Niko has purchased a brand new machine to produce its High Flight line of shoes.

Question

Niko has purchased a brand new machine to produce its High Flight line of shoes. The machine has an economic life of four years. The depreciation schedule for the machine is straight-line with no salvage value. The machine costs $432,000. The sales price per pair of shoes is $59, while the variable cost is $13. $158,000 of fixed costs per year are attributed to the machine. Assume that the corporate tax rate is 40 percent and the appropriate discount rate is 7 percent. What is the financial break-even point? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) Financial break-even point units

Explanation / Answer

Financial Creak Even is quite different from the normal accounting break even and is the level of sales where the Net Present Value (NPV) is ZERO. This is quite interesting and we need to calculate the Operating Cash Flow (OCF) for the same. This helps us to determine the break even quantity.

In this case, the economic life of the machine is 4 years and the project will have the zero NPV when the value of the OCF equals $432,000 investments. Here, we have not been provided with the annual revenue which seems to be uniform throughout till perpetuity. So we will solve the same by treating the same as ordinary annuity. The four year annuity factor at 7% comes out to be 3.38721. This can be calculated as –

PVAF(7%, 4Y) = 1/1.07^1 + 1/1.07^2 +1/1.07^3 +1/1.07^4 = 3.38721

$432,000 = OCF x 3.38721

OCF = $432,000 / 3.38721

= $127,539

The quantity can be calculated as –

Q = (FC + OCF) / (P – V)

= ($158,000 + $127,539) / ($59 - $13)

= 6207.36 or say 6207 pairs of shoes

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