Schweser Satellites Inc. produces satellite earth stations that sell for $100,00

Question

Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firms fixed costs, F, are $2 million; 50 earth stations are produced and sold each year; profits total $500,000; and the firms assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carry forwards that cause its tax rate to be zero, its cost of equity is 16%, and it uses no debt.
a. What is the incremental profit? To get a rough idea of the projects profitability, what is the projects expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment?
b. Would the firms break-even point increase or decrease if it made the change?
c. Would the new situation expose the firm to more or less business risk than the old one

Explanation / Answer

here take satelite earth station is a unit cost = 100000 fixed cost = 2 mil total sales = 50*100000 = 5 mill profit = $500000 here the Variable cost = sales -variable cost = fixed cost + profit variableccost = sales - fixed cost - profit = 5000000-2000000-500000 =2.5mill here break even point = fixxed cost / contribution per unti contribution per unit :[sales per unit -variable cost per unit] sales per unit = $100000 variablecost per unit = 2.5mill /50 =$50000 = 100000-50000 =$50000 so the break even point = 2000000 / 50000 40 units adding $4 million to investment and $500,000 to fixed operating costs.: then fixed cost = 2 mill+0.5mil = 2.5 mil (1) reduce variable costs per unit by $10,000 and then variable csot woud be per unit = 50000-10000 = $40000 for 70 units =40000*70 = $2800000 2)increase output by 20 units, out put would be = 50 units + 20 units =70 units 3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output slaes maout would be = 70*95000 =$6650000 profit = sale -v.c-fixed cost = 6650000-2800000-2500000 = 6650000-5300000 =$1350000 NOW WE CAN ANSWER ALL OF THE ABOVE QUESTION ASKED: a) What is the incremental profit? To get a rough idea of the projects profitability, what is the projects expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment?
incremental profit = with proposal profit - without proposal profit = 1350000 - 500000 =$850000 the expected return on the project would be =$850000 / 4000000 =21.25% b. Would the firms break-even point increase or decrease if it made the change?
the new break even point = f / contribution per unit = 2500000 / c c= s-v.c =95000-40000 =55000 so the new nreak even point = $2500000 / $55000 = 45.45 units the implimention of new proposal increases breakeven point to 45.45 units c) Would the new situation expose the firm to more or less business risk than the old one old bussines risk = $500000 / 5000000 10% after implimetation = $ 850000 / 5 mil+ 4mil(aditional) =9.44% it is been reduced bussiness risk from 10% to 9.44%

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