Chapter 10 - Project Analysis

Solutions_Break Even Analysis

10. a. There are various formulas that can be used. For the NPV to equal zero, the
present value of the operating cash flows must equal the initial investment. This
particular approach computes that OCF value and then works backwards up the
income statement to find the fixed cost amount.

Fixed costs at the NPV breakeven (NPV = 0):

OCF = Initial investment / ((1 / r) – {1 / [r(1 + r)t]})

OCF = $90,000 / ((1 / .10) – {1 / [.10(1 + .10)10]})
OCF = $14,647.09

Net income = OCF –Depreciation

Net income = $14,647.09 – 9,000
Net income = $5,647.09

Pretax income = Net income / (1 – Tax rate)

Pretax income = $5,647.09 / (1 – .30)
Pretax income = $8,067.27

Fixed costs = Sales – Variable costs – Depreciation – Pretax income

Fixed costs = $100,000 – (.50 × $100,000) – ($90,000 / 10) – $8,067.27
Fixed costs = $32,932.73

Fixed costs at the accounting breakeven (Net profit = 0):

FC = Sales – Variable costs – Depreciation

FC = $100,000 – (.50 × $100,000) – ($90,000 / 10)
FC = $41,000

b. Pretax income = Sales – Variable costs – Fixed costs – Depreciation

Pretax income = $100,000 – (.50 × $100,000) – $30,000 – ($90,000 / 10)
Pretax income = $11,000

Using the net income computed in part a for the NPV breakeven:

Tax rate = 1 – (Net income / Pretax income)

Tax rate = 1 – ($5,647.09 / $11,000)
Tax rate = .4866, or 48.66%

c.Both net income and pretax income equal zero at the accounting break-even
point. Thus, changes in the tax rate will have no effect on that point.

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Chapter 10 - Project Analysis

11. a. The accounting break-even point is found by summing the fixed costs and
dividing this amount by the per unit contribution:

Fixed Costs 200,000 Given

Depreciation 100,000 Given
Total Contribution Needed 418,437 =118,437 + 200,000 + 100,000
Contibution per unit $ 60.00 =100 - 40
Economic break-even units 6,974 =418,437/60

Year 0 Year 1 Year 2 Year 3 Yea

Units sold - 6,974 6,974 6,974
Investment (1,000,000) - - -
Revenue - 697,395 697,395 697,395 69
Direct Cost - 278,958 278,958 278,958 27
Contribution - 418,437 418,437 418,437 41
Fixed Cost - 200,000 200,000 200,000 20
Depreciation - 100,000 100,000 100,000 10
EBIT - 118,437 118,437 118,437 11

b. The NPV or “economic” break-even level can be found by first calculating

the equivalent annual cost (“EAC”) of the initial investment over the 10
year life. This EAC is the cashflow used to calculate NPV, so it can be
used to work back up the income statement to determine the level of
contribution needed before taxes to produce a zero NPV project:

Depreciation -
EBIT -
Taxes at 35% -
Net income -
Add back Dep'n -
Net CF (1,000,000,000)
Present value at 12% (1,000,000,000)
292,345,303

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Chapter 10 - Project Analysis

15. a.-b. While units produced increase by 100% [(4 million / 2 million) – 1], costs
only increase by 28.6% [($4.5 million / $3.5 million) – 1]. Therefore, it can
be inferred that variable costs make up 28.6% of the cost structure [
28.6% / 100%]. Thus, when 2 million units are produced, fixed costs are
$2.5 million, while variable costs are $1 million, for a total cost of $3.5
million.

c. If 1 million units are produced, the firm incurs $2.5 million in fixed costs
and $0.5 million in variable costs [ $1 million / 2 million units x 1 million
units]. Total costs are therefore $3 million and average cost per unit is $3.

d. At 2 million units production, total costs were $3.5 million, which is an

average cost per unit of $1.75 [$3.5 million / $ 2 million units]

e. When more units are produced, fixed costs are spread among more
production making each individual unit relatively less expensive. This is
the concept of economies of scale.

Other way to find Fc and Variable cost:

Part a and b:2*cost per unit+FC=3500000
4*cost per unit+FC=4500000
Then cost per unit=0.5
Total variable cost once 2 million hamburger is produced=2000000*0.5=1000000
Then Fc=25000000

16. a. The degree of operating leverage (“DOL”) indicates the percentage

change in profits for each 1% change in sales. If sales turn out to be 3.5
million, or a decline of –12.5% [(3.5 million / 4.0 million) –1], a DOL of 8
would imply profits will decline by –100% [ –12.5% x 8] to $0.

b. If sales turn out to be 4.5 million, or an increase of +12.5% [(4.5 million /

4.0 million) –1], a DOL of 8 would imply profits will increase by +100% [
+12.5% x 8] to $ 2 million.

19. A. Pretax profits increase by 40%,

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Chapter 10 - Project Analysis

Revenue 6,000 6,600 10.0%

Direct Cost 4,000 4,400 10.0%
Contribution 2,000 2,200 10.0%
Fixed Cost 1,000 1,000
Depreciation 500 500
Pretax Profit 500 700 40.0%
Taxes at 20% 100 140 40.0%
Net income 400 560 40.0%

B. DOL = 1 + 1500/500 = 4 or: 40%/10%=4

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McGraw-Hill Education.