A company has a cost of goods of 60% of the selling price of its products. It ha

Question

A company has a cost of goods of 60% of the selling price of its products. It has $250,000 in fixed overhead for administrative expenses, rent and salaries. In addition, it spends 18% of every sales dollar on marketing.
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 30% of the pre-tax profits to pay the investor, and he has guaranteed the investor he will get back $750,000.

Question #1: How long will it take to pay back the investor, if sales in year one are $2 million, and sales increase 15% each year. (Assume fixed expenses will increase each year at the rate of infllation or about 2%)

Question #2: Based purely on the financial return, and not factoring risk (think about this), 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?

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

Question #3: Would your answer be different if you did take into account Net Present Value in determining which alternative is better? Show calculations.

Explanation / Answer

The investor will be paid $750000 fully in the 7th year.

The investor would be better off by agreeing to be paid 30% out of profits as the amount being paid in the second scenario is higher.

Year Sales COGS Fixed Costs Marketing Profit Payment to investor Total 1 2000000 1200000 250000 360000 190000 57000 903246.2 2 2300000 1380000 255000 414000 251000 75300 3 2645000 1587000 260100 476100 321800 96540 4 3041750 1825050 265302 547515 403883 121164.9 5 3498012.5 2098807.5 270608.04 629642.25 498954.71 149686.41 6 4022714.38 2413628.63 276020.20 724088.59 608976.96 182693.09 7 4626121.53 2775672.92 281540.60 832701.88 736206.13 220861.84

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.