In: Finance
Break-even calculations are most often concerned with the effect of a shortfall in sales, but they could equally well focus on any other component of cash flow. Dog Days is considering a proposal to produce and market a caviar-flavored dog food. It will involve an initial investment of $90,000 that can be depreciated for tax straight- line over 10 years. In each of years 1 to 10, the project is forecast to produce sales of $100,000 and to incur variable costs of 50% of sales and fixed costs of $30,000. The corporate tax rate is 30%, and the cost of capital is 10%.
a) Calculate the NPV and accounting break-even levels of fixed costs.
b) Suppose that you are worried that the corporate tax rate will be increased immediately after you commit
to the project. Calculate the break-even rate of taxes.
c) How would a rise in the tax rate affect the accounting break-even point?
CALCULATION OF NPV | ||||||||||
I | Initial Cash Flow | ($90,000) | ||||||||
a | Annual Sales | $100,000 | ||||||||
b=a*50% | Annual Variable costs | $50,000 | ||||||||
c=a-b | Annual contribution margin | $50,000 | ||||||||
d | Annual Fixed Cost (excluding depreciation) | ($30,000) | ||||||||
e | Annual depreciation =90000/10 | -$9,000 | ||||||||
f=c+d+e | Annual Operating Profit (Before Tax) | $11,000 | ||||||||
g=f*(1-0.3) | Annual Operating Profit after tax | $7,700 | ||||||||
h | Add: Annual Depreciation (Non Cash expense) | $9,000 | ||||||||
i=g+h | Annual Operating Cash Flow | $16,700 | ||||||||
Rate | Discount Rate =Cost of Captal | 10% | ||||||||
Nper | Number of years of cash inflow | 10 | ||||||||
Pmt | Annual Operating cash flow | $16,700 | ||||||||
PV | Present Value of annual operating cash inflow | $102,614.27 | (Using PV function of excel with Rate=10%, Nper=10, Pmt=-16700) | |||||||
NPV=PV+I | Net Present Value (NPV) | $12,614.27 | ||||||||
ACCOUNTING BREAKEVEN OF FIXED COST | ||||||||||
a | Annual contribution margin | $50,000 | ||||||||
b | Annual Depreciation | -$9,000 | ||||||||
c=a+b | Accounting Breakeven Fixed Cost | $41,000 | ||||||||
(b) | BREAKEVEN RATE OF TAXES | |||||||||
a | Initial Investment | $90,000 | ||||||||
b | Required Present Value of Cash inflows | $90,000 | ||||||||
PMT | Annual after tax cash inflow required for breakeven | $14,647 | (Using PMT function of excel with Rate=10%, Nper=10, Pv=-90000) | |||||||
c | Annual Depreciation | $9,000 | ||||||||
d=PMT-c | Annual after tax Operating Profit Required | $5,647 | ||||||||
e | Annual Before tax Operating Profit | $11,000 | ||||||||
11000*(1-Tax Rate)=5647 | ||||||||||
BREAKEVEN RATE OF TAXES=1- (5647/11000) | 0.486628587 | |||||||||
BREAKEVEN RATE OF TAXES=1- (5647/11000) | 48.66% | |||||||||
.(c) | A Rise in taxes will reduce the after tax accounting profit | |||||||||
This will NOT affect the Break Even sales | ||||||||||
Break Even Sales =Fixed Cost/(Contribution Margin Ratio) | ||||||||||
These figures are not affected by tax rate | ||||||||||