Importance of interest rates

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1. Explain the importance of interest rates, and how risk is considered to businesses and economic activity.

2. Construct a pro forma income statement for the first year and second year for the following assumptions:

• Units of Sales in Year 1: 110,000
• Price per Unit: \$11
• Variable cost per unit: 30%
• Fixed Costs: \$125,000
• Income taxes: 15%
• Interest Expense: \$200,000
• In year 2, Price per unit increases to \$11.50, and unit of sales increases by 5%, all other assumptions remain the same.

3. Calculate the sustainable growth based on the following information:

• D= 30%
• ROE = 25%

4. Calculate a table of interest rates based on the following information:

a. The pure interest rate is 1.6%

b. Inflation expectations for year 1 = 3%, year 2 =3.5%, years 3-5 =5%

c. The default risk is .1% for year one and increases by .2% over each year

d. Liquidity premium is 0 for year 1 and increases by .2% each year

e. Maturity risk premium is 0 for years 1 and 2 and .2% for years 3-5

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