Question

A project has the following estimated data: price = $72 per unit; variable costs = $27.36 per unit; fixed costs = $8,000; required return = 14 percent; initial investment = $7,000; life = six years. Ignore the effect of taxes. a. What is the accounting break-even quantity? b. What is the cash break-even quantity? c. What is the financial break-even quantity? d. What is the degree of operating leverage at the financial break-even level of output?

Answer 1

a .Accounting break even point is determined by dividing the total fixed costs associated with production by the revenue per individual unit minus the variable costs per unit.in accounting fixed cash includes both cash and non cash expenses which means depreciation also.

Annual depreciation of current project will be

= Initial investment / life of project

= 7000 / 6

= 1167

Accounting break even point will be

= ( Fixed cost + depreciation ) ÷ ( price- varible cost)

= ( 8000 + 1167 ) ÷ (72 - 27.36)

= 9167 ÷ 44.64

= 205 units

b .Cash break even point is similar to accounting break even point but here we need to find minimum sales required to required to recover fixed costs that are cash only..

Cash break even point will be

= Fixed costs ÷ ( price - variable cost)

= 8000 ÷ (72 - 27.36)

= 8000 ÷ 44.64

= 179 units

c. Financi break even point considers that to break even the sales should recover not only fixed cost but also annualised equivalent of project cost also.

Which can be found as ...

Annualised project cost = project cost ÷ PVIFA(14%,6)

= 7000 ÷ 3.8887

= 1801

Now financial break even point is

= (1801 + 8000) ÷ ( 72 - 27.36)

= 9801 ÷ 44.64

= 219.55

= 220 units

d. Degr of operating leverage can be found out by diviy contribution by earnings before interest and tax.

Contribution at financial break even point will be

= 220 × ( 72- 27.36 )

= 220 × 44.64

= 9820.8

EBIT = contribution - fixed cost

= 9820.8 - 8000

= 1820.8

Degree of operating leverage will be

= Contribution ÷ EBIT

= 9820.8 ÷1820.8

= 5.39