First Four Days of our Sessions - July 1 to 4

We are taking up Chapters 4, 5, 6 and 8 of the Text Book

Some elements of Chapter 7 are also being covered

Accounting - Bal Sheet, P&L, Cash Flow, Bank, Cash, Journal - reasonably expert already
Finance is different
Accounting
Recording of the past
Some events happened, mehtaji who records them
Like keeping scores of a cricket match
Generally, facts are known (history happened)
Score 73 for 7 - this is generally accepted
Finance

Actually playing - batting, bowling, etc

Not scorekeeping
Taking business decisions - should I buy a house or rent one
Belgium - family tax rates are higher than individual rates - if you are single you
Marriages dont happen
Way back in 1600s, in Holland tax was based on the size of your windows
Bigger window, higher tax
Even today, windows are tiny
African tribes - marriage is very expensive, they cant afford that
Money plays a big role in every decision

Decision is based on future expectations

If I set up a factory, what kind of revenue will my product generate
Who knows - only God - he is not answering the phone
All uncertain, future, subjective, opinionated, nobody knows
Past may be an indicator - Indian population has been growing since Mahabhara
It may grow

Finance is so diff from Accounting that even if you are uncomfortable about Acc

Little more mathematical, more common sense

Rickshaw - what does the marwari do

Cost of the rickshaw, life, petrol cost, CNG cost, how many hours, kms, revenue, operatin
and make them ply in Jaipur, what return on investment
Great Lakes - fee, cost, prfit, investment, RoI
Projector - hiring, hire revenue, cost, depreciation,
Sas Bahu - cost of production, episode, selling films, studio - buy that studio, hire
Does your mind function that way
You can start today - very easy
Meru, Ola, Uber
Entrepreneur, industrialists - money money money
Whatever technical stuff you find is cosmetic - there is nothing technical - some jargon Success - money - know it
Dont accept something that you are not convinced about
Our areas were developed around 1915, 1920 - they are quite well settled - very ancient
Roaring 20s
Example, you work, responses, discuss, conclude

TIME VALUE OF MONEY

Time is Money
If you give Sanjit Rs 100 today and Sanjit returns Rs 100 after 6 years, that is not fair
Why
a
6% Inflation
b
9% Interest
c
23% Opportunity Cost - I could have bought a buffalo and that buffalo w

have sold all that milk and become a millionaire

10% Risk - Sanjit ?
3% What is the incentive to lend ? If not some form of income
10% I can earn interest on interest on int on int too
61%

d
e
f

All these factors above - are they different factors, are they the same, are they overlapp
a and c and b
Suppose I deposit these funds with a bank, then only b (others are irrelevant)
Inflation should be considered
Primarily, we have two forms of getting funding or providing funding
a
Debt
b
Equity
Debt
HDFC Bank is offering you 9% interest
Why are they offering 9% and not 19% or not 129%
They lend onward at 12%, 13% - so they cant afford 19% or 129%
Other bankers are offering even lower rates, be happy with 9%
RBI lends to them, that is their benchmark ? Thats not right
The fundamental driver of bank fixed deposit rate is inflation
Inflation is India is 5/6%, hence bank fixed deposit is 7 to 9%
Inflation in Nigeria is 35%, hence bank fixed deposit there is 42%
Inflation in Zimbabwe is 3500%, hence bank fixed deposit there is 4200%
Inflation in Venezuela is 1200%, bank deposit rate is 1400%
Inflation in Germany is 0%, bank deposit rate is 0.25%
BMW can borrow from Deutsche at 1.50%
HDFC Bank is offering 9% - this is called as nominal interest
Inflation is say 6%
Real interest rate is then understood to be 3%
100
109

1.00
1.03

100 Tomato Kgs

106

Inflation is an intrinsic part of interest

Having considered interest, dont once again include inflation - double counting
Interest
a
b
c

function
Inflation
Real interest rate for the Govt (if Govt wants to borrow)
Spread over Sovereign (Risk)

Interest includes inflation, risk

Equity
You are becoming a partner, owner, you seek high returns, you are okay with high risk (en
a
Inflation
b
Real interest rate for the Govt (if Govt wants to borrow)
c
Equity Risk

Credit rating - higher rated companies will get funds cheaper than the others
AAA 1%
S&P - US
AA 1.50%
India - CRISIL, CARE, ICRA, Fitch
A 2%
In finance, we are more micro guys - me, mine, mera - world Argentina, okay
Problem with CASA is lack of stability
I am a bank
You have kept Rs 50 lakhs with me in Savings
Can I lend this onward
Tom you come and withdraw it
I will not compensate you even for inflation, you will earn negative real interest, bcoz of
Current Account - zero percent
Wise people will not keep huge savings balances (negative return)

Example
You place Rs 5 lakhs with HDFC Bank who pay you 9% for a 4 year tenor
How much will you get on maturity
Year

Op Bal
Interest Cl Bal
1
5.00
0.45
2
5.45
0.49
3
5.94
0.53
4
6.48
0.58

5.45
5.94
6.48
7.06

9%

This is called compounding

When someone says 9%, he means two things:
a
9% is per annum
b
9% is compounded annually
r=
1+r=
Year

9%
109%

9% percentage format is the same as

9% means 9/100, that means 0.09

Balance
0
5.00
1
5.45
2
5.94
3
6.48
4
7.06

(1+r)^n

5.00

The next year balance will be 109% of the previous year bal
We are multiplying by (1+r)

109%

7.06

In the world of business, we generally hesitate to use math formulae

People dont understand
When senior people dont understand, you are finished
Example
HDFC Bank
ICICI Bank
Indus Ind
DCB

9.00% Annual
8.95% Half Year
8.90% Quarter
8.87% Month

7.06
7.09
7.11
7.12

7.10
7.10
7.40

9.15
8.77
9.23

Ratnakar

8.85% Day

HDFC Bank
ICICI Bank
Indus Ind
DCB
Ratnakar

7.12

9.00% Annual
8.95% Half Year
8.90% Quarter
8.87% Month
8.85% Day

9.25

Per/Year r / period (1+r)

1 9.000% 109.000%
2 4.475% 104.475%
4 2.225% 102.225%
12 0.739% 100.739%
365 0.024% 100.024%

8.85% compounded every day is equal to how much on annual compounding basis - 9.252%
CAGR =
[(Last Number / First Number) ^ (1/n)] - 1
Where n stands for number of years (not periods)
7.123

5.00
1.42469405

4
1.092523

1
0.092523
9.252%

LPY had 5,000 buffaloes in the year 1986

These grew to 15,000 buffaloes by the year 1997
What is his CAGR
10.50%
9.50%

15000

10.50%
110.50%

5000
3

11
1.105032

1
0.105032
10.50%

5000

15000

Discounting
In 9 years, I will need Rs 50 lakhs to buy a house
How much should I invest into an FD now
The FD rate of return is 10%
21.2
r=
1+r=
n=
(1+r)^n

10%
110%
9 years
235.79%

Maturity
Present
Compounding
Discounting

The 'future value' of Rs 21.20 lakhs (9 years, 10%

The 'present value' of Rs 50.00 lakhs (9 years, 10

50.00
21.20 Here we are dividing by (1+r)
Move from today to the future
Move back from the future to today

Multiply by (1+r)
Divide by (1+r)

Example
You need Rs 5 lakhs every year from year 3 to year 11 (end of each year)
How much should invest now (assume 10% rate of return)
32.47
23.79
14.01
18.60
33.80
19.90
Year

Earlier examples - single inflow, single outflow

This one - single outflow, multiple inflows
Present Value Factor
What is the present value of one rupee that we receive after x years
10%
110%

Nominal PV Factor
Cash Flow
1.000
1.000
1
1.000
0.909 If I give you 0.909 today and you return back one rupee afte
2
1.000
0.826

3
4
5
6
7
8
9
10
11
12
13
14
Year

1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000

0.751
0.683
0.621
0.564
0.513
0.467
0.424
0.386
0.350
0.319
0.290
0.263 If I give you 0.263 today and you return back one rupee afte

Nominal PV Factor Discounted

CashFlow
CashFlow
0
1.000
1
0.909
2
0.826
3
5.00
0.751
3.76
4
5.00
0.683
3.42
5
5.00
0.621
3.10
6
5.00
0.564
2.82
7
5.00
0.513
2.57
8
5.00
0.467
2.33
9
5.00
0.424
2.12
10
5.00
0.386
1.93
11
5.00
0.350
1.75
45.00
23.80 If I invest Rs 23.80 today and I get Rs 5 lakhs ev
I would have earned 10%

I paid Rs 10 lakhs for my Engg educatino

My father paid Rs 10,000 for his Engg education
So two people got educated for Rs 10.10 lakhs
Proof
Year

Opening Interest Repayment Closing

Bal
1
2
3
4
5
6
7
8
9
10
11

Balance
23.80
26.18
28.80
26.67
24.34
21.78
18.95
15.85
12.43
8.68
4.55

2.380
2.618
2.880
2.667
2.434
2.178
1.895
1.585
1.243
0.868
0.455

5.00
5.00
5.00
5.00
5.00
5.00
5.00
5.00
5.00 -

26.18
28.80
26.67
24.34
21.78
18.95
15.85
12.43
8.68
4.55
0.00

Compounding, discounting a
of determing interest

asonably expert already

tes - if you are single you pay 25%, if you marry 35%

e of your windows

fford that

uct generate

growing since Mahabharata, so next year also it will grow

uncomfortable about Accounting, it does not matter

s, kms, revenue, operating costs, if I buy 500 rickshaws

that studio, hire

echnical - some jargon - jargon you need to strip it

ll settled - very ancient in our knowledge

ears, that is not fair

uffalo and that buffalo would have given you milk and you could

form of income

same, are they overlapping

(others are irrelevant)

double counting
HDFC Bk XXX
6.00%
1.50%

7.50%
1.50%
9.00%

SmugglingHindi Mov
7.50%
6.00%
13.50%

7.50%
20.00%
27.50%

7.50%
36.00%
43.50%

e okay with high risk (entire investment may be wiped off)

6.00%
1.50%
20.00%
27.50% Shareholders Expectation

an the others

entina, okay

ve real interest, bcoz of your lack of loyalty

550 films, 5 hits, 545 dont

he same as
means 0.09

0.09 in comma format

of the previous year balance

9.2

4
n (periods(1+r)^n Maturity
EffAnnR
4 141.16%
7.058
9.000%
8 141.94%
7.097
9.150%
16 142.20%
7.110
9.201%
48 142.40%
7.120
9.240%
1,460 142.47%
7.123
9.252%

mpounding basis - 9.252%

100.0000
4.4750
104.4750
4.6753
109.1503
9.1503

21.20 lakhs (9 years, 10% rate) is Rs 50 lakhs

Rs 50.00 lakhs (9 years, 10% rate) is Rs 21.20 lakhs

ltiply by (1+r)
ide by (1+r)

From Present Value to Future Value

From Future Value to Present Value

we receive after x years

eturn back one rupee after 1 year, I have earned 10%

eturn back one rupee after 14 years, I have earned 10%

Bad total, should not be totalled

Differing points in time

ay and I get Rs 5 lakhs every year from Year 3 to Year 11,

mpounding, discounting are sophisticated formats

determing interest

50 films, 5 hits, 545 dont know

Future Value = Present Value x (1+r)^n

Present Value = Future Value / (1+r)^n

Compounding
Discounting

Example
You lent Rs 25 lakhs to your friend and he will repay you Rs 5 lakhs per annum starting Ye
for the next 7 years
What is your yield in this transaction
Yield means rate of return, it is a %

Know - PV, FV, n

We are solving for 'r'

40%
25.80%
4.92%
5.71%
9%
Year

r is complicated, it gets ra

r is iterative
You try and try and try and
Op Bal

1
2
3
4
5
6
7

25.00
22.30
19.35
16.13
12.61
8.77
4.58

Interest

2.30
2.05
1.78
1.48
1.16
0.81
0.42

Repay

Cl Bal

5.00
5.00
5.00
5.00
5.00
5.00
5.00

22.30
19.35
16.13
12.61
8.77
4.58
0.00

As we keep solving for 'r' in many situations, Bill Gates again thought about it and said let
a ready function for this purpose
In Finance, we have something called Internal Rate of Return (IRR), which is also provided
IRR requires positive and negative cash flows in one column
Usually, positive means inflows and negative means outflows (reverse is also fine)
Year

CashFlow
025.00

9.196% IRR uses the same Goal Se

1
2
3
4
5
6
7

5.00
5.00
5.00
5.00
5.00
5.00
5.00

background, but your life

IRR tells you what are you really earnin

People will make fools out of us, IRR wi

Between the IRR and the Goal Seek, the

and correct (at the nth decimal place)
Goal Seek is an approximation
The zero that you see in the above tabl
zero - it is probably 0.000000000001

IRR can easily handle multiple inflows, multiple ouflows, inflows then outflows then again
Life insurance, leasing, home finance - all these industries - their backbone is IRR
The haves know IRR, the have nots dont

Examples
Endowment policy - you pay a premium and you get back x amount on maturity or interim

Premium
Tenor
Maturity

60,072 Rs per annum

11 years
1,500,000

What is his yield on this policy

Year

CashFlow
060,072
160,072
260,072
360,072
460,072

IRR =

5.516%

560,072
660,072
760,072
860,072
960,072
10 60,072
11
12
13
14
15
16
17
18
19
20 1,500,000
Home Loans
How is the EMI determined, given the loan amount, tenor, interest rate - thro IRR
Loan Amount
2,600,000
Tenor
15 years
EMI
27,218
What is the interest rate on this loan
Month

CashFlows Interest
Princ Rep
Princ Bal
Int/EMI
0 - 2,600,000
2,600,000
1
27,218
20,677
6,541
2,593,459
76%
2
27,218
20,625
6,593
2,586,867
76%
3
27,218
20,573
6,645
2,580,222
76%
4
27,218
20,520
6,698
2,573,524
75%
5
27,218
20,467
6,751
2,566,773
75%
6
27,218
20,413
6,805
2,559,968
75%
7
27,218
20,359
6,859
2,553,109
75%
8
27,218
20,304
6,914
2,546,195
75%
9
27,218
20,250
6,968
2,539,227
74%
10
27,218
20,194
7,024
2,532,203
74%

11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

20,138
20,082
20,025
19,968
19,910
19,852
19,794
19,735
19,675
19,615
19,555
19,494
19,432
19,370
19,308
19,245
19,182
19,118
19,053
18,988
18,923
18,857
18,790
18,723
18,656
18,588
18,519
18,450
18,380
18,310
18,239
18,168
18,096
18,023
17,950
17,876

7,080
7,136
7,193
7,250
7,308
7,366
7,424
7,483
7,543
7,603
7,663
7,724
7,786
7,848
7,910
7,973
8,036
8,100
8,165
8,230
8,295
8,361
8,428
8,495
8,562
8,630
8,699
8,768
8,838
8,908
8,979
9,050
9,122
9,195
9,268
9,342

2,525,123
2,517,987
2,510,794
2,503,544
2,496,237
2,488,871
2,481,446
2,473,963
2,466,420
2,458,817
2,451,154
2,443,429
2,435,644
2,427,796
2,419,886
2,411,913
2,403,876
2,395,776
2,387,611
2,379,381
2,371,086
2,362,725
2,354,298
2,345,803
2,337,241
2,328,611
2,319,912
2,311,144
2,302,306
2,293,398
2,284,419
2,275,368
2,266,246
2,257,051
2,247,783
2,238,441

74%
74%
74%
73%
73%
73%
73%
73%
72%
72%
72%
72%
71%
71%
71%
71%
70%
70%
70%
70%
70%
69%
69%
69%
69%
68%
68%
68%
68%
67%
67%
67%
66%
66%
66%
66%

47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

17,802
17,727
17,652
17,576
17,499
17,422
17,344
17,265
17,186
17,106
17,026
16,945
16,863
16,781
16,698
16,614
16,530
16,445
16,359
16,273
16,186
16,098
16,009
15,920
15,830
15,740
15,649
15,557
15,464
15,370
15,276
15,181
15,085
14,989
14,892
14,794

9,416
9,491
9,566
9,642
9,719
9,796
9,874
9,953
10,032
10,112
10,192
10,273
10,355
10,437
10,520
10,604
10,688
10,773
10,859
10,945
11,032
11,120
11,209
11,298
11,388
11,478
11,569
11,661
11,754
11,848
11,942
12,037
12,133
12,229
12,326
12,424

2,229,025
2,219,534
2,209,968
2,200,326
2,190,606
2,180,810
2,170,936
2,160,983
2,150,951
2,140,839
2,130,647
2,120,373
2,110,018
2,099,581
2,089,061
2,078,457
2,067,768
2,056,995
2,046,136
2,035,190
2,024,158
2,013,038
2,001,829
1,990,531
1,979,144
1,967,666
1,956,096
1,944,435
1,932,681
1,920,833
1,908,891
1,896,854
1,884,722
1,872,492
1,860,166
1,847,742

65%
65%
65%
65%
64%
64%
64%
63%
63%
63%
63%
62%
62%
62%
61%
61%
61%
60%
60%
60%
59%
59%
59%
58%
58%
58%
57%
57%
57%
56%
56%
56%
55%
55%
55%
54%

83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

14,695
14,595
14,495
14,394
14,292
14,189
14,085
13,981
13,876
13,769
13,662
13,555
13,446
13,336
13,226
13,115
13,003
12,890
12,776
12,661
12,545
12,428
12,311
12,192
12,073
11,952
11,831
11,708
11,585
11,461
11,335
11,209
11,082
10,953
10,824
10,694

12,523
12,623
12,723
12,824
12,926
13,029
13,133
13,237
13,342
13,449
13,556
13,663
13,772
13,882
13,992
14,103
14,215
14,328
14,442
14,557
14,673
14,790
14,907
15,026
15,145
15,266
15,387
15,510
15,633
15,757
15,883
16,009
16,136
16,265
16,394
16,524

1,835,218
1,822,596
1,809,873
1,797,048
1,784,122
1,771,093
1,757,960
1,744,723
1,731,380
1,717,932
1,704,376
1,690,713
1,676,941
1,663,059
1,649,067
1,634,964
1,620,749
1,606,420
1,591,978
1,577,421
1,562,748
1,547,958
1,533,050
1,518,025
1,502,879
1,487,613
1,472,226
1,456,717
1,441,084
1,425,326
1,409,444
1,393,435
1,377,299
1,361,034
1,344,640
1,328,116

54%
54%
53%
53%
53%
52%
52%
51%
51%
51%
50%
50%
49%
49%
49%
48%
48%
47%
47%
47%
46%
46%
45%
45%
44%
44%
43%
43%
43%
42%
42%
41%
41%
40%
40%
39%

119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
148
149
150
151
152
153
154

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

10,562
10,430
10,296
10,162
10,026
9,889
9,752
9,613
9,473
9,332
9,189
9,046
8,901
8,756
8,609
8,461
8,312
8,161
8,010
7,857
7,703
7,548
7,391
7,234
7,075
6,915
6,753
6,590
6,426
6,261
6,094
5,926
5,757
5,586
5,414
5,241

16,656
16,788
16,922
17,056
17,192
17,329
17,466
17,605
17,745
17,886
18,029
18,172
18,317
18,462
18,609
18,757
18,906
19,057
19,208
19,361
19,515
19,670
19,827
19,984
20,143
20,303
20,465
20,628
20,792
20,957
21,124
21,292
21,461
21,632
21,804
21,977

1,311,460
1,294,672
1,277,750
1,260,694
1,243,502
1,226,174
1,208,707
1,191,102
1,173,356
1,155,470
1,137,441
1,119,269
1,100,953
1,082,490
1,063,881
1,045,124
1,026,218
1,007,161
987,953
968,592
949,077
929,407
909,580
889,596
869,453
849,149
828,685
808,057
787,265
766,308
745,185
723,893
702,432
680,800
658,997
637,020

39%
38%
38%
37%
37%
36%
36%
35%
35%
34%
34%
33%
33%
32%
32%
31%
31%
30%
29%
29%
28%
28%
27%
27%
26%
25%
25%
24%
24%
23%
22%
22%
21%
21%
20%
19%

155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
171
172
173
174
175
176
177
178
179
180

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

5,066
4,890
4,712
4,533
4,353
4,171
3,988
3,803
3,617
3,429
3,240
3,049
2,857
2,663
2,468
2,271
2,073
1,873
1,671
1,468
1,263
1,057
849
639
428
215

22,152
22,328
22,506
22,685
22,865
23,047
23,230
23,415
23,601
23,789
23,978
24,169
24,361
24,555
24,750
24,947
25,145
25,345
25,547
25,750
25,955
26,161
26,369
26,579
26,790
27,003 -

614,868
592,540
570,034
547,349
524,484
501,438
478,207
454,793
431,191
407,403
383,425
359,256
334,895
310,340
285,591
260,644
235,499
210,154
184,607
158,857
132,902
106,741
80,372
53,793
27,003
0

19%
18%
17%
17%
16%
15%
15%
14%
13%
13%
12%
11%
10%
10%
9%
8%
8%
7%
6%
5%
5%
4%
3%
2%
2%
1%

Excel default formulae are based on relative reference concept

What does relative reference mean
5
2

3
7

15 This formula looks like A284 x B284

35 But that is not the truth, that is only appearance
The formula is (one cell to my left) x (second cell to m
Most of the time, relative reference is fine

But sometimes, I want to freeze one cell reference

How do you freeze
You dollarize

HOME LOAN NUANCES

After 24 months, the rate of interest rises to 0.825% per month
You can either change the EMI or you can change the tenor
If you choose to change the EMI, what is the new EMI
If you choose to change the tenor, what is the new tenor
INTRODUCTION TO BONDS
A bond is a loan availed by a corporate
Difference between a simple loan and a bond is that the bond is an instrument
Instrument can be traded in the market
If Airtel has availed of a loan from SBI of Rs 500 cr, Airtel will repay SBI - loan
If Airtel has issued bonds of Rs 500 cr, which you and me have subscribed on day one

Samrendra subscribed to Rs 1 cr of bonds

His wife dont do all thi
He could sell off these bonds in the market
After 7 years, when the redemption date comes up, may be these bonds have b
Who gets the redemption proceeds - that fellow 787th fellow
Each guy made a gain or a loss
Face value was Rs 100 and Airtel repays 100
Bonds create a market, a livelihood for thousands of people, they create sophistication
Valuation of bonds, sensitivity to bonds to interest rate
Lots of computers are needed
Software guys employment
Virus
Maintenance
Jammer

Time, Money, dont know what to do - buy bonds - 100, 101 - why should it move to 101 -

Company can trade in its own bonds - yes, it can - but it needs to have tons of cash
The very fact that they issued bonds - means those tons are elsewhere - not with them
Various terms - that are part of the bond issuance
1 Face value of the bond
2 Issue price - leading to premium / discount
3 Redemption value - leading to premium / discount
4 Coupon
5 Frequency of the Coupon
6 Tenor
7 Convertibility
Other terms that come from bond market
1 Price
101.25
2 Current yield
Coupon / Price
3 Yield to Maturity
4 Duration - we will leave it for later
5 Convexity - we wil leave it for later

Frozen

Frozen

100 x 11% = 11
11 / 101.25 = 10.86%
Higher the price, lower th

Yield to Maturity YTM

If I buy this bond at Rs 101.25, what am I going to receive
I will receive 11, 11, 11, 11 and at the end I will receive Rs 100
What is the IRR on these cash flows
This YTM also captures the loss of Rs 1.25 that you will suffer finally
YTM is more accurate, current yield is misleading

You buy a house for Rs 1 cr

The rental income on the house is 3%, that is Rs 3 lakhs - so your yield is also 3% - life is s

The price of the house goes up to Rs 1.20 cr after 2 years, but rentals have not gone up (R
If someone bought the house today, what is his yield
3
120
2.50%

Control F - House
Replace With - Bond

PV, FV, n, r

hs per annum starting Year 1

now - PV, FV, n

We are solving for 'r'

is complicated, it gets raised to some power of n

is iterative
ou try and try and try and refine your past trials
r=

9.197%

Goal Seek

ught about it and said let me provide

R), which is also provided in Excel

verse is also fine)

RR uses the same Goal Seek logic at the

ackground, but your life is easier

hat are you really earning

ke fools out of us, IRR will help

R and the Goal Seek, the IRR is more accurate

the nth decimal place)
approximation
ou see in the above table is not really a perfect
bably 0.000000000001

then outflows then again inflows

r backbone is IRR

nt on maturity or interim or both

Home work
48,988
20
2,000,000

st rate - thro IRR

0.795% Monthly IRR

0.825%
- 2,427,796
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725

20,029
19,966
19,902
19,837
19,772
19,707
19,640
19,574
19,507
19,439
19,370
19,301
19,232
19,162
19,091
19,020
18,948
18,876
18,803
18,729
18,655
18,580

7,695
7,759
7,823
7,887
7,952
8,018
8,084
8,151
8,218
8,286
8,354
8,423
8,493
8,563
8,633
8,704
8,776
8,849
8,922
8,995
9,070
9,144

2,427,796
2,420,101
2,412,342
2,404,519
2,396,632
2,388,680
2,380,662
2,372,578
2,364,427
2,356,209
2,347,923
2,339,569
2,331,146
2,322,653
2,314,091
2,305,458
2,296,753
2,287,977
2,279,128
2,270,206
2,261,211
2,252,141
2,242,997

27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725

18,505
18,429
18,352
18,275
18,197
18,118
18,039
17,959
17,878
17,797
17,715
17,633
17,549
17,465
17,381
17,295
17,209
17,123
17,035
16,947
16,858
16,768
16,678
16,587
16,495
16,402
16,309
16,215
16,120
16,024
15,928
15,830
15,732
15,633
15,533
15,433

9,220
9,296
9,373
9,450
9,528
9,606
9,686
9,766
9,846
9,927
10,009
10,092
10,175
10,259
10,344
10,429
10,515
10,602
10,689
10,777
10,866
10,956
11,046
11,138
11,229
11,322
11,416
11,510
11,605
11,700
11,797
11,894
11,992
12,091
12,191
12,292

2,233,777
2,224,481
2,215,109
2,205,659
2,196,131
2,186,525
2,176,839
2,167,073
2,157,227
2,147,300
2,137,291
2,127,199
2,117,024
2,106,765
2,096,421
2,085,992
2,075,477
2,064,875
2,054,186
2,043,408
2,032,542
2,021,586
2,010,539
1,999,402
1,988,172
1,976,850
1,965,435
1,953,925
1,942,320
1,930,620
1,918,823
1,906,929
1,894,936
1,882,845
1,870,654
1,858,362

27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725

15,331
15,229
15,126
15,022
14,917
14,812
14,705
14,598
14,490
14,380
14,270
14,159
14,047
13,935
13,821
13,706
13,590
13,474
13,356
13,238
13,118
12,998
12,876
12,754
12,630
12,506
12,380
12,253
12,126
11,997
11,867
11,737
11,605
11,472
11,338
11,202

12,393
12,495
12,598
12,702
12,807
12,913
13,019
13,127
13,235
13,344
13,454
13,565
13,677
13,790
13,904
14,018
14,134
14,251
14,368
14,487
14,606
14,727
14,848
14,971
15,094
15,219
15,344
15,471
15,599
15,727
15,857
15,988
16,120
16,253
16,387
16,522

1,845,969
1,833,474
1,820,876
1,808,174
1,795,366
1,782,454
1,769,434
1,756,308
1,743,073
1,729,729
1,716,274
1,702,709
1,689,032
1,675,242
1,661,338
1,647,320
1,633,186
1,618,935
1,604,567
1,590,080
1,575,473
1,560,746
1,545,898
1,530,927
1,515,833
1,500,614
1,485,270
1,469,798
1,454,200
1,438,472
1,422,615
1,406,627
1,390,508
1,374,255
1,357,868
1,341,346

27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725

11,066
10,929
10,790
10,650
10,510
10,368
10,224
10,080
9,934
9,788
9,640
9,490
9,340
9,188
9,035
8,881
8,726
8,569
8,411
8,252
8,091
7,929
7,766
7,601
7,435
7,268
7,099
6,929
6,757
6,584
6,410
6,234
6,057
5,878
5,698
5,516

16,658
16,796
16,934
17,074
17,215
17,357
17,500
17,645
17,790
17,937
18,085
18,234
18,385
18,536
18,689
18,843
18,999
19,156
19,314
19,473
19,634
19,796
19,959
20,123
20,289
20,457
20,626
20,796
20,967
21,140
21,315
21,491
21,668
21,847
22,027
22,209

1,324,687
1,307,891
1,290,957
1,273,883
1,256,668
1,239,311
1,221,811
1,204,166
1,186,376
1,168,439
1,150,354
1,132,120
1,113,736
1,095,199
1,076,510
1,057,667
1,038,668
1,019,513
1,000,199
980,726
961,093
941,297
921,338
901,215
880,925
860,468
839,843
819,047
798,080
776,939
755,625
734,134
712,466
690,619
668,592
646,384

is only appearance
y left) x (second cell to my left)

erence is fine

27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725
27,725

5,333
5,148
4,962
4,774
4,585
4,394
4,201
4,007
3,811
3,614
3,415
3,215
3,012
2,809
2,603
2,396
2,187
1,976
1,764
1,550
1,334
1,116
896
675
452
227

22,392
22,577
22,763
22,951
23,140
23,331
23,523
23,717
23,913
24,110
24,309
24,510
24,712
24,916
25,121
25,329
25,538
25,748
25,961
26,175
26,391
26,609
26,828
27,050
27,273
27,498 -

623,992
601,415
578,653
555,702
532,562
509,231
485,708
461,990
438,077
413,967
389,657
365,148
340,436
315,520
290,398
265,069
239,532
213,783
187,823
161,648
135,257
108,648
81,820
54,770
27,498
0

eze one cell reference

an instrument

ay SBI - loan
bscribed on day one

ay be these bonds have been sold 787 times

y create sophistication

y should it move to 101 - interest rates

o have tons of cash

where - not with them
Example

100
100 No premium, no discount
102 Premium 2
100 No premium, no discount
105 Premium 5
11% Interest on face value
1, 2, 4, 12 Annual, Semi-Annual, Quarterly, Monthly
5 years - could be complex - I will redeem 20% every year from year 5 to year
The bond may get converted into shares

00 x 11% = 11
1 / 101.25 = 10.86%
igher the price, lower the yield

-101.25
11
11
11
111
10.6005%

yield is also 3% - life is simple, be happy

ntals have not gone up (Rs 3 lakhs)

0.825%
- 2,427,796
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

20,029
19,970
19,910
19,850
19,789
19,728
19,666
19,604
19,541
19,478
19,414
19,349
19,284
19,219
19,153
19,086
19,019
18,952
18,884
18,815
18,745
18,676

7,189
7,248
7,308
7,368
7,429
7,490
7,552
7,614
7,677
7,740
7,804
7,869
7,934
7,999
8,065
8,132
8,199
8,266
8,334
8,403
8,473
8,542

2,427,796
2,420,607
2,413,359
2,406,051
2,398,683
2,391,254
2,383,764
2,376,212
2,368,598
2,360,921
2,353,181
2,345,376
2,337,508
2,329,574
2,321,575
2,313,510
2,305,379
2,297,180
2,288,914
2,280,579
2,272,176
2,263,703
2,255,161

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

18,605
18,534
18,462
18,390
18,317
18,244
18,170
18,095
18,020
17,944
17,868
17,790
17,713
17,634
17,555
17,475
17,395
17,314
17,232
17,150
17,067
16,983
16,899
16,814
16,728
16,641
16,554
16,466
16,377
16,288
16,198
16,107
16,015
15,923
15,829
15,735

8,613
8,684
8,756
8,828
8,901
8,974
9,048
9,123
9,198
9,274
9,350
9,428
9,505
9,584
9,663
9,743
9,823
9,904
9,986
10,068
10,151
10,235
10,319
10,404
10,490
10,577
10,664
10,752
10,841
10,930
11,020
11,111
11,203
11,295
11,389
11,483

2,246,548
2,237,864
2,229,108
2,220,281
2,211,380
2,202,406
2,193,358
2,184,235
2,175,037
2,165,763
2,156,412
2,146,985
2,137,479
2,127,896
2,118,233
2,108,490
2,098,667
2,088,763
2,078,778
2,068,709
2,058,558
2,048,323
2,038,004
2,027,600
2,017,109
2,006,532
1,995,868
1,985,116
1,974,275
1,963,345
1,952,325
1,941,214
1,930,011
1,918,715
1,907,327
1,895,844

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

15,641
15,545
15,449
15,352
15,254
15,155
15,056
14,955
14,854
14,752
14,649
14,546
14,441
14,336
14,229
14,122
14,014
13,905
13,795
13,685
13,573
13,460
13,347
13,233
13,117
13,001
12,884
12,765
12,646
12,526
12,405
12,282
12,159
12,035
11,910
11,783

11,577
11,673
11,769
11,866
11,964
12,063
12,162
12,263
12,364
12,466
12,569
12,672
12,777
12,882
12,989
13,096
13,204
13,313
13,423
13,533
13,645
13,758
13,871
13,985
14,101
14,217
14,334
14,453
14,572
14,692
14,813
14,936
15,059
15,183
15,308
15,435

1,884,267
1,872,594
1,860,825
1,848,959
1,836,995
1,824,932
1,812,769
1,800,507
1,788,143
1,775,677
1,763,108
1,750,436
1,737,659
1,724,777
1,711,788
1,698,693
1,685,489
1,672,176
1,658,753
1,645,220
1,631,575
1,617,818
1,603,947
1,589,961
1,575,860
1,561,643
1,547,309
1,532,856
1,518,284
1,503,592
1,488,779
1,473,843
1,458,784
1,443,601
1,428,293
1,412,858

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

11,656
11,528
11,398
11,268
11,136
11,003
10,870
10,735
10,599
10,462
10,323
10,184
10,044
9,902
9,759
9,615
9,470
9,323
9,176
9,027
8,877
8,725
8,573
8,419
8,264
8,108
7,950
7,791
7,631
7,469
7,306
7,142
6,976
6,809
6,641
6,471

15,562
15,690
15,820
15,950
16,082
16,215
16,348
16,483
16,619
16,756
16,895
17,034
17,174
17,316
17,459
17,603
17,748
17,895
18,042
18,191
18,341
18,493
18,645
18,799
18,954
19,110
19,268
19,427
19,587
19,749
19,912
20,076
20,242
20,409
20,577
20,747

1,397,297
1,381,606
1,365,787
1,349,836
1,333,754
1,317,540
1,301,192
1,284,708
1,268,089
1,251,333
1,234,438
1,217,405
1,200,230
1,182,914
1,165,455
1,147,852
1,130,104
1,112,209
1,094,167
1,075,976
1,057,635
1,039,142
1,020,497
1,001,698
982,744
963,634
944,366
924,939
905,352
885,603
865,691
845,615
825,373
804,965
784,388
763,641

181
182
183
184
185
186

27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218
27,218

6,300
6,127
5,953
5,778
5,601
5,423
5,243
5,062
4,879
4,695
4,509
4,321
4,133
3,942
3,750
3,556
3,361
3,164
2,966
2,766
2,564
2,361
2,156
1,949
1,740
1,530
1,318
1,105
889
672
453
232

20,918
21,091
21,265
21,440
21,617
21,795
21,975
22,156
22,339
22,523
22,709
22,897
23,085
23,276
23,468
23,662
23,857
24,054
24,252
24,452
24,654
24,857
25,062
25,269
25,478
25,688
25,900
26,113
26,329
26,546
26,765
26,986

742,723
721,632
700,368
678,928
657,311
635,516
613,541
591,384
569,045
546,522
523,813
500,916
477,831
454,555
431,087
407,425
383,569
359,515
335,263
310,811
286,157
261,300
236,238
210,969
185,491
159,803
133,904
107,791
81,462
54,916
28,151
1,165

186, 187, 186.50, 186.14151151 is all fine

97 Discount 3
99 Discount 1

ear from year 5 to year 9

Various terms - that are part of the bond issuance - frozen on the date
1 Face value of the bond
100
2 Issue price - leading to premium / discount
100
3 Redemption value - leading to premium / disc
100
4 Coupon
12%
5 Frequency of the Coupon
1
6 Tenor
7
7 Convertibility
None

Other terms that come from bond market - these change every momen
1 Price - after 2 years of issue
102
2 Current yield
3 Yield to Maturity
On the date of issue, life is all peace and joy
Yield is 12% in the market, you also price the bond at 12% coupon
Issue price = Market value
Later on, the market yields start dancing
But your bond coupons are frozen (Rs 12 per annum)
So the price gets adjusted to reflect current market conditions
If interest rates move downwards, bond prices move up
If interest rates move up, bond prices fall

If you know the Price, you can get the YTM

If you know the YTM, you can get the Price

The price is 102, whats the YTM

If the YTM is say 11%, whats the p

Year

Year

CashFlow
0 -102.00 From
1 12.00 From
2 12.00 From
3 12.00 From
4 12.00 From
5 112.00 From
YTM/IRR 11.45%

the
the
the
the
the
the

market
bond
bond
bond
bond
bond

CashFlow
0 -103.69
1 12.00
2 12.00
3 12.00
4 12.00
5 112.00
YTM/IRR 11.00%

Markets are always forward looking

Past is gone
Yield to Maturity of the Bond is from today to maturity

12.00%
11.45%
11.00%

BOND PRICES ARE INVERSELY CORRELATED WITH INTEREST RATES

If interest rates fall, bond prices will move up and vice versa
Traders in the bond market quote prices on yield basis
If you ask a trader, whats the price - he may say 45
He means 11.45 YTM
11 is understood
11 is the Big Figure
45 46 Quote
If you want to buy from me, the price is 46
If you want to sell to me the price if 45
Bonds require a lifetime, which we dont have

BUSINESS PROJECTS
There are capital expenditure decisions (capital budgeting decisions) where hug
You wait for returns to come in over the long term (over 1 year)
How do you decide whether you should take up the project or not
Criteria
1 Payback Period
2 IRR
3 MIRR
4 NPV
5 Discounted Payback Period
6 Profitability Index
You decide to set up a McDonalds in your locality
The space deposit, furnishing will cost you say Rs 2 cr

Popular ones - Payback, I

You will earn Rs 25 lakhs in the first year, Rs 10 lakhs additional every year for 7
End of the 8th year, you will migrate to New Zealand and you will sell off the fur
Is this is a good idea
The nominal cash flow should come from domain experts, not finance experts
Finance people dont know the domain
12.50%
Year

Nominal CumuCF PV Fact DCF

CumuDCF
CashFlow
Domain
Finance Finance Finance
0
-200
-200 1.000 200 200
1
25
-175 0.889
22 178
2
35
-140 0.790
28 150
3
45
-95 0.702
32 119
4
55
-40 0.624
34 84
5
65
25 0.555
36 48
6
75
0.493
37 11
7
85
0.438
37
26 6 years and a few month
8
145
0.390
57
NPV
83

Payback Period
How long does it take for me to get back my investment
4 years and a few months
A very powerful driver of decisions
Long payback implies what ? Higher Risk

We dont know the future

But our understanding of short run future is better than our understanding of lon

I dont know how the world will change and how the need for my product wil cha
Tinplate industry - Ponds Talcum Powder - tins - plastic - usage of tin has reduce
Small and medium sector is afraid of paybacks beyond 3 years

Larger companies can afford risk - large, several businesses - some will fail som
L&T - an 8 year payback may be fine - if the potential is interesting - defence
Govts - they are okay with 25 year payback
Single reason why India got independence - Indian Railways
Coimbatore Jaipur - natoinalist slogans

Average travel radius - 20 miles in his whole life

British - commerical calculations - trade - 25 year payback - went ahead - cheap
L&T - may run large projects with 8 year payback
They will have hundreds of small projects - there the payback will be 2/3 years
IRR
20.81% What is your reaction on this
Pretty good
SBI FD
9%

Problem with the IRR - conceptual

The IRR assumes that you will be able to reinvest all your interim cash flows at t
Rather difficult assumption
The IRR is then not real, paper IRR, you may never realize this IRR
MIRR - Modified IRR
a
Finance rate (borrow)
b
Reinvest

17%
3%
13.98% This may be more practical

MIRR is a complex function - if you are keen, you go thro the Help in Excel and if
MIRR has 1,000 problems and limitations - I think you take it as an act of kindne
rather than the mechanics
MIRR is not very popular in the world
A high IRR cannot be trusted (something above 18%)
NPV
Net here means Net of Inflows and Outflows
NPV requires an external input - your cost of f 12.50%

IRR does not require any external input - it only uses project data - Internal Rate

Why 12.50%, why not 23.50% which is my lucky number

We will discuss this not even tomm, but next time
Even if somebody gifted you Rs 200 lakhs, there is still some cost to it - cost is n
Our NPV is positive, what does that mean
Sum (Inflows) > Sum (Outflows) (after discounting)
We are doing good, project looks interesting
We are beating the 12.50% hurdle rate
If this project were in Tanzania, where cost of funds is 45%, what would happen
NPV becomes negative
12.50% Positive
45% Negative
20.81% Zero

83
-107
Which point is this

The NPV becomes zero when you discount at the IRR rate
The IRR is that rate which makes the NPV zero
Which is the driver and which is the driven
The NPV also has mathematical assumptions
It assumes that all shortages are funded at the discounting rate (12.50%)
All surpluses are reinvested at the discountig rate (12.50%)
We believe this is quite practical
Finance guys are happy with the NPV
The non finance guys think they understand the IRR
NPV is superior to IRR, but most of the time, there is no fight anyway
It does not happen that IRR says go West and NPV says go East
Discounted Payback
Critics told us that the simple payback does not consider interest
Why should it not do so
Is it not wrong

We said fine, we will keep you also happy

Profitability Index
You have competing projects and you cant do both bcoz you dont have enough

Project Cost
IRR
NPV

McDonaldDominos
500
800
18%
19%
150
175

Which one would you choose

You need to conserve every naya paise that you have
You should find out the NPV per rupee of project cost
NPV / Project Cost

0.30
0.22
Rank I
Rank II

You have 3 exams this week and you need 500 minutes to study
But you have only 125 minutes
Where should you focus your efforts
Marks per minute of study
What is your constraint now
Minutes
The Goal by Ely Goldratt
Theory of Constraints

- frozen on the date of issue of the bond

12

change every moment

% coupon

s 102, whats the YTM

is say 11%, whats the price

ashFlow
Using Goal Seek

100.00
102.00
103.69

NTEREST RATES

ng decisions) where huge amounts are invested

ect or not

opular ones - Payback, IRR, NPV

ditional every year for 7 more years

d you will sell off the furniture for Rs 50 lakhs

s, not finance experts

112.50%

4 years and a few months

years and a few months

our understanding of long run future

d for my product wil change in the long run

usage of tin has reduced substantially

ses - some will fail some will succeed

nteresting - defence

ck - went ahead - cheap labour

back will be 2/3 years

r interim cash flows at the IRR rate

e this IRR

e more practical

the Help in Excel and if you understand, teach me tomm

ke it as an act of kindness by Bill Gates and appreciate the spirit

ject data - Internal Rate of Return

ome cost to it - cost is not zero - expectation theory

%, what would happen

ng rate (12.50%)

fight anyway

interest

you dont have enough funding

to study

10.33%

Finance, Financial Markets, Bonds, Equity, etc, etc

Most of this you should learn yourself
EcoTimes daily - at least 20 to 40 minutes - you will understand 2% in the beginning
In six months, you will understand 92%
8% you will never understand bcoz the writer also did not understand
Google, wikipedia
CNBC, ET NOW - awareness - takes 6 months to 1 year
Chaos

Invest a little bit - Rs 10,000, Rs 20,000 - think that this is gone - mentally you write it of
Mind becomes 10,000% more aware - when money gets in the way
My company, I am an owner - Me, Mine, Mera - huge diff in thought
Rs 100,000 cr on Jio ?
Suddenly you are a telecom expert, 4G, 7G
2 am - you are reading 7G - Payback, IRR, NPV ??
Books on Investing
1 Buffetology
2 One Up on Wall Street
3 Beating the Street
4 The Big Short - how a few people made money in that crisis
Wealth creation - this will help you immensely
QUIZZES
15 minutes each, objective questions, largely based on this Excel file
1st Quiz - first two days
2nd Quiz - second two days
MCQ, Fill in the blanks
Not ask you to calculate IRR

Practice from the text book

Cases

he beginning

ally you write it off - education

Cases 4
1 Lyons Document
2 Investment Analysis
3 Diamond Chemicals
4 Ocean Carriers

Bonds
NPV, IRR, Capital Budgeting
NPV, IRR, Capital Budgeting
NPV, IRR, Capital Budgeting

Text Book
We will call one Group to present (at random)
We will call one Group to critique
The entire class will then add their expert comments

Evaluate class presentations with a 40% weightage and Group submissions with
12 marks
Submission
Class Presentation

60%
40%

4.00
2.40
1.60

4.00
2.40
1.60

4.00
2.40
1.60

Two levels above what we are discussing in the class

HOW TO GET THE NOMINAL CASH FLOW
Yday we said you will earn Rs xxxx in 1st year, 2nd year
What does earnings mean
EBIDTA
EBIT
PBT
PAT
Assets
Reserves
Something else, then what something else
How is cash flow different from profit
Can you earn great profits and have no cash

We need CASH FLOW

Cash flow is not very easy to
P&L
Bal Sheet
Cash Flow

Can you generate huge losses and sit on tons of cash

Accountants have complicated life by introducing concept of accrual
Before accrual was discovered by humanity, only cash system worked
In those days, cash flow was the same as P&L
Cash coming in - brings happiness
Cash going out - brings sadness
Basic instinctive understanding

Mark Twain or Bernard Shaw - I did not allow my schooling to interfere with my e
I did not allow my cash to interfere with my profits
Cash is reality
Profit is theory

Cash is Take Home

Profit is CTC

Accounting is obsessed with profit, P&L

Owners of businesses know that cash is important, not profit
In the world of finance, for decision making, we focus on cash flow
Our IRR, NPV, payback all spring from cash flow
How to get cash flows - systematic step by step approach
This cash flow is slightly different from the one that you learnt (the classic one)

Let me assume that I will sell the business of at the end of the 8th year for say R

Cash Flow Statement for the purpose

Year
0
1
Sales Units
10,000
Selling Price
100
Sales Revenue
###
Operating Costs
57% 570,000
EBIDTA
430,000
Less : Depn Amortz
250,000
EBIT
180,000

of capex
2
10,800
106
###
652,536
492,264
250,000
242,264

evaluation
3
11,664
112
###
747,023
563,544
250,000
313,544

Tax on EBIT
30%
54,000
72,679
94,063
EBIT - Tax on EBIT
126,000 169,585 219,481
Add back : Depn
250,000 250,000 250,000
Less : Capex
###
Incr Working Capit - 300,000 - 43,440 - 49,730 - 56,931
FCFF
### 332,560 369,855 412,550
IRR
13.26%
Working Capital
300,000 343,440 393,170
30% of the next year's revenue

450,101

Working Capital means what

Current Assets minus Current Liabilities
Inventories, Receivables, Short Term Advances, Loans - Current Assets
Current Liab - Vendor Payables, Expense Payables, Short term Loans, Advances
Working Capital is a hungry gorilla - it keeps asking for money all the time

You want to increase volumes - you need to push cash into more inventories, mo

Sales
Sales
Opex
EBIDTA
Depn Am
EBIT
Interest
PBT
Tax
PAT
Gross Profit
Operating Profit

900

Business guys - Domain peo

Divisions, Branches, Zones,
Business is responsible to ge
EBIDTA

300

Finance guys (who dont kno

Corporate Office
PAT

35

These are slightly vague terms

These are slightly vague terms

FCFF - FREE CASH FLOW TO THE FIRM

What do we mean by 'free'

The meaning of Gross Profit

that in Unilever

Free' cash means the cash that you can comfortably withdraw without affecting
What do you mean by 'the firm'
Firm means 'business' in entirely and is comprised of
a
Owners who provide equity funding
b
Lenders who provide debt funding

FCFF means the cash flow that we generated before paying a single paise to the
Therefore, we ignore interest, we ignore loans taken, we ignore loans repaid
For the purposes of this discussion, lenders are also US not THEM

When we ignore interest, it is almost as if the lenders are also our partners (or c
Suppose I did not pay any interest to anyone, then my EBIT = PBT
The my tax on PBT is the same as tax on EBIT

This is unreal, in reality, there would be interest, there would be a diff between P
be the tax above
If the firm were funded 100% by equity, what would have happened
Interest would be zero
EBIT = PBT
Live with this for 10 minutes

TREATMENT OF DEPRECIATION
Depreciation is a non cash item
It has no impact on cash flow
The income tax dept allows you depn as an expense
So when you claim depn, your profits are lower and you pay lower taxes
Tax is not a non cash item (we have been praying for many years to make it non
Depn has an impact on tax
WORKING CAPITAL
You have a small shop selling coconuts
IN the morning, you buy 100 coconuts - these are your inventories
100
15
1,500 Working capital on day one
Slowly the volumes increase, you start selling 250 coconuts per day, which you

After 1 month
250
15
Day 1
Day 31
Incremen

1,500
3,750
2,250

3,750

I want to know cash flow for the month

Profit from coconuts
Incremental Work Cap
FCFF

On day one, you received a loan of Rs 1,500 from your friend

That has not been returned as yet

Every day you buy coconuts for Rs 1,500 and come to your shop
You sell them for Rs 1,600 and keep Rs 100 in a drawer at home
Second day - you take that Rs 1,500 and buy second day's coconuts which will g
Over 30 days, these Rs 100 rupees have grown to Rs 3,000
You paid some expenses of Rs 1,200 (rent, electricity, bribes)
Your net profit was Rs 1,800

On the first day of the next month, you see a big business opporutnity where yo
Next door coconut wallah has migrated to Australia and you can capture market

You can now sell 250 coconuts every day - potential

For buying 250 coconuts, you need Rs 3,750 of which you already have Rs 1,500
of profits
You are short by Rs 450
(250 x 15) = 3,750 - 1,500 - 1,800 = negative 450
1500

1500 Coconuts to Cash to Coco to Cash to CoCo to Cash - B R Chop

Cycle - Birth Life Death Birth Life Death
Simpler cycle - coc cas coc cash coc Working Capital Cycle

SECOND EXAMPLE

Many projects in the world are replacement projects - these have their own com

I have one semi auto machine and 35 workers

I can replace this with an auto machine which will need 15 workers
Should I do this, is this a good idea - payback, NPV, IRR, the works
My company has 153 machines and 2,551 workers
People mix up stuff like profits, losses, depreciation, cash flows, old machine, ne
Semi Auto Machine
Auto Machine
Salary per worker is Rs 15,0
Cost
50
100
Rises by 5% every year
Life
15 years
10 years
Rest of the operations are no
Scrap Val
1 end of life
1 end of life No retrenchment compensat
Elapsed
5 years
0
to another Division which i
Sale Val
3 today
0
Tax rate is zero

Would you replace this mach

Yes, we will
IRR, NPV, Payback
Payback 2 years and x months

-32%

40%

66%

Cash Flows
Semi Auto Machine
Automatic Machine
Year
MachineLabour
Year
Machine Labour
0
097.00
1
- 63.00
1
- 27.00
2
- 66.15
2
- 28.35
3
- 69.46
3
- 29.77
4
- 72.93
4
- 31.26
5
- 76.58
5
- 32.82
6
- 80.41
6
- 34.46
7
- 84.43
7
- 36.18
8
- 88.65
8
- 37.99
9
- 93.08
9
- 39.89
10
1.00 97.73
10
1.00 41.89
All these workers were asked to leave, they went home, they stayed there for 2
Then another department was recruting some new guys from the street
These other guys are required for that department
So the old HR manager remembered these loyal workers

The tax rate if changed to a non-zero rate will have immense ramifications
Not covered here

tal Budgeting
tal Budgeting
tal Budgeting

For
For
For
For

presentation / submission
your practice
presentation / submission
presentation / submission

For your practice

3 Groups
3 Groups
6
Other Groups will add spice

d Group submissions with 60% weightage

12.00
7.20
4.80 Quality - whole class

need CASH FLOW

h flow is not very easy to comprehend

ept of accrual
system worked

ing to interfere with my education

n cash flow

u learnt (the classic one)

d of the 8th year for say Rs 15 lakhs

valuation
4
12,597
119
###
855,192
645,145
250,000
395,145

5
13,605
126
###
979,024
738,562
250,000
488,562

6
14,693
134
###
###
845,506
250,000
595,506

7
15,869
142
###
###
967,935
250,000
717,935

8
9
17,138
18,509
150
159
### 2,950,102
###
###
250,000
858,092

118,543 146,569 178,652 215,380

276,601 341,993 416,854 502,554
250,000 250,000 250,000 250,000
- 65,175 - 74,612 - 85,416 - 97,784 461,427 517,381 581,438 654,771

515,276

589,888

675,303

773,087

257,428
600,664
250,000
###
111,943
###

885,030

Current Assets
rt term Loans, Advances received
money all the time

nto more inventories, more Receivables

siness guys - Domain people - Garment, Shipping, Cement

isions, Branches, Zones, Countries, SBU, PC
siness is responsible to generate EBIDTA

ance guys (who dont know Domain)

porate Office

e meaning of Gross Profit in Pfizer may be different from

at in Unilever

thdraw without affecting the business (extra, surplus)

ying a single paise to the owners and to the lenders

e ignore loans repaid
not THEM

re also our partners (or co-owners)

EBIT = PBT

would be a diff between PBT and EBIT and the real tax would not

ve happened

u pay lower taxes

many years to make it non cash, but they are not in a mood to listen)

inventories

nuts per day, which you buy in the morning

w cash flow for the month 1 (during month 1)

1,800 Professionally educated people
2,250
450 Owners

your shop
at home
ay's coconuts which will generate Rs 1,600 for the second day

ess opporutnity where you can scale up

d you can capture market share

ou already have Rs 1,500 of original funding and another Rs 1,800

CoCo to Cash - B R Chopra - Mein Samay Hoon

Working Capital Cycle

hese have their own complexities

100 new projects, 200 replacements

15 workers
, the works

sh flows, old machine, new machine, old workers, new workers, taxes
ary per worker is Rs 15,000 per month
es by 5% every year
t of the operations are not impacted
retrenchment compensation bcoz they will be transferred
another Division which is expanding
rate is zero

uld you replace this machine

Differential
Year
Machine Labour
NetCashFlow
097.00
97.00
1
36.00
36.00
2
37.80
37.80
3
39.69
39.69
4
41.67
41.67
5
43.76
43.76
6
45.95
45.95
7
48.24
48.24
8
50.66
50.66
9
53.19
53.19
10
55.85
55.85
Payback, NPV, IRR
, they stayed there for 2 hours
40.03%
s from the street

mense ramifications

Source
P&L
P&L
P&L
P&L
P&L
P&L
P&L

8%
6%

108%
106%

Hypothetical
Hypothetical
P&L
Bal Sheet
Bal Sheet
Hybrid