Problem 1Alagie DarboeChapter 5 Homework from Lecture

Problem 1Suppose that Bethlehem Steel has a current sales level of $2.5 billion, variable costs of $2 billion, and fixed costs of $400 million. If sales rise by 15 percent, how much will pre-tax profit increase in dollar terms? What will be the percentage increase in pre-tax profit? What explains the relationship between the percentage change in sales and the percentage change in pre-tax profit for Bethlehem?Answer:Sales in $(000)2,500,000,000.00Variable Cost2,000,000,000.00Fixed Cost $(000)400,000,000.00

Current Pre-Tax Profit100,000,000.00New sales after 15% rise2,875,000,000.00New Variable cost2,300,000,000.00Fixed Cost400,000,000.00New Pre-Tax Profit175,000,000.00Increment in Pre-tax Pro.75,000,000.00Percentage Increase75%This problem demonstrates the potential effects of operating leverage.

Problem 2Alagie DarboeChapter 5 Homework from LectureProblem 2In early 1990, Boeing Co. decided to gamble $4 billion to build a new long-distance, 350-seat wide-body airplane called the Boeing 777. The price tag for the 777, scheduled for delivery beginning in 1995, is about $120 million apiece. Assume that Boeings $4 billion investment is made at the rate of $800 million a year for the years 1990 through 1994 and that the present value of the tax write-off associated with these costs is $750 million. Based on estimated annual fixed costs of $100 million, variable production costs of $90 million apiece, a marginal corporate tax rate of 34 percent and a discount rate of 14 percent, what is the break-even quantity of annual unit sales over the Boeing 777s projected 15-year life? Assume that all cash inflows and outflows occur at the end of the year.Units sold per year1Price per unit$120,000,000Variable cost per unit$90,000,000Fixed Costs100000000Initial cost$4,000,000,000Life of the project15yearsDiscount rate14%DepreciationSLTax Rate34%see below for individual calc's-PV (cost)$(4,000,000,000)+PV(depreciation tax shield)0.0+PV(operating CF's)$1,256,694,120=NPV$(2,743,305,880)

PV (cost)$4,000,000,000Initial cost

PV(depreciation tax shield)266,666,667depreciation/year34%Tax Rate$90,666,6676.1422PVIFA15 yrs, 10% discount ratehttp://www.miniwebtool.com/pvifa-calculator/?r=14&n=15

PVIFA Calculator

PV(operating CF's)(Price-Cost)(units)(1-tax rate)PVIFA10,10Interest rate per period:%price$120,000,000Number of period:cost190,000,000price-cost$310,000,000PVIFA Result# of units16.1422(Price-Cost)(units)310,000,0001 minus the tax rate0.66PVIFA6.1422(1-tax rate)PVIFA10,104.053852PV(operating CF's)$1,256,694,120

see below for individual calc's-PV (cost)$(4,005,000,000)+PV(depreciation tax shield)$557,588,916+PV(operating CF's)$851,308,920=NPV$(2,596,102,164)

PV (cost)$4,005,000,000PV(operating CF's)added 5 mil to initial investment

PV(depreciation tax shield)267,000,000depreciation/year34%0$90,780,0006.1422PVIFA15 yrs, 14% discount ratePV(depreciation tax shield)$557,588,916http://www.miniwebtool.com/pvifa-calculator/?r=14&n=15

PV(operating CF's)(Price-Cost)(units)(1-tax rate)PVIFA14,15price$120,000,000cost$90,000,000reduced variable costprice-cost$210,000,000# of units$1(Price-Cost)(units)$210,000,0000.661-tax rate6.1422PVIFA15 yrs, 14% discount rate(1-tax rate)PVIFA10,104.053852PV(operating CF's)$851,308,920

Breakeven occurs when: PV(operating CF's) = PV (cost) - PV (depreciation tax shield)(4000000000-(190000000*5))(X)(.66)(6.1422)PV (cost)$4,000,000,00000.0$4,000,000,00030500000000units4.05385212364248600

Problem 6Alagie DarboeChapter 5 Homework from LectureProblem 6For the following project, the chief financial officer has prepared a set of certainty-equivalent factors to adjust the cash flows for the estimated risk. The economics department has also prepared a set of risk-adjusted interest rates at which to discount the projects cash flow. The projects initial investment is $150,000 and the Treasury security rate is 8 percent Year123Cash flows ($000)$50$75$130Certainty equivalents (finance department)0.9820.9640.947Risk-adjusted rates(economics department)10%12%14%a) What is the NPV of the project from the finance departments estimates? Answer:Year123Finance department$49.10$72.30$123.11NPV(000s)$55.177b) What is the NPV from the economics departments estimates? Answer:NPV(000s)42.9903833771c) What would you advise the company to do?Answer:Accept the project because it has positive net present value. The finance department method (CEQ) may be more reliable if risk and time value are measured consistently and separately.