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. Without these financial markets, the
total wealth of the economy would be lessened. Financial markets aid the rate of capital
formation in the economy.
14-3. Distinguish between the money and capital markets.
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?
Organized stock exchanges provide for:
(1)A continuous market. This means a series of continuous security prices is generated. Price changes between trades are dampened, reducing price volatility, and enhancing the liquidity of securities.
(2)Establishing and publicizing fair security prices. Prices on an organized exchange are determined in the manner of an auction. Moreover, the prices are published in widely available media like newspapers.
(3)An aftermarket to aid businesses in the flotation of new security issues. The continuous pricing mechanism provided by the exchanges facilitates the determination of offering prices in new flotations. The initial buyer of the new issue has a ready market in which he can sell the security should he need liquidity rather than a financial asset.
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 = 25%
Operating asset turnover = 5 times
Operating assets = $20 million
Degree of operating leverage = 4 times
Return on Operating Assets =
Net Operating Income = $20,000,000 × 25%
= $5,000,000
DOL =
Contribution Margin = $5,000,000 × 4
= $20,000,000
Since Net Operating Income = Contribution Margin – Fixed Costs
Fixed Costs = $20,000,000 - $5,000,000
= $15,000,000
Unit Contribution Margin = $20,000,000 / 10,000,000
= $2
Breakeven Point in Units =
Breakeven Point in Units = $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?
= 10,000 units
b. What is the dollar sales volume the firm must achieve in order to reach the break-even
point?
= 10,000 × $180
= $1,800,000
c. What would be the firm’s profit or loss at the following units of production sold:
12,000 units? 15,000 units? 20,000 units?
Allison RadiosUnit
Sales / Price / Total
Sales / Fixed
Costs / Unit
Variable Cost / Total
Variable Costs / Total
Costs / Total Profit (Loss)
12000 / $180 / $2,160,000 / $540,000 / $126 / $1,512,000 / $2,052,000 / $108,000
15000 / $180 / $2,700,000 / $540,000 / $126 / $1,890,000 / $2,430,000 / $270,000
20000 / $180 / $3,600,000 / $540,000 / $126 / $2,520,000 / $3,060,000 / $540,000
d. Find the degree of operating leverage for the production and sales levels given in part (c).
Units / Contribution Margin / EBIT / DOL12000 / $648,000 / $108,000 / 6
15000 / $810,000 / $270,000 / 3
20000 / $1,080,000 / $540,000 / 2