(See attached file for full problem description)
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:
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
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
a Fill in the following loan amortization schedule
b Why does the amount of interest decline as the loan ages?
Consider projects A and B:
Cash Flows, Dollars
Project 0 1 2 NPV IRR
A -30000 21000 21000
B -50000 33000 33000
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?
Answers to questions on Leverage, Amortizing Loan, NPV/IRR and stock valuation.