Lesson-1 on Finance

Question: What is Finance?

Answer:
Mobilization of funds from surplus economic unit & deployment of funds to deficit
economic units
Question: What is Financial Instrument?
Answer:
Financial instruments are the financial claim of holder against issuer.
Question: What is Cash Flow?
Answer:
A measure of a company's financial health, equals cash receipts minus cash payments
over a given period of time.
Question: What are the different types of Ratios?
Answer:

Profitability ratios (Gross Profit Margin, Net profit margin, Operating profit margin,
ROA, ROE)

Liquidity ratio (Current ratio, Quick ratio)

Asset Utilization Ratios (Inventory Turnover, Account Receivable Turnover)

Debt Utilization Ratios (Debt to equity, Debt to total assets)

Coverage Ratios (Debt Service Coverage ratio, Interest service Coverage Ratio)
Question: What is Current Ratio?
Answer:
An indication of a company's ability to meet short-term debt obligations; the higher
the ratio, the more liquid the company is. It is calculated as:
Current Ratio = Total Current Assets/Total Current Liabilities
In general, a Current ratio of

2 : 1 is accepted by most creditors.

Question: What is Quick Ratio?

Answer:
A measure of a company's liquidity and ability to meet its obligations. Quick ratio,
often referred to as acid-test ratio,
Acid-Test (Quick) Ratio = ( Total Current Assets Stock)/ Total Current Liabilities
In general, a quick ratio of 1 or more is accepted by most creditors.
Question: What is EBITDA?
Answer:
EBITDA stands for Earnings before Interest, Taxes, Depreciation and Amortization.
An approximate measure of a company's operating cash flow based on data from the
company's income statement. Sometimes also called operational cash flow.
Question: What is EBIT?
Answer:
EBIT stands for Earnings before Interest and Taxes. A measure of a company's earning
power from ongoing operations, equal to earnings before deduction of interest payments
and income taxes.

Lesson-2 on Finance
Question: What is Interest Coverage Ratio?
Answer:
A measure of ability to meet interest expense from the organization earnings. It is
calculated as :
Interest Coverage Ratio = Earning Before Interest & Taxes (EBIT)/Interest Payments
Question: What is Debt Service Coverage Ratio?
Answer:
A measure of ability to meet interest expense and current matured debt under 01 year
from its EBIT and Depreciation. It is calculated as :
Debt Service Coverage Ratio = (EBIT+ Depreciation)/(Interest Payments + Amortization
Amount)
Question: What is Earnings per Share (EPS)?
Answer:
Earning Per Share =
Shares outstanding

(Net Income Preferred dividends) /Average number of Common

Question: What is Price/Earnings Ratio?

Answer:
Price/Earnings Ratio = (Net Income Preferred dividends)/Average number of Common
Shares outstanding
Companies with high P/E ratios are more likely to be considered "risky" investments than
those with low P/E ratios.
Question: What is Retained Earnings?
Answer:
Earnings not paid out as dividends but instead reinvested in the core business or used to
pay off debt also called earned surplus or accumulated earnings or inappropriate profit.
Question: What is Accounts Receivable Turnover ?
Answer:
The accounts receivable turnover is a rough measure of how many times a companys
accounts receivable have been turned into cash during the year.
Accounts receivable turnover = Sales on Account/ Average accounts receivable balance
Question: What is Inventory Turnover ?
Answer:
The Inventory turnover measures how many times a companys inventory has been sold
and replaced during the year. It is calculated as follows
Inventory turnover = Cost of goods sold/ Average inventory balance
Question: What is Dividends payout ratio ?
Answer:
Dividend Payout Ratio = Dividends Per share/Earning Per share

Question: What is Dividends Yield ?

Answer:
The Dividend yield ratio measures the rate of return that would be earned by an investor
who buys the common stock at the current market price. It is calculated as follows:
Dividend yield = Dividends Per share/Market Price Per Share

Lesson-3 on Finance
Question: What is Dividends Yield ?
Answer:
The Dividend yield ratio measures the rate of return that would be earned by an investor who buys the
common stock at the current market price. It is calculated as follows:
Dividend yield = Dividends Per share/Market Price Per Share
Question: What is Net Asset Value (NAV)?
Answer:
The value of a single mutual fund or share, based on the value of the underlying assets of the share minus its
liabilities, divided by the number of shares outstanding.
Question: What is Book Value of assets?
Answer:
Book Value of Assets = Cost of assets Accumulated Depreciation of Assets
The value of an asset as it appears on a balance sheet, equal to cost minus accumulated depreciation.
Question: What is Book Value per Share ?
Answer:
The Book value per shares measure the amount that would be distributed to holder of each share of common
stock if all assets were sold and all creditors were paid off at their balance sheet. It is calculated as follows:
Book Value Per Share = (Total Stockholders equity- Preferred Stock)/Number of Common Shares Outstanding
Question: What is Return on Assets (ROA) Ratio?
Answer:
This measures how efficiently profits are being generated from the assets employed in the business when
compared with the ratios of firms in a similar business. The Return on Assets Ratio is calculated as follows:
Return on Assets = Net Profit before Tax/Total Assets
A low ratio in comparison with industry averages indicates an inefficient use of business assets.
Question: What is Return on Investment (ROI) Ratio?
Answer:
It is the percentage of return on funds invested in the business by its owners. The ROI is calculated as follows:
Return on Investment = Net Profit before Tax/Net Worth
Question: What is Leverage Ratio?
Answer:
This Debt/Equity or Leverage Ratio indicates the extent to which the business is reliant on debt financing
(creditor money versus owner's equity):

Debt/Equity Ratio = Total Liabilities/ Equity

Generally, the higher this ratio, the more risky a creditor will perceive its exposure in your business, making it
correspondingly harder to obtain credit.
Question: What is Interest?
Answer:
Interest is the Cost paid by the Borrower to the lender for the use of money that they borrow from a lender. It
is the price of the loan, expressed as percentage
Question: What is Effective Rate of Return(ERR)?
Answer:
Effective Rate of Return = ( Interest Income + Non Interest Income)/ Average Utilization of Fund
Question: What Does Yield To Maturity - YTM Mean?
Answer:
The rate of return anticipated on a bond if it is held until the maturity date. YTM is considered a long-term
bond yield expressed as an annual rate. The calculation of YTM takes into account the current market price,
par value, coupon interest rate and time to maturity.
Question: What is Working Capital ?
Answer:
Working Capital is the part of the capital which is required to complete the whole operating cycle.
Working Capital = Current Assets- Current liabilities
Question: What is Authorized Capital?
Answer:
The amount of equity capital, measured at par value, that a company is allowed to raise by issuing shares, as
set out in its memorandum of association. A company does not necessarily issue shares to the limit of its
authorized capital
Question: What is Issued capital ?
Answer:
The proportion of authorized capital which has been issued to shareholders in the form of shares.
Question: What is Paid up Capital ?
Answer:
The total amount of shareholder capital that has been paid in full by shareholders. The proportion of a
company's issued capital that has been paid for by its shareholders.
Question: What is Equity?
Answer:
Ownership interest in a corporation in the form of common stock or preferred stock.
Part of companys capital being paid by the shareholders.
Total assets minus total liabilities; here also called shareholder's equity or net worth or book value.
Question: What Does Face Value Mean?
Answer:
The value of a share certificate or Stocks or other securities as shown on the front or face of the document.
Question: What is Share?
Answer:
Part of the ownership of a company. A person who buys a portion of a company's capital becomes a
shareholder in that company's assets and as such receives a share of the company's profits in the form of an
annual dividend.
Question: What is Stock?

Answer:
Stock is the capital raised by a corporation through the issuance and distribution of shares
Question: What is Dividend?
Answer:
The amount paid out from company's profits to its shareholders, usually yearly (final dividend) and
sometimes half-yearly (interim dividend).

Lesson-4 on Finance
Question: What is Option?
Answer:
Option is a derivative security because value is derived from the value of another security.
The right to buy or sell a firms common stock at a specified price for a stated period of time
Question: What is Call Option?
Answer:
A call option gives the buyer the right but not obligation to call the underlying instrument for delivery at a
specified price (exercise price) & obligation to seller to sell the underlying instrument at the same price.
Question: What is Financial Leverage? Implications of Financial Leverage
Answer:
Financial leverage involves changes in shareholders' income in response to changes in operating profits,
resulting from financing a company's assets with debt or preferred stock
Financial leverage is concerned with the relationship between operating profits and earnings per share.
Question: What is operating leverage?
Answer:
Operating leverage is a measure of how sensitive net income is to percentage changes in sales.
Operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase in sales can
produce a much larger percentage increase in net income.
Question: What is degree of operating leverage?
Answer:
The degree of operating leverage may be defined as the percentage change in operating profit resulting from
a percentage changes in sales.
Question: What is Put option?
Answer:
A put option gives the buyer the right but not obligation to put the underlying instrument for delivery at a
specified price (exercise price) & obligation to seller to buy the underlying instrument at the same price.
Question: What is Future Contract?
Answer:
A commitment today to transact in the future, both parties have agreed to a deferred delivery at sales price
that is currently determined with no funds having been exchanged.
Question: What is Zero Coupon Bond ?
Answer:
A zero-coupon bond is a bond bought at a price lower than its face value, with the face value repaid at the
time of maturity. It does not make periodic interest payments, or have so-called "coupons,".
Question: What are the underlying assumption of Cost-Volume-Profit Analysis?
Answer:

CVP assumes the following:

Constant sales price;
Constant variable cost per unit;
Constant total fixed cost;
Constant sales mix;
Units sold equal units produced.
Question: What is cost of capital?
Answer:
The cost of capital is the discount rate used for evaluating the desirability of the investment project.
It is also know as the cutoff, or the target, or the hurdle rate. It is the minimum required rate of return on
the investment project that keeps the present wealth of shareholders unchanged
Question: What is weighted average cost of capital?
Answer:
The composite, or overall cost of capital is the weighted average of the cost of various sources of fund ,
weights being the proportion of each source of funds in the capital structure
Question: What are the Different Method of Project Evaluation?
Answer:
1) Traditional Methods
a) Pay Back Period Method
b) Accounting Rate of Return
2) Discounted Cash Flow Method
a) Net Present Value Method
b) Internal Rate of Return Method
c) Profitability Index Method
Question: What is Pay Back period in Finance?
Answer:
Payback period in business and economics refers to the period of time required for the return on an
investment to "repay" the sum of the original investment
Question: What are the limitations of Pay back Period Method in evaluation of Project ?
Answer:
1) The payback period only considers revenue, does not consider profits.
2) It ignores any benefits that occur after the payback period. It does not measure total income.
3) It ignores the time value of money.
4) It is dependent on cash inflows which are hard to predict.

Lesson-5 on Finance
Question: What is Accounting Rate of Return in Finance?
Answer:
The average rate of return expresses the profits arising from a project as a percentage of the initial capital
cost.
Question: What are the limitations of Accounting Rate of Return Method in evaluation of Project ?
Answer:
1) It considers Accounting profit instead of cash inflow in evaluation of project. The concept of profit can be
very subjective, varying with specific accounting practice and the capitalization of project costs. As a result, the
ARR calculation for identical projects would be likely to result in different outcomes from business
2) It ignores time value of money.
3) It does not consider that the profit can be reinvested.

4) There is no definitive signal given by the ARR to help managers decide whether or not to invest. This lack of
a guide for decision making means that investment decisions remain subjective.
Question: What Net Present value in Finance?
Answer:
The Net Present Value (NPV) is the difference between the present value future cash inflows and the initial
investment which determines whether the project is an acceptable investment.
Question: What are the limitations of Net Present Value Method in evaluation of Project ?
Answer:
1. It requires estimates of cash flows which is a tedious task.
2. It Requires computation of the opportunity cost of the capital which posed practical difficulties
3. It assumes a constant discount rate over life of investment
Question: What Internal Rate of Return(IRR) in Finance?
Answer:
The internal rate of return on an investment or project is the discount rate that makes the net present value
of all cash flows (both positive and negative) from a particular investment equal to zero.
An investment is considered acceptable if its internal rate of return is greater than an cost of capital.
Question: What are the limitations of Internal Rate of Return Method in evaluation of Project ?
Answer:
The calculated IRR can not be used to for taking decision on mutually exclusive projects, but only to decide
whether a single project is worth investing in.
IRR assumes reinvestment of interim cash flows in projects with equal rates of return (the reinvestment can
be the same project or a different project). Therefore, IRR overstates the annual equivalent rate of return for a
project whose interim cash flows are reinvested at a rate lower than the calculated IRR
Requires estimates of cash flows which is a tedious task.
Does not hold the value additivity principle (i.e IRRs of two or more projects does not add)
Relatively difficult to compute which require repetitive calculation. Thats why it also called Trial & Error
Method.

Lesson-6 on Finance
Question: What is profitability Index (PI) Method in Capital Budgeting?
Answer:
A method used in discounted cash flow for ranking a range of projects under consideration in which standard
cash flow patterns are projected. It is calculated as follows:
Profitability Index = Present value of future cash flows/ Initial investment
The projects with a PI of less than 1 are not expected to earn the required rate of return and are rejected.
Question: Which is a better measure for capital budgeting, IRR or NPV?
Answer:
All other things being equal, using internal rate of return (IRR) and net present value (NPV) measurements to
evaluate projects often results in the same findings. However, there are a number of projects for which using
IRR is not as effective as using NPV to discount cash flows.
IRR's major limitation is also its greatest strength: it uses one single discount rate to evaluate every
investment.
The NPV method is inherently complex and requires assumptions at each stage - discount rate, likelihood of
receiving the cash payment, etc.

The IRR method simplifies projects to a single number that management can use to determine whether or not
a project is economically viable. The result is simple, but for any project that is long-term, that has multiple
cash flows at different discount rates, or that has uncertain cash flows - in fact, for almost any project at all simple IRR isn't good for much more than presentation value.
Question: What is Capital Market Efficiency?
Answer:
Capital market efficiency reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss.
Question: What is commercial risk?
Answer:
Commercial risk The risk that a foreign debtor will be unable to pay its debts because of business events, such
as bankruptcy.
Question: What is the difference between risk and uncertainty in capital budgeting?
Answer:
Risk is present when future events occur with measurable probability.
Uncertainty is present when the likelihood of future events is indefinite or incalculable
Question: What is Sensitivity Analysis?
Answer
Sensitivity analysis is done to know what will happen to the viability of the project when variable is
changed from its expected value at a time.
Variables are not interrelated.
Question: What is Scenario Analysis ?
Answer:
Scenario Analysis is done to know what will happen to the viability of the project when more than one
variable is changed at a time.
Here variables are interrelated.