Question

Q:

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. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

a) FC at NPV Breakeven ________

a) FC at accounting breakeven _________

b) 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. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

b) Break-even tax rate __________%

c. How would a rise in the tax rate affect the accounting break-even point?

no effect, decrease, or increase

Answer 1

Sales	a	$100,000.00
Variable Cost @ 50%	b = a*50%	$50,000.00
Contribution	c = a-b	$50,000.00
Fixed Costs	d	$30,000.00
Depreciation ($90,000/10 years)	e	$9,000.00
Earnings before tax	f = c-d-e	$11,000.00
Taxes at 30%	g = f*0.3	$3,300.00
Earnings after tax	h = f-g	$7,700.00
Cash Inflow per year	i= h+e	$16,700.00
Cost of Capital		10%
Annuity Factor for 10 years at 10%	j	6.1446
Present Value of Cash Inflows	k = i*j	$102,614.27
Initial Outlfow	l	$90,000.00
NPV	m = k-l	$12,614.27
Accounting Break Even level of Fixed Cost
Earnings before tax	a	$11,000.00
Depreciation	b	$9,000.00
Fixed Costs	c	$30,000.00
	d = a+b+c	$50,000.00
Breakeven Rate of Tax
Initial Outflow	a	$90,000.00
Present Value of Inflow (for breakeven)	b = a	$90,000.00
Annuity Factor	c	6.1446
Cash Inflow per year	d = b/c	$14,647.09
Depreciation	e	$9,000.00
Earnings after tax	f = d-e	$5,647.09
Earnings before tax	g	$11,000.00
Tax	h = g-f	$5,352.91
Tax Rate for Breakeven	i= h/g	48.66%