Break-even Point Schweser Satellites Inc. produces satellite earth stations that
ID: 2791701 • Letter: B
Question
Break-even Point
Schweser Satellites Inc. produces satellite earth stations that sell for $95,000 each. The firm's fixed costs, F, are $2.5 million, 50 earth stations are produced and sold each year, profits total $600,000; and the firm's assets (all equity financed) are $6 million. The firm estimates that it can change its production process, adding $4 million to investment and $520,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 19 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 carry forwards that render its tax rate zero, its cost of equity is 14%, and it uses no debt.
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)? Round your answer to two decimal places.
_________%
Explanation / Answer
First, we need to find the variable costs per unit by putting all the information given in the equation below with the number in bold. We will get the sales per year and total contribution margin before working back to variable costs per unit.
Data:
Sales = $95,000 x 50 units 4,750,000
Total Variable Costs ($33,000 x 50 units) 1,650,000
Total Contribution Margin = Sales - Total VC = $3,100,000
Total Fixed Costs 2,500,000
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Net Income = Total CM - Total FC = $ 600,000
Now, company invests $4,000,000 and adds $520,000 to fixed operating costs.
New result will be:
Sales ($90,000 x (50 + 19 units)) 6,210,000
Total Variable Costs (($33,000 - $10,000) x 69 units) 1,587,000
Total Contribution Margin = Sales - Total VC 4,623,000
Total Fixed Costs ($2,500,000 + $520,000) 3,020,000
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Net Income = Total CM - Total FC = 1,600,000
Result of change is increase in Net Income.
Increase in Net income = $1,600,000 - $ 600,000 = $1,000,000 per year.
Thus, company should make the investment.
projects expected rate of return (defined as the incremental profit divided by the investment) = $1,000,000 / $4,000,000 = 0.25 = 25%
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