Sandro Aero Inc. produces satellite earth station that sells for RM100,000 each. The firm’s fixed cost are RM2 million, 50 earth stations are produced and sold each year, profits total RM500,000 and the firm’s assets (all equity financed) are RM5 million.The firm estimates that it can change its production process, adding RM4 million to investment and RM500,000 to fixed operating costs. This change will:Reduce variable cost per unit by RM10,000Increase output by 20 unitsThe sales price on all units will have to be lowered to RM95,000The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 16% and uses no debt.What is the incremental profit? What is the project’s expected return next year? Should the firm make the investment?Would the firm break-even point increase or decrease if it made the change?Would the new situation expose the firm to more or less business risk than the old one?

Given information: Sales RM 100,000 each 50 units of earth stations produced and sold each year,…

Answered: Sandro Aero Inc. produces satellite…

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter16: Capital Structure Decisions

Section: Chapter Questions

Problem 7P

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Sandro Aero Inc. produces satellite earth station that sells for RM100,000 each. The firm’s fixed cost are RM2 million, 50 earth stations are produced and sold each year, profits total RM500,000 and the firm’s assets (all equity financed) are RM5 million.

The firm estimates that it can change its production process, adding RM4 million to investment and RM500,000 to fixed operating costs. This change will:

Reduce variable cost per unit by RM10,000
Increase output by 20 units
The sales price on all units will have to be lowered to RM95,000

The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 16% and uses no debt.

What is the incremental profit? What is the project’s expected return next year? Should the firm make the investment?
Would the firm break-even point increase or decrease if it made the change?
Would the new situation expose the firm to more or less business risk than the old one?

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