Financial management principles and practices

Financial Management

Financial markets are the mechanisms by which financial instruments are bought and sold. Typically, financial markets today are electronic nodes that link buyers and sellers, but in the past they have been physical locations where buyers and sellers would meet. The function that financial markets perform is to allow companies and governments to raise capital by bringing those who need capital (companies, governments) together with those who have it (investors, financial institutions). An economy would be worse off without financial markets because it would be much harder for those with good business ideas to acquire the means to bring those ideas to market. This would stifle economic growth, and lead to a situation where good ideas took much longer to reach the market. Those with money would have a harder time investing that money well without financial markets, so there would be a much more inefficient use of both capital and ideas.

Problem 14-3.

Money is currency, the medium of exchange between parties in any non-barter economic system. Capital markets are systems by which money can be bought and sold, in particular with respect to debt securities, foreign exchange, stocks and physical goods. The capital markets are simply a medium by which money can change hands, the money itself is the actual medium of exchange that has value.

Problem 14-4.

Corporations and investors enjoy several benefits as the result of the existence of organized exchange. They have easy access to each other as the first benefit, which saves on the costs of finding investments and on finding capital. In addition, the organized exchanges provide increased liquidity for such exchanges, which allows investors in particular to exit an investment easily, removing a key disincentive against investment. Another benefit is that exchanges are able to enforce rules that govern participation on the exchange -- this allows for greater flow of information, more accurate information and generally more trustworthy transactions than if the exchange did not exist. In addition, the exchange provides an avenue for recourse if some remedy is required for a fraudulent transaction.

Problem 15-12.

The operating asset turnover of 5 times on operating assets of $20 million implies a total sales of $100 million. The return on operating assets being 25% indicates net profit of $5 million. The total costs therefore are $95 million.

DOL = Contribution Margin / Operating Margin

In this case, the operating margin is 5%, so the contribution margin would be 20%. This indicates that COGS is 80% of revenues or $80 million. That leaves $15 million as fixed costs. With a COGS of $8 per unit ($80 million / 10 million) and contribution per unit of $2 the break-even volume would be:

$15 million / $2 = 7.5 million units.

Problem 15-13.

a) the breakeven point in units for the company is as follows:

$180 - $126 = Contribution = $54 per unit. Breakeven = $540,000 / 54 = 10,000 units.

b) Dollar sales to reach breakeven would be 10,000 * $180 = $1.8 million

c) at the different levels the firm's income statement would be as follows: