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Basic Financial Concepts - Coggle Diagram

- - - - Exact Simple Interest Using the year of 365 days we have that t = 50/365 = 10/73 and I = Cit = 2,000.00(0.05)(10/73) = 1000/73 = $13.70.
        
        Ordinary Simple Interest Using a year of 360 days, we have that t = 50/360 = 5/36 and I = 2,000(0.05)(5/36) = 125/9 = $13.89.
        
        Present Value of a Debt The value of a debt, on a date prior to its maturity, is known as the present value of the debt on that date.
- - - - 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.
        
        Here we will take the generally accepted view that investors are risk averse.
        This implies that risky investments must offer higher expected returns than less risky investments in order for people to buy and hold them.
        (Keep in mind, however, that we're talking about expected returns; the actual return on a risky investment may be much less than the actual return on a less risky alternative. And, to have lower risk, you must be willing to accept investments that have lower expected returns.
- - - - 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.
        
        Break-even point (quantity).
        The intersection of the total cost line with the total revenue line determines the break-even point.
        The break-even point is the sales volume required for total revenue to equal total operating costs or for operating profit to equal zero.
        
        Likewise, it would be a mistake to consider the degree of operating leverage of the company as a synonym of its business risk.
        However, due to the underlying variability of costs of sales and production, the degree of operating leverage will affect the variability of operating earnings and, consequently, the company's business risk.
        Therefore, the degree of operating leverage should be considered as a measure of "potential risk" that becomes "asset" only in the presence of variability in sales and cost of production.
- - - - 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.
        
        In short, the higher the level of EBIT is above the indifference point and the less likely a downward swing is, the stronger the case for using debt financing.
        The EBIT-EPS breakeven analysis is just one of several methods for determining the appropriate amount of debt a company should hold.
        No method of analysis is satisfactory by itself. However, when several methods are carried out simultaneously it is possible to make generalizations.