5. L.J.'s Toys Inc. just purchased a $200,000 machine to produce toy cars.

The m achine will be fully depreciated by the straight-line method over its five-year economic life. Each toy sells for $25. The variable cost per toy is $5, and the firm incurs fixed costs of $350,000 each year. The corporate tax rate for the co mpany is 25 percent. The appropriate discount rate is 12 percent. What is the fi nancial break-even point for the project? When calculating the financial breakeven point, we express the initial investmen t as an equivalent annual cost (EAC). Dividing the initial investment by the sev en-year annuity factor, discounted at 12 percent, the EAC of the initial investm ent is: EAC = Initial Investment / PVIFA12%,5 EAC = $200,000 / 3.60478 EAC = $55,481.95 Note that this calculation solves for the annuity payment with the initial inves tment as the present value of the annuity. In other words: PVA = C({1 [1/(1 + R)]t } / R) $200,000 = C{[1 (1/1.12)5 ] / .12} C = $55,481.95 The annual depreciation is the cost of the equipment divided by the economic lif e, or: Annual depreciation = $200,000 / 5 Annual depreciation = $40,000 Now we can calculate the financial breakeven point. The financial breakeven poin t for this project is: QF = [EAC + FC(1 tC) Depreciation(tC)] / [(P VC)(1 tC)] QF = [$55,481.95 + $350,000(.75) $40,000(0.25)] / [($25 5) (.25)] QF = 20,532.13 or about 20,532 units

HeinShmidt Wines.com is considering the purchase of a new project witha four-yea r life. The depreciable basis is $100,000 and requires $20,000of additional work ing capital. The project will generate $87,000 of additional revenue with $50,00 0 of additional operating expenses foreach year of the four-year project. For ta x purposes, the equipment fallsinto the three-year property class using MACRS pe rcentages. Thecompany is subject to a marginal tax rate of 40%. The salvage valu e atthe end of the fourth year is expected to be $5,000. The initia l cashoutf l ow for the project is closest to which of the four suggested answersbelow? Your Answer: $120,000 HeinShmidt Wines.com is considering the purchase of a new project witha four-yea r life. The depreciable basis is $100,000 and requires $20,000of additional work

ing capital. The project will generate $87,000 of additional revenue with $50,00 0 of additional operating expenses foreach year of the four-year project. For ta x purposes, the equipment fallsinto the three-year property class using MACRS pe rcentages. Thecompany is subject to a marginal tax rate of 40%. The salvage valu e atthe end of the fourth year is expected to be $5,000. The incremental netcash flow for the first y ear of the project is closest to which of the foursuggested answers below? Your Answer: $30,798 Correct Answer: $35,532 ($87,000 - $50,000 - $33,330) x (1-.40) + $33,330 = $35,532. Notethat the deprec iation charge is 33.33% of $100,000.