[Problem 1] A recently retired corporate executive, Mr. CEO, plans to establish the Big Bike Bicycle Company and manufacture the bikes. He estimates the fixed costs of operations to be $500,000 annually. The variable cost of producing the bikes is forecasted to be $150 per unit.
(a) If the bikes are priced at $200, how many must be sold to break even?
(c) If Mr. CEO seeks to earn $100,000 in profits, how many bikes must be sold?
(d) How much would Big Bike's DOL (Degree of Operating Leverage) be:
(1) At a sales level of $22,000 units
(2) At 30,000 units?
(e) What would be the percentage loss of operating profit if Big Bike's sales tumbled to 24,000 from a high of 40,000 units?
(1) Answer by computing the operating profit at each level of sales.
(2) Answer by using the DOL method.
[Problem 2] You're a Corporate Loan officer for Mannington National Bank evaluating Aluminum Industries, Inc., which has requested a $3 million loan. As the loan officer you are required to assess the firm's financial leverage and risk.
Use the above Balance Sheet, Income Statement, and Industry Averages, prepare a table calculating the following ratios for Aluminum: Debt, Debt-Equity, and Times Interest Earned Ratios. Compare these ratios to the Industry Averages.
Based on your analysis of the calculations and comparisons, make a statement regarding the action you will choose regarding Aluminum's loan request.
[Problem 3] Eastern Chemical Company is considering two mutually exclusive investments. The projects' expected net cash flows are as follows:
Expected Net Cash Flows
Year Project A Project B
0 $(45,000) $(50,000)
1 (20,000) 15,000
2 11,000 15,000
3 20,000 15,000
4 30,000 15,000
5 45,000 15,000
a. Calculate the NPV for each project the RRR is 13%
b. Assuming the Cost of Capital is 13 percent, calculate the IRR for each project.
c. At 13% Cost of Capital, which project should Eastern choose?
d. At 9% Cost of Capital, which project should Eastern choose?
e. At 15% Cost of Capital, Which project should Eastern choose?
f. At what rate doe the NPV profiles of the two projects cross?
[Problem 4] The Hall Company expects to receive the following cash flows in the next 10 years. Calculate the Present Value of this stream of cash flows if the discount rate is 10%.
Year Cash flow
1 $ 2,500,000
2 $ 2,500,000
3 $ 2,500,000
4 $ 4,000,000
5 $ 5,150,000
6 $ 1,225,000
7 $ 5,000,000
8 $ 5,000,000
9 $ 5,000,000
10 $ 5,000,000
The solution explains various questions in finance. The variable costs of producing bikes for a CEO are determined.