Question

Schweser Satellites Inc. produces satellite earth stations that sell for$70,000 each. The firm's fixed costs, F, are $3 million, and 50 earth stations are produced and sold each year. Profits total $100,000 , and the firm's assets (all equity financed) are $4 million. The firm estimates that it can change its production process, adding $3 million to assets and $200,000 to fixed operating costs. This change will reduce variable costs per unit by $5,000 and increase output by 30 units. However, the sales price on all units must be lowered to $45,000 to permit sales of tile additional output. The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 16%and it uses no debt.

Required:
a. What is the incremental profit?
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?

Answer 1

Please see attached explanations

Step-by-step explanation:

a Incremental profit would be

= $160,000 - $100,000

= $60,000

b. The firm's break even point will increase by 27.8 units if it makes the change.

c. The new situation would have more business risk than the old one due to;

• Increase in fixed costs

• Business risk will also increase in new situations due to increase in break even point.