Problem #1

Maggie's Muffins Bakery generated $5,000,000 in sales during 2016, and its year-end total assets were $2,500,000. Also, at year-end 2016, current liabilities were $1,000,000, consisting of $300,000 of notes payable, $500,000 of accounts payable, and $200,000 of accruals. Looking ahead to 2017, the company estimates that its assets must increase at the same rate as sales, its spontaneous liabilities will increase at the same rate as sales, its profit margin will be 7%, and its payout ratio will be 80%. How large a sales increase can the company achieve without having to raise funds externallythat is, what is its selfsupporting growth rate?

Problem #2

Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 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 $4 million to assets and $500,000 to fixed operating costs. This change will reduce variable costs per unit by $10,000 and increase output by 20 units. However, the sales price on all units must be lowered to $95,000 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.

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)? Should the firm make the investment? Why or why not?
2. Would the firm's break-even point increase or decrease if it made the change?
3. Would the new situation expose the firm to more or less business risk than the old one?