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

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 $600,000, and the firm's assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $5 million to assets and $450,000 to fixed operating costs. This change will reduce variable costs per unit by $10,000 and increase output by 23 units. However, the sales price on all units must be lowered to $87,000 to permit sales of the additional output. The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 16%, 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.
%

Solutions

Expert Solution

Selling Price for Satelite Earth Stations =$95000
Units Produced and Sold                             = 50
Fixed Cost                                                         = $2000000
Profit                                                                   = $600000
Variable Cost Per Unit
Let us determine Variable Cost per Unit
Let us Calculate the Variable cost by using the Formula
Profit = Sales-(FC+VC)
$600000 = (50*$95000)-($2000000+50VC)
($2000000+50VC) = $4750000-$600000
($2000000+50VC)=$4150000
50VC                        = $4150000-$2000000
VC                            = $2150000/50
Variable Cost Per Unit = $43000
When it Changes its Production Process
Let us Calculate the new profit
New Sale Price = $87000
New Fixed Cost = $2000000+$450000=$2450000
New Variable Cost = $43000-$10000 =$33000
Profit = Sales -(FC+VC)
Profit = 73 *$87000-(($2000000+$450000)+$33000*73
             = $6351000-($2450000+$2409000)
             = $1492000
Incremenal Profit = $1492000-$600000 = $892000
Rate of return on new Investment
                                                                  = $892000/$5000000
                                                                  = 17.84%

jeff jeffy answered 6 months ago
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