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14-1. What are financial markets? What function do they perform? How would an
economy be
worse off without them?
Financial markets are institutions and procedures that facilitate transactions in all
types of
financial claims. Financial markets perform the function of allocating savings in the
economy to the ultimate demander(s) of the savings.
markets, the
total wealth of the economy would be lessened. Financial markets aid the rate of
capital
formation in the economy.
The money market consists of all institutions and procedures that accomplish
transactions
in short-term debt instruments issued by borrowers with (typically) high credit
ratings.
Examples of securities traded in the money market include U.S. Treasury Bills,
bankers
acceptances, and commercial paper. Notice that all of these are debt instruments.
Equity
securities are not traded in the money market. It is entirely an over-the-counter
market.
On the other hand, the capital market provides for transactions in long-term
financial
claims (those claims with maturity periods extending beyond one year). Trades in
the
capital market can take place on organized security exchanges or over-the-counter
markets.
14-4. What major benefits do corporations and investors enjoy because of the existence
of organized security exchanges?
(2)
(3)
15-5A (Leverage analysis) You have developed the following analytical income statement
for your corporation. It represents the most recent years operations, which ended
yesterday. Sales $45,750,000 Variable costs __2_2_,8_0_0_,_0_0_0 Revenue before
fixed costs $22,950,000 Fixed costs ___9_,2_0_0_,_0_0_0 EBIT $13,750,000 Interest
expense ___1_,3_5_0_,_0_0_0 Earnings before taxes $12,400,000 Taxes (.50)
___6_,2_0_0_,_0_0_0 Net income __$____6__,2__0__0__,__0__0__ Your supervisor in
the controllers office has just handed you a memorandum asking for written responses to
the following questions: a. At this level of output, what is the degree of operating
leverage? b. What is the degree of financial leverage? c. What is the degree of combined
leverage? d. What is the firms break-even point in sales dollars? e. If sales should
increase by 25 percent, by what percent would earnings before taxes (and net income)
increase? e.
a.
$22,950,000
$13,750,000
1.67
times
b.
times
c.
d.
EBIT
EBIT I
$13,750,000
$13,750,000 $1,350,000
$13,750,000
$12,400,000
1.85 times
F
VC =
1
S
$9,200,000
$22,800,000
1
$45,750,000
$9,200,000
.502
= $18,326,693.23
$9,200,000
1 .498
= 1.11
e.
(25%) (1.85)
= 46.25%
15-9A (Fixed costs and the break-even point) A & B Beverages expects to earn $50,000
next year after taxes. Sales will be $375,000. The store is located near the shopping
district surrounding Blowing Rock University. Its average product sells for $27 a unit.
The variable cost per unit is $14.85. The store experiences a 40 percent tax rate. a. What
are the stores fixed costs expected to be next year? b. Calculate the stores break-even
point in both units and dollars.
(a)
VC
F 1 T = $50,000
S S
S
[S VC - } (1 T) = $50,000
{$375,000 - $206,250 F} (0.6) = $50,000
($168,750 - F) (0.6) = $50,000
F = $85,416.67
(b)
F
PV
QB =
F
S* = 1 VC
S
$85,416.67
= $85,416.67
$27.00 $14.85
$12.15
= 7,030 units
$85,416.67
= $189,815
1 .55
(b)
QB
S*
F
VC =
1
S
$540,000
$126
1
$180
$540,000
$540,000
=
1 0.7
.3
= $1,800,000
(c)
Sales
12,000
Units
$2,160,000
15,000
Units
$2,700,000
20,000
Units
$3,600,000
(d)
Variable costs
Revenue before fixed costs
Fixed costs
1,512,000
$ 648,000
540,000
1,890,000
$ 810,000
540,000
2,520,000
$1,080,000
540,000
EBIT
$ 108,000
$ 270,000
$ 540,000
12,000 units
$648,000
= 6 times
$108,000
15,000 units
$810,000
= 3 times
$270,000
20,000 units
$1,080,000
= 2
$540,000
times
Notice that the degree of operating leverage decreases as the firm's sales
level rises above the break-even point.