Wettway Sailboat Corporation is considering whether to launch its new Margo-clas

Question

Wettway Sailboat Corporation is considering whether to launch its new Margo-class sailboat. The selling price will be $26,000 per boat. The variable costs will be about half that, or $13,000 per boat, and fixed costs will be $600,000 per year. The Base Case: The total investment needed to undertake the project is $2,300,000. This amount will be depreciated straight-line to zero over the five-year life of the equipment. The salvage value is zero, and there are no working capital consequences. Wettway has a 20 percent required return on new projects. 1formula16.mml Use the above expression to find cash, accounting and financial break-even points for Wettway Sailboat. Assume a tax rate of 38 percent. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Problem 11-25 Break-Even and Taxes [LO3] Wettway Sboat Corporation is considering whether to launch its new Margo-class sailboat. The selling price will be $26,000 per boat. The variable costs will be about half that, or $13,000 per boat, and fixed costs will be $600,000 per year. The Base Case: The total investment needed to undertake the project is $2,300,000. This amount will be depreciated straight-line to zero over the five-year life of the equipment. The salvage value is zero, and there are no working capital consequences. Wettway has a 20 percent required return on new projects. Use the above expression to find cash, accounting and financial break-even points for Wettway Sailboat. Assume a tax rate of 38 percent. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Cash break-even 81.54 119.89

Explanation / Answer

Cash break-even point = Fixed cost per year / (Price – variable cost)

= $600,000/ ($26,000 -$13,000)

= $600,000/ $13,000       

= 46.15 boats per year

Accounting break-even point = (Fixed cost per year + depreciation per year)/ (Price – variable cost)

= ($600,000+ $460,000)/ ($26,000 -$13,000)

= $1,060,000/ $13,000    

= 81.54 boats per year

Financial break-even point == (Fixed cost per year + operating cash flow per year at which NPV is zero)/ (Price – variable cost)

= ($600,000+ $1,151,073)/ ($26,000 -$13,000)

= $1,751,073/ $13,000    

= 134.70 boats per year

NPV calculation:

x= 134.70 Year (t) Initial Investment Depreciation (straight line): Intial Investment/5 Fixed cost Variable cost ($13000*x units) Revenue ($26000*x units) Operating cash Flow (OCF) = ( Revenue -Variable cost - fixed cost) Taxable Income = (OCF - depreciation) Income taxes = (Taxable Income *38%) After tax cash flow (ATCF) = (OCF - Income tax) PV of after tax cash flow @20% = ATCF/ (1+20%)^t 0 $2,300,000 N/A -$2,300,000 0 0 -$2,300,000 -$2,300,000 1 $460,000 $600,000 $1,751,073 $3,502,145 $1,151,073 $691,073 $262,608 $888,465 $740,388 2 $460,000 $600,000 $1,751,073 $3,502,145 $1,151,073 $691,073 $262,608 $888,465 $616,990 3 $460,000 $600,000 $1,751,073 $3,502,145 $1,151,073 $691,073 $262,608 $888,465 $514,158 4 $460,000 $600,000 $1,751,073 $3,502,145 $1,151,073 $691,073 $262,608 $888,465 $428,465 5 $460,000 $600,000 $1,751,073 $3,502,145 $1,151,073 $691,073 $262,608 $888,465 $357,054 NPV (sum of PVs) $0 Note: The value of x is calculated by trial and error method where NPV of the project is zero Cash break-even point = 46.15 Accounting break-even point = 81.54 Financial break-even point = 134.70

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