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# Leverage, amortization, NPV/IRR and stock valuation

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1) Leverage: Sinclair Manufacturing and Boswell Brothers Inc. are both involved in the production of brick for the homebuilding industry. Their financial information is as follows:
Sinclair Boswell
Capital Structure
Debt @12% \$600,000 \$-
Common stock, \$10 per share 400,000 1,000,000
Total 1,000,000 1,000,000
Common shares 40,000 100,000

Operating Plan
Sales (50,000 units at \$20 each) 1,000,000 1,000,000
Less: Variable costs 800,000 500,000
(\$16 per unit) (\$10 per unit)
Fixed costs - 300,000
Earnings before interest and taxes (EBIT) \$200,000 \$200,000

a If you combine Sinclair's capital structure with Boswell's operating plan, what is the degree of combined leverage? (Round to two places to the right of the decimal point.)
b If you combine Boswell's capital structure with Sinclair's operating plan, what is the degree of combined leverage?
c In part b, if sales double, by what percent will EPS increase?

2) Amortizing Loan: Consider a 4-year amortizing loan. You borrow \$10,000 initially, and repay it in four equal annual year-end payments.
Loan Amt \$10,000 beginning of year
Periods 4 years
Rate 10% per annum
Period Balance Interest Payment Amortization
0 \$10,000
1
2
3
4

a Fill in the following loan amortization schedule
b Why does the amount of interest decline as the loan ages?

3) NPV/IRR
Consider projects A and B:

Cash Flows, Dollars
Project 0 1 2 NPV IRR
A -30000 21000 21000
B -50000 33000 33000
WACC 10%

a Calculate the NPV and IRR for each project. The company's WACC is 10%.
b Assume only one project can be undertaken. Which project would you recommend and why?

4) Stock Valuation: Start-up Industries is a new firm that has raised \$200 million by selling shares of stock. Management plans to earn a 24 percent rate of return on equity, which is more than the 15 percent rate of return available on comparable-risk investments. Half of all earnings will be reinvested in the firm.
a What will be Start-up's ratio of market value to book value?
b How would that ratio change if the firm can earn only a 10 percent rate of return on its investments?
c Why do investments in financial markets almost always have zero NPVs whereas firms can almost always find many investments in their new product markets with positive NPVs?
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