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Chapter 3

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Strategic Fit Assessment (Conceptual Ratio)

Topic: Strategy FormulationChapter: Chapter 3
Strategic Fit=Alignment of Internal ResourcesExternal Environmental Opportunities\text{Strategic Fit} = \frac{\text{Alignment of Internal Resources}}{\text{External Environmental Opportunities}}
While often qualitative, this ratio represents the degree to which an organization's internal capabilities match the external market opportunities. A higher value indicates a stronger strategic formulation.

Competitive Advantage Gap

Topic: Strategy FormulationChapter: Chapter 3
ΔCA=Vfirm−Vcompetitor\Delta CA = V_{firm} - V_{competitor}
Used to measure the difference in Value (V) created by the firm's strategic choices compared to its competitors. In strategy formulation, the goal is to maximize this delta through unique resource deployment.

Net Present Value (NPV)

Topic: Capital BudgetingChapter: Chapter 3
NPV=∑t=1nCFt(1+k)t−I0NPV = \sum_{t=1}^{n} \frac{CF_t}{(1+k)^t} - I_0
NPV is the difference between the present value of cash inflows and the initial investment (I0I_0). CFtCF_t represents cash flow at time tt, and kk is the discount rate (cost of capital). A positive NPV indicates a profitable project.

Profitability Index (PI)

Topic: Capital BudgetingChapter: Chapter 3
PI=∑t=1nCFt(1+k)tI0PI = \frac{\sum_{t=1}^{n} \frac{CF_t}{(1+k)^t}}{I_0}
Also known as the Benefit-Cost Ratio. It measures the ratio of the present value of future cash flows to the initial investment. If PI>1PI > 1, the project is acceptable.

Payback Period (PBP)

Topic: Capital BudgetingChapter: Chapter 3
PBP=Time taken to recover I0PBP = \text{Time taken to recover } I_0
The time required to recover the initial investment from the net cash inflows. For uneven cash flows, it is calculated by accumulating cash flows until the initial outlay is met.

Accounting Rate of Return (ARR)

Topic: Capital BudgetingChapter: Chapter 3
ARR=Average Annual Profit after TaxAverage Investment×100ARR = \frac{\text{Average Annual Profit after Tax}}{\text{Average Investment}} \times 100
Unlike NPV, ARR uses accounting profits instead of cash flows. Average Investment is typically calculated as Initial Investment+Salvage Value2\frac{\text{Initial Investment} + \text{Salvage Value}}{2}.

Internal Rate of Return (IRR)

Topic: Capital BudgetingChapter: Chapter 3
0=∑t=1nCFt(1+IRR)t−I00 = \sum_{t=1}^{n} \frac{CF_t}{(1+IRR)^t} - I_0
The IRR is the discount rate that makes the Net Present Value (NPV) of a project equal to zero. It represents the actual rate of return expected from the project.
Chapter 3 Formulas — CA Intermediate | Kartavvya