Problem 1

GBK, Inc. is considering a new product. The proposal is as follows:

   Project cost: $2,000,000
   Project life: 5 yrs
   Salvage value: zero
   Depreciation: straight line to zero
   Sales projection: 180 units per year
   Price per unit: $20,000
   Variable cost per unit will be: $12,400
   Fixed costs per year: $490,000
   Required return on the project: 10%
   Relevant tax rate: 35%

Based on our past experience, the unit sales, variable costs and fixed cost projections are probably accurate to within plus or minus 10%

A] What are the upper and lower bounds for these projections?

B] What is the base case NPV?

C] What are the best case and the worst case scenarios?

D] Evaluate the sensitivity of your base-case NPV to changes in fixed costs.

E] What is the cash break-even level of output for this project (ignoring taxes)?

F] What is the accounting break-even level of output for this project? What is the degree of operating leverage at the accounting break-even point? How do you interpret this number?

Problem 2

You purchased one GBK, Inc. 6 percent coupon bond one year ago for $1,020. The bond makes annual payments and matures four years from now. You sell the bond today when the required return is 5 percent. The inflation rate was 2.8 percent over the past year. What was the real return on your investment?