Question

Grace P. has compiled this information related to a new project: Initial investment: $1,550,000; Fixed costs: $420,000; Variable costs: $8.10 per unit; Selling price: $28.80 per unit; Discount rate: 14 percent; Project life: 6 years; Tax rate: 25 percent. Fixed assets are depreciated using straight-line depreciation over the project's life. What is the financial break-even point?

		38,522
		39,211
		40,286
		41,804
		42,374

Answer 1

Solution

Initial investment =$15,50,000

Selling price =$28.80 per unit

Variable cost =$8.10 per unit

Contribution per unit = $28.80-$8.10= $20.70

Fixed cost =$4,20,000

Project life = 6 years

Tax rate = 25%

Depreciation = 15,50,000/6= $2,58,333

Tax saving on depreciation = $2,58,333*0.25 = $64,583

Financial break even point :-

Initial investment = present value of ( sales - variable cost - fixed cost) (1- tax rate) + present value of tax saving on depreciation

Assume number of units sold be X

15,50,000 = [(28.80 - 8.10) *X * 0.75]* PVAF ( 14%, 6 years) - 4,20,000*0.75*PVAF (14%,6 years) + 64,583* PVAF (14%,6 years)

15,50,000 = 60.37156X - $12,24,930 + $2,51,142

X =( 15,50,000 + 12,24,930 - 2,51,142) / 60.37156

X = 25,23,78/60.37156= 41,804

Financial break even point = 41,804

Option d is correct i.e. 41,804