Part 1What is financial leverage? What are the benefits and risks associated with financial leverage? Why do banks have a low ROA, relative to other industries, but a high ROE?

Part 21. You've been saving up for a new car that you think costs $25,000. You already have $10,000 and you think that, with interest and additional savings, the $10,000 will grow to $20,000 in three years. Suddenly, the phone rings and a voice at the other end of the line tells you that you've won $5,000. You have the choice of collecting the $5,000 immediately, or collecting it in three years which will give you enough money to buy the car. What would you do? Assume that the price of the car stays constant over the three years and that available interest for bank savings is 3%.

1a. You get the same prize but the choice changes to $5,000 now or $5,250 in three years. What do you do?

1b. You get the same prize but the choice changes to $5,000 now or $5,500 in three years. What do you do?

1c. Explain the time value of money using this scenario as an example.

2. What is the difference between EAR (effective annual rate) and APR (annualized percentage rate)? Which one does a better job of measuring return? Give an example (not from the book!) that illustrates your reasoning.

Part 3A. Risk-free assets. Government bonds are considered to be 'risk-free' assets. Why, then, do they give a return? Are they truly completely free of risk?

B. On January 27, 2010, Steve Jobs took the stage to announce, as expected, a new addition to the Apple's (AAPL) product line. The iPad, a tablet computer, recevied good reviews but the stock price fell from a close of $205.94 on January 26th to $192.06 by the weekend. In the same period, the Nasdaq index went from 2203.73 to 2147.35.

Why would the price of AAPL fall just when the company announces an exciting new product?

Comment on what part of the move in AAPL's price was systematic and what part was intrinsic. Assume that AAPL has a beta of 1.28 versus the Nasdaq index.

Part 4What is opportunity cost and why is it an important concept in the capital budgeting process? The opportunity cost concept applies to almost every financial decision we make as individuals. Can you give an example from your own experience? What is the relationship between NPV and discounted payback period. How would you use these concepts in evaluating the economic value of your course of study at UMUC?

Part 5Hotels and airline companies often sell their rooms and seats at deep discounts on sites like www.priceline.com andwww.hotwire.com. The prices for these hotel rooms and airline seats are often way below what the company needs to make to cover its costs.

A. Discuss why airline and hotel companies are willing to do this? (Think about the different types of costs as they apply to hotels and airlines when you present your reasoning.)

B. Airlines as well as hotel companies have their own websites where customers can buy seats or rooms. Why do you think they prefer to use priceline or hotwire for the 'deeply discounted' product rather than their own website? (Note: This is not from the text and is really more of a marketing issue. But, it is always interesting to see the interrelatedness of the different branches of business - so use your marketing knowledge, personally savvy or imagination on this one!)

Part 6This week's question focuses on cost allocation. A major manufacturer decided to put one of its divisions up for sale because managerial information showed the components produced by this division is losing money. A group of employees in the division purchased it. Under the new ownership, the division immediately became profitable.

A. Why do you think the division was profitable immediately under the new ownership?

B. What kind of cost allocation method may have caused the sale of a profitable division, and can you suggest a better method of cost allocation? Explain why?

Note the use of the word immediately above!

Part 7Please respond to the following questions.

2004

Starbucks in 2004 announced that it will increase prices at its stores before the end of year. Analysts expect prices to rise by 4% to 5%. Prices are going up to adjust for increases in dairy products and rents. The firm is seen as the clear leader in the retail coffee market but opinion is split on whether consumers will continue to pay more for their caffeine. Some surveys indicate that people already think they already pay too much for their coffee while others suggest that Starbucks is actually less expensive than many of its competitors.

Now Read and Watch/Listen to the clips on the links below concerning the "Coffee War" today.

Looks like NPR has removed the clip listed below. The clip describes the closing of as many as 600 stores by Starbucks based on performance and proximity to other stores. If you can't see the clip, read this New York Times article instead.

Fast Forward January 2008

http://www.npr.org/templates/player/mediaPlayer.html?&&&&

Current: Starbucks versus Dunkin Donuts

http://abcnews.go.com/video/playerIndex?

(1) From the case in 2004, explain the logic for a price increase from Starbuck's perspective.

(2) Can you discuss the effect of operating leverage to why Starbucks had to close about 600 stores in 2008 and why they are being outcompeted by Dunkin Donuts?