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com 1

TIME VALUE OF MONEY
Future Value Present Value

Tomorrows Value of Todays Money is
called Future Value.

Todays Value of Tomorrows Money is called
Present Value.
1. Basic Formula

A =PI(1+i)
n


A =Future Value
PV =Present value
i =Rate of Interest
n=No. of Years

PI =A_
1
(1+i)
n
_
A =Future Value
PV =Present Value
i =Rate of Interest
n=No. of Years
2. For Annuity
FIA =
A(1+i)
n
1
i


FVA =Future Value of Annuity
A =Annuity
i =Rate of Interest
n=No. of Years

PIA =A
_1
1
(1+i)
n
_
i

PVA =Present Value of Annuity
A =Annuity
i =Rate of Interest
n=No. of Years
3. For continuous
Compounding

A =P _1+
i

_
n ]


A =Future Value
P =Present Value
i =Rate of Interest
n=No. of Years
f =Frequency of compounding

PI =A

1
_1+
i

]
n ]

A =Future Value
P =Present Value
i =Rate of Interest
n=No. of Years
f =Frequency of compounding
4. For Growing
Annuity


PI =A(1+g) _
1
(1+g)
n
(1+i)
n
i g
_
A =Future Value
P =Present Value
i =Rate of Interest
n =No. of Years
g =Growth Rate
5. For Perpetuity

PI =
P
i


P =Perpetuity ; i =Rate of Interest
6. For Growing
Perpetuity


PI =
P(1+g)
i g

P =Perpetuity
i =Rate of Interest
g =Growth Rate

7. Effective Rate of Interest in case of Continuous Compounding:
Eccti:c Rotc o Intcrcst = _1+
i

_
]
1


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8. Rule 72: For finding out the doubling period
oubling pcrioJ =
72
i


9. Rule 69: For finding out the doubling period
oubling PcrioJ = 0.35+
69
i




COST OF CAPITAL


Specific Cost of Capital Overall Cost of Capital (WACC)

A. Specific Cost of Capital
a. Cost of Debt (K
d
)
Irredeemable Debt Redeemable Debt

K
d
=
I(1+I)
SI



K
d
=
I(1+I) +( +J +P

) N
(SI +RI) 2



I = Amount of Interest; T = Tax Rate; f =Floatation cost; d = Discount on issue of debentures;
P
r
= Premium on Redemption of Debentures; P
i
= Premium on Issue of Debentures; N =Maturity
Period; SV = Share/Debenture value; RV = Redemption Value


b. Cost of Preference Capital (K
p
)
Irredeemable Preference Capital Redeemable Preference Capital

K
p
=

SI
100


K
p
=
+( +J +P

) N
(SI +RI) 2


I = Amount of Interest; T = Tax Rate; f =Floatation cost; d = Discount on issue of debentures;
P
r
= Premium on Redemption of Debentures; P
i
= Premium on Issue of Debentures; N =Maturity
Period; SV = Share/Debenture value; RV = Redemption Value

c. Cost of Equity Capital (K
e
)
i. Dividend Capitalization Approach
K
c
=

1
P
0
100
ii. Earnings Capitalization Approach
K
c
=
E
P
0
100
iii. Bond Yield plus Risk Premium Method
K
c
=BonJ iclJ + Risk Prcmium

iv. Dividend Growth Model
K
c
=

1
P
o
+ g
v. Capital Asset Pricing Model (CAPM)
K
c
= R
]
+[(R
m
R
]
)

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d. Cost of Retained Earnings (K
r
)
Cost of Retained earnings is same as that of Cost of equity.
K

=K
c


B. Overall cost of capital / Weighted Average Cost of Capital (WACC) (K
o
)
K
0
=K
d
w
d
+K
p
w
p
+K
c
w
c


LEVERAGES

Leverages: Action of a lever, and the mechanical advantage gained by it

Leverage Formula Meaning
1. Operating Leverage

0I =
Contribution
EBII


OR

0I =
% congc in EBII
% congc in solcs



It defines the firms ability to use
fixed operating expenses, to magnify
the effects of changes in sales on its
EBIT.
2. Financial Leverage

FI =
EBII
EBI
0R
EBII
EBII I


OR

FI =
% Congc in EPS
% Congc in EBII



It defines the firms ability to use
fixed financial charges to magnify the
effects of changes in EBIT on the
EPS
3. Combined Leverage

DCL =DOL DFL
OR
0I =
Contribution
EBII

EBII
EBI

OR
CI =
Contribution
EBI


It defines the firms ability to use the

Marginal Cost Sheet
Particulars Amount (Rs.)
Sales
Less: Variable Cost
CONTRIBUTION
Less: Fixed Costs
Earnings Before Interest and Tax (EBIT or Operating
Profit)
Less: Interest
Earnings Before Tax (EBT)
Less: Tax
Earnings After Tax (EAT)
Less: Preference Dividends
Earnings Available to Equity Share Holders (EAESH)

()

()

()

()

()

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1. Inventory Control: Inventory control is a systematic control and regulation of purchase, storage and
usage of materials. It is done to maintain an even flow of production and at the same time avoid
excessive investment in inventories.
1. The main Objectives of inventory control are:
1. To provide continuous flow of required materials, parts and components for efficient and
uninterrupted flow of production.
2. To minimise investment in inventories keeping in view operating requirements.
3. To provide for efficient store of materials so that inventories are protected from loss by fire
and theft.
4. To minimise the handling time and cost.
5. To keep surplus and obsolete items to minimum.
2. Techniques of inventory control:
1. MIN-MAX PLAN: This is one of the oldest methods of inventory control. In this method, the
minimum and maximum level of each stock item is fixed keeping in view its usage and
requirement. When the stock reaches minimum level, order is placed for that quantity of
material which will bring the material to maximum level.
2. THE TWO-BIN SYSTEM: Under this method, for each item of stock, two bins are maintained.
First bin stocks the quantity of inventory which is sufficient to meet the requirement between
receipt of an order and placing another. The second bin contains the safety stock sufficient to
meet the requirement between placing an order and delivery date. As soon as the first bin is
empty, the second bin is tapped and an order is placed for purchase of material.
3. ORDER CYCLING SYSTEM: Under this method, stocks are reviewed periodically say once in
30days or 60 days or 90 days. In the course of review, if it is found that the stock item is not
sufficient to meet the requirement upto next periodic review, the material is ordered and
purchased. The review period will vary from firm to firm and also among different items of the
same firm. Critical items of stock usually require a short review cycle.
4. THE ABC ANALYSIS: It is based on Paretos law and also known as the 80:20 principles.
Materials are classified into A, B and C on the basis of their consumption value. In the following
indicator we can see that by controlling A & B category items which involve 60%of Quantity,
the company will be able to control 90%of consumption value.
Category
%of Consumption
Value
%of Consumption
Quantity
A 65 25
B 25 35
C 10 40
The steps involved in doing ABC analysis.
a. Compute consumption quantity and consumption value of each item of stock.
b. Arrange the materials in descending order of consumption value.
c. Compute cumulative value and cumulative quantity at the end of each item of stock.
d. Compute at the end of each item:
Cumulative value as a %of total value
Cumulative quantity as a %of total value.
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e. Split the items into A,B and C on the basis of predetermined rule such as 60:30:10

5. FIXATION OF VARIOUS LEVELS: Certain stock levels are fixed for every item of stores so that
stocks and purchases can be efficiently controlled.

Inventory Level Meaning Formula
Re-Order Level
[RoL]
Level at which fresh order for stock
should be placed.
Max. Consumption X Max. Re-order Period.
OR
Min. Level +Consumption during the Re-
order period.
Re-Order Quantity
[RoQ]
Quantity that is to be ordered at
Re-Order Level. It is also called
Economic Order Quantity.(EOQ)
(2AS)/C
Where :
A =Annual consumption/demand in units
S =Ordering cost per order
C =Carrying cost per unit per annum
Maximum Level It represents the quantity above
which stocks should not be held at
any time
RoL +RoQ [Min. Consumption X Min. Re-
Order Period]

Minimum Level It represents the minimum quantity
of stock that should be held at all
times.
RoL [Normal Consumption X Normal Re-
Order Period]

Average Level It is the Stock level that is normally
maintained. It is the simple average
of Min. Level and Max. Level.
[Min. Level +Max. Level] 2
OR
Min. Level + RoQ
Danger Level
OR
Safety stock level
Normal issues of stock are usually
stopped at this level and made only
under specific instructions.
Emergency action for purchase is to
be taken
RoL [Average consumption X Re-Order
Period]
OR
[Max. Consumption Average consumption]
X Emergency Re-Order period

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6. USE OF PERPETUAL INVENTORY SYSTEM AND CONTINUOUS VERIFICATIONS: The perpetual
inventory system records changes in materials, work-in-progress on a daily basis. Hence
managerial control and preparation of interim financial statements is easier. Perpetual
inventory derives its name because it indicated the amount of stock in hand at all times. It
facilitates verification of stocks at any time and helps to authenticate the correctness of stock
records. The two functions of perpetual inventory are:
a) It records the quantity and value of stock in hand.
b) There is continuous verification of physical stock.
Perpetual inventory method has the following advantages:
1. Helps preparation of Balance Sheet and Profit & Loss account easily.
2. Information regarding material on hand eliminates delays and stoppage in production.
3. The investment in stock can be reduced to the minimum, keeping in view the
operational requirements.
4. Production need not be stopped when stock-taking is carried out.
5. Stock figures are available for insurance purpose.
6. Reveals the existence of surplus, dormant, obsolete and slow moving materials, if any.
Hence remedial action can be taken.
7. These records give the cost of materials, thereby management can exercise control
over cost.
8. This method has a moral effect on the staff, makes them disciplined and careful and
acts as a check against dishonest actions.
9. Loss through deterioration and obsolescence can be avoided.
10. Loss of interest on capital invested in stock can be avoided.

Perpetual inventory system is comprised of:
1. BIN CARD: A bin card is the quantitative record of receipts, issues and closing balances of
items of stores. Each item is accompanied by a separate bin card. The bin card is posted as
and when a transaction takes place. The issue or receipt is made only after it is recorded in
the bin card.
2. STORES LEDGER: The stores ledger is maintained to record all receipt and issue
transactions in respect of materials. Here both quantity and values are entered in the
receipts, issues and balance columns. Additional information regarding quantity on order
and quantity reserved may be recorded. Separate sheets for each item of stock may be
maintained. Sheets should be serially numbered to avoid the risk of removal or loss.
3. CONTINUOUS STOCK-TAKING: The stores accounts reveal what the balances should be and
a physical verification reveals the actual stock position. The causes for such differences may
be many. Few of them are
Incorrect measurement; Carelessness; Improper storage; Pilferage, theft etc.,
Stores misplaced; Error in stock-taking.



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Difference between Bin Cards and Stores Ledger
BIN CARDS STORES LEDGER
1. It is a quantity record.
2. It is kept inside the stores.
3. It is maintained by stores keeper.

4. The postings are done before the
transactions takes place.
5. Each transaction is individually posted.
1. It is a record of quantity and value.
2. It is kept outside the stores.
3. It is maintained by the accounts
department.
4. The postings are done after the
transaction takes place.
5. Transactions may be posted periodically
and in total.
7. Use of Control Ratios:

Ratio Need Formula
Inventory
Turnover Ratio
[ITOR]
It helps the management to avoid capital
being blocked up in unnecessarily. It reveals
the efficiency of stock keeping.
Cost of materials consumed Cost of
average stock held during the period.

Cost of Average Stock =[Cost of opening
stock +Cost of Closing Stock] 2
Input-output
Ratio
It is the ratio of the quantity of input of
materials to production. It enables
comparison of actual consumption and
standard consumption. Thus indicating usage
of materials is favourable or adverse.

For reviewing
slow and non-
moving items.
The money locked in inventory is money lost
in business. If the more money is locked up,
lesser is the amount available for working
capital and the cost of carrying inventory also
increases.
Slow moving stores Total Inventory.

Economic Order Quantity: The optimum ordering quantity at which the cost of holding plus the cost of
purchasing are minimum is known as EOQ. At this ordering quantity, the total cost is represented by i)
Ordering cost; ii) Carrying cost, and iii) Material cost.
Ordering cost means the cost of placing an order and receiving the quantity ordered. It is the production
departments cost.
Carrying cost means the cost of carrying or holding inventory. It includes interest on money borrowed for
buying materials, storage cost, deterioration, pilferage, inefficient use of materials etc.,
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Assumptions of EOQ:
a. Annual demand is known with certainty.
b. Ordering cost per order, Carrying cost per order and material cost per unit are constant.
c. Uniform consumption of materials.
d. The next consignment of materials reaches exactly in the day when the previous consignment on
materials is exhausted.
Formulae:
a. EOQ =(2AS)/C Where: A =Annual consumption/demand in units; S=Ordering cost per
order; C =Carrying cost per unit per annum
b. Number of Orders =Annual demand EOQ
c. Time gap between two orders =365 Number of orders.

2. Control of Material Issues: Material issues are controlled to ensure that
1. Every issue is authorised
2. Every issue is correctly accounted for.
3. Every issue is properly priced
4. It is properly charged to costs.
5. It is reconciled with the financial books.

3. Pricing of Material Issues: When materials are issued to production department, a difficulty arises
regarding the price at which materials issued are to be charged. The reason being same type of
materials may have been purchased in different lots at different times at different prices.
Methods of pricing issues:

I. Cost Price Method. II. Average Price Method. III. Notional Price Method.
1. Specific Price.
2. First-in-First-out [FIFO]
3. Last-in-First-out [LIFO]
4. Highest-in-First-out [HIFO]
5. Base Stock.
1. Simple average.
2. Weighted average.
3. Periodic average.
4. Periodic weighted average.
5. Moving Simple average.
6. Moving weighted average.
1. Standard Price.
a. Current Standard.
b. Basic Standard.
2. Inflated Price.
3. Market Price.
a. Replacement Price.
b. Realisable Price.

1. Specific Price Method: Some times when materials are purchased to be utilised in a particular job
or issues can be identified with a particular receipt. In such cases, the actual purchase price can be
charged. This method can be adopted when prices are stable or when the materials are covered by
price control orders.
2. First-in-First-out: This method is based on the assumption that materials which are purchased first
are issued first. It uses the price of the first batch of materials purchased for all issues until all units
form this batch have been issued. After the first batch is fully issued, the price of the next batch
received becomes the issue price. In other words, the materials are issued at the oldest cost price
listed in the stores ledger account.
Advantages:
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a. It is a good inventory management system since the oldest unit are used first and inventory
consists of the latest stock
b. It is logical
c. It is easy to understand and operate.
d. It facilitates inter-firm and intra-firm comparison.
e. Valuation of inventory and cost of finished goods is consistent and realistic.
Disadvantages:
a. The cost of production is not linked to the current prices.
b. It does not present the true picture when many lots are purchased at different prices.
c. This method involves more calculations and increases the possibility of errors.
d. The pricing of material returns is difficult.
e. Cost comparison between two batches of production becomes difficult when issues are
priced differently.
3. Last-in-First-out: The principle adopted is that the materials use in production is from the latest
purchase. The inventory is priced at the oldest costs. As the method applies the current cost of
materials to the cost of units, it is also known as the replacement cost method. It is the most
significant method in matching cost with revenue in the process of revenue determination.
Advantages:
a. It is simple and useful when transactions are few.
b. It is a good method of avoiding tax.
c. It is a systematic method. This is because it matches current cost with current revenues in a
better way.
d. It reveals real income in times of raising prices.
Disadvantages:
a. When the rates of material receipts are highly fluctuating, the method becomes
complicated.
b. More than one price may have to be adopted for an issue.
c. Costs of different batches vary greatly, making inter-firm and intra-firm comparison
difficult.
d. The stock requires to be adjusted during falling prices.
e. The company can time the purchases to cause high or low costs thus changing reported
income at will.
4. Highest-in-First-out (HIFO) method: The principle adopted is that costliest material is issued first.
Inventory is valued at the lowest possible price. The method requires detailed records. It is mainly
used monopoly products or cost plus contracts. When stocks are undervalued, a secret reserve is
created.
5. Base Stock method: A certain minimum stock of a material is always carried and is priced at the
original cost (usually at the lowest purchase price). The portion of stock above this level is issued
and priced under any one of the methods.
6. Simple Average Method: The simple average is the average of prices ignoring the quantities
involved. It can be used when the prices are normally stable and the stock purchased are in equal
quantities or when the stock value is small. A new average is worked out after every receipt.
7. Weighted Average Method: in this method, the total quantities and total costs are taken into
account while calculating the average price. It is calculated after every purchase by adding the
quantity received to the stock in hand and the cost of this purchase to the cost of stock in hand.
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Total cost is divided by total quantity to arrive at the value. This method avoids price fluctuations
and reduces the number of calculations and gives an acceptable figure.
8. Periodic Simple Average Method: In this method, the materials are priced y taking average of the
prices of all receipts during a period, say a month, a week etc., for the subsequent period. Only
those prices relevant to the period is taken into account.
9. Periodic Weighted Average Method: The average price is calculated periodically and not every
time the material is received. It is calculated by dividing the total value of materials purchased
during a period by the total quantity purchased.
10. Moving Simple Average Method: In this method, periodic simple average prices are further
averaged, by dividing periodic average prices by the number of periods taken. The period chosen
should cover the period in which the material is issued. Under this method the closing stock may
over valued or undervalued. When prices are rising, the issue price worked out is lower than the
periodic average prices for the period concerned and vice-versa.
11. Moving Weighted Average Method: The material issue price is calculated by dividing the total of
the periodic weighted average prices for a number of periods by the total number of such periods.
12. Standard Price Method: The price of issued for each item is pre-determined for a stated period,
taking into account all the factors affecting the price. Eg. Market trends, transportation costs, etc.,
Standard prices are determined for each material. All the issues and receipts of inventory are kept
at the standard price. These should be revised form period to period.
13. Inflated Price Method: Here the price of the material included carrying costs, losses due to
evaporation etc. It aims to recover full costs of materials purchased
14. Market Price Method: Material may be issued at the replacement price. The replacement price is
the cost of the same type of materials in the market at any given time.