Schweser Satellites Inc. manufactures satellites earth stations which sell for $ 100,000 each. Firm's fixed costs. F, are $2 million; 50 earth stations are manufactured and sold each year; profits total $ 500,000; and firm's assets (all equity financed) are $5 million. Firm evaluates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) decrease variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) sales price on all units will have to be lowed to $95,000 to permit sales of extra output. Firm has tax loss carry-forwards which cause its tax rate to be zero, its cost of equity is 15 percent, and it uses no debt.
a) Must the firm make the changes?
b) Would firm's operating leverage increase or decrease if it made change? What about its breakeven point?
c) Would new situation expose firm to more or less business risk than the old one?