A project has the following estimated data: price = $48 per unit; variable costs

Question

A project has the following estimated data: price = $48 per unit; variable costs = $32 per unit; fixed costs = $20,500; required return = 8 percent; initial investment = $36,000; life = six years.

Ignoring the effect of taxes, what is the accounting break-even quantity? (Round your answer to 2 decimal places. (e.g., 32.16))

What is the financial break-even quantity? (Round your answer to 2 decimal places. (e.g., 32.16))

What is the degree of operating leverage at the financial break-even level of output? (Round your answer to 3 decimal places. (e.g., 32.161))

A project has the following estimated data: price = $48 per unit; variable costs = $32 per unit; fixed costs = $20,500; required return = 8 percent; initial investment = $36,000; life = six years.

Explanation / Answer

1. Accounting break-even quantity is the quantity where Profit is zero after deducting Total Cost, i.e. Cash and Non-cash cost.
Accounting break-even quantity = Total Fixed Cost/Contribution ratio

Depreciation per year = 36,000 / 6 = $6,000 per year

Total fixed Cost = 20,500 + 6,000 = $26,500

Contribution Ratio = Contribution per unit / Selling price = (48 - 32) / 48 = 33.33%

Accounting break-even = 26,500 / 33.33% = $79,500
Accounting break-even quantity = 79,500 / 48 = 1,656.25 units

Note: It is assumed that Fixed cost given in the question does not include Depreciation.

2. Cash Break Even Point is the point where profit after Cash costs is zero. Depreciation is excluded from total cost since it is the non-cash expense.

Cash Break Even Point = Cash Fixed Cost / Contribution ratio = 20,500 / 33.33% = $61,500
Cash Break Even Quantity = 61,500 / 48 = 1,281.25 units

3. Financial break even point is that level of EBIT where EPS(Earnings Per Share) is Zero. Financial Break Even Point is same as Accounting break even point. Thus, Financial break even point = 1,656.25 units

4. DOL is Contribution divided by EBIT. In this question EBIT at financial break even point is zero since here is no interest and no taxes. Thus, we cannot find DOL in this case and even if we try to calculate by keeping the denominator 0(zero), the DOL will be Infinite.

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