1.P12.4 Breakeven analysis 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.

a.Find the operating breakeven point in number of CDs.

b.Calculate the total operating costs at the breakeven volume found in part a.

c.If Barry estimates that at a minimum he can sell 2,000 CDs per month, should he go into the music business?

d.How much EBIT will Barry realize if he sells the minimum 2,000 CDs per month noted in part c?

2.P12.11 EPS calculations Southland Industries has $60,000 of 16% (annual interest) bonds outstanding, 1,500 shares of preferred stock paying an annual dividend of $5 per share, and 4,000 shares of common stock outstanding. Assuming that the firm has a 40% tax rate, compute earnings per share (EPS) for the following levels of EBIT:

a.$24,600

b.$30,600

c.$35,000

3.P12.24 Integrative—Optimal capital structure 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 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, rd No. of common stock shares Required return, rs

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.

4.P16.2 Loan interest For each of the loan amounts, interest rates, annual payments, and loan terms shown in the following table, calculate the annual interest paid each year over the term of the loan, assuming that the payments are made at the end of each year.

Loan Amount Interest rate Annual payment Term

A $14,000 10% $ 4,416 4 years

B 17,500 12 10,355 2

C 2,400 13 1,017 3

D 49,000 14 14,273 5

E 26,500 16 7,191 6

5.P16.5 Lease versus purchase Northwest Lumber Company needs to expand its facilities. To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 40% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows:

Lease The leasing arrangement requires end-of-year payments of $19,800 over 5 years. All maintenance costs will be paid by the lessor; insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the asset for $24,000 at termination of the lease.

Purchase If the firm purchases the machine, its cost of $80,000 will be financed with a 5-year, 14% loan requiring equal end-of-year payments of $23,302. The machine will be depreciated under MACRS using a 5-year recovery period. (See Table 3.2 on page 108 for the applicable depreciation percentages.) The firm will pay $2,000 per year for a service contract that covers all maintenance costs; insurance and other costs will be borne by the firm. The firm plans to keep the equipment and use it beyond its 5-year recovery period.

a.Determine the after-tax cash outflows of Northwest Lumber under each alternative.

b.Find the present value of each after-tax cash outflow stream, using the after-tax cost of debt.

c.Which alternative—lease or purchase—would you recommend? Why?

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