Schweser Satellites Inc.

Schweser Satellites Inc.

Schweser Satellites Inc. produces satellite earth stations thatsell for $100,000 each. The firm?s fixed costs, F, are $2 million, 50 earth stationsare 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 itsproduction process, adding $4 million to investment and $500,000 to fixed operatingcosts. This change will (1) reduce variable costs per unit by $10,000 and(2) increase output by 20 units, but (3) the sales price on all units will have to belowered to $95,000 to permit sales of the additional output. The firm has tax losscarryforwards that render its tax rate zero, its cost of equity is 16%, and it uses nodebt.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 thefirm make the investment?b. Would the firm?s 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 thanthe old one?

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