Question

Hydro Systems Engineering Associates, Inc. provides consulting services to city water authorities. The consulting firm’s contribution-margin ratio is 20 percent, and its annual fixed expenses are $250,000. The firm’s income-tax rate is 35 percent.

Required:

1. Calculate the firm’s break-even volume of service revenue.

2. How much before-tax income must the firm earn to make an after-tax net income of $140,000?

3. What level of revenue for consulting services must the firm generate to earn an after-tax net income of $140,000?

4. Suppose the firm’s income-tax rate changes to 25 percent. What will happen to the break-even level of consulting service revenue?

Answer 1

Solution:

Contribution margin ratio = 20%

Fixed cost = $250,000

Income tax rate i= 35%

1.

Break even volume of service service = (fixed cost / contribution margin ratio) = (250,000 / 20%) = $1,250,000

2.

Net income before income tax = Net income after tax / ( 1 - tax rate) = 140,000 / ( 1 - 35%) = 140,000 / 0.65

= 215,385

3.

Target sales = (fixed cost + net income before tax) / contribution margin ratio = (250000 + 215385) / 20%

= 2,326,923

4.

The change in income tax rate has no effect on break even sales.