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 40,000 tons of machine screws annually for automobile production. You will need an initial $5,400,000 investment in threading equipment to get the project started; the project will last for six years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $350 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the six-year project life. It also estimates a salvage value of $280,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $450 per ton. The engineering department estimates you will need an initial net working capital investment of $520,000. You require a return of 16 percent and face a marginal tax rate of 30 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.) Cash break-even Accounting break-even Financial break-even

Explanation / Answer

Accounting break even point is as follows:

Number of untis that can be sold=40,000 tons.

Contribution per ton=$450 -$350

=$100 per ton.

Total contribution earned=$100*40,000

=$4,000,000.

Initial investment =5.4 millions

Life of the equipment =5400000/6

=$900,000.

Other fixed overhead=$800,000

Total fixed cost=$800,000+$900,000

=$1,700,000.

Number of untis that must be sold to earn a contribution of $1,700,000 =

Total fixed cost/Contribution per ton

=$1,700,000/100

=17,000 tons.

Answer for cash break even point:

Cash fixed costs=$800,000.

Contribution per ton=$100.

Number of units to be sold to break even=$800,000/$100.

=8000 units.

Financial break even point:

NPV is zero at what level of sales is the financial break even point.

Total cash outflow at year 0=cost of the machine+net working capital

=$5,400,000+$520,000

=$5,920,000.----------(1)

Cash inflow from the salvage value=$280,000*(1-.30)

=$196,000.

Present value of after tax salvage value=$196,000/1.16^6

=$80,446.68.-------(2)

Present value of recovery of net working capital=$520,000/1.16^6

=$213,429.97.---------(3)

Present value of terminal cash inflows=(2)+(3)

=$293,876.65.-------(4)

Cash flows to be generated by sale of screws=(1)-(4)

=$5,626,123.35.

After tax cash flows required on sale of screws over six year period=present value annuity factor @16% for 6 years is (1-(1+.16)^-6)/.16

=3.6847.

Let x be revenue after tax to be generated per year.

3.6847x=$5,626,123.35.

x=$1526872.885.

This is after tax revenue.

After tax revenue to be generated before tax savings on depreciation=$1526872.885. - $900,000*30%

=$1256872.885

Before tax cash flows to be generated=$1256872.885./.7

=$1795532.69

Number of tons to be sold to generate a pre tax revenue of $1795532.69 is

=$1795532.69/100

=17,955.32 rounded to 17,956 tons of screws.

=$2181246.97

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.