NationalU FIN609A PROBLEM SET four 2022

Instructions

 PROBLEM SET FOUR(40 points)

Please answer all of the following questions.  make sure you show all your work.

1. A company is planning the financing of a major expansion.  It will use common stock to fund this expansion.

The company currently has 300,000 shares outstanding selling at an average of $130 per share.

It would sell an additional 50,000 shares to bring in an estimated $5 million.

The new project is expected to raise EBIT by 18% when implemented.

The company’s capital structure contains long-term debt of $10 million which pays interest of 11%.

Current Income Statement

  Net Sales           66,000,000

COGS    42,000,000

Gross Profits      24,000,000

S and A Expenses             9,300,000

Operating Profits             14,700,000

Interest on Debt              1,100,000

EBT         13,600,000

Taxes at 34%      4,600,000

EAT        9,000,000

Develop an analysis of EPS and show the effect of any dilution of earnings.

Develop the same analysis for an alternative issue of $5 million of 10% preferred stock, and an alternative issue of $5 million of 9% debt. Develop specific comparative costs of all three methods and discuss your findings.

 2 .Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment.  The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments.  Sutton can also lease the equipment for 5 end-of-year payments of $1,790,000 each.  How much larger or smaller is the bank loan payment than the lease payment?

3. Carmichael Cleaners needs a new steam finishing machine that costs $100,000. The company is evaluating whether it should lease or purchase the machine. The equipment falls into the MACRS 3-year class, and it would be used for 3 years and then sold, because the firm plans to move to a new facility at that time. The estimated value of the equipment   after 3 years is $30,000. A maintenance contract on the equipment would cost $3,000 per year, payable at the beginning of each year. Alternatively, the firm could lease the equipment for 3 years for a lease payment of $29,000 per

year, payable at the beginning of each year. The lease would include maintenance. The firm is in the 20% tax

bracket, and it could obtain a 3-year simple interest loan, interest payable at the end of the year, to purchase the

equipment at a before-tax cost of 10%. If there is a positive Net Advantage to Leasing the firm will lease the equipment.

 

Otherwise, it will buy it. What is the NAL?

(Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.1481, and 0.0741.)

Cost of Equipment          $100,000

Life of Equipment            3 years

Salvage Value    $30,000

Tax Rate               20%

Maintenance     $3,000 per year

Interest on Loan               10% Simple

4. US Auto Company would like to offer rebates to its customers in order to increase sales.  If it lowers prices sales will increase.    This will depend on the price elasticity of demand.  Assume that the price elasticity of demand is 1.5.  This firm is considering a $400 rebate on its cars.

Also assume the following information on prices and costs before the rebates:

          Average price per car                                   $9,000 per car

          Expected sales volume at $9,000) per car     1,000,000 cars

          Average total costs per car                           $8,200 per car

          Total variable cost                             $6,400,000,000

Calculate the present total fixed costs, average variable costs and average fixed costs.

What is the present breakeven point?

What is the change in revenue resulting from the $400 price reduction?

What is the effect on the cost per car after the change? In other words what is the average cost per car after the change?

Should the change be made?