Chapter 14 & 15 Assignments

Chapter 14 14-1. What are financial markets? What function do they perform? How would an economy be worse off without them? Financial markets are those institutions and procedures that facilitate transactions in all types of financial claims (securities). The function that financial markets perform is to be the mechanism that is needed to facilitate the transfer of savings from those economic units that have surplus to those that have a deficit. If financial markets did not exist the wealth of the economy would be less and the rate of capital formation would not be as high. (Keown, Martin, Petty & Scott, 2005) 14-3. Distinguish between the money and capital markets? A money market will handle transactions in short-term credit instruments whereas a capital market will handle transactions in long-term financial instruments. Short-term means a year or less whereas long-term means longer than a year. (Keown, Martin, Petty & Scott, 2005) 14-4. What major benefits do corporations and investors enjoy because of the existence of organized security exchanges? The major benefits that corporations and investors enjoy because of the existence of organized security exchanges are providing a continuous market, establishing and publicizing fair security prices, and helping businesses raise new capital. (Keown, Martin, Petty & Scott, 2005) Reference Keown, A. J., Martin, J. D., Petty, J. W., & Scott, D. F. (2005). Financial management: Principles and applications (10th ed.). Upper Saddle River, NJ: Pearson/Prentice Hall.

Chapter 14 & 15 Assignments

15-12A. (Break-even point) You are a hard-working analyst in the office of financial operations for a manufacturing firm that produces a single product. You have developed the following cost structure information for this company. All of it pertains to an output level of 10 million units. Using this information, find the break-even point in units of output for the firm. Return on operating assets Operating asset turnover Operating assets Degree of operating leverage Step (1) = 25% = 5 times = $20 million = 4 times

Compute the operating profit margin: Operating Profit Margin x Operating Asset Turnover = Return on operating assets (M) x (5) = 0.25 M = .05

Step (2)

Compute the sales level associated with the given output level: Sales___ $20,000,000 Sales = $100,000,000 =5

Step (3)

Compute EBIT: (.05) ($100,000,000) = $5,000,000

Step (4)

Compute revenue before fixed costs. The degree of operating leverage is 4 times EBIT: RBF = (4) x ($5,000,000) = $20,000,000

Step (5)

Compute total variable costs:

Chapter 14 & 15 Assignments

(Sales) (Total variable costs) = $20,000,000 $100,000,000 (Total variable costs) = $20,000,000 Total variable costs = $80,000,000

Step (6)

Compute total fixed costs: RBF Fixed costs = $5,000,000 $20,000,000 fixed costs = $5,000,000 Fixed costs = $15,000,000

Step (7)

Find the selling price per unit, and the variable cost per unit: P = $100,000,000 10,000,000 V = $80,000,000 10,000,000 = $10.00 = $8.00

Step (8)

Compute the break-even point: QB = F_ = $15,000,000 PV ($10) ($8) = $15,000,000 $2

= 7,500,000 units

15-13A. (Break-even point and operating leverage) Allison Radios manufactures a complete line of radio and communication equipment for law enforcement agencies. The average selling price of its finished product is $180 per unit. The variable cost for these same units is $126. Allison Radios incurs fixed costs of $540,000 per year. a. What is the break-even point in units for the company? b. What is the dollar sales volume the firm must achieve in order to reach the break-even point? c. What would be the firms profit or loss at the following units of production sold: 12,000 units? 15,000 units? 20,000 units?

Chapter 14 & 15 Assignments

d. Find the degree of operating leverage for the production and sales levels given in part (c).

a. QB b. S

F_ = ___$540,000__ PV ($180) ($126) $540,000 1 - $126 $180

= =

$540,000 $54 $540,000 1 0.7

= 10,000 units = $540,000 .3

= __F___ = 1 VC S = $1,800,000

c. Sales Variable costs Revenue before fixed costs Fixed costs EBIT d. 12,000 Units $648,000 $108,000 = 6 times

12,000 Units $2,160,000 1,512,000 648,000 540,000 $ 108,000 15,000 Units $810,000 $270,000 = 3 times

15,000 Units $2,700,000 1,890,000 810,000 540,000 $ 270,000 20,000 Units $1,080,000 $ 540,000 = 2 times

20,000 Units $3,600,000 2,520,000 1,080,000 540,000 $ 540,000