**There should be 5 answers... A through E** Schweser Satellites Inc. produces s
ID: 2753769 • Letter: #
Question
**There should be 5 answers... A through E**
Schweser Satellites Inc. produces satellite earth stations that sell for $95,000 each. The firm's fixed costs, F, are $2 million, 50 earth stations are produced and sold each year, profits total $500,000; and the firm's assets (all equity financed) are $4 million. The firm estimates that it can change its production process, adding $3.5 million to investment and $350,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $7,000 and (2) increase output by 25 units, but (3) the sales price on all units will have to be lowered to $90,000 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?
$ _________
B. 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)? Round your answer to two decimal places.
_________%
C. Should the firm make the investment?
Yes or No?
D. Would the firm's break-even point increase or decrease if it made the change?
Increase or Decrease?
E. Would the new situation expose the firm to more or less business risk than the old one?
I. The new situation would obviously have more business risk than the old one.
II. The new situation would obviously have less business risk than the old one.
III. It is impossible to state unequivocally whether the new situation would have more or less business risk than the old one.
Explanation / Answer
A.
Calculation of Incremental profit
50 Units
Per Unit
75 Units
Per Unit
Sales
$47,50,000
$95000
$67,50,000
$90000
Variable Cost
$2250000
$45000
$28,50,000
$38000
Contribution
$2500000
$50000
$39,00,000
$52000
Fixed Cost
$20,00,000
$40000
$23,50,000
$31333
Profit
$5,00,000
$10000
$15,50,000
$20667
The Incremental Profit is$10,50,000
B. Project’s Expected Rate of return = Incremental Profit/Investment
= $10,50,000/3500000*100
= 30%
C. Yes , The firm should make the investment as the return on investment of 30%> its cost of Equity 15%
D. Break even Point OLD = Fixed Cost/Contribution per unit
= 2000000/50000
= 40 Units
Break even Point New = Fixed Cost/Contribution per unit
= 2350000/52000
= 45 Units
On Accepting the Project the Firms Break even Point would Increase
E. It is impossible to state unequivocally whether the new situation would have more or less business risk than the Old one because the probability of sales and certainty about variable input is unknown. But the higher break even point and Higher Fixed cost suggest that the situation is more risky.
Calculation of Incremental profit
50 Units
Per Unit
75 Units
Per Unit
Sales
$47,50,000
$95000
$67,50,000
$90000
Variable Cost
$2250000
$45000
$28,50,000
$38000
Contribution
$2500000
$50000
$39,00,000
$52000
Fixed Cost
$20,00,000
$40000
$23,50,000
$31333
Profit
$5,00,000
$10000
$15,50,000
$20667
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