Break-even analysis: The Y Generation Soda Bottling Company purchased equipment
ID: 2787625 • Letter: B
Question
Break-even analysis: The Y Generation Soda Bottling Company purchased equipment for $50,000 that will reduce costs by $14,000 each year for N years. After N years, there will be no further need for the machine, and it will have no salvage value. Assume that the equipment will be depreciated on a straight-line basis over five years. If the effective income-tax rate is 40%, what is the minimum value of N that will ensure an after-tax rate of return of at least 10%?
Assume that your state tax rate is 7%, and your federal tax rate is 33%. If you want at least a 10% rate of return after taxes, what value should you use for your before-tax rate of return?
Explanation / Answer
Depreciation = Investment / No. of years = 50,000 / 5 = 10,000
Cash Flows = Net Income + Depreciation = (Savings - Depreciation) x (1 - tax) + Depreciation
= (14,000 - 10,000) x (1 - 40%) + 10,000
= 12,400
Now, no. of years N can be calculated using N function on a calculator or NPER function in excel
Insert I/Y = 10%, PMT = 12,400, PV = -50,000, FV = 0 => Compute N = 5.42 years
Before-tax rate of return = After-tax rate of return / (1 - taxes)
= 10% / (1 - 33% - 7%) = 16.67%