Review for chapter 14-15Review for chapter 14-15

Types of SecuritiesTypes of Securities

Treasury Bills and Treasury BondsTreasury Bills and Treasury Bonds Municipal BondsMunicipal Bonds Corporate BondsCorporate Bonds Preferred StocksPreferred Stocks Common StocksCommon Stocks

Movement of SavingsMovement of Savings

Direct Transfer of FundsDirect Transfer of Funds Indirect Transfer using Investment BankerIndirect Transfer using Investment Banker Indirect Transfer using a Financial Indirect Transfer using a Financial

IntermediaryIntermediary

Financial Market ComponentsFinancial Market Components

Public OfferingPublic Offering

Private PlacementPrivate PlacementPrimary MarketPrimary Market

Secondary MarketSecondary Market

Money MarketMoney Market

Capital MarketCapital Market

Financial Market ComponentsFinancial Market Components

Organized ExchangesOrganized Exchanges

Over-the-Counter (OTC)Over-the-Counter (OTC)

Investment BankingInvestment Banking

How do investment bankers help How do investment bankers help firms issue securities?firms issue securities?

Underwriting the issue.Underwriting the issue. Distributing the issue.Distributing the issue. Advising the firm.Advising the firm.

Distribution Methods Distribution Methods

Negotiated PurchaseNegotiated Purchase Negotiated PurchaseNegotiated Purchase Competitive BidCompetitive Bid Best EffortsBest Efforts

Privileged SubscriptionPrivileged Subscription

Direct SaleDirect Sale

Regulations:Regulations:The Primary MarketThe Primary Market

The Securities Act of 1933The Securities Act of 1933 Firms register with the Securities Firms register with the Securities

Exchange Commission (SEC).Exchange Commission (SEC). SEC has 20 days to review.SEC has 20 days to review.

SEC may ask for more information.SEC may ask for more information.The firm cannot solicit buyers during The firm cannot solicit buyers during

the review period but can advertise.the review period but can advertise.

Regulations:Regulations:The Secondary MarketThe Secondary Market

The Securities Exchange Act of 1934The Securities Exchange Act of 1934Exchanges must register with SEC.Exchanges must register with SEC.Company information must be Company information must be

available to the public.available to the public. Insider trading is regulatedInsider trading is regulated..

Business RiskBusiness Risk

The variability or uncertainty of a The variability or uncertainty of a firm’s operating income (EBIT).firm’s operating income (EBIT).

FIRMFIRMEBIT EPSStock-Stock-holdersholders

Business RiskBusiness Risk

Affected by:Affected by: Sales volume variabilitySales volume variability CompetitionCompetition Product diversificationProduct diversification Operating leverageOperating leverage Growth prospectsGrowth prospects SizeSize

Operating LeverageOperating Leverage

The use of The use of fixed operating costsfixed operating costs as as opposed to opposed to variable operating variable operating costscosts..

A firm with relatively high fixed A firm with relatively high fixed operating costs will experience operating costs will experience more variable operating incomemore variable operating income if if sales change.sales change.

Financial RiskFinancial Risk

The variability or uncertainty of The variability or uncertainty of a firm’s earnings per share (EPS) a firm’s earnings per share (EPS) and the increased probability of and the increased probability of insolvency that arises when a insolvency that arises when a firm uses firm uses financial leveragefinancial leverage..

FIRMFIRMEBIT EPSStock-Stock-holdersholders

Financial LeverageFinancial Leverage

The use of The use of fixed-costfixed-cost sources of sources of financingfinancing (debt, preferred stock) (debt, preferred stock) rather than rather than variable-costvariable-cost sources sources (common stock).(common stock).

CostsCosts

Suppose the firm has both Suppose the firm has both fixed fixed operating costsoperating costs (administrative (administrative salaries, insurance, rent, property salaries, insurance, rent, property tax) and tax) and variable operating costsvariable operating costs (materials, labor, energy, (materials, labor, energy, packaging, sales commissions).packaging, sales commissions).

Breakeven point (units of output)Breakeven point (units of output)

QQB = B = breakeven level of Q.breakeven level of Q. F = total anticipated fixed costs.F = total anticipated fixed costs. P = sales price per unit.P = sales price per unit. V = variable cost per unit.V = variable cost per unit.

Breakeven CalculationsBreakeven Calculations

QB = FP - V

Breakeven point (sales dollars)Breakeven point (sales dollars)

S* = breakeven level of sales.S* = breakeven level of sales. F = total anticipated fixed costs.F = total anticipated fixed costs. S = total sales.S = total sales. VC = total variable costs.VC = total variable costs.

Breakeven CalculationsBreakeven Calculations

S* = F VC S

1 -

DOLs = % change in EBIT% change in sales

change in EBIT EBITchange in sales sales

=

Degree of Operating LeverageDegree of Operating Leveragefrom Sales Level (S)from Sales Level (S)

If we have the data, we can use this formula:If we have the data, we can use this formula:

Degree of Operating LeverageDegree of Operating Leveragefrom Sales Level (S)from Sales Level (S)

Q(P - V) Q(P - V) - F

=

DOLs = Sales - Variable Costs EBIT

DFL = % change in EPS% change in EBIT

change in EPS EPSchange in EBIT EBIT

Degree of Financial Leverage Degree of Financial Leverage

=

Degree of Financial Leverage Degree of Financial Leverage

DFL = EBIT EBIT - I

If we have the data, we can use this If we have the data, we can use this formula:formula:

DCL = DOL x DFL

Degree of Combined Leverage Degree of Combined Leverage

=% change in EPS% change in Sales

change in EPS EPSchange in Sales Sales

=

Degree of Combined Leverage Degree of Combined Leverage

If we have the data, we can use this If we have the data, we can use this formula:formula:

DCL = Sales - Variable Costs EBIT - I

Q(P - V) Q(P - V) - F - I

=