I just need help with question 3, please. ABC company has a cost of goods of 60%
ID: 2772466 • Letter: I
Question
I just need help with question 3, please.
ABC 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.
1) What is the company’s break-even point? I got $ 595,238.10
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.
2) How long will it take to pay back the investor, if sales in year one are $2 million, and sales increase 15% each year. (It is assumed that fixed expenses will increase each year at the rate of infllation or about 2%)
Payback period= 2 years, 2 months, 17 days
3) 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.
Explanation / Answer
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Total Sales 2,000,000 2,300,000 2,645,000 3,041,750 3,498,013 4,022,714 4,626,122 5,320,040 6,118,046 7,035,753 COGS 1,200,000 1,380,000 1,587,000 1,825,050 2,098,808 2,413,629 2,775,673 3,192,024 3,670,827 4,221,452 Sales Expense 360,000 414,000 476,100 547,515 629,642 724,089 832,702 957,607 1,101,248 1,266,435 Fixed expenses 250,000 255,000 260,100 265,302 270,608 276,020 281,541 287,171 292,915 298,773 Pretax Profit 190,000 251,000 321,800 403,883 498,955 608,977 736,206 883,237 1,053,055 1,249,092 Option 1 Return to investor @30% pretax profit 57,000 75,300 96,540 121,165 149,686 182,693 220,862 264,971 315,917 374,728 1,858,862 Option 2 Loan balance from Investor 500,000 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 Principal repayment 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 Interest paid to Investor @10% 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 Total return to investor 100,000 95,000 90,000 85,000 80,000 75,000 70,000 65,000 60,000 55,000 775,000 If the investor is paid back $750,000 in the first option of 30% pretax profit pay off , then the second option of lending @10% interest and $50000 principal pay back for 10 yrs is better as the total return comes to $775,000 in 10 years