Investment Selection Methods: Static vs. Dynamic Criteria
Static Criteria
Static criteria do not account for the time value of money. They treat cash flows as having the same value, even when received at different times. This is unrealistic because it ignores inflation and interest rates. Consequently, static criteria can lead to flawed investment decisions.
Examples of static criteria include:
- Payback period
- Total net cash flow
- Net annual cash flow
Payback Period
The payback period represents the time required to recover the initial investment outlay from the
Read MoreArbitrage, Stock Options, and Ethical Considerations in Finance
Arbitrage and Forward Exchange Rates
Suppose, as of September 16, it was possible to buy 1 Euro for 1.1341 US Dollars, one year USD LIBOR was 0.82615% (simple interest), and one year EURIBOR was 0.128% (also simple interest).
No-Arbitrage Dollar-Euro Exchange Rate
a. What is the no-arbitrage Dollar-Euro exchange rate, one year forward?
If you buy one Euro for 1.1341 US Dollars and invest it at 0.128% for one year, you get 1.00128 Euro. Alternatively, if you invest the 1.1341 US dollars for one year
Read MoreEssential Corporate Finance Formulas and Ratios
Chapter 2: Key Financial Formulas
- Asset Equation:
Assets = Liabilities + Shareholder Equity - Market Capitalization (Market Value of Equity):
Market Price per Share * Number of Shares Outstanding - Net Working Capital (NWC):
Current Assets - Current Liabilities - Net Working Capital to Total Assets Ratio:
NWC / Total Assets - Debt-to-Equity Ratio:
Total Debt / Total Equity - Enterprise Value (EV):
Market Value of Equity + Debt - Cash - Current Ratio:
Current Assets / Current Liabilities - Quick Ratio (Acid-Test Ratio)
Practical Accounting Calculation Examples
Closing Stock Undervaluation Calculation
Calculate the correct value of closing stock when it is undervalued by 10%, and the current book value is Rs. 45,000.
Formula:
Revised Value = Book Value × 100 / (100 – % of Undervaluation)
Calculation:
= 45,000 × 100 / (100 – 10)
= 45,000 × 100 / 90
= Rs. 50,000
Answer: The correct value of the closing stock is Rs. 50,000.
Machinery Depreciation Calculation
Machinery worth Rs. 80,000 was purchased on 01-07-2022. Calculate the depreciation at 4% p.a. for the financial
Read MoreShort-Term Financing and Financial Ratio Analysis
Short-Term Financing Options
- Line of Credit: Offers a maximum loan balance the firm can access for a specific period. Involves interest payments and a commitment fee.
- Commercial Paper: Short-term, unsecured debt issued by large corporations, often a cheaper funding source than short-term bank loans.
- Sale of Short-Term Financial Investments: Financial assets acquired to temporarily invest excess cash flows. Generally very liquid, flexible in amount and maturity, and risk-free.
- Invoice Discounting: The
Derivatives and Hedging: Mock Exam Questions
Mock Exam (Theory)
Hedging and Risk Management
Hedging is used to:
- (a) Reduce risk.
- (b) Speculation.
- (c) Increase exposure to price movements.
Futures vs. Forwards
What is the difference between Futures and Forwards?
- (a) Futures are traded on an organized exchange, and forwards are traded OTC (Over-the-Counter).
- (b) Forwards are traded on an organized exchange, and futures are traded OTC.
- (c) Forwards have daily settlement, and futures settlement at the end of the period.
Bear Spread Payoff
A bear spread:
- (a)