# FINANCE 504 Review Session

3. A bond with a face value of $1,000 matures in 5 years. The bond has an 10% annual coupon and a yield to maturity of 12%. If market interest rates remain at 12%:

a. what will be the price of the bond one year later?

b. what is the current yield?

c. what is the capital gain yield?

7. Aed corporation has fixed cost of $100,000 and variable cost that are 70% of the current sales price of $20. Pavell sells 30,000 units at this price. Aed can increase sales by 10,000 units by cutting its unit price to $15, but variable cost per unit won’t change. Should It cut its price?

8. The following relationship exists for Shome Industries, a manufacturer of electronic components. Each unit of output is sold for $45; the fixed costs are $175,000; variable costs are $20 per unit.

a. What is the firm’s gain or loss at sales of 5,000 unit? Of 12,000 unit?

b. What is the breakeven point?

9. Weir Inc. is considering the purchase of a new production machine for $100,000. Although the purchase of this machine will not produce any increase in sales revenues, it will result in a reduction of labor costs by $31,000 per year. The shipping cost is $7,000. In addition, it would cost $3,000 to install this machine properly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory if $25,000. This machine has an expected life of ten years, after which it will have no salvage value. Finally, to purchase the new machine it appears that the firm would have to borrow $60,000 at 10% from its local bank, resulting in additional interest payment of $6,000 per year. Assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 30% marginal tax rate, and a required rate of return of 12%.

a. what is the initial outlay associated with this project?

b. what are the annual after-tax cash flows associated with this project, for years 1 to 9?

c. what are the terminal cash flows in year 10?

d. Should this machine be purchased?

10. Eolop company now has an investment plan which needs $5m. The company has two financing proposals. Plan A is to borrow $2m at 10% and $3m will need to sell stocks at $50 per common share. Plan B would involve a higher financial leverage. $1m would be raised by selling bonds with an effective interest rate of 10% and the remaining $4 million would be raised by selling common stock at the $50 price per share. The fixed operating cost will be $800,000. The corporate tax rate is 40%.

a. Find the EBIT indifference level associated with the two financing plans.

b. prepare an analytical EBIT-EPS analysis chart for this situation.

c. If a detailed financial analysis procet that long-term EBIT will be in the range of $0.8m to $1m annually, which plan will generate higher EPS?

d. please calculate DOL, DFL and DCL at the point of EBIT being $1 million under plan B.

e. Please describe the meaning of DOL, DFL and DCL.

11. The NDBA corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, NBA would have 200 shares of stock outstanding. Under Plan II, NDBA would have 100 shares of stock and $5,000 in debt outstanding. The interest rate is 12 percent and there are no taxes.

a. if EBIT is $1,000, which plan results in the higher EPS?

b. if EBIT is $2,000, which plan results in the higher EPS?

c. What is the break-even EBIT; that is, what EBIT generates exactly the same EPS under both plans?

a. what will be the price of the bond one year later?

b. what is the current yield?

c. what is the capital gain yield?

7. Aed corporation has fixed cost of $100,000 and variable cost that are 70% of the current sales price of $20. Pavell sells 30,000 units at this price. Aed can increase sales by 10,000 units by cutting its unit price to $15, but variable cost per unit won’t change. Should It cut its price?

8. The following relationship exists for Shome Industries, a manufacturer of electronic components. Each unit of output is sold for $45; the fixed costs are $175,000; variable costs are $20 per unit.

a. What is the firm’s gain or loss at sales of 5,000 unit? Of 12,000 unit?

b. What is the breakeven point?

9. Weir Inc. is considering the purchase of a new production machine for $100,000. Although the purchase of this machine will not produce any increase in sales revenues, it will result in a reduction of labor costs by $31,000 per year. The shipping cost is $7,000. In addition, it would cost $3,000 to install this machine properly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory if $25,000. This machine has an expected life of ten years, after which it will have no salvage value. Finally, to purchase the new machine it appears that the firm would have to borrow $60,000 at 10% from its local bank, resulting in additional interest payment of $6,000 per year. Assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 30% marginal tax rate, and a required rate of return of 12%.

a. what is the initial outlay associated with this project?

b. what are the annual after-tax cash flows associated with this project, for years 1 to 9?

c. what are the terminal cash flows in year 10?

d. Should this machine be purchased?

10. Eolop company now has an investment plan which needs $5m. The company has two financing proposals. Plan A is to borrow $2m at 10% and $3m will need to sell stocks at $50 per common share. Plan B would involve a higher financial leverage. $1m would be raised by selling bonds with an effective interest rate of 10% and the remaining $4 million would be raised by selling common stock at the $50 price per share. The fixed operating cost will be $800,000. The corporate tax rate is 40%.

a. Find the EBIT indifference level associated with the two financing plans.

b. prepare an analytical EBIT-EPS analysis chart for this situation.

c. If a detailed financial analysis procet that long-term EBIT will be in the range of $0.8m to $1m annually, which plan will generate higher EPS?

d. please calculate DOL, DFL and DCL at the point of EBIT being $1 million under plan B.

e. Please describe the meaning of DOL, DFL and DCL.

11. The NDBA corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, NBA would have 200 shares of stock outstanding. Under Plan II, NDBA would have 100 shares of stock and $5,000 in debt outstanding. The interest rate is 12 percent and there are no taxes.

a. if EBIT is $1,000, which plan results in the higher EPS?

b. if EBIT is $2,000, which plan results in the higher EPS?

c. What is the break-even EBIT; that is, what EBIT generates exactly the same EPS under both plans?

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