A company has a cost of goods of 60% of the selling price of its products. It has $200,000 in fixed overhead for administrative expenses, rent and salaries. In addition, it spends 18% of every sales dollar on marketing.
1: What is the company’s break-even point?
In order to start the business the owner got an investor to put up $500,000. The owner wants to pay back the investor out of profits, using 30% of the pre-tax profits to pay the investor, and he has guaranteed the investor he will get back $750,000.
2: How long will it take to pay back the investor, if sales in year one are $2 million, and sales increase 15% each year. (Assume fixed expenses will increase each year at the rate of infllation or about 2%)
3: Based purely on the financial return, and not factoring risk (think about this--what creates risk?), would the investor have been better off loaning the company $500,000 at 10% interest, to be paid back over ten years at $50,000 per year in principle plus interest, or agreeing to be paid out of profits each year at the rate of 30% of profits? For the above answers there is no need to take into account or to use Net Present Value concepts.
BONUS POINTS: Would your answer be different if you did take into account Net Present Value in determining which alternative is better? Show calculations.