Breakeven and Leverage calculations are used to adjudge the operational riskines

Question

Breakeven and Leverage calculations are used to adjudge the operational riskiness of a company, project or investment. The Breakeven and Leverage estimates are compared to projections to assess the forecasting risk associated with the project. Consider the following information for a project with an initial investment of $ 2,500,000, a five year project life and a required rate of return of 15%:

Unit Price                    Unit VC          Fixed Costs                 Depreciation

$ 47                           $ 22               $ 900,000                 $    450,000

What is the ACCOUNTING BREAKEVEN POINT for the project in UNITS?

What is the ACCOUNTING BREAKEVEN POINT in DOLLARS?

What would the CASH BREAKEVEN QUANTITY for the project be IF the CONTRIBUTION MARGIN PER UNIT could be raised to $ 30 through operating cost efficiencies?

What is the project’s FINANCIAL BREAKEVEN POINT for the project information first provided above (i.e. P = 47; VC = 22, FC = 900,000; DEPN = 450,000)?

What is the DEGREE of OPEATING LEVERAGE (DOL) at the FINANCIAL BREAKEVEN POINT calculated above?

Explanation / Answer

Answer:

Cash Break even point = (Fixed costs- Non-cash expenses)/Contribution per unit

= ($1,350,000 - $450,000) / $30 = 30,000 units

Computation of financial BEP:

It is EBIT required to pay off the fixed commitment to capital - i.e the required income on investment= $2,500,000*15% = $375,000

Particulars Per unit-in$ a Sales price 47 b Variable cost 22 c Contribution margin (a-b) 25 d Contribution ratio (c/a) 0.5319149 e Fixed cost 1350000 ($900000+450000) f Accounting break even -units(e/c) 54000 g Accounting break even-In$ (e/d) 2538000

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