Question

Tank Co. is evaluating a project that costs $100,000 and has a 5-year life.

Assume that depreciation is prime-cost to zero salvage value over the 5-years, and the equipment can be sold for $6,000 at the end of year 5. The average discount rate for such a project is 10 per cent on such projects. The individual tax rate is 15 per cent and

corporate tax rate is 30 per cent.

It is projected that they will sell 12000 units per year. Price per unit is $12, variable cost per unit is $3 and fixed costs are $21,000 per year.

(a) Calculate the accounting break-even point and cash break-even point.

(b) What is the degree of operating leverage at the accounting breakeven point?

(c) What is the estimated NPV for the project, and should Tank accept the project?

Answer 1

1.
Accounting breakeven point=(Fixed Costs+Depreciation)/(Price-Variable Cost)
=(21000+100000/5)/(12-3)
=4555.56

2.
Cash breakeven point=(Fixed Costs)/(Price-Variable Cost)
=(21000)/(12-3)
=2333.33

3.
Degree of operating leverage=quantity*(price-variable cost)/(quantity*(price-variable cost)-fixed costs)=4555.56*(12-3)/(4555.56*(12-3)-21000)=2.05

4.
NPV=-100000+6000*(1-30%)/1.10^5+((12000*(12-3)-21000-100000/5)*(1-30%)+100000/5)/10%*(1-1/1.1^5)
=156211.50

Accept as NPV is positive