ANSWER KEY

Question 1 (20 points):

Eric a student is considering setting up a caf at his university campus offering ready-to-drink coffee and cookies to students. To ease up operations, he plans to buy a coffee making machine which would help him prepare a coffee serving with only a finger tip within 1 minute. However, the machine requires quite a lot of investment. Below is a summary of his studies on the projected costs and revenues:
No. Descriptions 1 Fixed costs 1.1 Coffee making machine 1.2 Monthly rental of the caf surface area, including utilities expenses 1.3 Caf fixtures and amenities (tables, chairs, glasses, cups, dishes, etc) 1.4 Caf renovation 1.5 Monthly salaries 2 Variable costs per serving 2.1 Ground coffee 2.2 Cookies 2.3 Others (sugar, milk, ice, etc.) 3 Projected selling price / serving (1 cup of coffee + 2 pieces of cookies) Amount (US$) Remarks 36,000.00 1,500.00 9,600.00 12,000.00 1,000.00 0.40 0.20 0.15 0.05 1.00 Service life: 3 year For the total surface area Service life: 1 year Service life: 2 year

1. What is the total monthly fixed cost for Erics caf? (4 points) 2. How many servings must Erics caf sell a month in order to break even ? (5 points) 3. What are the break-even revenues per month? (5 points) 4. Suppose that Eric decides not to use the coffee making machine. He would employe 2 more people to help him prepare coffee instead. This would increase the monthly salaries to US$ 1,500 / month. Please recompute the break-even quantity (2 point) and break even revenues (2 point) 5. With the coffee making machine replaced by the 2 additional employees as stated in question 1.3 above, how many serveings must Eric sell if he wants US$ 2,000 profit / month? (2 points)

Question 2 (20 points): Apparel Co., has just received an inquiry for an enormous order which would require the company to invest in a new production line. The total investment into this new production line is US$ 1,000,000, quite a substantial amount to a young company like Apparel Co. However, the net cash flows the new production line brings back also seem promising. Here is the data prepared by the Accounting Department:
Year Initial investments Free cash flows Salvage value Required return 0 (1,000,000) 1 70,000 20.00% 2 300,000 3 500,000 4 600,000 5 700,000 200,000

(Notes: Initial Investment, Free cash flow, and salvage value are in US$)

1. Please compute the Net Present Value (NPV) that the new production line would bring back to Apparel Co. (5 points) 2. Suppose that Apparel Co. require a higher rate of return of 27%. Please recompute the NPV. (5 points) 3. What is the IRR of this investment? (7 points) 4. Should Apparel Co. invest in this new production line? If yes, why; If no, why not? (3 points) Question 3 (20 points):

1. What are the advantages and disadvantages of the corporation as a form of ownership? (10 points) 2. What are the differences among the S Corporation, the C Corporation, and the Limited Liability Company? (10 points)