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 30,000 tons of machine screws annually for automobile production. You will need an initial $3,800,000 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 $600,000 and that variable costs should be $350 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 $340,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $450 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. You require a return of 12 percent and face a marginal tax rate of 38 percent on this project.

  

Calculate the accounting, cash, and financial break-even quantities. (Do not round intermediate calculations and round your final answers to the nearest whole number, e.g., 32.)

  

This problem concerns the effect of taxes on the various break-even measures. Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $3,800,000 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 $600,000 and that variable costs should be $350 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 $340,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $450 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. You require a return of 12 percent and face a marginal tax rate of 38 percent on this project.

Explanation / Answer

Cash break-even = FC / (Price - VC) = 600,000 / (450 - 350) = 6,000

Accounting break-even = (FC + Depreciation) / (Price - VC) = (600,000 + 3,800,000 / 4) / (450 - 350) = 15,500

Financial break-even can be calculated using NPV analysis at which NPV = 0.

Financial break-even = 20,380

Detroit 0 1 2 3 4 Investment -$3,800,000 NWC -$380,000 $380,000 Salvage $340,000 Sales $9,171,180 $9,171,180 $9,171,180 $9,171,180 VC -$7,133,140 -$7,133,140 -$7,133,140 -$7,133,140 FC -$600,000 -$600,000 -$600,000 -$600,000 Depreciation -$950,000 -$950,000 -$950,000 -$950,000 EBT $488,040 $488,040 $488,040 $488,040 Tax (38%) -$185,455 -$185,455 -$185,455 -$185,455 Net Income $302,585 $302,585 $302,585 $302,585 Cash Flows -$4,180,000 $1,252,585 $1,252,585 $1,252,585 $1,843,385 NPV $1.70

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