Commodore Motors management is considering a project to produce toy cars. The pr

Question

Commodore Motors management is considering a project to produce toy cars. The project would require an initial outlay of $100,000 and have an expected life of 10 years. Management estimates that each year during the life of the project depreciation and amortization would be $8,000, capital expenditures would be $4,000, additions to working capital would be 2,000, and fixed costs would be $3000. Also, each toy car would sell for $15 and cost $7 to produce. Finally, the cost of capital for the project would be 12 percent, cash flow from the project would be taxed at a 25 percent rate, and the assets would be depreciated to a salvage value of $0. How many units must be sold each year in order for the project to break even from an economic standpoint?

Explanation / Answer

The break-even point (BEP) in economics, business, and specifically cost accounting, is the point at which total cost and total revenue are equal. In the linear Cost-Volume-Profit Analysis model, the break-even point (BEP) (in terms of Unit Sales (X)) can be directly computed in terms of Total Revenue (TR) and Total Costs (TC) as:

X(Units) = Total fixed cost/Unit Sale Price-Unit Variable Cost

               = Fixed cost + Depreciation and amortisation+ Depreciation of project /15-7

               = 8000+3000+(100000/10)/8

               = 22000/8

               = 2750 Units

Note: we did not consider Capital expenditure in fixed cost as it is not fall in asset definition. If we consider capital expenditure is asset,we calculate depreciation over it and calculate new break even accordingly.

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