Question

7.       XYZ Co. is evaluating whether to invest in a project with the following information:               (8 points total)

Project cost = $950,000

Project life = five years

Projected number of units sold per year = 10,000

Projected price per unit = $200

Projected variable cost per unit = 150

Fixed costs per year = $150,000

Required rate of return = 15%

Marginal tax rate = 35%

Assume straight-line depreciation to zero over five years, and ignore the half-year rule for accounting for depreciation.

a. Calculate the cash break-even sales quantity for this project.             (1 mark)

b. Calculate the accounting break-even sales quantity for this project.      (1 mark)

   

c. Calculate the financial break-even sales quantity for this project.        (3 marks)

d. Calculate the Degree of Operating Leverage (DOL) at the cash break-even, accounting break-even, and financial break-even sales quantities.                                                                     (3 marks)

Answer 1

a.Cash break-even sales quantity for this project = 3000 units

b. Accounting break-even sales quantity for this project = 6800 units

c. Financial break-even sales quantity for this project = 9674 units

d. DOL = 1+ 150,000 / 283399.7748 =1.529

Workings:

Depreciation per year	190000	[950000/5]
Fixed costs	150,000
	340,000
Projected price per unit	200
Projected variable cost per unit	150
Projected contribution per unit	50
Cash break-even sales quantity for this project	3000	[150,000/50]
Accounting break-even sales quantity for this project	6800	[340,000/50]

OCF	283399.7748	[950,000/3.352155]
Depreciation after tax	66500	[190000*35%]
Net costs	216899.7748
Post tax costs	333691.9613	[216899.7748/(1-0.35)]
Add: Fixed costs	150,000
	483,692
Financial break even	9674	[483692/50]

Year	PV factor @15%
1	0.869565217
2	0.756143667
3	0.657516232
4	0.571753246
5	0.497176735
	3.352155098