Operating leverage and break-even analysis

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OPERATING LEVERAGE AND BREAK-EVEN ANALYSIS 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.

Reference no: EM131035636

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