IV. Solve the following questions

1. Gumil Co. plans to purchase a new machine for $600,000 with 12%, 5-year loan. Assume the installment payment would be made immediately. What is the annual payment? (PVIF10%,5 =0.6209, PVIFA10%,5 = 3.7908)

3. (10%) You are considering buying common stock in Fabul Inc. The firm yesterday paid a dividend of $2. You have projected that dividends will grow at a rate of 6% per year indefinitely. The firm's beta is 1.5, the risk-free rate is 3%, and the market return is 13%.

(1) What is the required return of the common stock?

(2) What is the intrinsic value of the common stock?

(3) If the market price of this stock is $35 per share, would you buy or sell the stocks? Why?

4. (10%) The Leau Company manufactures products with the price of $200 per unit; the fixed costs are $1,000,000 for up to 30,000 units; variable costs are $150 per unit. (1) What is the firms EBIT at sales of 30,000 units?

(2) What is the quantity at break-even point?

(3) What is the sales at break-even point?

Comprehensive problems

1. Pural Co. is considering the purchase of a new machine for $900,000 and the installation cost would be $100,000. For the coming 5 years, sales will be $840,000 per year and annual operating costs (exclusive of depreciation) will be $500,000. The purchase of this machine would necessitate an increase in inventory of $100,000. This machine has an expected life of 5 years, after which it will have no salvage value. Assume that straight-line depreciation is used.

The firms cost of capital is 10% and the firms tax rate is 25%.

(1) What is the initial outlay associated with this project?

(2) What are the annual after-tax cash flows associated with this project for years 1 to 5? (3) Should this machine be purchased?

(PVIF10%,5 =0.6209, PVIFA10%,5 = 3.7908)

2. Geler co. now has an investment plan which needs 8 million dollars. The company has two financing proposals.

Plan A is to borrow $2million at 10% and $6 million will need to sell stocks at $40 per common share. Plan B would involve a higher financial leverage. $4 million would be raised by selling bonds with an interest rate of 10% and the remaining $4 million would be raised by selling common stock at the $40 price per share. The corporate tax rate is 25%.

(1) Find the EBIT indifference level associated with the two financing plans. (2) If a detailed financial analysis project that long-term EBIT will be in the range of $1 million to 1.5 million annually, which plan will generate higher EPS?

(3) If the fixed cost is $500,000, please calculate DOL, DFL and DCL at the point of EBIT being $1 million under plan B.