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Break-even Point Schweser Satellites Inc. produces satellite earth stations that sell for $95,000 each. The firm's fixed...

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Finance

Break-even Point

Schweser Satellites Inc. produces satellite earth stations thatsell for $95,000 each. The firm's fixed costs, F, are $2 million,50 earth stations are produced and sold each year, profits total$400,000; and the firm's assets (all equity financed) are $4million. The firm estimates that it can change its productionprocess, adding $3.5 million to investment and $370,000 to fixedoperating costs. This change will (1) reduce variable costs perunit by $12,000 and (2) increase output by 21 units, but (3) thesales price on all units will have to be lowered to $85,000 topermit sales of the additional output. The firm has tax losscarryforwards that render its tax rate zero, its cost of equity is16%, and it uses no debt.

  1. What is the incremental profit?
    $    
    To get a rough idea of the project's profitability, what is theproject's expected rate of return for the next year (defined as theincremental profit divided by the investment)? Round your answer totwo decimal places.

Answer & Explanation Solved by verified expert
4.5 Ratings (647 Votes)

Calculate variable cost per unit:

Number of units (n)                          50
Price/unit (p)                  95,000
Total sales (S = p*n)            4,750,000
Less: Fixed cost (fc)            2,000,000
Less: Profit (P)              400,000
Variable cost (vc = S -fc -P)            2,350,000
Variable cost/unit (vc/n)                  47,000

Profit if the production process is changed:

Increase of 21 units Number of units (n)                          71
Reduction to 85,000 Price/unit (p)                  85,000
Reduction of 12,000 Variable cost/unit (vc)                  35,000
Contribution margin (cm = p-vc)                  50,000
Total (T = n*cm)            3,550,000
Increase of 370,000 Less: Fixed cost (fc)            2,370,000
(T-fc) Profit (P)            1,180,000

a). Incremental profit = new profit - current profit = 1,180,000 - 400,000 = 780,000

b). Additional investment required = 3,500,000

ROI = Incremental profit/Additional investment = 780,000/3,500,000 = 22.29%
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Break-even PointSchweser Satellites Inc. produces satellite earth stations thatsell for $95,000 each. The firm's fixed costs, F, are $2 million,50 earth stations are produced and sold each year, profits total$400,000; and the firm's assets (all equity financed) are $4million. The firm estimates that it can change its productionprocess, adding $3.5 million to investment and $370,000 to fixedoperating costs. This change will (1) reduce variable costs perunit by $12,000 and (2) increase output by 21 units, but (3) thesales price on all units will have to be lowered to $85,000 topermit sales of the additional output. The firm has tax losscarryforwards that render its tax rate zero, its cost of equity is16%, and it uses no debt.What is the incremental profit?$    To get a rough idea of the project's profitability, what is theproject's expected rate of return for the next year (defined as theincremental profit divided by the investment)? Round your answer totwo decimal places.

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