fm16 4 - probability distribution and the uncertainty about...

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Answers and Solutions: 16 - 4 (4) Estimate the approximate rate of return on new investment: Return = Profit/Investment = $850,000/$4,000,000 = 21.25%. Since the return exceeds the 15 percent cost of equity, this analysis suggests that the firm should go ahead with the change. b. The change would increase the breakeven point: Old: Q BE = V P F = 000 , 50 $ 000 , 100 $ 000 , 000 , 2 $ = 40 units. New: Q BE = 000 , 40 $ 000 , 95 $ 000 , 500 , 2 $ = 45.45 units. c. It is impossible to state unequivocally whether the new situation would have more or less business risk than the old one. We would need information on both the sales
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Unformatted text preview: probability distribution and the uncertainty about variable input cost in order to make this determination. However, since a higher breakeven point, other things held constant, is more risky. Also the percentage of fixed costs increases: Old: ) Q ( V FC FC + = 000 , 500 , 2 $ 000 , 000 , 2 $ 000 , 000 , 2 $ + = 44.44%. New: ) Q ( V FC FC 2 2 2 2 + = 000 , 800 , 2 $ 000 , 500 , 2 $ 000 , 500 , 2 $ + = 47.17%. The change in breakeven points--and also the higher percentage of fixed costs--suggests that the new situation is more risky....
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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