Question

Time-Adjusted Cost-Volume-Profit Analysis with Income Taxes Honeydukes Treat Shop is considering the desirability of producing a new chocolate candy called Pleasure Bombs. Before purchasing the new equipment required to manufacture Pleasure Bombs, Neville Long, the shop's proprietor performed the following analysis: $2.23 1.73 $0.50 Unit selling price Variable manufacturing and selling costs Unit contribution margin Annual fixed costs Depreciation (straight-line for 4 years) Other (all cash) Total $23,000 45,000 $68,000 Annual break-even sales volume = $68,000 / $0.50 = 136,000 units Because the expected annual sales volume is 160,000 units, Long decided to undertake the production of Pleasure Bombs. This required an immediate investment of $92,000 in equipment that has a life of four years and no salvage value. After four years, the production of Pleasure Bombs will be discontinued. With a 40 percent tax rate and a 8 percent time value of money, determine the annual unit sales required to break even on a time-adjusted basis. Assume straight-line depreciation is used to determine tax payments. Round UP to the nearest unit. 256,000 units Check

Answer 1

Let Annual Sales be X Contribution 0.50 X () Depreciation 23000 (-) Other (all cash) -45000 Net Income before tax 0.50X-68000 () Tax at 40% -0.20X+27200 Net Income after tax 0.30X-40800 (+) Depreciation Cash flow after tax p.a 23000 0.30X-17800 PVA (8%, 4 yrs) 3.3121 Discounted Cash flow 0.9936X-58955 (0.30X-17800)*3.3121 To compute Break even point, The discounted cash flows total should be equal to equipment cost. Hence, 0.9936X-58955 92000 0.9936X 92000+58955 0.9936X 150955 X 150955/0.9936 151,928 units (approx.) X The Break even point is 151,928 units.