This problem concerns the effect of taxes on the various break-even measures. Co
ID: 2792724 • Letter: T
Question
This problem concerns the effect of taxes on the various break-even measures. Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,400,000 investment in threading equipment to get the project started; the project will last for four years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $180 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the four-year project life. It also estimates a salvage value of $620,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $300 per ton. The engineering department estimates you will need an initial net working capital investment of $340,000. You require a return of 11 percent and face a marginal tax rate of 38 percent on this project.
Calculate the financial break-even quantity.
Explanation / Answer
Cost of threading machine = $3,400,000, Salvage Value=$620,000, Estimated life of the machine = 4 years
Annual Fixed Depreciation = (Cost of machine - Salvage value)/ Life of the machine = ($3,400,000-$620,000)/4= $695,000
Annual Fixed Cost = $800,000
Depreciation charge = $695,000
Total annual fixed charge = $1,495,000
Return @11% which is = $1,495,000*11% = $164,450
Total amount to be recovered from sale to get 11% return = Total Fixed Charge + Return@11% = $1,495,000+$164,450=$1,659,450
if we consider this as post tax return and tax at 38% than this is 62% of total income
hence, total income = $1,659,450/62%=$2,676,532
Tax @38% of $2,676,532 =$1,017,082
Total annual fixed cost as calulated + tax = $1,659,450+$1,017,082=$2,676,532
Contribution = Sale price - Variable cost = $300-$180=$120 per ton
Breaki Even Point = Fixed Cost/ Contribution =$1,659,450/$120 = 13,829 units
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