Schweser Satellites Inc. produces satellite earth stations that sell for $99,100

Question

Schweser Satellites Inc. produces satellite earth stations that sell for $99,100.00 each. The firm's fixed costs, F, are $1.60 million, 65 earth stations are produced and sold each year, profits total $394,000.00; and the firm's assets (all equity financed) are $4 million. The firm estimates that it can change its production process, adding $3.26 million to investment and $410,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,345.00 and (2) increase output by 24 units, but (3) the sales price on all units will have to be lowered to $87,710.00 to permit sales of the additional output. The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 15%, and it uses no debt. a. What is the incremental profit? To get a rough idea of the project's profitability, what is the project's expected rate of return for the next year (defined as the incremental profit divided by the investment)?

Explanation / Answer

. New production volume = 65+24 = 89

New sales = 89*87710 = 7806190

Old contribution/unit = (profit+fixed cost)/no of units = (394000.00+1600,000)/65 = 30676.93

Old variable cost/unit = 99100-30676.93 = 68423.07

So new variable cost/unit = 68423.07-10345 = 58078.07 New profit = new units *(new sales price-new variable cost/unit) - new fixed price = 89*(877100-58078)-(1600000+410000) = 71702958

Incremental profit = new profit-old profit = 71702958-394000 = 71308958

Project's rate of return = 71308958/4,000,000 = 17.83%

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