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?