Question 1: Discuss the limitations of financial leverage.
Question 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.
Question 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?
Question 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.
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
Question 5: IRR/NPV. If the opportunity cost of capital is 11 percent, which of these projects is worth pursuing?
Question 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.
Question 7. IRR/NPV. Which project would you choose if the opportunity cost of capital were 16 percent?
Question 8. IRR. What are the internal rates of return on projects A and B?
Question 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?
Question 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?