P5-4 Risk Analysis a) Expansion Range A 24% - 16% = 8% B 30% - 20% = 10% b) Project A is less risky, since the

range of outcomes for A is smaller than the range for Project B. c) Since the most likely return for both projects is 20% and the initial investments are equal, the answer depends on your risk pr d) The answer is no longer clear, since it now involves a risk-return trade-off. Project B has a slightly higher return but more risk P5-5 Risk and Probability a) Camera Range R 30% - 20% = 10% S 35% - 15% = 20% b) Possible outcomes Pessimistic Most Likely Optimistic Pessimistic Most Likely Optimistic Probability Expected return Weighted Value (%) ( x ) 0.25 20 5 0.5 25 12.5 0.25 30 7.5 1 Expected return 25 0.2 15 3 0.55 25 13.75 0.25 35 8.75 1 Expected return 25.5

Camera R

Camera S

c) Camera S is considered more risky than Camera R because it has a much broader range of outcomes. The risk-return trade-off is present because Camera S is more risky and also provides a higher return than Camera R.

wer depends on your risk preference. higher return but more risk, while A has both lower return and lower risk.

P10-3 Breakeven cash inflows and risk

a) Project X = (15%,5 . ) = $10,000 x (3.352) = $33,520 NPV = - Initial investment NPV = $33,520 - $30,000 NPV = $3,520 b) Project X $CF x 3.352 = $30,000 $CF = $30,000/3.352 $CF = $8,949.88 c) Project Y $CF x 3.352 = $40,000 $CF = $40,000/3.352 $CF = $11,933.17 Project Y = PMT x (15%,5 .) = $15,000 x (3.352) = $50,280 NPV = - Inital investment NPV = $50,280 -$40,000 NPV = $10,280

Project X Project Y Probability = 60% Probability = 25% d) Project Y is more risky and has a higher potential NPV. Project X has less risk and less return while Project Y has more risk and e) Choose Project X to minimize losses; to achieve higher NPV, choose Project Y.

while Project Y has more risk and more return, thus the risk-return trade-off.

P12-18 Capital structure

a) Mort. Pay./Gross income = $1,100/$4,500 = 24.4% < 28% maximum, therefore OK b) Tot. instal. Pay./Gross income = ($375 +$1,100)/$4,500 = $1,475/$4,500 = 33% < 37% maximum, therefore OK c) Because Kristen's ratios meet the lenders standards, assuming she has adequate funds for the down payment and meet other lender requirements, Kristen will be granted the loan.

P12-20 Debt and financial risk

a) EBIT Calculation Probability Sales Less: Variable costs (70%) Less: Fixed costs EBIT Less Interest Earnings before taxes Less:Taxes Earnings after taxes b) EPS Earnigs after taxes Number of shares EPS

0.2 $200,000 140,000 75,000 ($15,000) 12,000 ($27,000) ($10,800) ($16,200) ($16,200) 10,000 ($1.62)

0.6 $300,000 210,000 75,000 $15,000 12,000 $3,000 1,200 $1,800 $1,800 10,000 $0.18

0.2 $400,000 280,000 75,000 $45,000 12,000 $33,000 13,200 $19,800 $19,800 10,000 $1.98

Expected EPS =
1

Expected EPS = (-$1.62 x 0.20) +($0.18 x 0.60) + $1.98 x 0.20) Expected EPS = -$0.324 + $0.108 + $0.396 Expected EPS = $0.18 c) EBIT* ($15,000) $15,000 $45,000 Less:Interest 0 0 0 Net profit before taxes ($15,000) $15,000 $45,000 Less:Taxes ($6,000) 6,000 18,000 Net profit after taxes ($9,000) $9,000 $27,000 EPS (15,000 shares) ($0.60) $0.60 $1.80 d) Summary Statistics With Debt All Equity Expected EPS $0.18 $0.60 $1.138 $0.76 6.32 1.265

Including debt in Tower Interiors capital structure results in a lower expected EPS, a higher standard deviation, and a much higher coefficient of variation than the allequity structure. Eliminating debt from the firms capital structure greatly reduces financial risk, which is measured by the coefficient of variation.

mum, therefore OK