A project has the following estimated data: price = $56 per unit; variable costs

Question

A project has the following estimated data: price = $56 per unit; variable costs = $35 per unit; fixed costs = $18,500; required return = 8 percent; initial investment = $45,000; life = five years.

Ignoring the effect of taxes, what is the accounting break-even quantity? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.)

  

  

  

What is the financial break-even quantity? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.)

  

  

What is the degree of operating leverage at the financial break-even level of output? (Do not round intermediate calculations. Round your answer to 3 decimal places, e.g., 32.161.)

  

Ignoring the effect of taxes, what is the accounting break-even quantity? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

(d) The DOL of the project is:

Solution: Ignoring the effect of taxes, what is the accounting break-even quantity? (a) The accounting breakeven for the project is: Fixed costs $18,500 Initial Investment $45,000 Life 5 years Price $56 per unit Variable costs $35 per unit Required return 8% Q A = [Fixed cost + (Initial Investment/ life)]/(Price – Variable cost) Q A = [$18,500 + ($45,000/5)]/($56 – 35)] $45,000/5 = $9,000 $9,000+$18,500 = $27,500 $56-$35 = $21 $27,500 / $21 = 1309.52 What is the cash break-even quantity? (b) The cash breakeven is: Q C = [Fixed cost /(Price – Variable cost)] Q C = [$18,500/($56 – 35)] $18,500/$21 = 880.95 What is the financial break-even quantity? (c) At the financial breakeven, the project will have a zero NPV. Since this is true, the initial cost of the project must be equal to the PV of the cash flows of the project. Using this relationship, we can find the OCF of the project must be: NPV = 0 $45,000 = OCF(PVIFA 8%,5 ) By using the PVIFA table @ 8% for the period of 5 years valueis 3.99271 OCF(PVIFA 8%,5 ) value = 3.99271004 OCF = $45,000 / 3.99271 = $11,270.54 OCF = $ 11,270.54 Using this OCF, we can find the financial breakeven is: Q F = (Fixed costs + OCF)/(Price – Variable Costs) Q F = ($18,500 + 11,270.54)/($56 – 35) = $1,417.64 Q F = ($29,770.54)/($21) = $1,417.64 What is the degree of operating leverage at the financial break-even level of output?

(d) The DOL of the project is:

DOL = 1+ (Fixed costs/ OCF) DOL = 1 + ($18,500/$11,270.54) = 1 + 1.64 = 2.64

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