Midterm Exam - Midterm Exam Answer 5 of the following 7...

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Midterm Exam October 17, 2013 Answer 5 of the following 7 questions. They each count 20%. Clearly label which question you are answering. 1. You have decided on a great business idea. To start the business you will need to purchase equipment (to be depreciated for 4 years, but an unlimited life) for $200,000.00, real estate for $500,000.00, and inventory for $30,000. It will take two years before you have any revenue. After that, your revenue will be $400,000 per year, and will remain at the level for ever. The Cost of Goods Sold will be 25% of your revenue while the Operating Expenses will be 20% of your revenue. You will be in the 30% tax bracket. To finance the start-up, you will invest $500,000 and receive 50,000 shares of stock. The remaining portion of the financing can come from one of two sources: (a) an investor that requires an annual return of 20%; or (b) an investor who will require a dividend equal to 25% of the after-tax cash flows until he gets 200% of his investment at which time his shares will be repurchased by the company for $0.01 in total. Assuming that your discount rate is 15%, which option do you choose? 2. CRAZY, Inc. is a new start-up business. The company will require an initial equipment purchase of $250,000, real estate of $400,000, inventory of $125,000, and accounts payable of $40,000. The operating expenses for the company will be $40,000 per year. It will take 3 full years before the company has any sales, it will then have sales of $200,000 per year for next 3 years, and then $225,000 per year every year after that. The equipment will be depreciated over 5 years using the straight-line method. To finance the business, the
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