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 20,000 tons of machine screws annually for automobile production. You will need an initial $2,800,000 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 $750,000 and that variable costs should be $260 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 $370 per ton. The engineering department estimates you will need an initial net working capital investment of $280,000. You require a return of 14 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.)

  

  Cash break-even?

  Accounting break-even?

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 $2,800,000 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 $750,000 and that variable costs should be $260 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 $370 per ton. The engineering department estimates you will need an initial net working capital investment of $280,000. You require a return of 14 percent and face a marginal tax rate of 38 percent on this project.

Explanation / Answer

Cash break-even = Fixed Cost / (Price - Variable Cost) = 750,000 / (370 - 260) = 6,818 units

Accounting break-even = (Fixed Cost + Depreciation) / (Price - VC)

= (750,000 + 2,800,000 / 5) / (370 - 260)

= 11,909 units

Financial break-even units can be calculated using NPV analysis. We need to find the units for which NPV = 0 using trial and error method. We get NPV = 0 when quantity = 15,929 which is the financial break-even.

Detroit 0 1 2 3 4 5 Investment -$2,800,000 NWC -$280,000 $280,000 Salvage $220,000 Sales $5,893,737 $5,893,737 $5,893,737 $5,893,737 $5,893,737 VC -$4,141,545 -$4,141,545 -$4,141,545 -$4,141,545 -$4,141,545 FC -$750,000 -$750,000 -$750,000 -$750,000 -$750,000 Depreciation -$560,000 -$560,000 -$560,000 -$560,000 -$560,000 EBT $442,192 $442,192 $442,192 $442,192 $442,192 Tax (38%) -$168,033 -$168,033 -$168,033 -$168,033 -$168,033 Net Income $274,159 $274,159 $274,159 $274,159 $274,159 Cash Flows -$3,080,000 $834,159 $834,159 $834,159 $834,159 $1,250,559 NPV $1.06

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