Week 5 1
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Running Head: WEEK 5 TEXT ASSIGNMENTS
Week 5 Text Assignments
Michael T. Ryan
University of Phoenix
FIN 419 – Finance for Decision Making
Dana Williams
July 14, 2010
Week 5 2
Week 5 Text Assignments
4.2
Future value calculation
Without referring to tables or to the preprogrammed function on your financial calculator, use
the basic formula for future value along with the given interest rate, i, and the number of
periods, n, to calculate the future value interest factor in each of the cases shown in the following
table. Compare the calculated value to the value in Appendix Table A–1.
Case Interest rate, i
Number of periods, n
A
12%
2
B
6
3
C
9
2
D
3
4
Case
A
B
C
D
FVIF12%,2 periods
FVIF6%,3 periods
FVIF9%,2 periods
FVIF3%,4 periods
 (1  0.12)2  1.254
 (1  0.06)3  1.191
 (1  0.09)2  1.188
 (1  0.03)4  1.126
4.3
Use the future value interest factors in Appendix Table A–1 in each of the cases shown in the
table on the facing page to estimate, to the nearest year, how long it would take an initial deposit,
assuming no withdrawals,
a. To double.
b. To quadruple.
Case
Interest rate
A
7%
B
40
C
20
D
10
Week 5 3
Case A
(a) 2  1  (1  0.07)n
2/1  (1.07)n
2  FVIF7%,n
10 years n  11 years
Nearest to 10 years
Case B
(a) 2  1  (1  0.40)n
2  FVIF40%,n
2 years  n  3 years
Nearest to 2 years
Case C
(a) 2  1  (1  0.20)n
2  FVIF20%,n
3 years  n  4 years
Nearest to 4 years
Case D
(a) 2  1  (1  0.10)n
2  FVIF10%,n
7 years  n  8 years
Nearest to 7 years
(b) 4  1  (1  0.07)n
4/1  (1.07)n
4  FVIF7%,n
20 years  n  21 years
Nearest to 20 years
(b) 4  (1  0.40)n
4  FVIF40%,n
4 years  n  5 years
Nearest to 4 years
(b) 4  (1  0.20)n
4  FVIF20%,n
7 years  n  8 years
Nearest to 8 years
(b) 4  (1  0.10)n
4  FVIF40%,n
14 years  n 15 years
Nearest to 15 years
12.4
Barry Carter is considering opening a music store. He wants to estimate the number of CDs he
must sell to break even. The CDs will be sold for $13.98 each, variable operating costs are
$10.48 per CD, and annual fixed operating costs are $73,500.
1. Find the operating breakeven point in number of CDs.
2. Calculate the total operating costs at the breakeven volume found in part a.
3. If Barry estimates that at a minimum he can sell 2,000 CDs per month, should he go
into the music business?
4. How much EBIT will Barry realize if he sells the minimum 2,000 CDs per month
noted in part c?
Week 5 4
(a) Q 
$73, 500
 21, 000 CDs
 $13.98  $10.48
(b) Total operating costs  FC  (Q  VC)
Total operating costs  $73,500  (21,000  $10.48)
Total operating costs  $293,580
(c) 2,000  12  24,000 CDs per year. 2,000 records per month exceeds the operating breakeven
by 3,000 records per year. Barry should go into the CD business.
(d) EBIT  (P  Q)  FC  (VC  Q)
EBIT  ($13.98  24,000)  $73,500  ($10.48  24,000)
EBIT  $335,520  $73,500  $251,520
EBIT  $10,500
12.19
Data-Check is considering two capital structures. The key information is shown in the following
table. Assume a 40% tax rate.
Source of capital
Structure A
Structure B
Long-term debt
$100,000 at 16% coupon rate
$200,000 at 17% coupon rate
Common stock
4,000 shares
2,000 shares
a. Calculate two EBIT–EPS coordinates for each of the structures by selecting
any two EBIT values and finding their associated EPS values.
b. Plot the two capital structures on a set of EBIT–EPS axes.
c. Indicate over what EBIT range, if any, each structure is preferred.
d. Discuss the leverage and risk aspects of each structure.
e. If the firm is fairly certain that its EBIT will exceed $75,000, which structure
would you recommend? Why?
Week 5 5
(a) Using $50,000 and $60,000 EBIT:
Structure A
$50,000
$60,000
16,000
16,000
$34,000
$44,000
13,600
17,600
$20,400
$26,400
EBIT
Less: Interest
Net profits before taxes
Less: Taxes
Net profit after taxes
EPS (4,000 shares)
EPS (2,000 shares)
$5.10
Structure B
$50,000
$60,000
34,000
34,000
$16,000
$26,000
6,400
10,400
$9,600
$15,600
$6.60
$4.80
Financial breakeven points:
Structure A
$16,000
$7.80
Structure B
$34,000
(b)
Comparison of Financial Structures
8
Sructure B
7
Cros s ove r Point
$52,000
6
5
EPS($
)
4
Structure A
3
2
1
0
10000
20000
30000
40000
50000
60000
EBIT
($)Structure A is preferred. If EBIT is expected to be
(c) If EBIT is expected to be below $52,000,
above $52,000, Structure B is preferred.
(d) Structure A has less risk and promises lower returns as EBIT increases. B is more risky since
it has a higher financial breakeven point. The steeper slope of the line for Structure B also
indicates greater financial leverage.
(e) If EBIT is greater than $75,000, Structure B is recommended since changes in EPS are much
greater for given values of EBIT.
12.21
Medallion Cooling Systems, Inc., has total assets of $10,000,000, EBIT of $2,000,000, and
preferred dividends of $200,000 and is taxed at a rate of 40%. In an effort to determine the
EBIT
($)
Week 5 6
optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of
common stock for various levels of indebtedness, and the overall required return on investment:
Capital structure debt ratio
Cost of debt,kd
No. of common stock shares
Required return,ks
0%
0%
200,000
12%
15
8
170,000
13
30
9
140,000
14
45
12
110,000
16
60
15
80,000
20
a. Calculate earnings per share for each level of indebtedness.
b. Use Equation 12.12
and the earnings per share calculated in part a to
calculate a price per share for each level of indebtedness.
c. Choose the optimal capital structure. Justify your choice.
Week 5 7
(a)
Debt Ratio
EBIT
Less interest
EBT
Taxes @40%
Net profit
Less preferred
dividends
Profits available to
common stock
# shares
outstanding
EPS
0%
$2,000,000
0
$2,000,000
800,000
$1,200,000
15%
$2,000,000
120,000
$1,880,000
752,000
$1,128,000
30%
$2,000,000
270,000
1,730,000
692,000
$1,038,000
45%
$2,000,000
540,000
$1,460,000
584,000
$876,000
60%
$2,000,000
900,000
$1,100,000
440,000
$660,000
200,000
200,000
200,000
200,000
200,000
$1,000,000
$928,000
$838,000
$676,000
$460,000
200,000
$5.00
170,000
$5.46
140,000
$5.99
110,000
$6.15
80,000
$5.75
EPS
ks
Debt: 0%
$5.00
P0 
 $41.67
0.12
Debt: 15%
$5.46
P0 
 $42.00
0.13
Debt: 30%
$5.99
P0 
 $42.79
0.14
Debt: 45%
$6.15
P0 
 $38.44
0.16
(b) P0 
Debt: 60%
$5.75
P0 
 $28.75
0.20
(c) The optimal capital structure would be 30% debt and 70% equity because this is the
debt/equity mix that maximizes the price of the common stock.