Breakeven Calculation
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A firm produces satellites that sell for $100,000 each. The firm's fixed costs, F, are $2 million. 50 satellites are produced and sold each yr.
Profits total $500,000.
The firm's assets (all equite financed) are $5 million.
The firm estimates it can change the production process by adding $4 million to investments and $500,000 to fixed operating costs.
This change will (1) reduce variable costs by $10,000 and (2) increase output by 20 units, but (3) the sales price on all the units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carryforwards that cause its tax rate to be 0. and its cost of equity is 15% and it uses no debt.
a. Should the firm make the change?
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?
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Solution Summary
The solution explains how to calculate the breakeven point.
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a. Should the firm make the change?
The present return on investment is 500,000/5,000,000=10%, while the cost of capital is 15%, so the firm is actually not generating enough money to service the equity. With the change, the profit is 1,350,000 and the ROI on an investment of 9,000,000 is 15%. This is the return required by ...
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