This problem concerns the effect of taxes on the various break-even measures. Co

Question

This problem concerns the effect of taxes on the various break-even measures. Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,000,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $300 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $220,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $360 per ton. The engineering department estimates you will need an initial net working capital investment of $200,000. You require a return of 10 percent and face a marginal tax rate of 38 percent on this project. Calculate the accounting, cash, and financial break-even quantities.

Please show work!

Cash break-even    Accounting break-even    Financial break-even

Explanation / Answer

Cash break-even = Fixed Cost / (Price - VC) = 800,000 / (360 - 300) = 13,333

Accounting break-even = (Fixed Cost + Depreciation) / (Price - VC) = (800,000 + 2,000,000 / 5) / (360 - 300) = 20,000

Financial break-even can be calculated using NPV analysis for which NPV is zero. We get financial break-even quantity at 23,367 units at which NPV is almost zero.

Detroit 0 1 2 3 4 5 Investment -$2,000,000 NWC -$200,000 $200,000 Salvage $220,000 Sales $8,412,127 $8,412,127 $8,412,127 $8,412,127 $8,412,127 VC -$7,010,106 -$7,010,106 -$7,010,106 -$7,010,106 -$7,010,106 FC -$800,000 -$800,000 -$800,000 -$800,000 -$800,000 Depreciation -$400,000 -$400,000 -$400,000 -$400,000 -$400,000 EBT $202,021 $202,021 $202,021 $202,021 $202,021 Tax (38%) -$76,768 -$76,768 -$76,768 -$76,768 -$76,768 Net Income $125,253 $125,253 $125,253 $125,253 $125,253 Cash Flows -$2,200,000 $525,253 $525,253 $525,253 $525,253 $861,653 NPV $0.60

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