Question

Problem 15-07
Break-even Point

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 $500,000, and the firm's assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $3 million to assets and $490,000 to fixed operating costs. This change will reduce variable costs per unit by $10,000 and increase output by 16 units. However, the sales price on all units must be lowered to $89,000 to permit sales of the additional output. The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 12%, and it uses no debt.

1. 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.
   %

Answer 1

Selling price	95,000
Units sold/year	50
Total Revenues	selling price*units sold/year	4,750,000
Total Profits	500,000
Fixed Costs (F)	2,000,000
Total Assets	5,000,000
Change of production process
Asset addition	3,000,000
Total Assets	8,000,000	<--5,000,000+3,000,000 (existing+addition)
Addition to fixed cost (F)	490,000
Total fixed cost (F)	2,490,000	<--2,000,000+490,000 (existing+addition)
increase in poutput/year	16
Total output/year	66	<--50+16 (existing+addition)
Reduction in var cost/unit	10,000
New sales price/unit	89,000
Sales price/unit adjusted for variable cost/unit	79,000	<--(89,000-10,000)
Total Revenues	5,214,000	<--66*79,000(total units * selling price per unit)
Total costs (Fixed)	2,490,000
Total Profits	2,724,000	<--(Total revenues-total fixed costs)
Incremental Profits	2,224,000	<--2,724,000-500,000(Profits after change-profits before change)
Expected rate of return	incremental profits/addition to assets
	74.13%	<--2,224,000/3,000,000

The case facts and answers are given in the above tabel

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