Olinde Electronics Inc. producesstereo components that sell at P= $100 per unit. Olinde’s fixed costs are $200,000, variable costs are $50 per unit, 5,000 components are produced and sold each year, EBIT is currently $50,000, and Olinde’s assets (all equity-financed) are $500,000. Olinde can change itsproduction process by adding $400,000 to assets and $50,000 to fixed operating costs. Thischange would (1) reduce variable costs per unit by $10 and (2) increase output by 2,000units, but (3) the sales price on all units would have to be lowered to $95 to permit sales ofthe additional output. Olinde has tax loss carry-forwards that cause its tax rate to be zero,it uses no debt, and its average cost of capital is 10%.a. Should Olinde make the change? Why or why not?b. Would Olinde’s break-even point increase or decrease if it made the change?c. Suppose Olinde was unable to raise additional equity financing and had to borrow the$400,000 at an interest rate of 10% to make the investment. Use the DuPont equationto find the expected ROA of the investment. Should Olinde make the change if debtfinancing must be used? Explain.
Olinde Electronics Inc. produces
stereo components that sell at P= $100 per unit. Olinde’s fixed costs are $200,000, variable costs are $50 per unit, 5,000 components are produced and sold each year, EBIT is currently $50,000, and Olinde’s assets (all equity-financed) are $500,000. Olinde can change its
production process by adding $400,000 to assets and $50,000 to fixed operating costs. This
change would (1) reduce variable costs per unit by $10 and (2) increase output by 2,000
units, but (3) the sales price on all units would have to be lowered to $95 to permit sales of
the additional output. Olinde has tax loss carry-forwards that cause its tax rate to be zero,
it uses no debt, and its average cost of capital is 10%.
a. Should Olinde make the change? Why or why not?
b. Would Olinde’s break-even point increase or decrease if it made the change?
c. Suppose Olinde was unable to raise additional equity financing and had to borrow the
$400,000 at an interest rate of 10% to make the investment. Use the DuPont equation
to find the expected ROA of the investment. Should Olinde make the change if debt
financing must be used? Explain.
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