Problem 1: Future value calculation
Without referring to tables or to the preprogrammed function on your financial calculator, use the basic formula for future value along with the given interest rate, i, and the number of periods, n, to calculate the future value interest factor in each of the cases shown in the following table. Compare the calculated value to the value in Appendix Table.
|
Case
|
Interest rate, i
|
Number of periods, n
|
|
A
|
12%
|
2
|
|
B
|
6
|
3
|
|
C
|
9
|
2
|
|
D
|
3
|
4
|
Problem 2: Breakeven analysis
Barry Carter is considering opening a music store. He wants to estimate the number of CDs he must sell to break even. The CDs will be sold for $13.98 each, variable operating costs are $10.48 per CD, and annual fixed operating costs are $73,500.
1. Find the operating breakeven point in number of CDs.
2. Calculate the total operating costs at the breakeven volume found in part a.
3. If Barry estimates that at a minimum he can sell 2,000 CDs per month, should he go into the music business?
4. How much EBIT will Barry realize if he sells the minimum 2,000 CDs per month noted in part c?
Problem 3: Integrative—Optimal capital structure
Medallion Cooling Systems, Inc., has total assets of $10,000,000, EBIT of $2,000,000, and preferred dividends of $200,000 and is taxed at a rate of 40%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:
|
Capital structure debt ratio
|
Cost of debt, kd
|
No. of common stock shares
|
Required return, ks
|
|
0%
|
0%
|
200,000
|
12%
|
|
15
|
8
|
170,000
|
13
|
|
30
|
9
|
140,000
|
14
|
|
45
|
12
|
110,000
|
16
|
|
60
|
15
|
80,000
|
20
|
1. Calculate earnings per share for each level of indebtedness.
2. Use Equation and the earnings per share calculated in part a to calculate a price per share for each level of indebtedness.
3. Choose the optimal capital structure. Justify your choice.
Problem 4: DFL and graphical display of financing plans
Wells and Associates has EBIT of $67,500. Interest costs are $22,500, and the firm has 15,000 shares of common stock outstanding. Assume a 40% tax rate.
1. Use the degree of financial leverage (DFL) formula to calculate the DFL for the firm.
2. Using a set of EBIT–EPS axes, plot Wells and Associates’ financing plan.
3. If the firm also has 1,000 shares of preferred stock paying a $6.00 annual dividend per share, what is the DFL?
4. Plot the financing plan, including the 1,000 shares of $6.00 preferred stock, on the axes used in part b.
5. Briefly discuss the graph of the two financing plans