Question

# A company has a cost of goods of 55% of the selling price of its products. It

has \$275,000 in fixed overhead for administrative expenses, rent and salaries. In addition, it spends 16% of every sales dollar on marketing.

Question #1: What is the company's break-even point?

In order to start the business the owner got an investor to put up \$500,000. The owner wants to pay back the investor out of profits, using 35% of the pre-tax profits to pay the investor, and he has guaranteed the investor he will get back \$750,000.

Question #2: How long will it take to pay back the investor, if sales in year one are \$2 million, and sales increase 14% each year. (Assume fixed expenses will increase each year at the rate of infllation or about 4%)

Question #3: Based purely on the financial return, and not factoring risk (think about this--what creates risk?), would the investor have been better off loaning the company \$500,000 at 10% interest, to be paid back over ten years at \$50,000 per year in principle plus interest, or agreeing to be paid out of profits each year at the rate of 30% of profits? Are there any other factors that should be considered in making a decision.

For the above answers there is no need to take into account or to use Net Present Value concepts.

Would your answer be different if you did take into account Net Present Value in determining which alternative is better? Show calculations.

You may answer the question by providing a mathematical formulas and solving the formulas, or you may answer the question by building a simple spreadsheet. Spread recommended