The Cost of Capital; Financial Leverage; Which Counts Most Term Paper

The Cost of Capital; Financial Leverage; Which Counts Most - Term Paper Example The high sale will result in higher profits and a reduction in variable costs signifies that the organization does not have to incur any extra expenses for each unit sold. An increased volume of sales will enable to company to save gain benefits from its fixed costs. The idea of operating leverage was initially developed for utilizing in capital budgeting. Operating leverage is a significant concept as it affects how responsive profits are to transforms into sales volume. â€Å"The Degree of Operating leverage is a function of the cost structure of a firm and is usually defined in terms of the relationship between fixed cost and total costs. A firm that has high fixed costs relative to total costs is said to have operating leverage. A firm with high operating leverage will also have higher variability in operating income than would a firm producing a similar product with low operating leverage† (Choi 20). Other things remaining the same, the high difference in operating income will guide to a high beta for the industry with higher operating leverage. It is helpful to recognize how operating profit will vary with a given change in units formed; operating leverage is helpful to decide the business risks. Operating leverage can also be understood as the degree to which an organization utilizes fixed costs in creating its goods or offering its facilities. A fixed cost contains advertising expenses, equipment and technology, administrative costs, taxes, and depreciation. However, it excludes interest on debt, which is an element of financial leverage. By using fixed production costs, an organization can raise its earnings. If an organization has a high amount of fixed costs, it has a high level of operating leverage. High-tech and automated companies, airlines, utility companies etc commonly have high amounts of operating leverage. The difference between variable and fixed costs is an old idea. This separation of costs by behavior is the basis for breakeven a nalysis. â€Å"The idea of â€Å"break even analysis† is based on the simple question of how many units of product or service a business must sell in order to cover its fixed costs before beginning to make a profit. Presumably, unit prices are set at a level high enough to recoup all direct unit costs and leave a margin of contribution toward fixed cost and profit† (Helfert 193). Once adequate units have been sold to accrue the total contribution required to offset every fixed costs, the margin from any extra units sold will become revenue unless a latest layer of fixed expenses has to be added at any future point to support the high volume. Understanding this attitude will enhance the insight into how operational features of a business involve the elements of financial projections and planning. This information is also useful in setting operational strategies, which, particularly in an unstable business setting might, for instance, focus on reducing fixed costs during outsourcing certain operations. Cost of Capital: The cost of capital means the required rate of return for making capital budgeting. Cost of capital comprises the cost of debt and the cost of equity acquired through different sources. Cost of capital is the average rate of return required by the investors for their long term investments such as equity fund, preference fund and long term capital. When the firm makes long term investm

EXAM Assignment Example | Topics and Well Written Essays - 750 words

EXAM - Assignment Example The impacts of the United States Tax Code on the amount of capital held by the insurers The United States code has reformed in such a way that the individuals who are eligible for paying the insurance fee receive much of the benefits from the insurance companies. The tax codes instituted by the United States have increased the number of people covered in the insurance plans. This enhances a lot of capital tied up in the insurance issues. This increases the amount of capital held by the insurers. Reason why workers are willing to accept the pay as you earn plan instead of the private pension plan One of the fundamental reasons why workers would prefer the pay as you go unfunded pension plans to the private pension plans is due to the cost burden associate with the private pension plan The Pay as you go pension plan offers provisions that allow a regular deduction of a specified amount from the worker’s salary. This would enhance a long run cost benefit to the workers. Private p ension plans also do not have any subsidy and; therefore, the workers may not prefer it. Benefits planners and statutory laws The benefit planners ought to understand the statutory laws provided in the carious sources in order to facilitate an effective plan design and management within the various sectors. Statutory laws are essential to the benefit planners since they are the basis of all other rules, court cases, and regulations affecting the planners. Sources of statutory law in the benefit area The internal revenue code is one of the sources of statutory laws in the benefit area. This involves the taxation that pertains to the amount of deductibles and taxation pensions to the employee benefit programs. This is essential in the determination of the amount of funds deductible from the different employees. It contributes the pay as you go pension plans. Security laws are another statutory law in the benefit area. It involves the protection of the investors. This benefit plan is e ssential in the protection of the amount of money that the employees have. It is, therefore, essential in ensuring the protection of the employee’s excess funds placed forwards as investments. Civil rights laws are also a given law designed for the statutory sectors. This part of the employee compensation policies prohibits different discriminatory elements in employment. This is essential in enhancing fair employee practices during operations. Employee Retirements Income Security Act also affects the benefit planners. This involves the provisions set aside to safeguard the employees’ funds set aside for future benefits. This act ensures protection against fraudulent actions on employee benefit funds. Realized rate of return John’s salary= $20,000 Contribution= 3% Pre-tax return= 15% Tax bracket= 28% John contribution = Yield/dividend after 1year= Final yield= $600+$90= $690 After tax rate of return = Tax deducted = Final amount = $690-$74.52= $615.48 Realized r ate of return = Realized rate of return= 2.58% Mr. Miller’s Illness Mr. Miller’s illness falls under critical illness. By medical diagnosis, to the extent that Mr. Miller have been bedridden for the last three months and does not take solid food, he must be have been diagnosed with histological conformation shown by rapid growth of malignant cells and invasion of tissues of the digestive system. Insurance policies treat these conditions as critical illness. Part A question 1 The liability in this case may be