Schweser satellites inc produces

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HOMEWORK SET 5

Directions: Answer the following questions on this document. Explain how you reached the answer

or show your work if a mathematical calculation is needed, or both. Submit your assignment using

the assignment link in the course shell. This homework assignment is worth 100 points.

YOU MUST ENTER CORRECT INFORMATION IN THE YELLOW-CODED CELLS

DO NOT TOUCH THE NON-YELLOW-CODED CELLS

ANSWERS ARE IN THE RED-BORDERED CELLS

Use the following information for Questions 1 through 3:

Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013

Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings

are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion.

This one-time unusual earnings growth won't be maintained, though, and after 2014 Boehm will return

to its previous 8% earnings growth rate. Its target debt ratio is 35%.

Calculate Boehm's total dividends for 2014 under each of the following policies.

1. Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.

6.00% Boehm's stable earnings growth rate

$2,000,000 Boehm's 2013 dividends (amount)

$2,120,000 Dividends for 2014

It continues the 2013 dividend payout ratio.

$10,000,000 Net income in 2013

$2,000,000 Dividends paid in 2013

$15,000,000 Net income in 2014

20.00% Dividend payout ratio in 2013

$3,000,000 Dividends for 2014

2. It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million

investment is financed with debt).

$8,000,000 Cost of plant expansion

65.00% Portion financed with equity (100% - 35%)

$5,200,000.00 Equity financing needed

$13,000,000 Net income for 2014

$7,800,000 2014 Dividends = Net income - equity financing

It employs a regular-dividend-plus-extras policy, with the regular dividend being based on

the long-run growth rate and the extra dividend being set according to the residual policy.

$7,855,000 Dividends required by residual policy (calculated in No. 3 above)

$2,808,000 Regular dividends based on long-run growth rate (1.08% times $2013 dividend)

$5,047,000 Extra dividend

Use the following information for Questions 5 and 6.

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 investment and $500,000 to fixed operating costs. The change will

(1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on

all units will have to 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.

3. 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?

First, determine the variable cost per unit (V) at present:

Profit = P (Q) - FC - V (Q)

$400,000 Annual profits

$90,000 Price per unit

50 Units sold per year

$2,000,000 Fixed costs per year

$42,000 = Variable Cost per Unit

Second, determine the new profit level if the change is made:

New Profit - P2 * Q2 - FC2 - V2 (Q2)

$80,000 New Price per unit

70 New Units sold per year

$2,500,000 New Fixed costs per year

$32,000 New Variable costs per year

$860,000 = New Profit Level

Third, determine the incremental profit.

$860,000 New Profit Level

$500,000 Previous Annual Profit Level

$360,000 = Incremental Profit

9.00% Return on the Investment

16.00% Cost of capital (equity)

Don't Make Investment Should the investment be made?

4. Would the firm's breakeven point increase or decrease if it made the change?

42 Old Breakeven Point

52.08 New Breakeven Point

Breakeven point increases

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