This problem concerns the effect of taxes on the various break-even measures. Co

Question

This problem concerns the effect of taxes on the various break-even measures. Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,200,000 investment in threading equipment to get the project started; the project will last for four years. The accounting department estimates that annual fixed costs will be $700,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the four-year project life. It also estimates a salvage value of $350,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $310 per ton. The engineering department estimates you will need an initial net working capital investment of $320,000. You require a return of 13 percent and face a marginal tax rate of 38 percent on this project.

  

Calculate the accounting, cash, and financial break-even quantities. (Do not round intermediate calculations and round your final answers to the nearest whole number, e.g., 32.)

  

This problem concerns the effect of taxes on the various break-even measures. Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,200,000 investment in threading equipment to get the project started; the project will last for four years. The accounting department estimates that annual fixed costs will be $700,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the four-year project life. It also estimates a salvage value of $350,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $310 per ton. The engineering department estimates you will need an initial net working capital investment of $320,000. You require a return of 13 percent and face a marginal tax rate of 38 percent on this project.

Explanation / Answer

Cash break-even = FC / (Price - VC) = 700,000 / (310 - 200) = 6,364 units

Accounting break-even = (FC + Depreciation) / (Price - VC) = (700,000 + 3,200,000 / 4) / (310 - 200) = 13,636 units

Financial break-even can be calculated by changing the units such that the NPV = 0

Financial break-even = 17,635 at which NPV = 0

Detroit 0 1 2 3 4 Investment -$3,200,000 NWC -$320,000 $320,000 Salvage $350,000 Sales $5,466,717 $5,466,717 $5,466,717 $5,466,717 VC -$3,526,914 -$3,526,914 -$3,526,914 -$3,526,914 FC -$700,000 -$700,000 -$700,000 -$700,000 Depreciation -$800,000 -$800,000 -$800,000 -$800,000 EBT $439,803 $439,803 $439,803 $439,803 Tax (38%) -$167,125 -$167,125 -$167,125 -$167,125 Net Income $272,678 $272,678 $272,678 $272,678 Cash Flows -$3,520,000 $1,072,678 $1,072,678 $1,072,678 $1,609,678 NPV $1.14

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