recalculated loss probabilities associated B u s i n e s s F i n a n c e

From the PDF attached, complete the following 7 questions

1. Verify the current and projected (with the new technology) breakeven levels of sales reported by Wynona Hill. Calculate the degree of operating leverage (DOL) at the projected annual sales level of 5,000 units, first with the current technology (assuming the firm could, in fact, produce 5,000 units with the existing technology) and then with the proposed new technology. Interpret the calculated DOL figures and explain the significance of the higher DOL at the expected sales level with the proposed new technology.

2. Create a graph illustrating Nelson’s total revenue curve and the two total cost curves that C. J. is considering. Identify the two breakeven sales levels (calculated for Question 1 above) on the graph.

3. Calculate the sales volume at which NOI for Nelson is the same under both production methods and show that sales level on the graph.

4. Assume that Wynona’s sales projections come from a normal distribution and the weighted average price of the mix of guitars sold by Nelson is $800 per guitar. Superimpose onto the graph created for Question 2 a probability distribution of sales with an expected sales level, E(Q), of 5,000 units and a standard deviation of 1,100 units. (Be sure the left tail of the probability distribution extends beyond the breakeven level of output for the current production method.) What is the expected net operating income, E(NOI), and the probability of an operating loss with the current technology? With the proposed technology? Identify the areas of operating loss with each technology under the probability distribution.

5. Discuss how you would use your graph to explain the risk-reward implications of the greater operating leverage inherent in the cost structure expected with the proposed new production process.

6. Assume that, upon further investigation, Wynona and her team conclude that the correct standard deviation of the sales distribution is only 600 units rather than 1,100 units. What are the recalculated loss probabilities associated with the current and proposed technologies? How would this new information affect your explanation of the risk-reward implications of the greater operating leverage inherent in the cost structure expected with the proposed new technology?

7. Do you think C. J. has sufficient information to make her final recommendation to Toby and Charley? If so, what do you think her recommendation should be? And if not, what other information or analysis does she need to present to the two officers?

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