Question

1. A project requires an initial investment of $1,000,000 and is depreciated straight-line to zero salvage over its 10-year life. The project produces items that sell for $1,000 each, with variable costs of $700 per unit. Fixed costs are $350,000 per year. What is the accounting break-even quantity and financial break-even quantity (assume 10% as discount rate)? I'm not too sure how to go about this question. Any help?

Answer 1

Depreciation = Initial Investment / Life
Depreciation = $1,000,000 / 10
Depreciation = $100,000

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $1,000 - $700
Contribution Margin per unit = $300

Answer A.

Accounting Breakeven Quantity = (Fixed Costs + Depreciation) / Contribution Margin per unit
Accounting Breakeven Quantity = ($350,000 + $100,000) / $300
Accounting Breakeven Quantity = $450,000 / $300
Accounting Breakeven Quantity = 1,500 units

Answer B.

Operating Cash Flows = Initial Investment / PVA of $1 (Required Return, Life)
Operating Cash Flows = $1,000,000 / PVA of $1 (10%, 10)
Operating Cash Flows = $1,000,000 / 6.144567
Operating Cash Flows = $162,745.40

Financial Breakeven Quantity = (Fixed Costs + Operating Cash Flows) / Contribution Margin per unit
Financial Breakeven Quantity = ($350,000 + $162,745.40) / $300
Financial Breakeven Quantity = $512,745.40 / $300
Financial Breakeven Quantity = 1,709.15 or 1,709 units