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Chapter 13

1. A $1,000 bond has a coupon of 6 percent and matures after 10 years.

a. What would be the bonds price if comparable debt yields 8 percent?


Price = $1,000 x 0.4632 + $1,000 x 6% x 6.7101
Price = $463.20 + $402.61
Price = $865.81

b. What would be the price if comparable debt yields 8 percent and the bond matures
after five years?
Price = $1,000 x 0.6806 + $1,000 x 6% x 3.9927
Price = $680.60 + $239.56
Price = $920.16

c. Why are the prices different in a and b?


The price is different in a and b because a has longer period.

d. What are the current yields and the yields to maturity in a and b?
Current Yield:
a. $60 / $865.81 = 6.93%
b. $60 / $920.16 = 6.52%

Yield to Maturity (using Financial Calculator)


a. 8%
b. 8%

2.
a. A $1,000 bond has a 7.5 percent coupon and matures after 10 years. If current interest
rates are 10 percent, what should be the price of the bond?
Price = $1,000 x 0.3855 + $1,000 x 7.5% x 6.1446
Price = $385.50 + $460.85
Price = $846.35

b. If after six years interest rates are still 10 percent, what should be the price of the
bond?
Price = $1,000 x 0.6830 + $1,000 x 7.5% x 3.1699
Price = $683 + $237.74
Price = $920.74

c. Even though interest rates did not change in a and b, why did the price of the bond
change
The price of the bond changed because certain time period passed.
d. Change the interest in a and b to 6 percent and rework your answers. Even though the
interest rate is 6 percent in both calculations, why are the bond prices different?
a.
Price = $1,000 x 0.5584 + $1,000 x 7.5% x 7.3601
Price = $558.40 + $552.01
Price = $1,110.41

b.
Price = $1,000 x 0.7921 + $1,000 x 7.5% x 3.4651
Price = $792.10 + $259.88
Price = $1,051.98

Bond prices are still different because the time period remains different.

4. Black stone, inc. has a five-year bond outstanding that pays $60 annually. The face
value of each bond is $1,000, and the bond sells for $890.

a. What is the bonds coupon rate?


Coupon Rate = $60 / $1,000 = 6%

b. What is the current yield?


Current Yield = $60 / $890 = 6.74%

c. What is the yield to maturity?


Using Financial Calculator: 8.814%

9. A bond has the following features:


coupon rate interest: 8%
principal: $1,000
term to maturity: 10 years

a. what will the holder receive when the bond matures? The principal of $1,000

b. If the current rate of interest on comparable debt is 12 percent, what should be the
price of this bond?
Price = $1,000 x 0.3220 + $1,000 x 8% x 5.6502
Price = $322 + $452.02
Price = $774.02

Would you expect the firm to call this bond? Why?


No; because the price of the bond is lower than the par (principal) value.
c. If the bond has a sinking fund that requires the firm to set aside annually with a
trustee sufficient funds to retire the entire issue at maturity, how much must the firm
remit each year for 10 years if the funds earn 9 percent annually and there is $10 million
outstanding?

FV = Annual Payments x FV of Annuity Factor @9% for 10 years


$10,000,000 = Annual Payment x 15.19293
Annual Payment = $10,000,000 / 15.19293
Annual Payment = $658,200.89

The firm should set aside $658,200.89 at the end of each year.

Chapter 19

3. The management of a firm wants to introduce a new product. The product will sell
for $4 a unit and can be produced by either of two scales of operation. In the first total
cost are
TC = $ 3,000 + 2.8Q.
In the second scale of operation, total costs are
TC = $ 5,000 + 2.4Q.

a. What is the break-even level of output for each scale of operation?


First Scale:
Breakeven = $3,000 / ($4 $2.80)
Breakeven = $3,000 / $1.2
Breakeven = 2,500 units

Second Scale:
Breakeven = $5,000 / ($4 $2.40)
Breakeven = $5,000 / $1.6
Breakeven = 3,125 units

b. What will be the firms profits for each scale of operation if sales reach 5,000 units?
First Scale:
Profit = ($4 x 5,000 units) [$3,000 + (2.8 x 5,000 units)]
Profit = $20,000 $17,000
Profit = $3,000

Second Scale:
Profit = ($4 x 5,000 units) [$5,000 + (2.4 x 5,000 units)]
Profit = $20,000 $17,000
Profit = $3,000
c. One half of the fixed costs are noncash (depreciation). All other expenses are for
cash. If sales are 2,000 units, will cash receipts cover cash expenses for each scale of
operation?
First Scale:
Total Cost (Cash) = $1,500 + ($2.8 x 2,000 units) = $7,100
Cash Sales = $4 x 2,000 units = $8,000
Yes; cash receipt can cover cash expenses

Second Scale:
Total Cost (Cash) = $2,500 + ($2.4 x 2,000 units) = $7,300
Cash Sales = $4 x 2,000 units = $8,000
Yes; cash receipt can cover cash expenses

d. The anticipated levels of sales are


Year Unit sales
1 4,000
2 5,000
3 6,000
4 7,000
If management select the scale of production with higher fixed cost, what can it expect in
years 1 and 2?
On Year 1, the management can expect lower profit using the scale with higher fixed
cost. On Year 2, the management can expect indifference of profit between either
scales of production.

On what grounds can management justify selecting this scale of operation?


The indifference point, which is shown in (b), should be the ground in selecting
which scale of production should be used. If the management forecasted a sale below
5,000 units, it is better to use the first scale; if above 5,000 units, the second scale
should be used and if equal to 5,000 units, either of the scales of production may be
used.

If sales reach only 5,000 a year, was the correct scale of operation chosen?
Generally, yes. At 5,000 level of sales, neither scales of production is a wrong choice
as either of the two may be used because they will just yield the same profit.

3. A firm has the following total revenue and total cost schedules:
TR = $2Q.
TC = $4,000 + $1.5Q

a. What is the break-even level of output?


Breakeven = $4,000 / ($2 $1.50)
Breakeven = $4,000 / $0.5
Breakeven = 8,000 units
What is the level of profits at sales of 9,000 units?
Profit = (9,000 units x $2) [$4,000 + ($1.50 x 9,000 units)]
Profit = $18,000 $17,500
Profit = $500

b. As the result of a major technological breakthrough, the total cost schedule is


changed to: TC = $6000 + $ 0.5Q.

What is the break-even level of output?


Breakeven = $6,000 / ($2 $0.50)
Breakeven = $6,000 / $1.50
Breakeven = 4,000 units

What is the level of profits at sales of 9,000 units?


Profit = (9,000 units x $2) [$6,000 + ($0.50 x 9,000 units)]
Profit = $18,000 $10,500
Profit = $7,500

4. The manufacturer of a product that has a variable cost of $2.50 per unit and total
fixed cost of $125,000 wants to determine the level of output necessary to avoid losses.

a. What level of sales is necessary to break even if the product is sold for $4.25?
Breakeven = $125,000 / ($4.25 $2.50)
Breakeven = $125,000 / $1.75
Breakeven = 71,429 units

What will be the manufacturers profit or loss on the sales of 100,000 units?
Profit = (100,000 units x $4.25) ($125,000 + (100,000 units x $2.50)
Profit = $425,000 375,000
Profit = $50,000

b. If fixed costs rise to $175,000, what is the new level of sales necessary to break
even?
Breakeven = $175,000 / ($4.25 $2.50)
Breakeven = $175,000 / $1.75
Breakeven = 100,000 units

c. If variable costs decline to $2.25 per unit, what is the new level of sales necessary to
break even?
Breakeven = $125,000 / ($4.25 $2.25)
Breakeven = $125,000 / $2.00
Breakeven = 62,500 units
d. If fixed costs were to increase to $175,000, while variable costs declined to $2.25
per unit, what is the new break-even level of sales?
Breakeven = $175,000 / ($4.25 $2.25)
Breakeven = $175,000 / $2.00
Breakeven = 87,500 units

e. If a major proportion of fixed costs were noncash (depreciation), would failure to


achieve the break-even level of sales imply that the firm cannot pay its current
obligations as they come due?
No; it does not imply so.

Suppose $100,000 of the above fixed costs of $125,000 was depreciation expense, what
level of sales would be the cash break-even of sales?
Cash Breakeven = $25,000 / ($4.25 $2.50)
Cash Breakeven = $25,000 / $1.75
Cash Breakeven = 14,286 units