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Scott, MIT Graduate
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Experience:  MIT Graduate (Math, Programming, Science, and Music)
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Schweser Satellites Inc. produces satellite earth stations

Customer Question

Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 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 $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating cost. The change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales 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 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 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)? Should the firm make the investment

b. Would the firm’s breakeven 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?
Submitted: 8 years ago.
Category: Homework