Cash Flow Breakeven Point
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** Please see the attached file for the complete problem description **
Mr. Smith is considering using some funds accumulated in the past in order to start a new retail store. The fixed investment in the store is expected to be $6.5 million. The investment will require no maintenance expenditures for the first 5 years but after the first 5 years a $700,000 expense will be needed in order to maintain the facility. The required investment in net working capital is expected to be 30% of annual sales. Variable cost is estimated to be 40% of sales. Assume that there are no taxes payables on the business income.
Do your calculations, read the information in the background material, look for more information, and then write a 4 to 5 page paper answering the following questions:
1) What is the cash flow breakeven point of the venture during the first five years? What is it after the fifth year?
To answer question 1, you may consider using the following equations to calculate cash flow breakeven points:
Break-even point (in sales revenue) = Fixed Costs ÷ Contribution Margin Ratio
Contribution margin ratio = 100% - VC%
For example, based on the 40% variable costs (VC), contribution margin ratio is 100% - 40% = 60% [or 1 - .40 = .60]
2) Suppose Mr. Smith projects first year sales of $3 million, second year sales of $5 million, and sales after the second year of $4 million each year.
- How much of an investment will be required to undertake the project?
- How much surplus cash is the venture expected to generate each year in the first six years of operations?
To answer question 2, you may consider using the following additional help:
Required investment to undertake project (total investment): Fixed investment for 1st five years + maintenance expenditures + average net working capital
Investment in net working capital = Sales x investment in net working capital percentage (e.g., $3,000,000 x .30 = $900,000)
You may use the following Table to calculate investment in net working capital:
(please see the attached file)
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Solution Summary
Response explains the computation of Cash Flow Break-even Point
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