Question

Consider a project to supply Detroit with 27,000 tons of machine screws annually for automobile production. You will need an initial $6,000,000 investment in threading equipment to get the project started; the project will last for 6 years. The accounting department estimates that annual fixed costs will be $1,450,000 and that variable costs should be $275 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 6-year project life. It also estimates a salvage value of $825,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $392 per ton. The engineering department estimates you will need an initial net working capital investment of $580,000. You require a return of 11 percent and face a tax rate of 22 percent on this project.

  

Calculate the accounting, cash, and financial break-even quantities.

Answer 1

Answer to the question :

Given :

Annual Requirement – 27,000 tons

Selling Price $392 per ton

Variable cost $275 per ton

Therefore contribution is $117 per ton ($392-$275)

Annual Fixed cost = $1,450,000 per year

Capital Investment $6,000,000

Salvage value $825,000

Depreciation method is straight line

Therefore annual depreciation = $6,000,000 -825,000

                                                                        6 years

                                                            =$862,500 per year

Initial working capital investment required = $580,000

Required rate of return = 11%

Tax rate = 22%

Therefore interest expenses =$63,800 ($580,000 * 11%)

PARTICULARS	AMOUNT IN $
SALES (27000*392)	$10,584,000
Variable cost (27000*275)	$7,425,000
Contribution	$3,159,000
Less: Fixes Cost	$1,450,000
Less; Depreciation	$862,500
EBIT	$846,500
Less: Interest	$63,800
EBT	$782,700
Less: Tax @22%	$172194
Earning after tax	$610506

Calculation of accounting cash and financial break even quantities:

Breakeven point = fixed cost / contribution per tons

1) Accounting breakeven point is the sales level at which business generates exactly zero profit.

Here the fixed cost means the fixed annual charges that a company must incurred for each of the respective year, including salaries, rental charges and interest expenses.

Therefore fixed cost in the above question is comprises of fixed cost, depreciation and interest charges on working capital loan

Fixed cost = 1,450,000 +$862,500 + $63,800 = 2,338,800

Therefore accounting breakeven point = $2,376,300/117 per tons

                                                                        = 20310.26 tons

                                                                        = say 20311 tons

2) Cash breakeven point = Cash fixed cost / contribution per tons

In the question given, the cash fixed cost is only annual fixed cost as well as interest on working capital loan

Therefore total cash fixed cost = $1,450,000 + $63,800 = $1,513,800

Hence cash breakeven point = $1,513,800/$117 per tons

                                                      = 12938.46 tons

                                                      = say 12939 tons

3) Financial breakeven point = Financial breakeven point is the level of earning before interest and tax that will result in zero net income or zero earning per share

Therefore financial breakeven point = fixed cost + depreciation + interest (1-tax) / contribution per ton

=$1,450,000+$862,500+$63,800(1-0.22)/$117

=$2,362,264/117

=20190.29 tons

=say 20191 tons