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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

    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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    Solution Summary

    Answers to questions on Leverage, Amortizing Loan, NPV/IRR and stock valuation.