Question

1. Mod Inc. sells parts for $125 each. Fixed costs are $1,800 per year and variable costs are $80 per unit. If the initial investment is $10,000 and is expected to last for 8 years and the firm pays 35% taxes, what is the accounting and economic break-even level of sales respectively? The initial investment will be depreciated straight-line over 8 years to a final value of zero, and the discount rate is 12%.Please show all work!

Answer 1

Initial Investment = $10,000
Life = 8 years

Depreciation = Initial Investment / Life
Depreciation = $10,000 / 8
Depreciation = $1,250

Contribution Margin per unit = Price per unit - Variable Cost per unit
Contribution Margin per unit = $125 - $80
Contribution Margin per unit = $45

Answer A.

Accounting Breakeven Quantity = (Fixed Costs + Depreciation) / Contribution Margin per unit
Accounting Breakeven Quantity = ($1,800 + $1,250) / $45
Accounting Breakeven Quantity = $3,050 / $45
Accounting Breakeven Quantity = 67.78 or 68 units

Answer C.

Operating Cash Flows = Initial Investment / PVA of $1 (Required Return, Life)
Operating Cash Flows = $10,000 / PVA of $1 (12%, 8)
Operating Cash Flows = $10,000 / 4.967640
Operating Cash Flows = $2,013.03

Operating Cash Flows = [Economic Breakeven Quantity * Contribution Margin per unit - Fixed Costs] * (1 - Tax Rate) + Tax Rate * Depreciation
$2,013.03 = [Economic Breakeven Quantity * $45 - $1,800] * (1 - 0.35) + 0.35 * $1,250
$2,013.03 = [Economic Breakeven Quantity * $45 - $1,800] * 0.65 + $437.50
$1,575.53 = [Economic Breakeven Quantity * $45 - $1,800] * 0.65
$2,423.89 = Economic Breakeven Quantity * $45 - $1,800
$4,223.89 = Economic Breakeven Quantity * $45
Economic Breakeven Quantity = 93.86 or 94 units