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 $492,000. The sales price per pair of shoes is $59, while the variable cost is $13. $173,000 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.)

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 $492,000. The sales price per pair of shoes is $59, while the variable cost is $13. $173,000 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.

Explanation / Answer

Answer:

Financial Break Even = [EAC + After Tax Fixed Cost – Tax on Depreciation] / [(SP – VC) * (1 – Tax Rate)]

Equivalent Annual Cost = Initial Investment / PV of n Annuity of $1 (7%,4)
Equivalent Annual Cost = 492,000 / 3.3872
Equivalent Annual Cost = $145,252.70

After Tax Fixed Cost = $173,000 * (1 – 0.40)
After Tax Fixed Cost = $103,800

Depreciation = 492,000 / 4 = $123,000
Tax on Depreciation = $123,000 * 40% = $49,200

Financial Break Even = [145,252.70 + 103,800 – 49,200] / [(59 – 13) * (1 -0.40)]
Financial Break Even = 199,852.70 / 27.60
Financial Break Even = 7,241.04 units or 7,241 units

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