Unit 2

MBA/BBA/B.com /UGC Net

By
Dr. Anand Vyas
 Concept of Opportunity Cost,
• Opportunity costs represent the benefits an individual, investor or
business misses out on when choosing one alternative over
another. While financial reports do not show opportunity cost,
business owners can use it to make educated decisions when they
have multiple options before them.
• The term “opportunity cost” comes up often in finance and
economics when trying to choose one investment, either financial
or capital, over another. It serves as a measure of an economic
choice as compared to the next best one. For example, there is an
opportunity cost of choosing to finance a company with debt over
issuing stock.
 Cost of Debenture,
If a company needs funds for extension and
development purpose without increasing its share
capital, it can borrow from the general public by
issuing certificates for a fixed period of time and at
a fixed rate of interest. Such a loan certificate is
called a debenture. Debentures are offered to the
public for subscription in the same way as for issue
of equity shares. Debenture is issued under the
common seal of the company acknowledging the
receipt of money.
 Preference and Equity capital,
• The Preference Capital is that portion of capital which is
raised through the issue of the preference shares. This is
the hybrid form of financing that has certain characteristics
of equity and certain attributes of debentures.
• Invested money that, in contrast to debt capital, is not
repaid to the investors in the normal course of business. It
represents the risk capital staked by the owners through
purchase of a company’s common stock (ordinary shares).
 Composite Cost of Capital,
• Composite cost of capital is a company’s cost to finance
its business, determined by, and also referred to as
“weighted average cost of capital” or WACC. The
calculation involves multiplying the cost of each capital
component by its proportional weight and taking the
sum of the results. A company’s debt and equity, or its
capital structure, typically includes common stock,
preferred stock, bonds and any other long-term debt. A
high composite cost of capital, indicates that a
company has high borrowing costs; a low composite
cost of capital implies lower borrowing costs.
 Cash Flows as Profit
• Cash flow is the money that flows in and out of the firm
from operations and financing and investing activities. It’s
the money you need to meet current and near-term
obligations. But there are two things to keep in mind about
cash flow:
• Profit, also called net income, is what remains from sales
revenue after all the firm’s expenses are subtracted. It’s
obvious in principle that a business cannot long survive
unless it is profitable, but sometimes, as with cash flow, the
very success of a product can raise expenses
 Components of Cash Flows,
• (i) Cash Flow from Operating Activities

• The net amount of cash coming in or leaving from the day to day business operations of an entity is called Cash Flow from
Operations. Basically it is the operating income plus non-cash items such as depreciation added. Since accounting profits are
reduced by non-cash items (i.e. depreciation and amortization) they must be added back to accounting profits to calculate
cash flow.

• Cash flow from operations is an important measurement because it tells the analyst about the viability of an entities current
business plan and operations. In the long run, cash flow from operations must be cash inflows in order for an entity to be
solvent and provide for the normal outflows from investing and finance activities.

• (ii) Cash Flow from Investing Activities

• Cash flow from investing activities would include the outflow of cash for long term assets such as land, buildings, equipment,
etc., and the inflows from the sale of assets, businesses, securities, etc. Most cash flow investing activities are cash out flows
because most entities make long term investments for operations and future growth.

• (iii) Cash Flow from Finance Activities

• Cash flow from finance activities is the cash out flow to the entities investors (i.e. interest to bondholders) and shareholders
(i.e. dividends and stock buybacks) and cash inflows from sales of bonds or issuance of stock equity. Most cash flow finance
activities are cash outflows since most entities only issue bonds and stocks occasionally.
Capital Budgeting Decisions,
Calculation of NPV and IRR, Excel
Application in Analyzing Projects.