BREAKEVEN ANALYSIS Simply put it, breakeven analysis concerns the most straightf
ID: 2667568 • Letter: B
Question
BREAKEVEN ANALYSISSimply put it, breakeven analysis concerns the most straightforward question in business: How many sales are needed to get revenues exceed costs? This exercise provides an overview of this method. To fix idea, let’s consider some particular numbers: A firm, called A, has purchased a $250,000 machine to produce certain products. The machine will be fully depreciated by the straight-line method over its five-year useful life. Each product sells for $25. The variable cost per product is $6, and the firm incurs fixed costs of $360,000 each year. The corporate tax rate for the company is 34%. The relevant discount rate is 12%
d) Up to now, we haven’t considered the role played by the initial cost for purchasing the machine. It is always the case that when taking into account of initial cost, the cash flow break-even point sales level will lead to a negative NPV, since all cash flows are 0 in the subsequent periods. Let r denote the discount rate. Then a fairly easy way to find out the so called present value break-even point starts by first calculating the equivalent annual cost EAC of the initial investment. In our case, EAC is defined by the following equation $250,000 = EAC x Ar^5
Then we could define the adjusted operating cash flow AOCF by including EAC as one term of cost in each year AOCF = OCF- EAC = [n(p - c) - FC](1 - t) + Dt - EAC. The present value break-even point n is the solution of the equation be setting AOCF = 0. Work out the expression of n using the above equation and find out n of firm A?
Explanation / Answer
d) $250,000 = EAC * A12%^5 =EAC * 3.6048. EAC = $250,000/3.6048. =69351.98. AOCF = [n(p - c) - FC](1 - t) + Dt - EAC Here AOCF is Zero, and p is 25, c is 6, FC is 360,000, D is 50,000. 0 = [n(25 - 6) - 360,000](1-0.34) + 50,000*0.34 - 69,351.98 =(19n - 360,000)0.64 + 17,000 - 69,351.98 =19n -230,400 +17,000 - 69,351.98. 19n =282,751.98 n =282,751.98/19 =14,881.68 =14,881.68Related Questions
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