Discuss the limitations of financial leverage


Problem 1. Discuss the limitations of financial leverage.

Problem 2. The Hartnett Corporation manufactures baseball bats with Sammy Sosa's autograph stamped on. Each bat sells for $13 and has a variable cost of $8. There is $20,000 in fixed costs involved in the production process.

a. Compute the break-even point in units.
b. Find the sales (in units) needed to earn a profit of $15,000.

Problem 3. Bond Yields. An AT&T bond has 10 years until maturity, a coupon rate of 8 percent, and sells for $1,100.

a. What is the current yield on the bond?

b. What is the yield to maturity?

Problem 4 Profitability Index. What is the profitability index of a project that costs $10,000 and provides cash flows of $3,000 in Years 1 and 2 and $5,000 in Years 3 and 4? The discount rate is 9 percent.
Problems 5 - 8 refer to two projects with the following cash flows:

Year Project A Project B

0 -$200 -$200

1 80 100

2 80 100

3 80 100

4 80

Cash Flows, Dollars

Project C0 C1 C2 NPV at 10%

A    -30,000 21,000 21,000 +$6,    446

B -50,000 33,000 33,000 +$7,    273

Problem 5. IRR/NPV. If the opportunity cost of capital is 11 percent, which of these projects is worth pursuing?

Problem 6. Mutually Exclusive Investments. Suppose that you can choose only one of these projects. Which would you choose? The discount rate is still 11 percent.

Problem 7. IRR/NPV. Which project would you choose if the opportunity cost of capital were 16 percent?

Problem 8. IRR. What are the internal rates of return on projects A and B?

Problem 9. Cash Flows. We've emphasized that the firm should pay attention only to cash flows when assessing the net present value of proposed projects. Depreciation is a noncash expense. Why then does it matter whether we assume straight-line or MACRS depreciation when we assess project NPV?

Problem 10. Shock Electronics sells portable heaters for $25 per unit, and the variable cost to produce them is $17. Mr. Amps estimates that the fixed costs are $96,000. What is the BEP?

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Finance Basics: Discuss the limitations of financial leverage
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