Time-Adjusted Cost-Volume-Profit Analysis with Income Taxes Honeydukes Treat Sho

Question

Time-Adjusted Cost-Volume-Profit Analysis with Income Taxes Honeydukes Treat Shop is considering the desirability of producing a new chocolate candy called Pleasure Bombs. Before purchasing the new equipment required to manufacture Pleasure Bombs, Neville Long, the shop's proprietor performed the following analysis: Unit selling price Variable manufacturing and selling costs Unit contribution margin Annual fixed costs $2.18 1.73 $0.45 Depreciation (straight-line for 4 years) Other (all cash) Total $21,750 45,000 $67,500 Annual break-even sales volume = $67,500 / $0.45 = 150,000 units Because the expected annual sales volume is 160,000 units, Long decided to investment of $87,000 in equipment that has a life of four years and no salvage value. After four years, the production of Pleasure Bombs will be discontinued. With a 40 percent tax rate and a 8 percent time value of money, determine the annual unit sales required to break even on a time-adjusted basis. Assume straight- line depreciation is used to determine tax payments Round UP to the nearest unit. 162,583 x units

Explanation / Answer

We have to determine the no. Of units to be sold, so that the profit earned after taxes should be equal to the additional investment. By considering the time basis so we should use NRV method which is most appropriate.

So we need to the following items:

Let the no. Of units be x.

Total Contribution = $ 0.45x.

Profit Before taxes          = Total contribution – Fixed cost

                                                = $0.45x-67,500

Tax @ 40%                          = 0.40(0.45x-67500)

                                                = 0.18x – 27,000

Profit After taxes             = PBT – Tax

                                                = 0.27x – 40,500.

Cash flows after Taxes = 0.27x – 40,500 + 45,000 (Since Depreciation is non cash expense)

                                                = 0.27x + 4,500.

Since, need to break even the Investment of $87,000 on time basis, the NPV of the Investment should be Zero.

Annual Cash Inflow         = 0.27x + 4,500

NPV factor @8% is (0.9259+0.8573+0.7938+0.7350) = 3.312

Present Value of Future Cash flows = 87,000 (as discussed)

Therefore, 3.312(0.27x + 4,500) = 87,000

0.89424 x + 14,904            = 87,000

Implies x = 80,623 Units.

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