. Also it
does not say what the formula for at begin of year (annuity due) is.
4) PRESENT VALUE of a -growing- PERPETUITY FORMULA : PVp= I/i-g where g= growth
in decimals eg 0.08
Other extra formulas

1) PV of DEBT Formulas :There are 2 possible situations & formulas here:
a) For “Perpetuity Type ” Loan :PRESENT VALUE (PV) formula of Debt :
PV= Cash-Flow/Kd this is where the loan is indefinite/infinite with no repayment date specified. The answer is not
fixed- it changes if looked at from a PV or FV.
b) For “Repayment Time Specified ”Loan : (PV) formula of Debt : PV=
Cash-Flow
/(1+Kd)n here you must work out the PV with this formula for every year of the loan individually, and
then add up all the answers to get the total.- but you still only use the current market interest rate for Kd.
c) Where
i) Cash-Flow = the FV – ie money that is to flow in the future- the Future Value =this is the interest in
Rands OR/AND the capital repayments that will be paid back in the future.
ii) Kd = the interest rate charged for debt- if tax is deductable then first deduct the tax % from the rate
before you use it. Interest After Tax = interest rate X [100% - tax rate% ]%. This Kd is the current
market value of debt , not at the actual interest rate actually being paid back by company, but at the
lowest you could get today instead- even if it is.
SHARES
a) STATIC DIVIDENDS FORMULA(no growth )

i) There are 2 Ways this can get calculated: depending on if the shares are to be held “for ever” or to be
“sold” after a specific time. The difference is for the “for ever” one it works similar to the ‘perpetuity’
formula = [ Do/Ke ] and the second works similar to the Present Value formula [ like =FV/(1+i) ]
(1) PERPETUITY Type FORMULA: where the share is to held for an indefinite period ie: ‘in perpetuity’.
Do
(a) Ex-Dividend formula: Value = /Ke X Number of shares : means if
the shareholder receives a dividend today that dividend is EXCLUDED
(b) Cum-Dividend formula: Value = Dividend + (Do/Ke X TOTAL
number of shares.) means if the shareholder receives a dividend today then that
dividend is INCLUDED in the calculation of value of share (you just add the dividend to
answer-simple)
(c) Remember: you can ALSO get the PV of an ANSWER from this formula if it only will
occour in eg 3 yrs time. : say that for the next 2 years the share price will fluctuate ( or grow
etc) but in 3 years time it will start to remain the same from there on- static. If you are looking for
the value of the share today, you must first calculate the PV of the next 2 years separately using
another method ( directly or using growth formula below etc.) THEN you can calculate the value of
the 3rd year onwards using the above formula and bring this to PV by substituting your FV you got in
the for it to bring it to PV. : ie: [Do/Ke] = FV , so PV today = [D0/Ke ] / (1+i)n ……where we would use
‘Ke’ for ‘i’ here.!
(2) “TO BE SOLD “ Type PRESENT VALUE FORMULA : where the shares are to be sold after a specific
period of time :now it’s a PV calculation.
Do
(a) Ex-Dividend formula: Value = /(1+Ke)n X Number of shares :
means if the shareholder receives a dividend today that dividend is EXCLUDED You use
this formula once for each separate year to come, so for 3 years you must do the calc. 3 times and
add the answers up to get the total.
(b) Cum-Dividend formula: Value = Dividend + (Do/(1+Ke)n X
TOTAL number of shares.) means if the shareholder receives a dividend today then
that dividend is INCLUDED in the calculation of value of share (you just add the dividend to answer-
simple)
(c) Remember you could do the above calc. for years 3 & 4 but do years 1&2 with another formula for
eg.”growth” and just add the answers up to get the total.( say there was growth for first 2 yrs then
no growth for 2 yrs.)
b)GROWTH / FALLING DIVIDENDS (growth or getting less)
i) PERPETUITY Type FORMULA: where the share is to held for an indefinite period ie: ‘in perpetuity’. Do not use year 0
dividends, only end year 1
D1
(a) Ex-Dividend formula: Value = /Ke - g X Number of shares : means
if the shareholder receives a dividend today that dividend is EXCLUDED
(b) Cum-Dividend formula: if they ask for cum-dividend then (probably) just add the dividend you
are receiving to the answer per share.
ii) “TO BE SOLD “ Type PRESENT VALUE FORMULA : where the shares are to be sold after a specific period of
time :now it’s a PV calculation.
D1
(a) Ex-Dividend Formula : Value = /(1+Ke )n X Number of shares :
(ie cash flow/for this one you MUST work each year out separately using the PV formula given
here. To accommodate the growth (g) in dividends each year you cannot do it with the formula, you
must manually increase the dividends each year, then work out the Present Value for each separate
year using the above formula .THE SELLING PRICE AT THE END OF THE PERIOD MUST BE INCLUDED
IN THE final year PV calculation.(ie just add it to the final year dividends and get the PV of the total,
no need to do a separate calculation!)Then add all the years up to get the present value of the
shareholding.

(b) Cum-Dividend Formula: Cum-Dividend: probably just add the dividend you are receiving to the
answer
(c) Remember:you might have to work out the PV for only 2 years using this formula, then
switch to another formula if question says there will be no more growth from the 3rd
year onward : that new answer then gets in
turn brought to P.V.
2) Debt : Present value of debt:

1. There are 2 possible situations & formulas here:
a. For “Perpetuity Type ” Loan :PRESENT VALUE (PV) formula of
Debt : PV= Cash-Flow/Kd this is where the loan is indefinite/infinite with no repayment date
specified. The answer is not fixed- it changes if looked at from a PV or FV.
b. For “Repayment Time Specified ”Loan : (PV) formula of Debt :
PV= Cash-Flow/(1+Kd)n here you must work out the PV with this formula for every year of the
loan individually, and then add up all the answers to get the total.- but you still only use the current
market interest rate for Kd.
MARKET VALUE OF A COMPANY:
1) The Market Value of a Company : there are 2 formuals :Formula 1: V0 = MVe +

MVd
a) The Market Value of a Company Formula : is simply the Market Value of Equity ( ie the PV valuation of the
shares) PLUS the Market Value OF all Debt (ie PV valuation of debt) ,these valuations of debt and equity above
must be done using the “FV of cash flows” at “current market rates” to get the Present Value of all future cash
flows.
2) The Market Value of a Company : there are 2 formulas :Formula 2 : V0 = Y
/WACC
= Dividends(Do) + DebtInterest Paid in Cash/WACC (AFTER TAX)
MARKET VALUE OF CONVERTIBLE DEBENTURES OR PREFERENCE SHARES.

1) The Valuation of Convertibles is carried out in 2 steps:
a) At the option date, compare the value of each option and choose the option with the highest value.
b) Calculate the value of future cash flows and the terminal value of the option chosen, back to year 0. (date at
which the you want to know the value – not date of option but date today)
2) If You Convert From One Type Of Security To Another, (Eg: Debentures To Shares, Or Pref. Shares To
Debentures). Use The Current Type’s Ke Or Kd To Bring The “Future Market Value Fv” At Date Of
Conversion To Todays Present value- NOT the Kd or Ke of what it will be when its converted. So: if you are
going to choose to convert to ordinary shares at the date of the option in say 3 years , from debentures , then
there is one complication : TO GET THE Present Value OF THE MARKET VALUE OF THE NEW ORDINARY SHARES
today in order to add it to the PV of any cash flows up to the date of conversion = Market Value of DEBENTURES,
TOU MUST USE THE DEBENTURE Kd (LESS TAX), AND NOT THE ORDINARY SHARE Ke at which the FV market
value of the shares were worked out

2-TERMS:(vig ch 1+2)
TABLE OF ALTERNATIVE TERMINOLOGY /USA /UK
1) COST RECOVERY RATE.: the rate or basis eg machine hours. at which costs are recovered to a specific eg
production dept.
2) BASIS : the rate/basis is the measurement used to allocate costs eg: labour hours or machine hours.
3) COST PLUS BASIS :means you work out the final figure by starting with the cost price and then adding a
certain amount or % to it.
4) LIMITING FACTORS OF PRODUCTION: like a bottleneck at the machine dept – because machines only produce a
maximum amount each , or one cannot get more than a certain amount of some raw input product per month etc
5) Management accounting : is primarily concerned with producing budgets, setting performance standards, and
evaluating performance
1) Acc sys used for measure costs for profit measurement,inventory valuation ,decision making,performance
measurement, control.
CAPEX= capital expenditure ( eg buying PPE like land or machines)
the production point of indifference, :

Where the total cost of a capital-intensive company = the total cost of a labour-intensive company.
analysis of the companies cost structure:

Its fixed costs and contribution per unit.
Capital structure
means whether the company is using equity or debt and what combination of the 2 and interest rates etc etc.

annuity:
The Receipt or Payment of a fixed amount over a number of years or periods.
ANNUITY DUE: if payment is made at the beginning of each period, it is called this
REGULAR /ORDINARY /DEFERRED ANNUITY : if payment is made at the end of the period.
over-trading
Means the company is selling too mush on credit and debtors are taking too long to pay- too many debtors and too
long to pay. This means it is taking chances with it’s selling on credit policy and over doing it.
COST OBJECTS:
1. COST OBJECT :Definition: ANY ACTIVITY for which a SEPARATE MEASUREMENT of COSTS is desired.
a) Eg; cost of a product , of rendering a service to a bank customer ,of operating a particular sales territory or
dept.
The Cost Collection System works as such ; it accumulates costs-by assign into categories-eg labour,materials
,overheads.( or by fixed & variable).THEN assigns these costs to cost objects.
DIRECT AND INDIRECT COSTS
inventory valuation:(note)
IAS 2 : INTERNATIONAL STATEMENT ON INVENTORIES states that : Firstly, closing stock – work
completed but unsold- (??? What About inventories & work in progress???) must be valued at the lower of
cost and net realisable value.Inventories are valued at : all costs incurred in bringing to current state –
ONLY manufacturing direct and indirect costs-The Costs of conversion of inventories include costs directly
related to the units of production,such as direct labour.They also include a systematic allocation of fixed &
variable overheads that are incurred in converting material into finished goods.Fixed production overheads
are those indirect costs of production that remain relatively constant regardless of the volume of
production, such as depreciation ,maintenance of factory buildings and equipment,and the cost of factory
management and administration.
However FIXED OVERHEADS are only allocated at the normal production capacity(over anumber of seasons
or periods under normal circumstances,taking into account the loss of activity relating to planned
maintenance) .If idle plant /low production inventory costs are ONLY allocated at normal prod. Capacity
Levels.BUT in periods of abnormally high production, the amount of fixed averheads allocated to each
product unit is decreased so inventories are not valued at below cost.
As a result of this accounting definition ,the valuation of stock is carried out on a FIFO or weighted average
basis.LIFO is strictly prohibited.
DIRECT COSTS :
Costs that can be specifically and exclusively identified with a particular cost object. . .. Eg:wood in
a desk, maintenance labour in -(cost object maintenance dept)-but NOT Maint.Labour in a –(cost object
desk produced).The more direct cost and less indirect costs =the more accurate the estimate.
INDIRECT COSTS :
Costs that cannot be identified specifically and exclusively with a particular cost object, but can only be identified
with a a number of depts.. /cost objects.
Categories of manufacturing costs. – with direct/indirect costs.

Direct Materials Xx
Direct Labour Xx
Prime Cost Xx
Manufacturing Overhead Xx
Total Manufacturing Cost Xx
i) In manufacturing organisations traditional product costs accumulated as follows – ( developed esp.

from/for ext. accounting requirements.
DIRECT MATERIALS :
Cost of all materials that can be identified with a specific product.eg wood for desk is, but maintenance
materials on machine to produce with is not,that is an indirect materials cost.
INDIRECT MATERIALS :
cannot be identified with any one product, eg:because used for all.eg maintenance materials spares.
DIRECT LABOUR :
can be specifically traced to or identified with product eg:labour assemble product
INDIRECT LABOUR
can not be specifically traced to or identified with product eg:labour maintenance of many different
product lines machines.
DIRECT EXPENSE :
NOT labour/materials/overheads/ can be specifically traced to or identified with product eg hiring of
machine to produce a specific quantity of a product is a direct expense. (other than /not labour/materials-
in this context) anything else in this category would be classed as 'OVERHEADS' –see below.
PRIME COST
= Direct materials+Direct Labour +Direct Expenses.
MANUFACTURING OVERHEAD :
All manufacturing costs exept : Direct materials+Direct Labour +Direct Expenses eg:rent of factory.
COST ALLOCATIONS :
process of assigning indirect costs(overheads) to products- using surrogate ,not direct measures.ALSO –
the assigning of eg: rent between mnftring and / non-mnftring depts.
TOTAL MANUFATURING COST :

Direct materials+Direct Labour +Direct Expenses+Mnfctring overheads
Period and Product Costs.

2) Because of external fin acc rules in most countries that require that for inventory evaluation ONLY
MANUFACTURING COSTS /or RETAILER = PURCHASE COSTS + FREIGHT IN -should be included in the calculation of
product costs AS WELL AS ONLY costs related directly to the units of production- accountants therefore classify
costs as product costs and period costs.
a) BECAUSE OF THIS ONLY the FIFO or weidghted average methods may be used to calc. inventory- NOT
L.I.F.O.-ie. Costs must relate directly to units of production.
REASONS CITED FOR THIS:
b) Inventories represent a future probable inflow of revenue , period costs(overheads) do not
c) Many non-manufacturing costs are NOT incurred when the product is being stored-thus inappropriate to
include them in inventory valuation.
INTERNATIONAL STATEMENT ON INVENTORIES states that :Inventories are valued at : all costs incurred in bringing to
current state – ????ONLY manufacturing direct and indirect costs- ie:COSTS OF CONVERSION ???????YES OR NO.
Includes systematic allocation of fixed & variable overheads.
However FIXED OVERHEADS are only allocated at the normal production capacity.If idle plant /low production
inventory costs are ONLY allocated at normal prod. Capacity Levels.BUT in periods of abnormally high production, the
amount of fixed averheads allocated to each product unit is decreased so inventories are not valued at below cost.
PRODUCT COSTS :
costs identified with goods purchased or produced for resale.-in mnftring is costs attached to product for inventory
valuation of finished goods ,work in progress, matched against sales for recording profits. ONLY MANUFACTURING
OVERHEADS may be INCLUDED as part of absorbtion costing in the valuation of closing stock.Variable costing would
treat it as a period cost and write it off in period it occoured.(IFRS/etc) =recorded as an ASSET until sold ,then as an
expense.(when you 'write out' last inventory count and write in new inventory in the profit & loss statement at year
end I THINK? ) ! Product costs= TOTAL MANUFACTURING COSTS =direct labour+dir.material+direct expenses
+Mnftring overheads( from last section) NOT eg: distribution+telephone for telesales .as per book exactly: Admin
Overheads or selling overheads may never be assosiated with production.
PERIOD COSTS :
costs treated as expenses in the period in which they occoured, BUT NOT included in the cost calc. of inventory
valuation.(or /sales/work in progress.)recorded as an expense ONLY,never as an asset! Period costs= eg: sales
expenses+ admin +distribution expenses.
RELEVANT AND IRRELEVANT COSTS:
RELEVANT COSTS AND REVENUES :

Those Future costs and Revenues that will be changed by any specific decision relating to production volume or
selling volume.eg: material costs change if choose to produce more
IRRELEVANT COSTS AND REVENUES:

Those Future costs and Revenues that will NOT be changed by any specific decision relating to production volume
or selling volume.. Eg: rent for factory will not change if higher production or selling volume.
AVOIDABLE OR UNAVOIDABLE COSTS:
AVOIDABLE=
relevant costs (sometimes used in place of other name)
UNAVOIDABLE
irrelevant costs (sometimes used in place of other name)
OPPORTUNITY COSTS:
3) OPPORTUNITY COST =The cost of a foregone opportunity in favour of having chosen another one :eg . if the
cost of selling a new product is to stop selling another one , the opportunity cost is the rvenue one used to receive
from the old one.
-INCREMENTAL /OR DIFFERENTIAL- AND MARGINAL COSTS
INCREMENTAL or DIFFERENTIAL COSTS :

Accountants use this : means the different in total costs for ALL THE EXTRA PRODUCTS WHEREBY the PRODUCTION
HAS BEEN INCREASED.
MARGINAL COSTS :
Economists use this : means difference in costs for ONLY ONE extra product –ie. For each separate new product
whereby production has been increased.
JOB COSTING AND PROCESS COSTING SYSTEMS:
JOB COSTING SYSTEMS:

Relates to a costing system where all the costs associated with each job could be different for each job
completed and , so direct materials and labour are allocated at actual cost and fixed overheads are allocated on a
pre-determined cost rate for each separate job.This is also known as a fully integrated absorption costing system.
eg. In constructiion industry –where each house could be unique and have a completely different set of costs to
other houses.
PROCESS COSTING SYSTEMS:

The method used to value stock in mnftring where at end of period some of the closing stock is partially
manufactured-not all finished yet.
ABSORPTION COSTING AND VARIABLE COSTING:AND STANDARD COSTING.

inventory valuation:(note)
IAS 2 on INVENTORIES States the Following.:
IAS 2 : INTERNATIONAL STATEMENT ON INVENTORIES states that : Firstly, closing stock – work
completed but unsold- (??? What About inventories & work in progress???) must be valued at the lower of

cost and net realisable value.Inventories are valued at : all costs incurred in bringing to current state –
ONLY manufacturing direct and indirect costs-The Costs of conversion of inventories include costs directly
related to the units of production,such as direct labour.They also include a systematic allocation of fixed &
variable overheads that are incurred in converting material into finished goods.Fixed production overheads
are those indirect costs of production that remain relatively constant regardless of the volume of
production, such as depreciation ,maintenance of factory buildings and equipment,and the cost of factory
management and administration.
However FIXED OVERHEADS are only allocated at the normal production capacity(over anumber of seasons
or periods under normal circumstances,taking into account the loss of activity relating to planned
maintenance) .If idle plant /low production inventory costs are ONLY allocated at normal prod. Capacity
Levels.BUT in periods of abnormally high production, the amount of fixed averheads allocated to each
product unit is decreased so inventories are not valued at below cost.
Variable Production overheads are those indirect costs of production that vary directly,or nearly
directly,with the volume of production,such as indirect materials and indirect labour.
As a result of this accounting definition ,the valuation of stock is carried out on a FIFO or weighted average
basis.LIFO is strictly prohibited.
Cost accounting grew out of the need that financial accountants have for financial information ,and gathers
and analyses costs for the purposes of :product costing,job costing,stock valuation.
Absorbtion costing :
IN EXAM, OR REAL LIFE, AS SOON AS ONE GETS AN INCOME STATEMENT OR FIGURES PREPARED USING
ABSORBTION COSTING, ONE MUST QUICKLY CALCULATE THE SAME FIGURES USING VARIABLE COSTING –
OR YOU WILL NOT BE ABLE TO DO PROPER COMPARISONS AND WORK THINGS OUT! Due to fixed costs
being in there- always take them out and convert to CONTRIBUTION ..
Method used to VALUE CLOSING STOCK that includes ALL MANUFACTURING COSTS-VARIABLE AND FIXED-NOT
any NON-MNFTRING COSTS AT ALL!!!!!! ((WHICH DOES/can INCL. RENT AND MAINTENANCE per book)–
The fixed cost element can be determined by budget or by actual,and is added to all variable mnftring costs(eg
direct material) to get the total per unit product cost for inventory valuation per the IAS definition ( which says ALL
MNFTRING COSTS must be included in Inventory Valuation incl. fixed mnftring costs eg: Maintenance etc.) .ONLY
Financial Accounting uses it. NOTE: every time production volume changes ,the cost per unit will change
because fixed costs get divided by a larger /or smaller number now.So it is an inconvenient method requiring
constant raising of under/over recovery charges to balance the figures.The 2 reasons for this is:
1-Actual volume is different to budget volume.
2-Actual manufacturing overhead being different to budget overhead.
That is why Management Accounting uses a different method –: called "Variable Costing".
FOR ABSORBTION COSTING THRE ARE 2 WAYS OF VALUING STOCK:1-BUDGET AND 2-

ACTUALVARIABLE PLUS FIXED COST OF PRODUCTION. But for variable costing ther are also these 2
ways , exept there it is only VARIABLE COSTS OF PRODUCTION, not fixed and variable in the stock
valuation(per book vigario pg14-concl.
ALSO, FOR ABSORBTION COSTING THERE ARE 3 POSSIBLE WAYS OF PRESENTING THE INFORMATION
IN THE FINANCIAL STATEMENTS.
1-FULLY INTEGRATED ABSORBTION COSTING (BUDGET COST)
2-NON-INTEGRATED ABSORBTION COSTING (BUDGET COST)
3-ACTUAL COST ABSORBTION COSTING. (all exactly per vig. Pg 14 book!)
IS ABSORBTION COSTING ACCEPTABLE:?
NO, because it will distort true company profits due to showing fixed costs as closing inventory
costs –you cannot compare 2 periods properly,or budget properly if you use include rent at a pre-
determined rate eh R300 per product it will not be accurate if production rises or falls.- it will eg
show excessive profits when stock holding is rising ? per book vig pg14.
HOW DO YOU MAKE IT ACCEPTABLE:
You explain on any budget that the Per Unit cost can vary by the TOTAL FIXED COSTS AMOUNT included
in the costing eg R500 –at any level above or below the no. of units that the budget was calculated at.
However ,for calculating costs of products in a Job Costing environment, where the costs are used to quote on
future jobs eg: Printers , when using absorbtion costing, one must remember that one company allocates fixed
costs differently to another one,and there is no right or wrong method to allocate fixed costs really, ie some
allocate all overheads, some only admin + management , some only maintenance and depreciation etc.

Cost Absorbtion Rate :
the cost rate at which a group of costs or fixed costs or overheads are charged to a specific product eg: machine
hours divided between no. of products.(it is used by fin . accountants to calculate absorbtion costing system.
Fully Integrated Absorbtion costing System ( or “full” absorb. costing system)

If the fixed element is pre-determined .So when fixed elements eg: rent+maintenance ,are pre-calculated in the
previous years as a per unit cost, from per average normal production levels,so eg R1000 rent /500products
made per mnth= R2 rent per product ;and these amounts are added to normal vriable costseg direct material, to
get a (estimated/ avg)total cost per product unit . (NOTE: not all fixed costs need to be allocated as such ONLY
mnftring costs MUST BE(WHICH DOES INCL. RENT AND MAINTENANCE per book), other fixed costs eg admin and
computer,marketing costs(more 'sales costs' types get left out)can be left out and the system would still be called
Fully Integrated absorbtion Costing) ONLY where the fixed cost element is pre-determined though and not based
on actual fixed costs ,which is another type of absorbtion costing.The actual amount will differ from the allocated
amount though and OVER or UNDER recovery of fixed overhead will occour, which must be balanced by a
BALANCING AMOUNT known as the over/under –recovered fixed overhead.This amount is included by 'raising a
charge' (possibly it's very own ledger account-CRJ/CPjournal) and including it in the Cost of sales breakdown in
Income statement for Gross Profit calc.
Do NOT ASSUME every company uses fully integrated abs.cost. to allocate costs in order to arrive at the cost of a
product.Only companies that have a JOB COSTING environment , require a pre-determined FIXED COST to allocate
to FUTURE production.Very few companies will allocate costs to production and service depts. , followed by re-
allocation from service depts. to production depts. However , when using absorbtion costing, one must remember
that one comapny allocates fixed costs differently to another one,and there is no right or wrong method to
allocate fixed costs really, ie some allocate all overheads, some only admin + management , some only
maintenance and depreciation etc.
Variable Costing (or Marginal or Direct Costing)
IN EXAM, OR REAL LIFE, AS SOON AS ONE GETS AN INCOME STATEMENT OR FIGURES PREPARED USING
ABSORBTION COSTING, ONE MUST QUICKLY CACULATE THE SAME FIGURES USING VARIABLE COSTING –
OR YOU WILL NOT BE ABLE TO DO PRPER COMPARISONS AND WORK THINGS OUT! Due to fixed costs
being in there- always take them out and convert to CONTRIBUTION ..
The method used to VALUE CLOSING STOCK using variable manufacturing costs only- fixed costs are written off as
period costs.(as per book- fixed mnfrtring costs are charged to the Income statement as an expense for the period.So
closing stock is valued on manufacturing variable costs only. Ie: the valuation excludes all mnfring fixed costs.The
System is representative of managerial accounting for decision making.
Variable costing is consistent with CVP analysis,ie fixed costs are treated as period costs.(per book exactly)
FOR VARIABLE COSTING ,THERE ARE 2 WAYS OF VALUING STOCK – 1-BUDGET OR 2-ACTUAL.
Direct Costing.
Marginal Costing.
Standard Costing:
Another method of VALUEING CLOSING STOCK – but at a pre-determined rate for BOTH VARIABLE AND FIXED
COSTS.
Standard Variable Costing:
(a) when only pre-determined variable costs are used.
Standard Fixed Costing:
(b) when only pre-determined fixed costs are used.
SUNK COSTS:
SUNK COSTS :
These are COSTS created by a decision in the PAST that cannot be changed by any future decision – or which has a
zero value when making future decision: eg:depreciation,or money spent on material that is no longer required/ or
sellable.-OR buy a car for 10000, when you sell it the 10000 is sunk cost because selling price depends on what the
buyer will pay –it can be above or below 10000 .
RESPONSIBILITY ACCOUNTING :

RESPONSIBILITY ACCOUNTING :
accounting for a RESPONSIBILITY UNIT -an organisation unit or part of a business for which a manager is
reponsible.Revenues & Costs so deviations from performance budget can be attributed to resposible individual.
PROFIT CENTRE :
same as above :Accountability for profitability of assets placed under a managers control.
COST CENTRE:
SAME AS above but AREA or DEPT. for which a manager is responsible.
INVESTMENT CENTRE:
term defines accountability for profit generation AS WELL AS choices in what will or will not be purchased by way
of capital expenditure in running a business.
MAINTAINING A COST DATABASE:

1) Database to be maintained so relevant cost info can be extracted easily.
2) Need eg: By products, responsibility centres,depts.,distribution channels, + categ. of expense eg direct labour
+ categ. of cost behaviour eg fixed and variable.
3) For cost control and performance measurement:
a) Reports by resposibility centre per week/ etc
b) Future reports for eg: possible price changes.
c) Standards costs stored & used to evaluate
FIXED AND VARIABLE PRODUCTION OVERHEADS : AND COST BEHAVIOUR OF

a) Measurements of volume needed to :patients seen-one more patient/day?=costs/revenue/(or units sold ?
reduce price to sell more?,or units produced ,guests booked etc)
VARIABLE COSTS :
vary directly or very nearly directly according to incr./decr. in volume(eg:of production).See chart below : total
variable costs are linear/direct and Unit var. cost is constant.
UNITS vs VARIABLE COSTS GRAPH
VARIABLECOSTS: (a)TOTAL
TOTAL Variable
5000 5000
4000 4000
Cost
3000 3000
2000 2000
1000 1000
0 0
0 100 200 300 400 500
ActivityLevel
PROFIT vs VARIABLE COSTS GRAPH.

FIXED PRODUCTION COSTS :
basicaly stay constant regardless of volume of production –OVER a specific period of time- (before inflation pushes up
input prices etc),but also called ‘long term variable costs’ because over the long term ALL costs are seen a variable-
due to inflation etc. eg:rent, municipal rates
UNITS vs FIXED COSTS GRAPH
PROFIT vs FIXED COSTS GRAPH

SEMI-FIXED (or STEP-FIXED COSTS) :
They are fixed in (Relevant Ranges )at specific activity levels :eg at 100 – 5000 products ,-within a specific time
period (same as fixed –to exclude inflation etc)- but if production goes above that they change to the next level etc.–
usually in steps-
SEMI-VARIABLE (or MIXED COSTS) :

These include both a FIXED and a VARIABLE component eg:maintenance = fixed cost + a variable cost according to
amount of activity ; or sales rep. costs =salary + commission per amount of sales. Eg rent= rent +10%gross revenue
RELEVANT RANGE
Relevant Range:
A limited level of activity under which costs are analysed as either fixed or variable,eg for production of 1-1000 units,
over that another costing structure is used,or another range.
SELLING COSTS
Selling Costs :
relate to sales, written off in period incurred. Eg :commission costs,etc.
CONVERSION COSTS:
Conversion Costs :
All costs other than Direct Material costs that are incurred in manufacturing a product.The word conversion is
normally associated with process costing and refers to all costs exept direct material directly related to the
manufacturing process.
ADMINISTRATION Costs:
Administration Costs: treated as a manufacturing overhead only if relate to work being carried out in mnftring process
– but in most instances they are written off as a period cost- not mnftr. Cost. Eg: cost of accountant= period cost ,
cost of person who records all manufacturing processes number produced, materials used etc only in mnftring =
manftring admin cost .
HIGH-LOW COST ANALYSIS:

REFERS TO ANALYSIS OF SEMI-VARIABLE COSTS where the var. & fixed. Elements are calc. by analysing incr. in cost
in comparison to incr. in prod. Volume.
contribution:
CONTRIBUTION is the SELLING PRICE of a product LESS all VARIABLE COSTS.The term used by Management
accountants to describe the incremental profit that a company will make as the company sells one more unit of
production.(DOES NOT include FIXED COSTS, ONLY SELLING PRICE – VARIABLE COSTS = contribution, then after
that ,CONTRIBUTION-FIXED COSTS=NET LOSS/PROFIT.) Variable costs would include
selling,marketing,distribution costs etc,so ALLl variable costs,none are left out. Mngmn acc only concerned with
contribution,not profit since incr. sales = incr.contribution where fixed costs stay constant. Means ' Profit contributed
toward total profit of firm before fixed costs' so.This happens because fixed costs do not change , but production
volume does, so once all fixed costs have been paid by current production volume, any increase in production volume
above this results in a higher profit than before the fixed costs were paid for.Thus before fixed profit is paid for ,
PART OF THE CONTRIBUTION goes to fixed costs, but after the fixed cost is paid for, ALL OF THE CONTRIBUTION
goes toward profit.
SALES
- Variable Costs
(incl.marketing,selling,distrib
ution ie: ALL.
= CONTRIBUTION
- Fixed Costs
= PROFIT
budget:
A budget is a quantitative analysis of a plan or corporate action.It is intended that production/sales etc be co-
ordinated by various depts. to achieve expectations about future income/cash flows/fin pos , fin perf and supportin
plans.
“Standard Hours Produced”:
-“– is the time it takes to produce one product ,used as a common denominator to divide up costs into different
products.
“Standard PROFIT STATEMENT”:

This is an income statement , using pre-determined standard cost rates , showing what profit we can expect from a
given sales volume.The volume is usually estimated from known sales and production capacity, but could also just
mean the volume for the flexed budget, when using standard costing.
STATIC BUDGET
The plain original realistic budget for the year drawn up at beginning of year.
FLEXED BUDGET
Standard Budget : The budget the is drawn up using the ACTUAL sales VOLUME, but with the original costs from
the Original Budget, not the Actual Costs. This can then be compared to the actual Income statement to see what
the difference in each cost was once converted to the actual sales level.
BILL OF MATERIALS
A list of all the actual materials needed to manufacture a specific product. Does not include labour/overheads etc.
like the ‘Standard Cost Card.’
STANDARD COST CARD

Card with the costs of all the Inputs used to make 1 output product.(That should (actual) be used to produce a
product.)1 card is kept for each different product made. (-historical cost -not a goal type cost).Nowdays on computer.
more definitions
1.1. Indirect (common) fixed cost : applies to all products eg rent
1.2. Direct (avoidable) fixed costs : applies only to single 1 of many products.
1.3. Sales mix: the ratio to each other of the different products which are made eg 1: 5: 8
2. AGENCY RELATIONSHIP: definition : it is the relationship between owners and shareholders
3. AGENCY PROBLEM or COST definition : The possibility of conflict of interest between owners and mngmnt is
called the. Eg mngrs see short terms goals not long term goals , like maximize profit for bonus’s etc. Or if sell a
car for someone for a flat fee, then you wont go for a higher price for him.- so commission could be better option.
3.1. DIRECT AGENCY COST: 2 types : 1 - like mngmnt buy a corporate jet / 2- need for hiring auditors to audit the
firm each yr
3.2. INDIRECT AGENCY COSTS: like mngmnt does not invest in a new venture because it is riskt and some of their
jobs might be lost, even though it will increase the share value a lot for shareholders /
4. Corporate finance : DEFINITION: IS THE MANAGEMENT OF capital budgeting/long tyerm investment decisions
and capital structure/long term financing as well as everyday financial activities of a company.
5. CAPITAL BUDGETING DEFINITION: deciding on whether to aquire and seeking and evaluating any long term
investments.
6. CAPITAL STRUCTURE definition : it is the mix used of equity vs debt vs (or use own profits) decision,.
7. WORKING CAPITAL definition: Refers to short term assets eg inventory and short term liabilities eg supplier
creditors
8. THE GOAL OF FINANCIAL MANAGEMENT Definition : is Officially defined as : TO MAXIMIZE THE CURRENT
VALUE OF OWNERS EQUITY / VALUE PER SHARE FOR EXISTING SHARES.
8.1.

1) INTRODUCTION TO CORPORATE
FINANCE ch1 textbook
DEFINITIONS:
called the. Eg mngrs see short terms goals not long term goals , like maximize profit for bonus’s etc. Or if sell
a car for someone for a flat fee, then you wont go for a higher price for him.- so commission could be better
option.
a. DIRECT AGENCY COST: 2 types : 1 - like mngmnt buy a corporate jet / 2- need for hiring auditors to
audit the firm each yr
b. INDIRECT AGENCY COSTS: like mngmnt does not invest in a new venture because it is riskt and some
of their jobs might be lost, even though it will increase the share value a lot for shareholders /
4. CAPITAL BUDGETING DEFINITION: deciding on whether to aquire and seeking and evaluating any long
term investments.
creditors
7. THE GOAL OF FINANCIAL MANAGEMENT Definition : is Officially defined as : TO MAXIMIZE THE
CURRENT VALUE OF OWNERS EQUITY / VALUE PER SHARE FOR EXISTING SHARES.
8. Securites : the various types of debt or equity that can be issued by the firm.
9.
WHAT IS CORPORATE FINANCE:

1. Corporate finance is broadly speaking, the study of ways to do the following 3 questions:
a. LONG TERM INVESTMENTS : WHAT LONG TERM INVESTMENTS SHOULD YOU TAKE ON :
buildings,machinery,equipment for your line of business.
b. LONG TERM FINANCING : WHERE WILL YOU GET THE LONG TERM FINANCING TO PAY FOR
INVESTMENTS : 1-retain profits you make to use for this or 2- bring in other owners 3-borrow
c. EVERDAY FINANCIAL ACTIVITIES MANAGEMENT : how will you manage your everyday financial
activities, such as collecting from customers & paying suppliers
ETHICS
1. In order to provide a more stable firm which is less like ly to get into financial diffucties and thus has a lower
possibility of cheating on quality etc, and a high possibility of being strong so they can say to customers – you
can trust us so that customers are prepared to pay a higher price and come back again(provide a more
assured stream of future income for the firm) the firm must be safe. This means ;
a. Lower leverage, fewer leases, engageing in more hedging to be a safer company and a more quality
company.
THE FINANCIAL MANAGER

1. Company appoints mangaers to represent owners and make decisions on their behalf- striking feature of large
companies.
2. 2 MAJOR FUNCTIONS of the Financial Manager .
a. CAPITAL STRUCTURE :/ Financial Planning
b. CAPITAL BUDGETING :/Capital Expenditures/: long term investments planning & managing . - -.
3. Subsidiary Objectives/activites
a. Maximizing shareholders return on investment :
i. Value added: in 2 ways
1. Dividends
2. Share price ( if you sell)
b. Cash control
c. Credit control
d. Financial record keeping
i. Management information systems
e. Share price : Ensure market price of shares remains high as possible
f. Expansion & growth targets
g. Diversification -Reduce risk of company by diversification
h. Financial gearing is used effectively
i. Attract loan capital , ensure interest paid & investment protected
j. Social responsibility – so ensure long term future of company .
CAPITAL BUDGETING
1. CAPITAL BUDGETING DEFINITION: deciding on whether to aquire and seeking and evaluating any long
term investments.
2. FINANCIAL MANAGERS MAJOR/ONLY CONSIDERATION : the TIMING , SIZE and RISK of future cash
flows coming in..
3. How much you expect to receive, when, how risky/(close to like discount rate)
4. Seeking investment opportunites
5. Depends a bit on type of business , eg:generally :buy new IT system , or Pep Stores. open a new store. ,
Oracle/Microsoft : develop new computer .program
6. Use of forecasting techniques to estimate future markets+ evaluate risk of failure before investing
CAPITAL STRUCTURE
2. Risk impacts on return expected and cost of funds obtained.
3. Principle is seek money at lowest possible costs and apply such funds to investments that yield the highest
possible returns.
4. What slice of pie of profits goes to lenders, what slice to shareholders(dividends) eventually.
5. Choosing amoung lenders and loan types is another job of fin mngr. there are many exotic types of lending, eg
debentures, pref shares etc.
6. In order to provide a more stable firm which is less like ly to get into financial diffucties and thus has a lower
possibility of cheating on quality etc, and a high possibility of being strong so they can say to customers – you
can trust us so that customers are prepared to pay a higher price and come back again(provide a more
assured stream of future income for the firm) the firm must be safe. This means ;
a. Lower leverage, fewer leases, engageing in more hedging to be a safer company and a more quality
company.
7.
Working capital management

creditors
2. NET Working capital : would be one minus the other = difference ie whats left.
3. So not run out of cash/ into trouble
4. Eg how much inventory keep on hand , shall we sell on credit / terms to offer on credit / who to allow credit to?
Do we purchase on credit or borrow short term and pay cash.?
FORMS OF BUSINESS ORGANISATION
SOLE PROPRIETOR
a. 3 major disadvantages =
i. Unlimited liability
ii.Limited Lifespan (= owners lifespan)
iii.Selling /transfer difficult (= sell whole business)
b. Equity raising extra = difficu;lt, limit to owners equity Simplest to start
c. Least regulated
d. Keep all profit
e.
PARTNERSHIP
f. 2-20

g. Partnership agreement
h. 3 major disadvantages = same as the sole proprietor
i. Unlimited liability
ii.Limited Lifespan (= owners lifespan)
iii.Selling /transfer difficult (= sell whole business)
i. tax – each individual separately
2. COMPANY:
COMPANIES
1.1. Identity in eyes of law separate from owner.
1.2. Least risky form because liability usually limited to value of shares owned.
1.3. Attract better financing through eg: shares ,bonds,bank credit.
1.4. MEMORANDUM OF ASSOCIATION: lifespan, name,no shares can be issued, business purpose etc
1.5. ARTICLES OF ASSOCIATION : rules made themselves about how to run company- whats allowed/not allowed
etc
1.6. Separation of owner /mangement can create problems.
1.7. Specialists can be employed to manage firm.
1.8. Can be sometimes abused by unscrupulous people.
1.9. Significant red tape to establish.
1.9.1.TWO TYPES: PRIVATE company:
a. Max 50 members
b. Right to transfer shares restricted
c. Only must have 1 member
d. (Pty)Ltd in RSA:Proprietry limited.
e. eg:Alusaf (Pty Ltd),Clicks stores(Pty Ltd),Johnson tiles(Pty Ltd)
1.9.2.PUBLIC company.
a. Not fewer than 50 shareholders(new act isn’t it 7 or something????)
b. Any max shareholders
c. Company that wishes to raise finance through the issuing of shares thus shares easily transferable.
d. Shares easily transferable
e. Many listed on JSE
f. eg:Anglo american,Remgro,Old Mutual,Sappi
1.10. many foreign owned or multinational companies operate in RSA eg:siemens,microsoft,shell,ibm.
Close Corporations.
1.11. Since 1985 RSA new type.
1.12. Founding statement document
1.13. Display cc after name ,must by law.
1.14. Easier to establish than private or public companies.
1.15. max 10 min 1 members.
1.16. Each member "% Specified interest in close corporation."
1.17. Can only dispose of interest with permission of other members.
1.18. Created to afford advantages of companies without having to register as a fully fledged company under the
companies act.
1.19. By 1990 more CC's than companies in RSA
Other forms of Business enterprise :

1.20. Co-operatives(eg agriculture)
1.21. Trusts
1.22. Public enterprise (Gov.eg eskom,sabc)
1.23. Informal sector:spaza,hawker,shebeen,subsistence farmers.
THE GOAL OF FINANCIAL MANAGEMENT

1. THE GOAL OF FINANCIAL MANAGEMENT Definition : is Officially defined as : TO MAXIMIZE THE
CURRENT VALUE OF OWNERS EQUITY / VALUE PER SHARE FOR EXISTING SHARES.
2. (one could have defined corporate finance as the relationship between business decisions and value of the
shares, from Official goal of financial management definition : is officially defined as : to maximize the
current value of owners equity / value per share for existing shares .)
THE AGENCY PROBLEM

called the. Eg mngrs see short terms goals not long term goals , like maximize profit for bonus’s etc. Or if sell
a car for someone for a flat fee, then you wont go for a higher price for him.- so commission could be better
option.
a. DIRECT AGENCY COST: 2 types : 1 - like mngmnt buy a corporate jet / 2- need for hiring auditors to
audit the firm each yr
b. INDIRECT AGENCY COSTS: like mngmnt does not invest in a new venture because it is riskt and some
of their jobs might be lost, even though it will increase the share value a lot for shareholders /
3. Problems with mngmnt
a. Organisational survival : loose jobs
b. Corporate power : overpay for a take-over to be bigger
c. Dislike interference so independence & corporate self sufficiency.
4. Management of mangers: good reasons to act in shareholders interest
a. Share options for managers
b. Promotion for better performers
c. Salary tied to share performance/ profit etc
5. Mechanisms to Replace Management :
a. Shareholders appoint/fire BoD who in turn hire/fire management
b. Proxy Fight : a group of shareholders seek permission from other shareholders to use their votes as
proxies (authority to vote someone elses shares) due to bad management – vote them out.
c. Takeover by another firm : badly run companies are cheaper shares, so you can jack them up easily to
get a profit.
FINANCIAL MARKETS ,FINANCIAL INSTITUTIONS,
CASH FLOWS TO / FROM THE FIRM

1. Securites : the various types of debt or equity that can be issued by the firm.
MONEY VS CAPITAL MARKETS

1. FINANCIAL MARKETS: definition: different market which bring seller & buyers together.debt & equity
securities are bought and sold. There are only 2 different types 1-Money markets , 2- capital markets
2. MONEY MARKETS:
a. Short term debt securities of many types are bought or sold here. These are called money market
instruments and are essentially IOU’s.

b. Eg ;
i. bankers acceptances : short term borrowing by large firms
ii.Treasury bills : IOU by the gov.
iii.Main participants are Banks, other financial institutions &large companies . they are connected
electronicly so there is no real pyysical location of this money market.
3. CAPITAL MARKETS : raising & trading of securities of a long term nature.
a. STOCK EXCHANGE:eg JSE shares are traded
b. BOND MARKET: eg BOND exchange of SA. Gov and other bonds are traded , eg eskom customers
include banks, public investment commissioners, insurance companies, pension,unit tructs etc.
PRIMARY VS SECONDARY MARKETS

1. PRIMARY : companies themselves offer shares or debt to others , not via the stock exchange.
a. This is not on the JSE or anything at all, it is private.
b. Usually done by a merchant bank, who underwrites the offering which guarantess the take-up by the
bank itsef of any shares not sold by them.By law a prospectus registered with the registrar of
companies must accompany any issue to the public like this . the costs and the info to be disclosed are
considerable so many companies just offer it straight to large insurance companies etc to avoid the
costs of a pblic offering through a merchant bank.
2. SECONDARY : the JSE or Bond Exchange.
FINANCIAL INSTITUTIONS
Eg trust funds, insurance, pension, banks, unit trusts etc.
ENVIRONMENTAL FACTORS
1. Dynamic Enviromment : past performance is a good indicator to judge future performance. And also
understand vairiables in enviromnment as follows : eg
a. INTERNATIONAL ENVIRONMENT:
i. World economy
ii.Trading partners economy
iii.Sentiment towards SA
iv.Sources of offshore borrowing
b. NATIONAL ENVIRONMENT:
i. Interst rates
ii.Exchange rates
iii.Gold price
iv.Money supply
v.GNP
vi.Inflation
vii.Politics
viii.Potential markets
ix.Sources of finance available
c. COMPANY ENVIRONMENT:
i. Growth prospects
ii.If diversify neeccessary
iii.Other seeking to takeover your company
iv.Competitive forces
v.Shareholder sentiment
vi.Public perception

CHAPTER 2 TIME VALUE OF MONEY
PRESENT & FUTURE VALUE OF MONEY.
INTRODUCTION:
1) Time value of Money is an essential concept in the understanding of finance.
2) BANK OVERDRAFT : is not seen as debt unless a part of it IS ACTUALLY being used as a form of long term
financing/debt THEN that part used as such should be accounted for as ‘debt’ in the debt: equity ratio.
3) DEFERRED TAXATION: DEFERRED TAX IS NOT included as tax when calculating the capital structure of a
company, because the timing of tax payments is accounted for when evaluating the project investment decision.
You just ignore it outright. This will only really apply when calculating the WACC at ‘book value’ method- so ignore
it always when you do this.
4) THE ‘CURRENT MARKET VALUE’ TO USE AS THE Ke OF Kd WHEN DOING ALL THE CALCULATIONS
:where “actual todays market values” instead of the interest rate being paid today due to previous years dealings,
is as follows:
a) First Choice: if the same type of security’s current interest rates are given.Use that one, even if it is higher
than other securities in same class eg if you have got debentures and ‘loans’ are cheaper than ‘debentures at
current rates, you still only use debentures rates.
b) Second Choice: if only a similar and not the same type of security’s market rates are given , then use tah
one: eg if you got debentures and only current rates for loans are given then use the loans rates as your
current market rates for debentures.
5)
FUTURE VALUE:
1) Future Value FORMULA : FV= PV(1+i)n

a) Where FV= future value
b) PV= present value
c) I = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
2) COMPOUND INTEREST : The future value of an investment over 3 years FV=PV(1+i) (1+i) 1+i) = PV(1+i) X
(1+i) X (1+i), that is what PV(1+i)n means : to the power of n means all this. So it basicly is the interest gained in
year 1 and 2 etc reinvested and this is called compound interest.
3) FUTURE VALUE TABLES : the future value table can be used instead of using a calculator.It basicly works like
this : it gives you a “Factor” for each year from 1 ,2,3,4 etc. upwards in a column for each percentage rate. So for
10% interest you go to the 10% column , go down it to the year number you want, take the ‘Factor” from there
and multiply it by the Present Value to get the answer you want. (the ‘factor’ =(1+i)n )
4) SOLVING FOR i . (INTEREST RATE). : if a question asks you to find the interest rate if given the ONLY the : PV
& FV & n : 3 ways :
a) what happens is you get stuck at the point of FV/PV = (1+i)n after algebra : so you say FV/PV1/n = 1+i so
i = FV/PV1/n - 1 .
b) A back of Envelope method :” RULE OF 72” = for reasonable rates of return, the time it takes to double your money is
given Approximately by : 72 / r% .
c) (ANOTHER way to do this so after working out the formula backwards is to start trying to substitute different values for i in the formula
FV/PV = (1+i)n until you hit on the right one OR one can use the Future Values Table and look across, (not down), the 3 year row till you
get the FV/PV . To use the calculator all you have to remember is to put the PV as a “–“ and FV as “+” (or visa versa-works same) or the
calculator will not do it-it says “error”.)
5) SOLVING FOR n (NO. OF YEARS) : if a question asks you to find the number of years if given only { i & PV &
FV } OR ANOTHER WAY IS go as far as you can with the formula, then either try different values till you hit the
right one or use the FV table. The calculator also just needs a PV as “+” or FV as “-“
6) Using MONTHS, WEEKS OR QUARTERLY instead of YEARS in the FORMULA : if the interest is compounded monthly,
weekly or quarterly then you have to simply have more periods for ‘n’ in the formula and divide up the interest rate to a lower
figure by :
a) Interest rate : divide the yearly interest rate by the number of periods in the year eg : for months by 12, or for quarters
by 4 : this will give you the interest rate per period to put in the formula above.
b) Number of Periods: here you multiply the number of years by the number of periods in each year to get the (higher)
figure to put in the formula. So for months X 12 , or for quarters X 4 etc.
PRESENT VALUE: (PV)

7) Present Value Formula : PV = FV/(1+i)n
8) Present Value calculations are the inverse of future value calculations.
9) Remember that in all finance calculations the value of a project or company or Investment is always the Present
value of Future Cash Flows.
10) The present value factors are the inverse of the future value factors, so on the future value table, the PV ‘Factor’
will simply be 1/FV factor , and the other way around too – the inverse of the PV table value for “PV FACTOR” ie
1/’PV factor’ is ALSO = to the FV Factor : so it works both ways,and back again,and again, etc.
11) To CREATE A PV TABLE easy way :To solve for some problems eg solve for i or n, you should create a PV table
to make it easier. The easy way to create one is:
a) Eg for the 10% column
i) for row 1 : 1/ (1+0.1) = 1/1.1 = 0.909 .
ii) for row 2 :just leave the previous answer on the calculator and then divide it by 1.1 again to get next “row
2” answer :
iii) for row 3 = year 3 : just leave the previous answer on the calculator and then divide it by 1.1 again to get
next “row 3” answer :
iv) continue as for last one.
12)MULTIPLE FUTURE PAYMENTS:
a) To calculate the PV of multiple future payments you must do each one individually, then add them up. Watch
out for begin of first year receipts with zero interest .Remember to evaluate multiple future payments in
different years against each other one can convert them with these formulas to any common year ie year 5 or
6 or 7 etc, but very often it is most convenient to convert them all to PV present value. – even if the first
payment for some of them is only in 3 or 4 years from now you can still convert it to PV to compare it to other
investment options.
13) Solving for n or I : works same as for “PV” above.
APR AND EFF : EFFECTIVE ANNUAL RATE AND ANNUAL PERCENTAGE RATE
1. Effective rate: EFF = (1+ “APR’in decimalsQUOTED monthly RATE” /M)M - 1
a. WHERE M= months or periods, Eff = effective rate and APR= annual rate
2. Annual rate : APR = just fill in the Eff rate and periods you have got already into the equation above, then
solve for “APR’in decimalsQUOTED monthly RATE”
a. WHERE M= months or periods, Eff = effective rate and APR= annual rate
3. Just use the formula below to work out any of these 2 rates from the other.
ANNUITY:
1) An annuity refers to a stream of EQUAL payments of a fixed amount over a number of years or periods. Eg 1000
invested every year for 10 years is called a 10 year annuity investment.
2) BEGINNING / or END OF THE YEAR : the timing of the investment can take place at begin or end of year. Each one
has a different formula
a) “ANNUITY DUE “: for the FV at beginning of year (.: For the FV , the only difference between the 2 is that for
beginning of year annuity due all you have to do is multiply the Ordinary Annuity-end year- by (1+i) (ie the PV
factor) to get the -begin year- “annuity due”, for PV you must * it by the 1/(1+i) which is the future value
factor.
b) “ORDINARY or REGULAR or DEFERRED ANNUITY” : at end of year.
3) Future Value FORMULA for ORDINARY/DEFERRED/REGULAR ANNUITY. : FVa = I x [ (1+i)n –

1 / i] (1+i)
a) I = Constant Amount invested each year ie PMT

e) Doing the above formula manually :
4) Future Value FORMULA for ANNUITY DUE : FVa= I x [ {(1+i)n – 1 }/ i] (1+i)

e) Doing the above formula manually :
5) Present Value FORMULA for Regular ANNUITY : PVa= I x [ {1 – 1/ (1+i)n } / i] DO

A SCAN)
b) PVa = present value of the annuity.
e) This is where the payments are at the end of the year.
6) Present Value FORMULA for ANNUITY DUE : PVa= I x [ ( {1 – 1/ (1+i)n } +1 ) / i] (

DO A SCAN)
e) This one is where payments are at the beginning of the year.-annuity due.
LOAN: PERIODIC PAYMENT OF A LOAN

1) The Periodic Repayments of a loan can be calculated by using the “Present Value formula for a Regular Annuity”
by making the I the subject of the formula as follows:
2) CHANGING the Present Value FORMULA for Regular ANNUITY to MAKE I THE SUBJECT below:
a) PVa= I x [ {1 – 1/ (1+i)n } / i]
PVa
i) Becomes : I = / [ {1 – 1/ (1+i)n } / i]

PVa * i
ii) Or: I= / [ {1 – 1/ (1+i)n } / i] : this formula is easier to use than the one above
for manual calculations – the /I is just changed mathematicaly to go on top as “ * PVa “
iii)Where:
(1) I = Constant Amount invested each year
(2) PVa = present value of the annuity.
(3) i = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
(4) n= number of years/periods
3) Where there are monthly instead of yearly payments you have to divide i/12 and multiply nX12 .
4) Where the interest is compounded monthly but the loan repayments are made once per year, I tried to get the
answer by using the effective interest rate over a year and then just leaving out the compounded part and
sticking to the years as the n , then you get the right answer it seems .But if you just go work out the monthly
repayments and multiply by 12 it wont work because you are reducing the original loan monthly (too soon) and
not yearly so your interest payable will not compute properly.(you might be able to otherwise use the other
method for multiple cash flows aver a period.-not sure)
5) To use The P.V. tables instead:
a) Just get the PVa annuity factor from the table by going to the relevant ‘interest’ column and ‘periods’ row.
b) Then, since I= PVa/factor as in the above formulas, you just divide the PVa ‘Loan Amount’ by the factor you
read off the table.
PERPETUITY: (OR CONSOL IN UK)

1) A Perpetuity is a normal Annuity but with an infinite life.
2) You only work it out by using a special formula:
3) PRESENT VALUE of a PERPETUITY FORMULA : PVp= I/i
a) PVp = Present Value of a Perpetuity.
b) I = Constant Amount invested each year
d) This one is where payments are at the end of the year.- I think- it does not say in the book what it is. Also it
does not say what the formula for at begin of year (annuity due) is.
D1
4) PRESENT VALUE of a -growing- PERPETUITY FORMULA : PVp= /i - g where g=growth
and D1 is the same as I above but indicates the payment received at the end of the first year, NOT
at the beginning of the first year : so it will normally be the given payment with the first years
growth added ie; not 100 but 100X 5% growth = 105!
5) Remember : D1 means: if you get 2 odd payments in Year 1 and 2, then from year 3 a dividend of 400
growing at 5 %, it means that year 3 =400 is D1 , because year 2 is Y0 for the 400 onwards part and the 400 is Y1.
Then on top of it year 2 is = n in the formula for PV if you want to bring the whole part from year 3 : the 400-
onwards answer: down to PV-because For D1 you take year 2 of course. Watch out for this one in questions; it
catches you easy.
AMORTISATION
PURE DISCOUNT LOANS
1. This is simply where the loan is a plain PV calculation : interest + principle repaid at end of term
2. Usually for short term loans, but also used for long term loans
3. Note ; the interest rate on treasury bills is usually quoted as the amount in rands of interest / money received
at end of term , not in the usual way of interest in rands/ money lent out , for some stupid ‘historical reason’
thing.
INTEREST ONLY LOANS

1. This is where the borrower pays back only interest each year, then the principle at end of term.
2. There is no compounding of interest, you pay R100 interest every year and then the original amount exactly
back at the end. , it is a funny type of loan with no compounding at all
AMORTISED LOANS
1. This is just an ordinary annuity type thing.
2. They can however complicate this one a bit by saying that you must pay back the interest for the year
+ a certain amount of the principle eg R1000 is repaid every year. Then one e must do a Table called
an amortization schedule and work out the decrease each year in interest due to the decrease in
principle manually and work it out one by one from there.
SHARES : PRESENT VALUE OF SHARES

The diagram shows the formula in the special notation:
1) The Value of an Investment or Project or Company or Company Shares is the “Present Value of Future Cash
Flows”.If you are valuing a share and if the share pays regular dividends, then there are 2 scenarios : static or
growing dividends. There is a formula for each:
2) BANK OVERDRAFT : is not seen as debt unless a part of it IS ACTUALLY being used as a form of long term
3) 3) DEFERRED TAXATION: DEFERRED TAX IS NOT included as tax when calculating the capital structure
of a company, because the timing of tax payments is accounted for when evaluating the project
investment decision. You just ignore it outright. This will only really apply to WACC using ‘book value
method”- so always ignore deferred tax here.
a) STATIC DIVIDENDS (no growth )

i) There are 2 Ways this can get calculated: depending on if the shares are to be held “for ever” or to be
“sold” after a specific time. The difference is for the “for ever” one it works similar to the ‘perpetuity’
formula = [ Do/Ke ] and the second works similar to the Present Value formula [ like =FV/(1+i) ]
(1) PERPETUITY Type FORMULA: also called a CONSOL in UK where the share is to held for an indefinite period ie:
‘in perpetuity’.
Do
(a) Ex-Dividend formula: Value = /Ke X Number of shares : means if
the shareholder receives a dividend today that dividend is EXCLUDED
(b) Cum-Dividend formula: Value = Dividend + (Do/Ke X TOTAL
number of shares.) means if the shareholder receives a dividend today then that
dividend is INCLUDED in the calculation of value of share (you just add the dividend to
answer-simple)
(c) Remember: you can ALSO get the PV of an ANSWER from this formula if it only will
occour in eg 3 yrs time. : say that for the next 2 years the share price will fluctuate ( or grow
etc) but in 3 years time it will start to remain the same from there on- static. If you are looking for
the 3rd year onwards using the above formula and bring this to PV by substituting your FV you gott
in the above formula to bring it to PV. : ie: [Do/Ke] = FV , so PV today = [D0/Ke ] / (1+i)n ……where we
would use ‘Ke’ for ‘i’ here.!
(2) “TO BE SOLD “ Type PRESENT VALUE FORMULA : where the shares are to be sold after a specific
period of time :now it’s a PV calculation.
Do
(a) Ex-Dividend formula: Value = /(1+Ke)n X Number of shares :
means if the shareholder receives a dividend today that dividend is EXCLUDED You use
this formula once for each separate year to come, so for 3 years you must do the calc. 3 times and
add the answers up to get the total.
(b) Cum-Dividend formula: Value = Dividend + (Do/(1+Ke)n X
TOTAL number of shares.) means if the shareholder receives a dividend today then
that dividend is INCLUDED in the calculation of value of share (you just add the dividend to answer-
simple)
(c) Remember you could do the above calc. for years 3 & 4 but do years 1&2 with another formula for
eg.”growth” and just add the answers up to get the total.( say there was growth for first 2 yrs then
no growth for 2 yrs.)
ii) Where:
(a) Do = Current Dividends or Year 0 dividends, per share. ( “D”=dividends “0” =Year 0)
(b) Ke = Shareholders Required return or Discount Rate. –use in DECIMALS eg for 15% Use 0.15 NOT
15% (K = latin e=Equity) (‘Ke is the same as i in the PV formula’-as per book vertabim)
(c) n = number of years (only in the ‘To Be Sold” formula)
iii) When: the question is silent as to Cum- or Ex-Dividends you must use Ex-dividends. Another reason for
doing an ex-dividend valuation (unless otherwise asked) is that PV assumes that the first cash flow will
take place at the end of the period.
b) GROWTH / FALLING DIVIDENDS (growth or getting less)
i) Cum-Dividend or Ex-Dividend : the book says nothing about this for this type but it probably works
exactly the same as for static dividends. If it is Cum-Dividends then you probably just have to add the
dividend you receive today to the answer!
ii) There are also 2 types of formula for this one- the Perpetuity type and the “To Be Sold Soon”
one.
iii) Do not use year 0 dividends, only end year 1 dividends!!!!
iv) PERPETUITY Type FORMULA: where the share is to held for an indefinite period ie: ‘in perpetuity’. Do not use year 0
dividends, only end year 1
D1
(a) Ex-Dividend formula: Value = /Ke - g X Number of shares :
(b) Cum-Dividend formula: if they ask for cum-dividend then (probably) just add the dividend you
are receiving to the answer per share.
(c) Remember: you can get the PV of an answer from this formula if it only will occour in eg
3 yrs time. : say that for the next 2 years the share price will fluctuate ( or grow etc) but in 3
years time it will start to remain the same from there on- say at 5% growth. If you are looking for
the 3rd year onwards using the above formula and bring this to PV by substituting your FV you get
into the PV formula again to bring it to PV. : ie: [D1/Ke – g] = FV , so PV today = [D1/Ke – g] / (1+i)n ……
where we would use ‘Ke’ for ‘i’ here.!
v) “TO BE SOLD “ Type PRESENT VALUE FORMULA : where the shares are to be sold after a specific period of time
:now it’s a PV calculation.
DO NOT USE g HERE! And remember to use D1 and not D0.
D1 n
(a) Ex-Dividend Formula : Value = / (1+Ke )X Number of shares :
(ie cash flow/for this one you MUST work each year out separately using the PV formula given
here. To accommodate the growth (g) in dividends each year you cannot do it with the formula, you
must manually increase the dividends each year, then work out the Present Value for each separate
year using the above formula .THE SELLING PRICE AT THE END OF THE PERIOD MUST BE INCLUDED
IN THE final year PV calculation.(ie just add it to the final year dividends and get the PV of the total,
no need to do a separate calculation!)Then add all the years up to get the present value of the
shareholding.
(b) Cum-Dividend Formula: Cum-Dividend: probably just add the dividend you are receiving to the
answer
(c) This is an Odd-one out: You have to be very careful here : there are 2 odd things to
watch for:
(i) For this one you DO NOT USE g , you just use the PV formula ALONE:
so here you must work each year out separately 1 by 1, and for each year just increase the
dividend MANUALLY.
(ii) How you work this out depends on the VANTAGE POINT of the person:
who is working it out. You might have to use the other ‘perpetuity type’ formula even if it
dos’nt look like it; because: So if you are selling in 3 years time at 500 each, with a dividend
growth of 5% ,you say work out the PV today of all 3 years to come (all 3 dividends to be paid +
the selling price you will get) = your valuation from your vantage point. BUT if the person who is
buying them from you wants to work out the value of the same shares at the exact same point
in time in 3 years time, he will use a completely different formula for the same thing AND WILL
ALSO ALLWAYS GET A DIFFERENT ANSWER: You see, HE only uses the ‘perpetuity type ’
formula –because he has no plans to sell the share yet and the NOTE: (3+1= 4th) years
dividend to be paid out (his first one) and (ke-g) as the dividend(as per perpetuity
formula).Remember to use the dividend from 1 year ahead of when he buys-not the dividend on
the date of ‘year 3’ when he gets the shares( ie D1 NOT D0 ) Anyway ,so his valuation could very
well be higher than the sellers and , on paper at least, he could make a profit if he were to sell it
on the spot there and then when he receives it! See example on pg 27/28 Vig-Finance.
(d) Remember : D1 means: if you get 2 odd payments in Year 1 and 2, then from year 3 a
dividend of 400 growing at 5 %, it means that year 3 =400 is D1 , because year 2 is Y0 for the 400
onwards part and the 400 is Y1. Then on top of it year 2 is = n in the formula for PV if you want to
bring the whole part from year 3 : the 400-onwards answer: down to PV-because For D1 you take
year 2 of course. Watch out for this one in questions; it catches you easy.
(e) Remember:you might have to work out the PV for only 2 years using this formula, then
switch to another formula if question says there will be no more growth from the 3rd
year onward : say that for the next 2 years the share price will fluctuate ( or grow etc) but in 3
years time it will start to remain the same from there on- say at 5%. (or visa versa). If you are
looking for the value of the share today using all this info., you must first calculate the PV of the
next 2 years separately using this PV method THEN you can calculate the value of the 3rd year
onwards using the ‘perpetuity –non-growth’ formula and bring the answer to PV by substituting
your answer as the FV in the PV formula to bring it to PV. : ie: [D1/Ke – g] = FV , so PV today = [D1/Ke –
g] / (1+i)
n ……
where we would use ‘Ke’ for ‘i’ here.! See pg 28/29 in vig.-finance.
Where:
(f) D1 = DO NOT USE YEAR 0 DIVIDENDS! ONLY USE end of year 1 dividends! D1 means
Current Dividends or Year 1 dividends, per share. ( “D”=dividends “1” =Year 1 ie -end of year 1-)So for
the ‘Static/No-Growth’ one we use year 0 but for this one we use the dividends you will get at end of
year 1: Remember this! ‘
(g) Ke = Shareholders Required return or Discount Rate. –use in DECIMALS eg for 15% Use 0.15 NOT
15% (K = latin e=Equity) (‘Ke is the same as i in the PV formula’-as per book vertabim)
(h) n = number of years (only in the ‘To Be Sold” formula)
(i) g = Growth in annual dividends. : use in DECIMALS eg for 15% Use 0.15 NOT 15% (rem 8% =o.O8
not o.8.)
4) How To Determine Growth Rate:
a) Method most used: get average of growth rate over a few years., or make an estimate based on unknown
information.Finance is not an exact science and we at times need to estimate inputs that are not necessarily
100% correct.
b) Alternatively: calc. growth rate based on ROE-return on assets. Problem with this is ROE is at historical
values, not market values.
c) Or Alternatively : use Future rate of Investment and Return from that investment:
i) The future rate of investment and the return on that investment are the factors which generate future
dividends, but then the criterion is that a constant proportion of cash earnings per share is reinvested in
projects which produce an average rate of return.
d) FORMULA : G= br ,then to get the answer to % multiply by 100.
e)
f) The book value of total capital employed is the “TOTAL EQUITIES & LIABILITIES” section on the balance sheet.
It may be calculated as the balance at the beginning of the financial year, or the average assets employed
over the year, ie beginning asset value plus end of year asset value divided by 2.
g) ASSUMPTIONS: this formula only works subject to the following being true:
i) ) retained earnings must be the only source of investment capital
ii) a constant proportion of earnings must be reinvested each year
iii) the reinvested earnings must generate a constant annual rate of return.
RETURN ON SHARES- RETURN ON INVESTMENT:
1) THE RETURN TO SHAREHOLDERS FORMULA :IS CALCULATED by

DIVIDENDS / CURRENT MARKET VALUE of shares, not book
value.?????????????????
DEBT : PRESENT VALUE OF DEBT:
1. Definition: “Any form of finance that is not an ordinary share or does not have an option to convert to ordinary
shares”. There are however certain Grey Areas / types of debt which are partly debt and partly share equity.
2. Types of Debt and Taxability
a. Long Term Loans : Interest is Tax Deductable
b. Debentures : Interest is Tax Deductable
c. Mortgage Bonds : Interest is Tax Deductable
d. Preference Shares: Dividends After Tax
e. Lease. : ?????
3. BANK OVERDRAFT : is not seen as debt unless a part of it IS ACTUALLY being used as a form of long term
4. 3) DEFERRED TAXATION: DEFERRED TAX IS NOT included as tax when calculating the capital
structure of a company, because the timing of tax payments is accounted for when evaluating the
project investment decision. You just ignore it outright. This will only.
5. Rem: In your calculations you only ever use the cost of similar debt today AFTER tax, at market cost- not
ever the actual interest rate being charged for the loan. This principle is you go borrow elsewhere at cheap
rates to pay off the more expensive debt.
6. Tax: you always deduct tax first from the interest rate to get the actual interest rate charged = interest
rate X [100% - tax rate% ]%
7. Note: a funny thing is if a company is paying 20% interest on a loan which appears on the balance sheet at
100, but the current market interest on debt rate is lower eg: 15% so they are dof and should only be paying
this, not 20%, then you say : quote “ in real terms the company has more debt than is shown in the
balance sheet” the reason for this is that if you were to put 20% (same market rate) in the formula below as
Kd instead of 15% (lower market rate) as Kd your answer as to the “Market Value” of the debt would be
EXACTLY 100., but if you use 15% as Kd then the answer would always be MORE than 100, but if you use 25%
(higher market rate) the Market Value will always be lower!
8. Note: The formulas below are ONLY to work out the MARKET VALUE of the debt amount today. So basicly
what would that debt be worth if the bank somehow could ‘sell’ the loan to someone else- I think. It is weird
figures they get from this formula though !-note!
9. There are 2 possible situations & formulas here:

a. For “Perpetuity Type ” Loan :PRESENT VALUE (PV) formula of
Debt : PV= Cash-Flow/Kd this is where the loan is indefinite/infinite with no repayment date specified.
The answer is not fixed- it changes if looked at from a PV or FV. The cash flow at top as well as the Kd at bottom
are both AFTER tax, so tax must first be deducted from BOTH.
i. Using the “Perpetuity” formula BUT ONLY FROM a year in the FUTURE:
1. If they said that from year 2 the interest paid will remain the same, you can use the
‘perpetuity type’ debt formula to calculate the ‘market value’ at that time-ie in 2 years.
But then you must bring that Future value to the Present Value using the normal PV
formula. So a ‘market value‘ can be changed to it’s Present Value using the PV formula.
ii.An ‘ EQUIVALENT MARKET VALUE‘ can be changed to it’s Present Value using the PV
formula.
1. As said above , the answer to the ‘perpetuity’ formula must be changed to its PV using
the PV formula if it was worked out for a year in the future only. So a ‘market value’ is
not a fixed thing, it changes as soon as you want to know its value in another year-
whether past or future.
b. For “Repayment Time Specified ”Loan : (PV) formula of Debt :
PV= Cash-Flow/(1+Kd)n here you must work out the PV with this formula for every year of the loan
individually, and then add up all the answers to get the total.- but you still only use the current market
interest rate for Kd. The cash flow at top as well as the Kd at bottom are both AFTER tax, so tax must first be
deducted from BOTH.
c. Where
i. Cash-Flow = the FV – ie money that is to flow in the future- the Future Value =this is the
interest in Rands OR/AND the capital repayments that will be paid back in the future.
ii.Kd = the interest rate charged for debt- if tax is deductable then first deduct the tax % from
the rate before you use it. Interest After Tax = interest rate X [100% - tax rate% ]%. This
Kd is the current market value of debt , not at the actual interest rate actually being paid back
by company, but at the lowest you could get today instead.
iii.To calculate the PV of Debt : you only ever :
1. Get value of future cash flows: what is the company actually paying back each year:
a. For an indefinite/INFINITE/ “perpetuity” loan : If they state the interest rate used
to pay back the loan then calculate the interest payment in rands: this is your “FV
of Cash Flow” and ONLY use the “perpetuity” type formula above, not the other
one.
b. If loan is Repayable in 3 years : you must include the amount of the repayment as
a cash flow for the year it is paid back. So that year would be ‘interest+capital’=
‘cash flow’ in formula. For multiple repayments each repayment must be added
as a cash flow in it’s specific year/month etc-.and only use the “Repayment time
specified” type formula above.
iv.To calculate the Kd: You only ever use the “current market value” of debt today, so this Kd
is the current market value of debt , not at the actual interest rate actually being paid back by
company, but at the lowest you could get today instead. The logic is you go lend today at the
lower rate and pay the other loan back.
d. Note: to get year 1 + 2 + 3 PV using above formula DO AN ANNUITY( PMT) on the calculator, not a PV
calculation!
e. Preference Shares: to value pref. shares you use the exact same method as for debt
here.Remember-no tax to deduct!Dont!
f. Debenture : treated exactly same as debt, also DO deduct tax
g. You are paying interest For 2 Years at 15% and thereafter at 25% :
i. Do the first 2 years using the “temporary” PV formula then from year 2 on using the
“perpetuity” formula, but then it must be PV’d.
ii.Using the “Perpetuity” formula BUT ONLY FROM a year in the FUTURE:
1. If they said that from year 2 the interest paid will remain the same, you can use the
‘perpetuity type’ debt formula to calculate the ‘market value’ at that time-ie in 2 years.
But then you must bring that Future value to the Present Value using the normal PV
formula. So a ‘market value‘ can be changed to it’s Present Value using the PV formula.
h. To evaluate a 3 different debenture options: work them out 1 by 1 and get a Market VALUE for each
option, then compare. Usually you get the market value at the time in the future when the options
become a actual option eg in 2 years time one may choose between 3 options- not todays PV.
i. ‘Conversions’ : If a debenture will have a new value in the future due to its being ‘converted’ when it
falls due to debentures with a different/same interest rate, then you take it as if it were the same
debentures as the originals- not a different one completely. So is asked for the present value of these
debenture you MUST include the future value of the debentures in eg 2 years, and use the PV formula
to change it to Present Value – and add this to the PV value of each year up to then=total PV Market
Value. (eg if there are 3 options when the debentures fall due then ( as a result of choosing one of the
above options) then the highest choice will be the FV market value it will have in the future-to be added
to in between years values to get total) pg 32 33 viggio –fin
mngmnt. intere 129X 465
j. Show all calculations in a simple way, even if you use a st 3.60
calculator. Eg: 5
Where the calculation is second part(bold ) by calculator from capita 1000 567
formula l X
0.56
MARKET VALUE OF DEBENTURES. 7
1032
1) FORMULA FOR MARKET VALUE OF Redeemable DEBENTURES:

MV= i/(1+Kd) n + i/(1+Kd) n
+ i/(1+Kd) n + R/(1+Kd)n
a) The market value of debentures is calculated -exactly- the same as market value of debt. It is just the PV of
future cash flows –incl. interest & capital repayments.
2) FORMULA FOR MARKET VALUE OF ‘perpetual’ Irredeemable DEBENTURES: MV= i(1-T)/Kd
here you must work out the PV with this formula for every year of the loan individually, and then add up all the
answers to get the total.- but you still only use the current market interest rate for Kd. The cash flow at top as well as
the Kd at bottom are both AFTER tax, so tax must first be deducted from BOTH.
MARKET VALUE OF A COMPANY:
1) The Market Value of a Company : there are 2 formuals :Formula 1: V0 = MVe +

MVd
a) The Market Value of a Company Formula : is simply the Market Value of Equity ( ie the PV valuation of the
shares) PLUS the Market Value OF all Debt (ie PV valuation of debt) ,these valuations of debt and equity above
must be done using the “FV of cash flows” at “current market rates” to get the Present Value of all future cash
flows.
2) The Market Value of a Company : there are 2 formuals :Formula 2 :Dividends(Do) + Debt
Interest Paid in Cash
/WACC
a) This is simply a mathematical formula that will work as well as the above reason , for some mathematical
reason.
3) MAXIMUM MARKET VALUE OF A COMPANY: Fact:The market value that minimizes WACC , maximizes the
Market Value of the company, and thus Maximises the market value of the equity capital (shares) , because of the
way & formulas one uses to calculate the “Market Value of a Company “ namely the fact that ‘current market
values of interest=Kd ’ and ‘shareholders required return= Ke ’ are used, plays the prominent role here.

ISSUE COSTS
1) Any issue cost from any form of financing where the company incurs a cost in issuing a form of finance, is NOT
EVER added to the cost of equity or cost of debt finance( share issue costs & debenture issue costs) , INSTEAD
these costs are supposed to be included as part of the cost of the project being financed. So if investment cost=
200; and issue costs = 10 then actually; investment cost= 210.
2) HOWEVER, where it is deemed as desirable to issue costs in determining the Market Value or (Market dividend
from it) then the cost per share must be deducted from the market value of the share.
HOW TO DETERMINE GROWTH RATE:

a) Method most used: get average of growth rate over a few years., or make an estimate based on unknown
information.Finance is not an exact science and we at times need to estimate inputs that are not necessarily
100% correct.
b) Alternatively: calc. growth rate based on ROE-return on assets. Problem with this is ROE is at historical
values, not market values.
c) Or Alternatively : use Future rate of Investment and Return from that investment:
i) The future rate of investment and the return on that investment are the factors which generate future
dividends, but then the criterion is that a constant proportion of cash earnings per share is reinvested in
projects which produce an average rate of return.
d) FORMULA : G= br ,then to get the answer to % multiply by 100.
e)
f) The book value of total capital employed is the “TOTAL EQUITIES & LIABILITIES” section on the balance sheet.
It may be calculated as the balance at the beginning of the financial year, or the average assets employed
over the year, ie beginning asset value plus end of year asset value divided by 2.
g) ASSUMPTIONS: this formula only works subject to the following being true:
i) ) retained earnings must be the only source of investment capital
ii) a constant proportion of earnings must be reinvested each year
iii) the reinvested earnings must generate a constant annual rate of return.
MILLER & MODIGLIANI MARKET VALUE OF COMPANY
1) Formula = dividend + interest/WACC : all done at market values and interest etc to be after
tax of course.
a) This seems to be the only formula they use for moglidani ,- not the other one.

3)CASH FLOW : Financial Statements,
Taxes & Cash Flow Ch 2 fundamentals
corporate textbook
TABLE OF ALTERNATIVE TERMINOLOGY /USA /UK
1-BALANCE SHEET:
NET WORKING CAPITAL

1. This is the difference between current assets and current liabilities.
2. WORKING CAPITAL definition: Refers to short term assets eg inventory and short term liabilities eg
supplier creditors
3. NET Working capital : would be one minus the other = difference ie whats left.
4. So not run out of cash/ into trouble
5. Eg how much inventory keep on hand , shall we sell on credit / terms to offer on credit / who to allow credit
to? Do we purchase on credit or borrow short term and pay cash.?
3 MOST IMPORTANT THINGS ON A BALANCE SHEET

1. The 3 most important things on a balance sheet are :
a. LIQUIDITY : any asset can be converted to cash if the price is right. A highly liquid asset can be sold
Quickly without significant loss in Value. An illiquid asset cannot be converted without a substantial
price reduction(specialised production line VS krugerrands)
b. DEBT versus EQUITY amounts : lenders are entitled to first share when liquidated- equity gets rest.
Acc.Equation is E= A-L.Financial leverage is the use of debt in a company. It levers- it can magnify
both profit AND losses a lot.

c. MARKET VALUE vs BOOK VALUE : in SA assets are shown at Historical cost in the balance sheet. Market
value could be different : Eg cell phone can loose vale fast (old make) while land gets more valuable
quickly. Goal of Fin Manager is to Maximise the MARKET VALUE of the shares (not book value)
2-INCOME STATEMENT
1. Note: EPS does not first minus ordinary dividends.
NOTE: 3 THINGS TO KEEP IN MIND WHEN LOOK AT INCOME STATEMENT :

a. GAAP causes non cash items to be recorded eg debtors
b. CASH vs NON CASH items : eg depreciation / impairment /provisions
c. TIME and COSTS : over long enough time all debts can be paid – , and also SEMI-VARIABLE costs can
be fixed in short term and variable in long term (salaries), so fixed short term costs are variable long
term costs.
3-MARGINAL VS AVERAGE TAX RATE

1. Taxes can be one of the largest cash outflows that a firm actually experiences.
2. AVERAGE TAX RATE definition :your tax bill divided by your taxable income
3. MARGINAL TAX RATE: definition: the extra tax you would pay if you earned one more rand. (ie marginal rates
are those shown in the tax tables, like 100000 to 120000 is 18%, and 120000 to 180000 is 25% etc)
4-CASH FLOW STATEMENT
1. The CASH FLOW IDENTITY : Cashflow from assets = Cash flow to lenders + Cash flow to shareholders.
a. To shareholders can mean to ‘retained earnings’ etc.
FROM CORPORATE FINANCE BOOK- CHAPTER 3 ‘WORKING WITH FIN STATS’:

b. Note – GAAP allows some flexibility in the way cash flow stats. are prepared. So in some published fin
stats it may somehow somewhere either be shown in ‘investment activities ‘ sect . or in ‘cash flow
from operating activities section’ ???But all of them fit it into the 3 main headings-
operational/investment/finance
c. There are 2 activities in a company – those that are SOURCES (bring in)of cash and those that are USES
(spend) of CASH. To do a Business Analysis we need to know exactly what these were, and as the cash
flow statement sets these out in a simplified format – ie net investing activities- so if we want more info
we must often go to the Balance sheet or income stat. for eg how much N-C assets were sold and how
much were bought- not just the NET figure .
d. We will say in a business analysis eg inventory rose by 29m (USE) and accounts payable rose by
4m(SOURCE) and accounts payable (bank overdraft) rose by 30m (SOURCE), so these were the major
SOURCE&USES of cash- and we will use this to start making a reasoned analysis of the Business Model
of the firm , ie inventory increased by 29m funded by –‘ostensibly’- accounts payable&bank overdraft.-
and from there on to ratios etc.
e. Examples of SOURCES & USES of CASH:
i. SOURCES:
1. Incr. accounts payable
2. Incr. share capital
3. Incr. Retained profit (net profit less dividends)
ii.USES:
1. Decr. Accounts payable
2. Incr.Accounts receivable
3. Incr.inventory
4. Decrease long term debt.
5. Net n-c assets aquisitions
From MACN202 notes VIGGIO

1. SET 1:
a. Net profit :Where cash from operations after working capital changes is negative or much less than
profit ,the company Is in severe trouble.So even if profit is improving this figure is the big one- the
engine room.
b. Working capital changes :must all increase in same proportion to turnover change up or down. But
creditors up +debtors up(debtor days) + inventories up is bad- so it goes with (1)

c. Interest expense /dividends &taxes: look at the times interest earned ratio. And how much of
interest payment is from CASH generated from operations( not just from profit) lots of tax should not be
paid from little CASH from operations. And Dividends should be low for low CASH from operations – not
just right for ‘profit’.(in case profit is from some weird adjustments)
d. Purchase of equipment: is there enough CASH to pay, or is too much debt being taken on
with the rest of the figures looked at
e. Financing Activities: should it be more from equity or from debt , how much did each put
in? look at other figures to see if lots of debt is good here.
2. SET2: (from Business Modeling section of chapter- working out the business model)
a. STAGE 4: Cash Flow Statement.
i. Most important financial analysis tool.(by far)
ii.Its not polluted by fair value adj and shows where cash comes and goes to.The cash flow
statement is the company blueprint, all other ratios and analysis are simply commentaries.
iii.Cash is King
iv.The only place it can be manipulated is if debtors are sold as debtor finance- take care check
here.(often bad quality ones are kept while good quality ones are sold)
v.The Debtors adj. in it shows 1-debtor control & 2-quality of sales/turnover.( companies
manipulate fin.stats. here by doubtful payer sales)
vi.Analysis & Ratios:
1. Current ratio
2. Acid Test ratio
3. Debtors Collection
4. Stock Turnover
3.
WORKING OUT THE CASH FLOW STATEMENT BACKWARDS (corp fin book)
1. You can work out A SIMPLE cash flow statement from just a few amounts that might be given in an exam
:namely you use ONLY these following 9 amounts to work it out :
i. Depreciation
ii.Tax
iii.PBIT
iv.begin/end Net non-current assets
v.End/begin net operating working capital
vi.Interest paid
vii.“net” new borrowing
viii.Dividends paid
ix.“net” newly raised equity
2. FORMAT of ANSWER: you do the thing with the headings given in the large scan below. Note: for “Cash Flow
From Assets” you use the headings in the SMALL scan below as the main headings and put the workings for
each under each heading:
3.
4. . see scan for details: just do it exactly like the following diagram illustrates – you can rename the major
headings to be the same as the accounting format or use this format – any of the 2.

5. The following scanned in pages are just the other pages in the book that explain the diagram above –very easy
, just check it out.

ANALYSIS OF FIN STATS & RATIOS
chapter3 fundamentals.txtbook
1. SEE Ch6 VIGGGIO notes in MACN202 notes- “business analysis”- it is very good and covers all ratios and they
rest of it plus extra.
2. This chapter and the one before this go together , also they are covered all in 1 chapter in VIGGIO – ch6. Put
both books together to get a really good idea of this.
3. Much of the language of the corporate world is rooted in this chapter- the primary means of communicating
company info is in fin stats, and this chapter takes it all apart and gives it a “index” or “reference”
4. A financial manager will rarely if ever have full market info on all the firms assets. Also we cannot even always
obtain part of the full market info we want about any particular firm.So we must rely on what we can get and
compare different aspects to measure their correctness so we don’t get fooled by one or more
incomplete/incorrect parts.- and use this method to formulate opinion on efficiency/profitablility etc.
CASH FLOW STATEMENT:(THIS CHAPTERS BIT OF EXTRA INFO ABOUT CASH FLOW STATS
ETC)
1. FROM CORPORATE FINACE BOOK- CHAPTER 3 ‘WORKING WITH FIN STATS’:
a. Note – GAAP allows some flexibility in the way cash flow stats. are prepared. So in some published fin
stats it may somehow somewhere either be shown in ‘investment activities ‘ sect . or in ‘cash flow
from operating activities section’ ???But all of them fit it into the 3 main headings-
operational/investment/finance
b. There are 2 activities in a company – those that are SOURCES (bring in)of cash and those that are USES
(spend) of CASH. To do a Business Analysis we need to know exactly what these were, and as the cash
flow statement sets these out in a simplified format – ie net investing activities- so if we want more info
we must often go to the Balance sheet or income stat. for eg how much N-C assets were sold and how
much were bought- not just the NET figure .
c. We will say in a business analysis eg inventory rose by 29m (USE) and accounts payable rose by
4m(SOURCE) and accounts payable (bank overdraft) rose by 30m (SOURCE), so these were the major
SOURCE&USES of cash- and we will use this to start making a reasoned analysis of the Business Model
of the firm , ie inventory increased by 29m funded by –‘ostensibly’- accounts payable&bank overdraft.-
and from there on to ratios etc.
d. Examples of SOURCES & USES of CASH:
i. SOURCES:
1. Incr. accounts payable
2. Incr. share capital
3. Incr. Retained profit (net profit less dividends)
ii.USES:
1. Decr. Accounts payable
2. Incr.Accounts receivable
3. Incr.inventory
4. Decrease long term debt.
5. Net n-c assets aquisitions
STANDARDISED FINANCIAL STATEMENTS (COMMON SIZE)
1. It is difficult to compare the fin stats of 2 companies because of differences in size, and also over time even
comparing the same company to itself may be difficult because of a change in size. Therefore we convert all
figures to % ‘s to be able to compare-there are also other methods. (Also some companies may span a
number of industries eg Barloworld ( you cannot fit it in retail standard figures for ratios or auto.. because it
covers them all) and some may be one of a kind- eg Sappi/Vanadium corp etc.- but not sure if standardizing
fixes that???)
2. Expressing the following stats as % of sales or % of assets or as a % of a base year makes them easier to
compare with each other- you can easy see incr. or decreases over time and compare to another company in
same sector etc.
3. EFFECTIVELY, THE RESULT OF THIS METHOD IS : you must be very careful with these things because it
is all as a % of sales, or assets. So it only show a RATIO really. This means if assets or sales change a lot , you

had better know this or you will not see why the other ratios change in proportion to these base figures. The
base year one is pretty safe in this way though. So, from book basicly : For example, looking at Table 3.6,
Bushbuck’s accounts receivable were Ri 65, or 4,86 per cent of total assets in 2007. In 2008, they had risen to
R1,88, which is 5,24 per cent of total assets. If we do our analysis in terms of rand, then the 2008 figure would
be R1, 88 / R1, 65 = 1,139, a 13,9 per cent increase in receivables. However, if we work with the common-size
statements, then the 2008 figure would be 5,24 per cent /4,86 per cent = 1,078.
This tells us accounts receivable, as a percentage of total assets, grew by 7,8 per cent. Roughly. speaking, what we
see is that, of the 13,9 per cent total increase, about 6,1 per cent (13,9 per cent7,8 per cent) is attributable to the
overall growth in the firm (i.e. growth in its total assets), and the balance of 7,8 per cent is the result of giving
Bushbuck’s customers increased credit terms.
4.
5. COMMON SIZE STATEMENTS:
a. BALANCE SHEET: % of TOTAL ASSETS ; All Figures are expressed as a % of TOTAL ASSETS.
b. INCOME STATEMENT: % of SALES ; All Figures are expressed as a % of SALES.
c. CASH FLOW&ST.CH.EQ ????
d. This “TOTAL ASSETS” & “TOTAL EQUITY and LIABILITY” will always be =100% so the change in these
is incomparable over years.
e.
6. COMMON BASE YEAR STATEMENTS (or indexed statements)
a. ALL FIN STATS: set one year as a base year and make it =1. then a futureYr/baseYr = fraction of base
YR. so if between 2000 and 2007 , then we set base YR as 2000, and say inventory in 2000 = 1, so if
inventory in 2000 was 393 and in 2005 it was 422, then we say 422/393= 1,074. So we say it grew by
7.4% For multiple years we divide each year by the 393 then to make them comparable.
b. This means year one(base year) will always be incomparable because all the figures must be 1
(because it is the base year)
7. COMMON SIZE & BASE YEAR STATEMENTS:
a. First you do the Base Year common sizing, then after that you do the other common sizing to % of
assets or % of sales.
b. This means year one(base year) will always be incomparable because all the figures must be 1 (it is the
base year) , and also “TOTAL ASSETS” & “TOTAL EQUITY and LIABILITY” will always be =100% so the
change in these is also incomparable.
RATIOS:
Du Pont Identity:

a. This is a financial analysis and planning tool first used by Du Pont in USA. It is designed to provide an
understanding of the factors that provide a return on equity of the firm. It can be shown in a flow chart
where ROE is decomposed one ratio at a time into its elements.
b. IF ROE is unsatisfactory management is able to trace back throughthe flowchart and identify those
ratios where improvement can be achieved.
c. The Du Pont IDENTITY is : ROE = [1-Profit Margin] * [2-Total Asset turnover] * [3-Equity Multiplier ]
i. [1-ROE= NPAT/Sales] * [2-Sales/Total assets] * [3-Total assets / Equity. ]
ii.This tells us ROE is affected by 3 things :
1. Operational Efficiency –(profit margin)
2. Asset use efficiency –(total asset turnover)
3. Financial leverage – (equity multiplier)
d. The Financial Leverage part can be further expanded (through the profit margin part though) to a show
a tax effect and an interest effect as well. This is called the : EXPANDED DU PONT IDENTITY :
i.
ii.Here we can see the effect of tax and interest as well.
e. The flowchart below is used to trace through the Du Pont Identity to get to the the factor causing the
problem.
f.
RATIOS
1. PER textbook, different books and different people/organizations compute the following ratios in slightly
different ways. So one must be careful when comparing ratios between sources that you find out exactly what
method each one used so you know that they are worked out the same or NOT.
2.

1.
Unit Min
Short termSolvencyor LiquidityRatios
1-The primaryconcern isthe abilityof the firmto payits accounts
Current Assets
timesor
Current Ratio Min 1
Current Liabilities
rand per
Current Assets-Inventory
Quick Ratio
Current Assets
Cash Ratio
Net WorkingCapital to Total Assets
Interval Measure

1.
FROM VIGGIO (MACN202) : go through these and re-do , then join

them up with the ones from the ‘fundaments of corporate’ book. To
make 1 set of notes
MARGIN OF SAFETY:
a) Difference between : Budgeted Sales Volume MINUS Break-Even Sales Volume.
b) Sometimes Expressed as % of Budgeteted Volume or Budgeted Revenue.
KEY RATIOS FOR CVP

1) (PV ratio) Profit Volume ratio: ( or also called ‘contribution RATIO or margin %’ )
= Contribution / Sales. =0.abxy or ( * 100/1= ab.xy %) TO 4 decimal places OR to 2 decimal places for %
1) profit ratio
=Profit / Sales =0.abcd or ( * 100/1= ab.cd %) TO 4 decimal places OR to 2 decimal places for %
2) (B/E sales) break-even sales revenue:( not a ratio)
=Fixed Expenses / PV Ratio = Rands ,2 decimal cents.
REM: FIXED expenses is NEVER just the totals that do not change –you must FIRST CHECK
EVERY TOTAL eg: labour-MATERIALS-OVERHEADS ETC FOR THE FIXED PART AND VAR. PART
BEFORE you calc. the total fixed costs.
3) break-even sales volume:( not a ratio)
=Fixed Expenses / Contribution per unit. = units (round- off downwards only –ie: per unit)
4) margin of safety ratio
Sales - (B\E Sales revenue) / Sales =answer as % OR decimal =0.XXXX or ( * 100/1= XX.YY %) TO 4
decimal places OR to 2 decimal places for % {sales means budget sales revenue. –but could also be actual...
depends on needs)
5) OTHER TYPES:
1.1. CONTRIBUTION RATIO = marginal contribution/marginal sales
1.2. VARIABLE COST RATIO = marginal variable costs / marginal sales

BUSINESS RISK ASSESMENT
BUSINESS RISK RATIOS (THERE ARE 8 OF )
BUSINESS RISK RATIOS (THERE ARE 3 OF )
Contribution : High – Low method to get it from the income statement.

You can get VARIABLE COSTS : by: given 2 years figures – then change in turnover Minus change in EBIT.
You can get CONTRIBUTION Margin by: change in EBIT / change in TURNOVER.
You can get CONTRIBUTION by : then use this % from contribution margin to MULTIPLY by any TURNOVER =
Contribution .
1. Note: For contribution,
a. If given both Revenue AND Turnover figures in an exam one above the other (revenue
PROBABLY INCLUDES “Other Income” and turnover is from normal operations) , you don’t
use you do not use REVENUE, you use TURNOVER , I THINK – just check with lecturer on
this.
b. For EBIT - remember not to use ‘net profit’, but to use EBIT instead here.
OPERATING LEVERAGE: = CONTRIBUTION/EBIT (Earnings Before Interest and Tax) | =Decimal

Answer |low=1,5 high=3 |
1) A high operating leverage eg: 3 means
i. CONTRIBUTION (ratio) is HIGH AND
ii. CAPITAL INTENSIVE (PROBABLY)
iii. BUSINESS RISK & ?OPERATING RISK? is high as it is Captal Intensive with
HIGH FIXED COSTS.
iv. B/E POINT is HIGH probably (because of probably high fixed costs)
v. FIXED COSTS is probably HIGH
2) A low operating leverage eg: 1,5 means:
i. CONTRIBUTION (ratio) is LOW AND
ii. LABOUR INTENSIVE (PROBABLY)
iii. ?BUSINESS RISK &? OPERATING RISK is low as it is Labour Intensive with
LOW FIXED COSTS.
iv. B/E POINT is LOW probably (because of probably low fixed costs)
v. FIXED COSTS is probably LOW
3) The ratio trends toward 1-the absolute minimum- this would be very low(no fixed costs basicly). This ratio is very
useful when evaluating companies because it helps us asses comparative operating risk in terms of operating
fixed costs. So the fixed costs will be in the EBIT, and thus even if it has a high contribution, but somehow a low
fixed costs, we will quickly see if there is a maybe a low risk, where usually a high contribution margin means it is
a high risk company because there are then usually high fixed costs and this will in turn bring down the EBIT and
make for a HIGH answer which of course means a high business risk and high operating risk.
4) Another way to see the light this ratio provides is to work out the cost structure (variable/fixed cost structure) –
and a high fixed/low variable will mean a high ratio&low risk , but a low fixed /high variable will probable mean a
low ratio&low risk.
(GP%) GROSS PROFIT Percentage % RATIO: = Gross Profit/TURNOVER | =% ANSWER

|
Note: you did bogger something op here when it comes to GP% ratio and how it works with some of the other ratios.
Read carefully- not fixed yet in notes, somewhere further. You found out in a test or something that your notes are
incorrect- not fixed yet!
1) Remember it is turnover , not revenue, so if there are figures for both use turnover because GP% is for
“operations”, not including “other income “ like rent or dividends (I THINK-CHECK WITH LECTURER)
2) Most important business risk assessment when operating leverage and B/E information are not available.
3) HOW IT WORKS:
a) if turnover increases by 500, by how much will GP% increase :ANSWER by the contribution. (unless you were
operating at a loss before turnover increased!)
b) the contribution ratio must be higher than the GP% ALLWAYS unless fixed costs are = 0!
4) FINANCIAL ANAYSIS:
a) If turnover increases: THE more capital intensive it gets (high fixed,low var.), the greater an increase in GP
% for an increase in turnover ,and greater the drop in GP% for a drop in turnover % . So if for capital intensive

business, we would expect the GP% to increase quite substantially if turnover increases. nIf it does not then it
shows the company has not performed as well as it should have(might have been going at a loss before the
increase, or maybe fixed costs were slaphappily increased as well, or contribution decreased)
b) If GP% increases : ALL WE SAY IS THAT THE PROFITABILITY OF THE COMPANY HAS Improved
c) WHAT negative factors could cause GP% to go up less when Turnover% increases a lot:
i) Selling price drop (most common reason)
ii) Var. cost increase (next most common reason)
iii) Fixed cost increase.
return on operating assets: earnings before interest and tax/ Operating Assets *100/1 |
= % answer
1) Use gross profit before interest. From ALL(not other income)
2) Use (fixed assets – long term investments) + ALL current assets,
3) Exclude “long term investments” in the “fixed costs” section.
4) Current assets include all bank + debtors + inventory.
5) Use value at beginning of period for assets, unless question specifically states “average asset value” the
begin+end/2
a) When they do the average of 2 years, they sometimes take average of fixed assets but add it to the current
assets without getting an average of the current assets , only of fixed assets? It seems you do not have to ,
but may sometimes do it this way to balance some kind of oddities.
6) Interest is a cost of finance just like dividends are a cost of finance, thus both are excluded from the calculation
7) This ratio can be got from Profitability ratio X Operating asset Turnover ratio = this Ratio
RE_DO THE SUB RATIOS BELOW-no time

For each of these ratios + the rest also check
whether they should use ‘turnover ‘ or ‘revenue’
ie: including “other income” or only “income
from operations”.
8) Use gross profit before interest. From ALL(not other income)
9) Use fixed assets+current assets
10) Use value at beginning of period for assets, unless question specifically states “average asset value” the
begin+end/2
11) Interest is a cost of finance just like dividends are a cost of finance, thus both are excluded from the calculation
12) Note ; this ratio is equal to the: GP% (profitability ratio) x operating asset turnover ratio answer.
13) It shows the return for Business + Financial risk.
14)FINANCIAL ANAYSIS:
i) Important ratio
ii) 15 % is very low so it means that not efficient OR that there is an opportunity to increase profit (sales)
without investing more in assets for a while.
iii) It shows how well the company is performing in terms of the investment in assets has been returning a
profit((efficient etc), as long as assets did not deteriorate too much.
iv) BEWARE, one thing to watch out for is if the company has been running down it’s operating assets and
allowing the asset base to deteriorate, then the ratio will increase significantly.Therfore one must check
this first
sub-ratio -operating asset turnover = turnover/Operating assets [FA+CA for year Average(b-end/2)]
| decimal answer | 40c per rand is very low

1) An answer of 0.39 means that you get a profit of about 40 c per rand , which is very low. This means there is
underutilized capacity or over-investment in fixed assets, one of the two.
sub-ratio – Profitability ratio: = EBIT / Turnover

An answer of 0.39 means that you get a profit of about 40 c per rand , which is very low. This means there is
underutilized capacity or over-investment in fixed assets, one of the two.

net profit percentage % ratio= net profit after tax/turnover * 100/1 |%=answer|
2) Not very important ratio
3) The difference between GP% ratio and is is just interest- which could be from debt .used instead of equity.
4) This ratio could also be calc. as net profit before tax/turnover – it does not matter , as long as we are consistent in
our comparisons.
Roe : return on equity = earnings after tax/total shareholders funds *100/1 |% =answer|
1) Total shareholders funds = includes ordinary shares + share premium + all reserves + retained earnings BUT
EXCLUDES PREFERENCE SHARES.
2) It means the firm has managed to give the shareholders a higher/lower profit per rand invested.
increase in Turnover or sales growth – as a ratio =new-old/old |=%answer |

1) ALLWAYS SAY: I expect a substantial increase in cash flow and increase in profity
2) Note; Business Risk will INCREASE where a increase in turnover does not result in an increase in CASH FLOW.
b/E point = fixed costs/pv ratio % (contribution margin) | =% answer |

1) Say has improved or got worse every year. Less means an IMPROVEMENT IN BASIC PROFITABILITY of the company
debtor turnover
Stock turnover
Note: not the following headings below:
The Profitablility ratios are: 1-net profit%, 2-GP%, 3-sales growth, 4-profitability ratio.(not sure – just
check)
The liquidity ratios are: NOT SURE- check up (I think 1-debt2-liquidity3-acid-4times interest earned
Times interest earned ratio is also called the ‘gearing ratio’( I think – check)
Financial ratios:
FOR FINANCIAL RATIOS NOTE THAT THE RATIO FOR DEBT-EQUITY: YOU DO USE DEBT=ONLY
LONG TERM DEBT + BANK OVERDRAFT NOT CREDITORS AT ALL!!!!!!!! IN VIGGIO BOOK, BUT
IN OTHER NOT SURE
Must finish all these to end of chapter, because did not have enough time to finish .
ALSO do Z-score + A score + financial assessment template etc.
END OF VIGGIO PART

I. Short-Term Solvency or Liquidity Ratios A (7 t
Current ratio — Current assets L.
Current liabilities -=-t
Quick ratio = Current assets — Inventory
Current liabilities
Cash ratio = Cash If
Current liabilities
Net working capital to total assets — Net working capital .,
Total assets
Interval measure = Average daily operating costs
II. Long-Term Solvency or Financial Leverage Ratios -r’
Total debt ratio = Total assets —Total equity “
Total assets
C Debt/equity rati Total debt+ Current liabilities
Equity multiplier = Total assets
Total equity
Long-term debt ratio = Long-term debt
Long-term debt + Total equity
Times interest earned ratio = Profit before interest and tax
Interest
Cash coverage ratio = Profit before interest and tax + Depreciation ,‘,
Interest
Ill. Asset Utilization or Turnover Ratios
Inventory turnover Costs of goods sold
Inventory

Days’ sales in inventory = Inventory x365 days
Cost of goods sold
Days’ sales in receivables = Accounts receivable x 365
Credit sales
Days’ purchases in payables Accounts payable x 365
Credit purchases
Net working capital turnover = Sales
Networking capital
Non-current asset turnover = Sales
Net non-current assets
Total asset turnover = Sales
Total assets
IV. Profitability Ratios I / , /\ ( (
Profit margin — Net profit aftertax
Sales
Return on assets (ROA) — Net profit after tax
Total assets
Return on equity (ROE) = Net profit after tax ,_)
Total equity
V. Market Value Ratios
Price “
Price-to-earnings ratio = per s are / ,
Earnings per share
Market-to-book ratio — Market value per share— ‘7j
Book value per share ,
¶f.]J jffI Common fmanctal ratios;0]

CURRENT ASSET MANAGEMENT CH19
INTRODUCTION
1. The basic objective in current asset mngmnt is to keep the investment in it as low as possible while still
keeping the firms activities operating efficiently&effectively. The lower the investment, the higher the ROA
will be, but very low increases business risk.
2. MOST LIQUID is cash, less is marketable securities , debtors, LEAST LIQUID is inventories.
3. Most mnftring firms = 40% part of total assets
REASONS FOR HOLDING CASH

1. Speculative(take advantage of bargains), Transaction, Precautionary.
2. COSTS OF HOLDING CASH :
a. Opportunity Cost of investing in marketable securities.
FLOAT , CASH COLLECTION, AND CASH CONCENTRATION

1. FLOAT : difference between book cash & bank cash. : due to the net effect of cheques in the postal system /
or in the process of clearing.
a. DISBURSEMENT FLOAT :when you pay someone else and cheque is still being cleared. You can invest in
marketable securities and earn interest during this time you gain.
b. COLLECTION FLOAT : they pay you by cheque and cheque is still being cleared. : you loose because you
could have earned interest in this time, + customers funds might get used before your cheque actually
clears.
c. NET FLOAT : difference between the 2. A firm must be more concerned with this than book net cash.
2. EDI : ELECTRONIC DATA INTERCHANGE : term referring to practice of direct electronic data interchange
between all types of businesses. Also includes EFT which can replace cheques and reduce float to nearly zero.
Examples are point of sale transfers, electronic trade payables, etc.
3. Automated clearing bureau: operated by BankServ, it clears cheques from local SA banks in major urban
centres on the same day, - and can reduce collection float to zero.
4. CASH CONCENTRATION : practice & procedures of moving cash from multiple banks into firms main
accounts. A frim wants to pool all its funds in one main account to be able to negotiate best possible interest
rates on positive OR negative balances, and net them out against each other to avoid paying interest in one
place and earning a bit of interest in another.Also only a small no. of accounts need to be tracked
scrupulously. Each evening the bank can sweep all accounts and move them into 1 single one.
INVESTING IDLE CASH

1. SURPLUSS: Temp cash surplus can be invested in marketable securities
2. DEFICIT : sell marketable securities
3. Money market : market for short term financial assets. money market securities are generally highly
marketable and short term with low default risk. Usually issued by Gov, Banks, Companies.
4. Maturity : for short term fin assets trading in money market is 1 year or less
5. REASONS FOR TEMP CASH SURPLUSS :
a. SEASONAL/CYCLICAL : EG toys max out at Christmas.
b. PLANNED/POSSIBLE EXPENDITURES : eg issue bonds/equities to finance expansion/expenses , invest in
marketable securities until cash is needed then sell them.
6. CHARACTERISTICS of MARKETABLE SECURITIES : THERE ARE 3
a. MATURITY: for long term securities interest there is greater risk than for short term ones because
interest rates change more in the long term than in short term, thus you could win/loose more easily
with long term(miss a better rate or miss a worse rate)therefore firms usually invest in <90days
maturity to limit risk. But returns are usually less on short term than long term.
b. DEFAULT RISK: that the bond issuer can not pay. Gov.Treasury Bills have lowest default risk usually.
c. MARKETABILITY: means about the same as liquidity- can it be converted quickly or not?
7. SOME DIFFERENT TYPES OF MARKETABLE SECURITIES.
a. SA Treasury Bills : T-Bills : issued by Gov, by weekly auction, maturity 91 and 182 days, even 1
year.
b. SHORT TERM GOV BONDS ; GOV LOANS < 1 year mature. Less liquid than t-bills.
c. NCD – negaotiable certificate of deposit : one of the class of Bankers Acceptances : lowest
risk & highest liquidity of private sector.<1yr, where banks lend from you.

d. COMMERCIAL PAPER ; issued by larger companies – not banks- same as NCD but by companies
instead, default risk depends on company.
CREDIT & RECEIVABLES :

1. Granting credit is investing in a customer, an investment tied to the sale of a product or service.
2. 1/5 of all assets in SA companies are in accounts receivable on average nationwide., thus receivables
represent a major investment of financial resources by SA companies.
3. COMPONENTS OF CREDIT POLICY:
a. TERMS OF SALE: cash or credit- for credit it is credit period, cash discount& cash discount period,
tyepe of credit instrument.
b. CREDIT ANALYSIS: firm determines how much effort to expend to determine probability that
customers will or will not pay. – many methods one can use
c. COLLECTION POLICY: problem of collecting due cash – like the 10 steps of a collection policy etc (1st
2nd etc letters, hand over to lawyers in time, watch out for prescription etc.
4. Investment in receivables / CASH FLOWS FROM GRANTING CREDIT : the average time it takes to
collect debts..debtor days is called the receivables period / average collection period /days sales in
receivables interchangeably. This ratio is influenced by:
a. FLOAT : the longer it takes to collect cheques , your debtor days ratio will be longer as well.
b. Credit policy
5. RATIO calculations : to get “Avg. accounts receivable” you multiply “Avg. daily sales” X “Avg.Collection
Period.”
CREDIT POLICY
1. Credit policy has 3 components : each is handled 1 by one below:
a. TERMS OF SALE
b. CREDIT ANALYSIS
c. COLLECTION POLICY:
1) TERMS OF SALE
1. Terms Of Sale is in turn made up of 3 parts :, each discussed in 1 heading below
a. CREDIT PERIOD
b. CASH DISCOUNT & DISCOUNT PERIOD
c. CREDIT INSTRUMENT TYPE
2. Notation Shorthand for Terms of Sale : ----- 2,5/30, net 60 ---- means 60 days to pay, 2,5% discount if
paid in 30 days.
3. Common terms of sale :
a. In SA : electrical wholesaler : 2.5/30,net 60
A) CREDIT PERIOD
1. Almost always between 30-120 days.
2. If cash discount is offered then credit period has 2 components : net credit period and cash discount
period
3. INVOICE DATE :
a. By convention, invoice date is usually either shipping date or invoicing date, not the date the buyer
receives the goods or the invoice.
b. EOM terms common in SA : (End Of Month) it is assumed all sales made in month were made on last
day of month (one of 25th to 31st, depending on supplier method in books)
c. Seasonal dating : to encourage sales in off-season : all sales from winter for sunscreen are presumed
to have been made on 1st November.
d. Other terms are possible eg: if invoice states ‘receipt of goods’, then it is counted from then, esp for
customer in remote location.
4. LENGTH OF CREDIT PERIOD; a number of factors influence the choice of credit period:
a. Most important: Buyers Operating cycle : which has 2 components ;Inventory Period +
Receivables Period : if you extend credit past the buyers Inventory period then you are not financing
buyers inventory purchases but part of the buyers Receivables as well. So you give him and also his
customers credit. FURTHERMORE: you are then providing finance for aspects of buyers business
beyond the purchase&sale of our merchandise – so when he has to order gain because inventory is
sold, you must go take out a loan to buy stock to supply him because he has not paid you yet!!- this is
if you finance him beyond his inventory cycle.

b. For this reason the buyers ‘operating cycle’ is often cited as the very upper limit at all possible
to credit period . So even if you do finance his receivables as well, you cannot possible go and finance
other things wil nothing to do with your merchandise at all.
c. Factors That Influence Credit Period:
i. Perishability&collateral value : rapid turnover/low collateral fruit&veg =net 7 days jewelry=5/30
net4mnths
ii.Consumer demand : higher demand=shorter credit period.
iii.Cost,profitability&standardization: cheap = short period , standardised = short period,
iv.Credit risk: high = short period
v.Size of account: larger = long period
vi.Competition: many = long period
vii.Customer type : different customers often have different terms
:B)CASH DISCOUNT & DISCOUNT PERIOD

d. Eff and Apr :Cost of Credit: Effectively: for 5/30 net 45, if the customer gives up the discount he is
effective paying 5/(100-5) % = 5.263% for 45-30=15days extra credit. That is what he is effectively
paying by not taking up the offer of the discount.- 5.263 for 15 days extra credit. That means if calc.
Eff. From this you get : 5.263 for 15 days = effective annual rate of := 365/15=24.3 *5.263=121.6%
APR – annual percentage rate. If you take the compounding effect into consideration this means an Eff
or EAR effective annual rate of 247.8% !!!!!!!!!!!!
e. Note the method of working out the EFF :first get APR by 365/ 15 days= 24.3. then say if 5%
DISCOUNT is for 15 days,then DISCOUNT CONVERTED TO INTEREST would be 5/(100-5) = 5/95 =
5.263% interest being paid for the extra 15 days you get. So for 5% discount it is= 5.263% Interest on
amount owed ! because the 5% would be minused from the total owed if you took the discount .Then
24.3*5.263% = for 365 days.=127.89 % APR. then do compounding effect over 24.3 periods, 127.89 %
EFF comes out on calculator as 247.8%. THE TRICK part is to say 5/(100-5) = 5.263% over 15 days
because if you paid early to get discount, your price would have been 95%, not 100 %. So 5 parts of
95=5.263%
f. INTHIS SENSE CASH DISCOUNTS ARE A CONVENIENT WAY OF CHARGING FOR THE CREDIT GRANTED
TO A CUSTOMER, WITHOUT IT BEING OBVIOUS that you are charging him for it.
g. Cash discount INFLUENCING the average debtor days :(collection period) ; if it encourages
customers to pay early it will shorten the average debtor days .the calculation works as follows : if
discount of 2/10 net 30 will cause 50% of customers to pay early, what will the new Debtor Days(or
ACP ie average collection period)be:
i. To calculate you say 0.5% customers pay in 10 days , 0.5% of customers pay in 30 days, so
average = 0.5*10 + 0.5*30 = 5+15=20 days!!!!( not 15 days!!!)
ii.WHAT WILL HAPPEN TO ‘RECEIVABLES’ if annual sales are 15mil ? daily sales are
15mil/365=41096. So 41,096*20= 821920 and 41096* 30 =123288 so we see Receivables
will fall by one minus the other = 410960 , which is a lot!.
C)CREDIT INSTRUMENT TYPE.

1. Open account ;: most common way of offering trade credit, here a waybill& invoice are formal
instruments.waybill signed as evidence of receipt
2. Promissory note: basic IOU, used to ensure provability in courts without having to prove supplier received the
goods.used if amounts are larger, collection problems are anticipated etc. customer signs it to verify receipt of
goods
3. Commercial draft: you send shipping invoices+ this draft to buyers bank. Here either he signs it or bank signs
it to guarantee payment after delivery. Bank handles the back and forth sending etc. to make it a bit official.
a. Trade acceptance: customer signs to guarantee payment(not bank)
b. Bankers acceptance: bank signs it to guarantee. Commonly traded on money market – it is negotiable
after bank signs.
c. Time draft: pay after time elapsed
d. Sight draft: pay on presentation(sight)
2) CREDIT ANALYSIS
Analyzing Credit Policy

1. Granting credit only makes sense if the NPV of granting credit is positive.
2. NPV EFFECTS FROM POLICY TO GRANT CREDIT:

a. Revenue Effects: total sales may increase and may charge higher price, but delay in revenue
collections
b. Cost Effects: whether or not frims grants credit , it will still have to pay for stock. So delayed revenue
collection but still have to pay for stock means it may have to lend to finance purchase own stock.
c. The Cost of Debt: the cost of debt to finance buying own stock , because no money comes in for
sales on credit for a few weeks/mnth.
d. The Probability of Non-Payment: some % of credit buyers may not pay. This will not happen if sell
for cash.
e. The cash discount: some customers will choose to pay early- this means lower selling price.
3. EVALUATING A PROPOSED CREDIT POLICY : how to calc NPV of SWITCHING POLICIES.
a. NPV of Switching Policies:
i. FORMULA :
where:
BREAKDOWN OF FORMULA :
1-BENEFIT OF SWITCHING:
The PV of these future cash flows is therefore:
-(this is from Perpetuity Formula ie: every mnth you will still get this extra
sales)
2-COST OF SWITCHING:
CREDIT ANALYSIS:deciding whether to give a specific customer credit or not:
MATHEMATICLY
1. ONE TIME SALE :
a. FORMULA TO USE :
i. Where:
1. v= variable cost per unit
2. R= required return on receivables
3. P= price
4. ii pie sign is = probability of default, (get it from how many new customers default on
average)
b. Here we are using (1+ R) to discount revenue to NPV because it is once off, not a perpetuity or
anything but normal PV calc.
c. Very simple formula really to understand.

i. OLD CUSTOMER /NEW CUSTOMER : note: if we extend to an old customer there are 2 points to
consider- We are risking the total price P , not just the variable costs v, in the sale because the
customer would have bought anyway whether credit was given or not, But The possibility of
default probably is lower than new customer.
2. REPEAT BUSINESS:
1. Assumption: a new customer who does not default will remain one forever and never default.
2. FORMULA = (NPV is PV of the whole idea, ie: positive or negative)

a. Where:
1. v= variable cost per unit
2. R= required return on receivables
3. P= price
4. ii pie sign is = probability of default, (get it from how many new customers default on
average)
3. note: (P-v) takes the place of P here because we assume for every one sold, we will sell another one to him so
pay v this month already to get the product ready for customer so long.
4. We divide by R as it is a perpetuity ( repeat business)
5. Book says , the best way of figuring out a credit policy & possibility of default is to just extend credit to almost
anyone/or to those above a certain risk etc .. Then work it out from there, just keep the credit limits low in the
beginning.
6. SOLVING FOR : BREAK-EVEN PROBABILITY :
a. JUST SET NPV to zero and solve for ‘pie sign’. Note- higher mark-ups mean more leeway with
probability / credit terms allowed.
CREDIT INFORMATION ON CUSTOMERS

1. There are various SOURCES of info on customers ;
a. ASK FOR FIN STATS OF CUSTOMERS : then work out ratios from this to determine credit
worthiness.
b. CREDIT BUREAUS: like transunionwww.kredit.co.za, or dun&bradstreet-www.dnb.com-(international
largest in world all fin info)
c. CUSTOMERS PAYMENT HISTORY WITH FIRM.
CREDIT EVALUATION AND SCORING

1. The five C’s of credit are the basic factors :
a. CHARACTER: willingness to meet obligations
b. CAPACITY: ability to meet out of operating cash flows
c. CAPITAL: financial reserves
d. COLLATERAL: pledged asset in case of default
e. CONDITIONS: general economic conditions in Customers Line OF Business
2. CREDIT SCORING : a firm allocates a point 1-10 for each of the 5 C’s above . then compute a total score out of
it. Then from experience you gain you later decide to only give credit to those with a score over eg 30.
OPTIMAL CREDIT POLICY

1. We wish to determine the optimal amount of credit and the optimal credit policy.
2. Optimal amount of credit is : in principle where 1- incremental cash flows from increased sales are
exactly equal to the 2-incremental costs of carrying the increase in investment in accounts
receivable.

a. Incremental costs of carrying the increase in investment in accounts receivable:
i. Required return on receivables
ii.Losses from bad debts
iii.Cost of managing credit& credit collections
b. A
3. If the firm has a very restrictive credit policy, then all the above costs will be low. BUT the firm will probably be
offering less than the optimal amount of credit, so there will be an OPPORTUNITY COST of sales foregone
because credit is refused.But if too much credit is offered additional cash flow will not carry additional
investment in receivables.
4. OPPORTUNITY COSTS : there are 2 obvious parts:
a. Incr. in qty sold
b. Higher price chargeable
c. Plot all the above info on the graph below to read off the result.
5. These are some other factors which may influence decision to extend credit:
a. Excess capacity
b. Low variable operating costs
c. Repeat customers
3) COLLECTION POLICY
1. Involves :
a. Monitoring Receivables to spot trouble
b. Collecting on overdue
2. MONITORING RECEIVABLES:
a. Monitor ACP(average collection period ratio) if it changes a lot it means some or all customers
are taking too long to pay.
b. age analysis: summary just gives totals & % of Total, for each of 0-10 days, 10-30 etc etc., details gives
this for each customer.
c. Seasonal sales might cause dramatic changes in age analysis as well.
d. A good way around seasonal problem is for each of past 4 mnths get a ratio of receivables to monthly
sales ratio. The change in this ratio will show up collection problems as well
3. COLLECTING:
a. Refusal to sell until bills are paid may antagonize a good customer.conflict between sales & collections
dept.
b. Procedures:
i. Phone customer payables dept. +send duplicate invoices
ii.Letter informing of overdue status
iii.Second letter, registered post, stronger wording.
iv.Customer notifed of only COD allowed, or denied further deliveries.
v.Large amounts- legal action Small Amounts-collection agency usually employed.
-EOQ : DETERMINING THE ECONOMIC ORDER QUANTITY:

1. E.O.Q (economic order quantity) : the optimum order size is known as the EOQ. This means if you make larger
orders, then you also have to make fewer orders so your total ‘ORDERING COSTS” come down, BUT then at the
same time you HOLDING COSTS go up because you have to keep the larger orders in the warehouse.
2. There are 3 methods for balancing the 2 :
2.1. TABULATION METHODS :
2.2. GRAPHICAL METHOD:
2.3. FORMULA METHOD :
TABULATION METHOD :
1. (see example below) You make a table up with columns for a range of order qty’s you just make up and try out -
eg 10 , 20 , 30 etc. And then you just see which order qty causes the lowest overall relevant cost- THAT’S IT.
2. You must put the average stock that will be in the warehouse in the table, because you need it to calculate
the AVERAGE holding costs. You get the average stock by dividing the order qty in half and ADD safety
stocks to this– since it will be zero when you order and Max when you receive order- so avg is half.
3. Remember – if they quote opportunity costs as a yearly interest % * cost price of each item, then your costs are
YEARLY not MONTHLY –don’t mix them up with other costs which are monthly. In a question they might not say
what time period other costs they give you are measured in so, so it could mean all the same timeframe or be
tricky – check carefully . but it seems it is normally done on TOTAL YEARLY COSTS.
GRAPHICAL METHOD:
1. (See example below)YOU must get info like above for various order qty’s. in a table form .
2. Then make a graph with x axis = ORDER QTY and y axis = ANNUAL COSTS.
3. You plot the holding costs on one line , then make another line with ordering costs. where these 2 lines cross, will
be the lowest Total Relevant Cost. You make a 3rd line with both line added together to make a third. The lowest
point of this 3rd line will also the answer, ie Lowest Total Relevant Cost.
4. Note that (interesting) in example below the annual costs are not that sensitive to order qty – a 25% increase in
order qty leads to just a 2.5% to 4 % increase in annual costs.

FORMULA METHOD:
1. All the holding costs & ordering costs below are ANNUAL costs, not monthly costs.
2. ORDERING COST =
3. HOLDING COST =
4. TOTAL COST =
5. To get the special formula you use to work out the E.C.Q. , you must ‘differentiate the total cost formula above
with respect to Q and set the derivative equal to zero .’ what ever that means : then you get the following formula
. Just solve for Q to get the lowest order qty possible.

5.1. Use the following :
5.1.1.HOLDING COSTS : per unit per year (note , for the tabulation method you use the average annual
holding costs of all units (ie order qty/2 + safety stock * holding costs) but for this method you only use
the annual holding cost of 1 one uno een eins unit. ( which might have to be calculated using the
average holding cost method, but only for 1 unit, not all.
5.1.2.ORDERING COSTS : per any 1 complete order
5.1.3.DEMAND : per year
MORE NOTES ON EOQ Model
Assumptions of the ECQ model:

1. Holding cost per unit will be constant. – note that this might not be true as holding costs might increase in
steps, not constant , as more storemen might be needed as stocks increase, and less casual labour as stocks
decrease.
2. The Average Stock holding is one half of order qty : Seasonal&cyclical factors and if a constant amount of
stock is not used per day, this assumption will be violated.
3. HOWEVER : due to the way the curves generally interact with each other, even if your holding costs were
estimated 50% lower than they actually are by accident, it would only mean a 6% difference from the optimal
financial result. So the EOQ method is still very valuable as an indicator even if some of the variables are
estimated incorrectly.
Applications of the EOQ model in determining the optimum lot size for a production
run.
1. The EOQ model can be adapted to determine the optimum length of the production runs when a set – up cost is
incurred only once for each batch produced.
2. You just use “SET-UP COSTS” instead of of purchase “ORDERING COSTS”- That’s it.
3. So just substitute symbol S for the symbol O in the formula and go.
4. NOTE : after working out Q = EOQ, you know how many to make in each production run. Now, to work out from
this, if asked in exam, at what stock level one should start to manufacture the next run : you do a huge complex
calc., saying total demand per year / working days = how many per day to make. Then calc how many days it will
take to make the previously calculated EOQ, at this number per day. This is the length of a production run ,and
now see how much stock you will need to carry you from the begin to the end of 1 production run. This is the
minimum stock re-production level.
quantity discounts
1. Buying in larger consignments to take advantage of quantity discounts will lead to the following savings:
1.1. Lower purchase price (from discount)
1.2. Lower total ordering cost because fewer orders are placed to take advantage of discounts.
2. METHOD :
2.1. To work out if it is better to order more and get a discount , or order less and decrease holding costs, you
have to take 3 factors into account : 1-holding costs, 2-ordering costs , 3-discount
2.2. What you do is : first work out the normal EOQ. Using any method.
2.3. Then work out your savings from taking the discount : it will be 1-discount vs 2–lower ordering costs.
2.4. Then work out your HIGHER holding costs from taking discount/ordering higher Qty’s.
2.5. NOW SEE IF THE SAVINGS IS MORE THAN THE EXTRA COSTS YOU WILL INCUR. = answer
3. That’s it – no clever formulas. Bopa.
determining when to place the order :

1. Simple :
2. Lead Time is the time it takes between placing the order till you get the delivery. (or between starting production
and getting the finished products)
3. The Time to Place an Order : is when the stock level reaches a point just before where you will not have
enough to carry you through the “lead time” till you get more. This is easy to work out, just move figures around
till you get it.
1. Take demand needed per year , and after working out Q = EOQ, you know how many to make in each
production run/or order each time. Now, to work out from this, if asked in exam, at what stock level one should
start to manufacture the next run/ or order the next load : you do a huge complex calc., saying total demand per
year / working days = number needed/sold per day . Then take your lead time . This is the length of a production
run ,and now see how much stock you will need to carry you from the begin to the end of this lead time. This is
the minimum stock re-order or re-production level.
uncertainty and safety stocks and probability theory.

1. SAFETY STOCKS : to protect itself from uncertainty, a firm will maintain a level of raw material, WIP and finshed
goods Thus when lead time & demand are uncertain there must be safety stocks added.
2. The 2 factors are the stockout costs (cost of running out of stock- lost sales etc) VS cost of holding
extra stock
3. STOCKOUT COSTS (Cost of running out of stock)=
3.1. Loss of contribution from loosing sales
3.2. OR by permanently loosing regular customers = discounted value of the lost contribution on future sales
3.3. OR cost of : stoppage in production (idle labour +
4. : HOLDING COSTS :once the stockout costs have been established, the costs of holding safety stocks for various
demand levels should be calculated.
5. MAXIMUM LEVEL OF STOCKHOLDING POSSIBLE: = re-order level + order qty – ( Minimum lead time X Min.
daily usage) note : minimum!!!!=least use possible, not max use possible.
6. WITHOUT PROBABILITY THEORY : to calculate the level at which stocks must be re-ordered :
6.1. Re-order level= MAXIMUM daily usage X MAXIMUM lead time (do not use averages for any of these 2, unless
they give you probabilities for each as well to work with)
7. WITH PROBABILITY THEORY :It is better to attach probability levels to potential demand levels, and
from this work things out.
7.1. NOTE : the EXAM ANSWER for re-order level ALLWAYS = safety stock + average usage during lead time
(not just the average usage in the lead time)
7.2. METHOD type 1 : for COST OF STOCKOUT METHOD
7.2.1. FIRST :You get a table with different possible “usages during the lead time” and with probailites for
each. You ALLWAYS work out the total “average usage during the lead time “ by multiply each usage by
its probability and add all the answers up. This gives the statistical average lead time.
7.2.1.1.If demand varies : throughout the year, then you must do this calculation for each separate
period and adjust your ‘safety stock” at the beginning of each successive period.( instead of just
having one “safety stock level”, you have more than one.
7.2.2.SECOND :they give you “stockout costs per unit” and “holding costs per unit”. So you make up a table
with (don’t understand- it seems they did errors on the table on page 629) re-do
7.3. METHOD type 2 : for Maximum Probability OF RUNNING OUT OF STOCK to be Allowed Method :
7.3.1. If the firm cannot easily estimate ‘stockout costs’ it might just say it does not want the probability of a
stockout to exceed say 10 %. Then you go to your given table of probabilities of each ‘usage in lead time
“ and ADD UP THE probabilities starting at the HIGHEST USAGE downwards .As soon as the answer gets
above the say 10% specified you stop there-that single one is your re-order point. You still use your
“total average usage during the lead time” as the basis of your calculation , and then your “safety stock
level” is just the difference between your ‘stock re-order point” and your “total average usage during the
lead time “ – so you will have to quote both figures for an answer.

control of stock through classification:
1. In large firms it is possible to have tens of thousands of different types of items . So it is impossible to apply these
tequnques in this chapter to all of them. So then stocks are classified in to categories of importance so that
elaborate tequniques are then used on ONLY the most important items, and easier , less time consuming
tequniqes are used on the rest ( like subjective methods ie: asking how much is needed per past experience.
The ABC classification method :

1. This is a common method of classifying stock in order to guage which ones to apply complex tequniques to and
which not.
2. METHOD :
2.1. You class all your stock in 3 categories A,B,C.
2.1.1.CATEGORY A : top 10 % of ANNUAL PURCHASE COST (not price per unit, but total cost of all units of the
same type bought per year eg: total price of all 10 mm bolts bought per year )
2.1.1.1.Then the most sophisticated tecniuques from this chapter are done on CATEGORY A , also you try
to keep safety stocks as low as possible ( avoid high storage costs) but high enough to avoid high
stockout costs.
2.1.2.CATEGORY B : next 20 %
2.1.2.1.you use the same quantitative techniques but slightly less sophisticated.
2.1.3.CATEGORY C : last 70 %
2.1.3.1.Here use more subjective methods like per past experience , and also higher safety stocks
( storage costs will be lower here) and larger orders because of that.
3. In most manufacturing concerns, the normal levels are usually that 10-15% of items account for 70-80 % of total
purchases value, and on the other extreme normally 70-80% of items only account for only 10% of total value.
other factors influencing the choice of order quantity:

1. Shortage of future supplies :one may ignore these results form these methods and over-order if eg there is
going to be a country wide shortage of some item in the near future etc
2. Future Price increases : you over-order here
3. Obsolecence : you under- order here if there is a danger of imminent obsolescence
4. Steps to reduce safety-stocks : if one puts pressure on suppliers to reduce lead time, or find a better supplier,
you can reduce the level of safety stocks.
MATERIALS REQUIREMENT PLANNING(MRP)

1. MRP 1 originated in the 1960 s as a computereised approach to coordinating the planning of materials acquisition
and production.

1.1. You type in the approximate finished goods needed, then the system works out how many of each sun-
components, and sub-sub-component and so forth is needed, until only DIRECT MATERIALS(DM) ie goods to
be purchased in, are left.
2. MRP II is another similar type of system known as Manufacturing Resource Planning which is an upgraded version
of MRP I , and extends to labour scheduling and machine capacity planning.
3. EOQ method can be used together with this system to organize the whole process, as long as the major
assumption of the EOQ model- constant demand -applies
JIT : Just in Time Purchasing arrangements.

1. JIT seeks to ensure delivery of materials just before their use, to minimize stock holding needs and costs.
2. Normally it requires suppliers to do quality inspections on stock before delivery to guarsntee quality.they must get
production schedules to estimate their deliveries, and have a close commitment to JIT to be chosen as suppliers.
So not any supplier can be chosen for JIT- it takes commitment to JIT.
3. This co-operation from suppliers is achieved by placing higher orders with fewer suppliers and for a longer term It
has a few goals :
3.1. eliminating non-value adding activities – like some activities related to purchasing
3.2. a batch size of 1
3.3. zero inventories
4. It can cause savings in - purchase costs, volume discounts, holding costs

INTERNATIONAL CORPORATE FINANCE
CH20
DEFINITIONS:
1. ADR : American depository receipt : security issued in USA that represents shares of a foreign counry
allowing those shares to be traded in USA.
2. Eurobond: bond issued outside issuers home country ,in many countries, but denominated in 1 currency ,
usually issuers home currency. diversify borrowing base without exchange rate cover
3. Eurocurrency : is money depoisited in a financial centre outside of a the country whose currency is involved.
Eurodollar is most common.
4. Foreign bonds: issued in a foreign currency by a foreign issuer, usually denominated in that countries
currency.usually have tougher disclosure rules, and tax laws/restrictions. Nicknamed by country issued in eg
Yankee bonds, Samurai bonds etc. not as popular as Eurobonds due to tougher restrictions etc.
5. Gifts: technically British/South African/Irish government securities, although the term also includes some local
authority and other public sector offerings.
6. LIBOR: like the JBAR, it is the London interbank offer rate.the rate most international banks charge each other
for loans in Eurodollars overnight in the London market. It is a cornerstone of pricing of short term securities
by gov. etc, who quote a LIBOR +/- % rate which then floats with the LIBOR rate.
7. SWAPS: there are 2 kinds: interest rate & currency. Often both occour at same time when debt denominated
in different currencies is swapped.
a. Interest rate: 2 parties exchange a floating rate for a fixed rate payment or visa versa.
b. Currency swaps: agreement to deliver 1 currency for another.
FOREIGN EXCHANGE MARKETS & EXCHANGE RATES

1. Undoubtedly the worlds largest financial market- some 3 trillion $ per day totals / and 11 bil $ in rands.
2. It is over the phone/internet , not physical location etc/ and banks use the SWIFT organization in Belgium
to send messages between each other.
3. Used by traders, speculators, exporters/importers etc.
Exchange rate quotations:

1. Direct quote: price in rand of a foreign currency
2. Indirect quote /rate: amount of foreign currency per rand
3. Mid-rate: average of buying&selling rates for exchange rates for currencies
4. Cross rates; : exchange rate for a non- US currency expressed in terms of another non-US currency .you use
another currecy as the common denominator in quoting exchange rates. So with 5 currencies instead of 10
rates you only have 5 rates.also cuts down on inconsistincies in the quotations.
5. Triangle arbitrage: sometimes the cross-rate is inconsistent with the direct exchange rates. Then what one
can do is buy directly and sell at the cross rate , or visa vrsa, over the 3 (tringle) currencies to take advantage
of the different rates -
Web sites for exchange rates:

1. Historical&current = www.oanda.com
2. Current : www.xe.com, and , www.exchange rate.com
3.
Types of transaction:
1. There are basicly 2 types of trade in the exchange rate market:
i. Spot trade; : agreement to exchange on the spot , usually meaning within 2 days , the rate
agreed is the Spot trade exchange rate
ii.Forward trade: agreement to exchange at some time in the future. Usually to be completed
within the next 12 months.Rate agreed upon is the Forward exchange rate.
2. The formard rate is the rate quoted if you only want it in 6 mnths or 12 etc. this is for businesses that want
to eliminate the risk of an exchange rate fluctuation of some import etc , so they get this to be sure.Is usually
more expensive than the spot price.It is called at a premium . you work it out by :
a. Forward-spot/spot = %

3. Exchsnge rates are usually quoted against the dollar – so CHF6 means 6 swiss francs per dollar.
PURCHASING POWER PARITY

INTEREST RATES AND BOND VALUATION
CH7
1) BOND CALCULATIONS:
BOND FEATURES
1. COUPON RATE : :the interest rate ie: the annual coupon divided by the nominal value of the bond
2. COUPON: :the stated interest payments on the bond in rands.
3. NOMINAL VALUE : or PAR VALUE : the principle amount of bond that is repaid at end of period.
4. MATURITY: :specified date at which principle amount is to be repaid.
5. General :
a. Bond Proof of Ownership: historically they used to hold share certificates issued by issuer of bond,
stating all the above, but today it is held in a central registry, and you just get a brokers note as proof
of purchase.
CALCULATIONS FOR BONDS

1. YTM : YIELD TO MATURITY: the INTEREST RATE (not value of) required in the market for a bond.
a. The % interest you would earn on the price of the bond over its full life. (to calc. YTM use market not
bond rate!)
b. As market interest rates change, the old bond interest rate stays the same. So in order to match the
market interest rate, the bond must be sold at a discount to what its [nominal+ coupons left over] is
worth .
2. YTM: TO CALCULATE THE YIELD TO MATURITY: it is (PV AT market rates of ALL FUTURE CASH FLOWS – PRICE
PAID) / PRICE PAID. ie interest on price paid.
3. CURRENT YIELD: a bonds annual coupon dividend divided by its CURRENT PRICE –[not nominal price!]. (This
will be lower than what the YTM is because it does not take the effect of the final ‘nominal value’ payout into
effect, only the effect of coupon/price. )
4. PRICE OF A BOND : TO CALCULATE
a. You USE THE MARKET INTEREST RATE, NOT the BOND INTEREST RATE at all even a bit.
b. Fist calc PV of nominal amount of bond, that will be repaid at maturity, BUT using the MARKET
INTEREST RATE, not original coupon rate on the bond.(on calculator its just the PV calc.)
c. 2nd calc. the PV of all the coupons of bond over its lifetime. (ANNUITY formula : on calculator it is : each
coupon is “PMT” and you are looking for PV, BUT USE THE MARKET INTEREST RATE as the “I”, NOT the
original coupon rate on the bond. You want to know max you would be willing to sacrifice considering
you can get a higher/lower interest rate elsewhere on the market today.)
d. FORMULA :
i. Bond Value = PV of Coupons + PV of Nominal amount.
= PV Annuity Formula + PV formula
5. SEMI-ANNUAL COUPONS : TO CALCULATE : Semi-annual means the coupon is paid twice a year.
a. In SA bonds are paid twice a year, so for all PMT coupon PV calculations, you would need to double the
number of periods you use and half the Annual Coupon quoted on the Bond. So if coupon is R 50 per
year, and it runs for another 8 years till maturity, then the ANNUITY calculation to get the PV (or even
FV) of all coupon payments is R25 for 16 periods (at the MARKET, not coupon, interest rate of course)
b. EFFECTIVE ANNUAL YIELD: it is just the effective interest rate , worked out from annual interest rate,
because you would be able to invest your 6 monthly payment for the last 6 mnths of the year and earn
interest while you wait for the final yearly payment. Si it is the EFF of APR , so use effective interest
rate formula , on calculator it is the EFF function.
6. CLEAN PRICE / ALL IN PRICE:
a. CLEAN PRICE: the price of a bond excluding accrued interest
b. ALL-IN PRICE: the price of a bond inclusive of accrued interest
i. TO CALCULATE :
1. You just work out the Days Interest Earned Already/ TOTAL DAYS, then * by the coupon
to get the amount to add to the total Clean Price. So you add this to the Price of the bond
because this money is already owed on the bond to whoever will be the owner. NOTE : if
you use the calculator or annuity formula, you just include current year as if it were at
the beginning of this year. THEN MINUS the PV of 1 coupon payment * cannot
understand- you will be getting the clean price anyway if you buy the bond, why add any
amount to it for the last 3 mnoths the bond already earned interest.? You are getting it
anyway! ?
c. Ex-INTEREST : when bond is traded after the “Register closes 10 days before the Coupon
payment date to allow the bond issuer to determine to whom to pay the interest” the bond
is traded at the Clean Price because the seller will get the coupon, not the buyer . cause his name was
as the owner when the register closed.
d. Cum-INTEREST: : when bond is traded at any time other than when the “register is closed” , you
must work out what the interest is that has been accrued for the Pro-Rata portion of the year so far,
and include that in your valuation.(add THE PV of that to what the PV of all the rest of your valuation is)
7. . CALCULATING THE YIELD TO MATURITY: if you do not know the % yield to maturity it can be very
difficult to use the manual formula to calc. the % YTM , because the formula has 2 r’s(stands for interest
“R”ate) in different places, and it is difficult to isolate them, as per the textbook.So when using the manual
method with the formula- ie BondPrice= Annuity. But on the calculator it is easy, you just solve for I(interest)
on the calculator, PV as the price, PMT as the coupon, and N as number of periods. Easy.WATCH OUT IF YOU
PUT FV as NEGATIVE to since you also have a PV. Here PV must be negative because you paid it out, and FV is
positive because you are getting in, or ELSE YOUR ANSWER FOR “interest rate” WILL BE WRONG- don’t ask me
why but by trial and error that is what happens here. – it gives some other value for i somehow 2% out or so.
INTERST RATE RISK:

1. RULES:
2. Al other things being equl, the longer time to maturity, the greater the interest rate risk
a. This means, over a long period, if interest rates change a lot, up or down, the VALUE of your bond could
drop, or go up, much more than for a short term bond. This is because of the formula one uses to work
the whole thing out. – long term means more years of low interest payments & low interest earned.
3. All other things being equal, the lower the coupon rate, the greater the risk.
a. Here, it is about the same as for the other one, except one is making the nominal payout at maturity
more dominant than the coupon. , because the long period of nominal at some different interest rate, if
it changes, will make the TOTAL VALUATION of the bond far less. This is because the cash flows from
the coupon at early stages of life are larger, which lessens the effect of the long term rule above.
4. Because of the very marked mathematical time effect on risk- most people only want to buy bonds for short
period only – it is far more secure for your investment. If the interst rate changes today by a few%, long
period bonds will have maybe a 45% change in their value, while short period bonds will have maybe a 28%
change in their value- on that same day- maybe in a few weeks time from buying it!!! Low coupon rate bonds
should have an effect similar to this effect.
5. Interest rate risk, like most things in finance & economics, increases at a decreasing rate. 1 yr VS 10 yr
is far more of a risk difference than 20yr VS 30yr.
GENERAL NOTES ON BONDS
DIFFERENCE BETWEEN DEBT & EQUITY

1. DEBT does not get voting power –as owners of firm
2. Interest payments are FULLY tax deductable , dividend payments are NOT
3. Unpaid debt is a liability, unpaid dividends are NOT. It can lead to insolvency with consequences of
LIQUIDATION (or RESTRUCTURING/ like a takeover or debt for equity swaps etc.) because debtors have a legal
claim over the assets of a firm.
CLSSIFYING IT AS DEBT OR EQUITY?

1. EG perpetual bonds with a condition interest only has to be paid if there is profits , becomes an issue of TAX
and LAW courts to decide- a legal and semantic issue- because it is not clear if it is debt or equity. Same with
redeemabae pref. shares- issue. This is since companies want the tax benefits of debt with the insolvency
benefits of equity.
2. General rule is: Equity interests are a residual claim, and represent ownership interests,debt is a direct claim
on assets.
3. Time:
4. LONG TERM DEBT- >1/3/5/10
5. MEDIUM / INTERMEDIATE: 1-3/5/10
6. SHORT : <1YR
HOW BONDS WORK

THE TRUST DEED
1. A WRITTEN AGREEMENT BETWEEN company and lenders detailing terms of the debt issue.
2. Contains : terms,amounts,security, repayment, call provisions, protective covenants.
3. TRUSTEES are appointed to ensure issuer adheres to conditions of trust deed, they also represent the
bondholders in default.
4. For SA bond exchange, an offering circular takes place of trust deed detailing the listing requirements of the
bond exchange.
TERMS OF A BOND
1. THEY are issued in values of eg 1000, par value is initial accounting value of the bond, usually same as
nominal value.
2. TYPES:
a. “REGISTERED FORM”: THE owners are registered with the company, payment is made to them
b. “BEARER FORM”: no registration, the holder can claim the interest etc. he detaches the coupon slip
and sends it to company for claim interest payment.(bad for lost /stolen/notify of company events)
3. SECURITY:
a. REFERS TO THE COLLATERAL FOR THE DEBT.
b. DEBENTURES: usually unsecured bond ,maturity of 10yrs +, same claim over assets as creditors over
otherwise unsecured property.
c. NOTES : maturity of 10 yrs or less
d. COMMERCIAL PAPER : unsecured debt maturity under 5 yrs.
4. SENIORITY:
a. INDICATES PREFERENCE in position to other lenders, senior is more first claim, junior is less than first
claim +/- eg subordinated debenture – certain other lenders have first choice over assets.
b. REPAYMENT: some bonds may be repaid partly before maturity, or at maturity , or bought back by
borrower etc.
c. SINKING FUND : account managed by trustee for bond repayment. Company makes annual paments
to trustee who uses it to repay potion of debt. OR ret.earn. can be transferred to CRRF to build up funds
to repay debt.
d. CALL PROVISION: allows company to repurchase all or part of the bond issue at stated prices over a
specific period. Normally higher than stated value/par value of bond. . USUALLY BECIOMES SMALLER
OVER TIME.
i. CALL PREMIUM : difference between stated value/par value and call price
ii.DEFERRED CALL: usually call is only allowed after first 10 yrs or so .Said to be “call protected”
during this time.
iii.Make whole type – type where call is = current value of bond-
5. PROTECTIVE COVENANT :
a. That Part of the trust deed or loan covenant limiting certain actions that can be taken during term of
loan.
b. Two types:
i. NEGATIVE COVENANATS: thou shalt not : eg:
1. May not pledge assets to other lenders
2. Limit dividends paid to some formula
3. Cannot issue long term debt/merge/ etc
ii.POSITIVE COVENATS: thou shalt : eg
1. Maintain working capital at above certain level, maintain collateral good condition,
furnish audited statements. Etc
FISHER EFFECT:
1+R/1+h = 1+r where h= inflation, R= nominal , r = real returns.


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Contents

1 MACN 302 :CORPORATE FINANCE Own Notes

2 MACN 302 :CORPORATE FINANCE Own Notes

3 MACN 302 :CORPORATE FINANCE Own Notes

4 MACN 302 :CORPORATE FINANCE Own Notes

5 MACN 302 :CORPORATE FINANCE Own Notes

6 MACN 302 :CORPORATE FINANCE Own Notes

7 MACN 302 :CORPORATE FINANCE Own Notes

8 MACN 302 :CORPORATE FINANCE Own Notes

9 MACN 302 :CORPORATE FINANCE Own Notes

EVALUATING A PROPOSED CREDIT POLICY : how to calc NPV of SWITCHING POLICIES.

The EOQ=economic order qty formula :

PV –FV annuities etc formulas :

1) Future Value FORMULA for ORDINARY/DEFERRED/REGULAR ANNUITY. : FVa = I x [ (1+i)n –

2) Future Value FORMULA for ANNUITY DUE : FVa= I x [ {(1+i)n – 1 }/ i] (1+i)

10 MACN 302 :CORPORATE FINANCE Own Notes

4) Present Value FORMULA for ANNUITY DUE : PVa= I x [ ({1 – 1/ (1+i)n } / i) + 1 ] (

LOAN: PERIODIC PAYMENT OF A LOAN

Other extra formulas

a) STATIC DIVIDENDS FORMULA(no growth )

12 MACN 302 :CORPORATE FINANCE Own Notes

2) Debt : Present value of debt:

MARKET VALUE OF A COMPANY:

1) The Market Value of a Company : there are 2 formuals :Formula 1: V0 = MVe +

MARKET VALUE OF CONVERTIBLE DEBENTURES OR PREFERENCE SHARES.

13 MACN 302 :CORPORATE FINANCE Own Notes

CAPEX= capital expenditure ( eg buying PPE like land or machines)

the production point of indifference, :

analysis of the companies cost structure:

14 MACN 302 :CORPORATE FINANCE Own Notes

DIRECT AND INDIRECT COSTS

Categories of manufacturing costs. – with direct/indirect costs.

i) In manufacturing organisations traditional product costs accumulated as follows – ( developed esp.

TOTAL MANUFATURING COST :

Period and Product Costs.

RELEVANT AND IRRELEVANT COSTS:

RELEVANT COSTS AND REVENUES :

IRRELEVANT COSTS AND REVENUES:

AVOIDABLE OR UNAVOIDABLE COSTS:

-INCREMENTAL /OR DIFFERENTIAL- AND MARGINAL COSTS

INCREMENTAL or DIFFERENTIAL COSTS :

JOB COSTING AND PROCESS COSTING SYSTEMS:

JOB COSTING SYSTEMS:

PROCESS COSTING SYSTEMS:

ABSORPTION COSTING AND VARIABLE COSTING:AND STANDARD COSTING.

17 MACN 302 :CORPORATE FINANCE Own Notes

FOR ABSORBTION COSTING THRE ARE 2 WAYS OF VALUING STOCK:1-BUDGET AND 2-

18 MACN 302 :CORPORATE FINANCE Own Notes

Fully Integrated Absorbtion costing System ( or “full” absorb. costing system)

Variable Costing (or Marginal or Direct Costing)

19 MACN 302 :CORPORATE FINANCE Own Notes

MAINTAINING A COST DATABASE:

FIXED AND VARIABLE PRODUCTION OVERHEADS : AND COST BEHAVIOUR OF

UNITS vs VARIABLE COSTS GRAPH

PROFIT vs VARIABLE COSTS GRAPH.

20 MACN 302 :CORPORATE FINANCE Own Notes

UNITS vs FIXED COSTS GRAPH

PROFIT vs FIXED COSTS GRAPH

21 MACN 302 :CORPORATE FINANCE Own Notes

SEMI-VARIABLE (or MIXED COSTS) :

HIGH-LOW COST ANALYSIS:

“Standard Hours Produced”:

“Standard PROFIT STATEMENT”: