Introduction

The Financial Manager plays a dynamic role in the development of a modern company, although this has not always been the case. Until around the first half of this century, such professionals basically raised the funds and managed the cash position of the company, and that was about it.

In the 1950s, the increased acceptance of present value concepts caused financial managers to expand their responsibilities and become interested in the selection of capital investment projects.

Currently external factors have an increasing impact on the financial manager.

Almost all financial decisions, both personal and business, include considerations of the time value of money.

• Interest: It is the yield of a capital placed at a determined rate and time.

  
  

• Interest Rates: Allows us to adjust the value of cash flows whenever they occur at a particular point in time.

  
  
  

The interest rate accrued or charged is the ratio of the interest accrued to the principal, in the unit of time.

Unless otherwise stated, the agreed time unit is one year.

The annual interest rate, represented by i, is given as a percentage (for example, 6%), or as its equivalent in decimal form (0.06).

The decimal fraction is used in the calculations.

Exact And Ordinary Simple Interest:

The exact simple interest is calculated on the basis of the year of 365 days (366) in leap years). Ordinary simple interest is calculated based on a 360-day year. Using the 360-day year simplifies some calculations, however it increases the interest charged by the creditor.

The return on holding an investment for some period, say a year, is equal to any cash payment received due to the property, plus the change in market price, divided by the asking price. For example, you could buy a $100 security that would pay you $7 in cash and be worth $106 a year later.

The return would be ($7 + $6) / $100 = 13%. Thus, your return comes from two sources: income, plus any price appreciation (or price loss).

To begin managing risk, let's first consider a couple of examples. Suppose you buy a 1-year Treasury bond with a yield of 8%.

If you hold it year-round, you'll earn a government-guaranteed 8% investment return—no more, no less. Now, you buy a common share in any company and hold it for one year.

The cash dividend that you projected to receive may or may not materialize as expected. And, what is more, the price at the end of the year of the share may be much less than expected, perhaps less than at the beginning.

For risk-averse individuals, the difference between the certainty equivalent and the expected value of an investment constitutes a risk premium; this is the additional expected return that the risky investment must offer to the investor in order for this individual to accept the risky investment.

Note that in our example, the expected value of the risky investment had to exceed the safe offer of $3,000 by $2,000 or more for you to be willing to accept it.

Operating or operating leverage is present whenever a company has fixed operating expenses—regardless of volume.

In the very long run, of course, all costs are variable. Therefore, our necessity analysis includes the short term.

Assets with a fixed cost are used in the confidence that the volume will produce more than enough revenue to cover all fixed and variable costs.

One of the most drastic examples of operating leverage is found in the airline industry, where a large portion of total costs are fixed.

Beyond a certain break-even load factor, any additional passenger represents a direct core profit for the airline (earnings before interest and taxes, EBIT).

The bottom line is that fixed costs do not vary with volume changes.

These costs include things like depreciation on buildings and equipment, insurance, property taxes, part of overall utility bills, and a part of the cost of administration.

An interesting potential effect caused by the presence of fixed operating costs (operating leverage) is that a change in sales volume results in a more than proportional change in operating profit (or loss).

Consequently, like a lever used to amplify a force applied at one point, into a larger force at some other point, the presence of fixed operating costs causes a percentage change in sales volume to generate an amplified percentage change. in profits (or losses).

To illustrate how equilibrium analysis is applied to the study of operating leverage, consider a company that produces a high-quality helmet for child bikers that it sells for $50 per unit.

The company has fixed annual operating costs of $100.00 and variable operating costs of $25 per unit regardless of volume sold.

We wish to study the relationship between total operating costs and total revenue. One means of doing this is by using the equilibrium graph.

Financial leverage involves the use of fixed cost financing.

Interestingly, financial leverage is acquired by selection, while operating leverage is sometimes not.

The amount of operating leverage (the amount of fixed operating costs) employed by a company is sometimes dictated by the physical requirements of the company's operations.

Financial leverage is employed in the hope of increasing returns to holders of common stock. Favorable or positive leverage is said to occur when the firm uses funds raised at a fixed cost (funds raised by issuing doubt with a fixed interest rate or preferred stock with a constant dividend rate) to earn more than the fixed costs of financing. paid.

• Calculation of earnings per share.
  
  

As an example from an EBIT-EPS breakeven analysis, suppose the Cherokee Tire Company, with a long-term capitalization of $10 million made up entirely of common stock, wants to raise another $5 million for expansion through one of three possible investment plans. financing.

The company can be financed with a new issue of:

1) all in common stock,

2) all through debt at 12% interest, or 3) all through preferred stock with a dividend of 11%.

Current annual profits. Before interest and taxes (EBIT), they are $1.5 million, but it is expected that with the expansion they will rise to $2.7 million.

The income tax rate is 40% and 200,000 shares are outstanding.