# Break Even Point and Capital Budgeting

2. (Payback period, net present value, profitability index, and internal rate of return calculations) You are considering a project with an initial cash outlay of $160,000 and expected free cash flows of $40,000 at the end of each year for 6 years. The required rate of return for this project is 10 percent.

a.) What is the project's payback period?

b.) What is the project's NPV?

c.) What is the project's PI?

d.) What is the project's IRR?

3. What would be the discounted payback for the period for the project in problem #2?

4. (Break-even point) Roberto Martinez is the chief financial analyst at New Wave Pharmaceuticals (NWP), a company that produces a vitamin claimed to prevent the common cold. Roberto has been asked to determine the company's break-even point in units. He obtained the following information from the company's financial statements for the year just ended. In addition, he found out the NWP'S production manager that the company produced 40 million units in that year. What will Roberto determine the break-even point to be?

Sales $20,000,000

Variable cost 16,000,000

Revenue before fixed cost $ 4,000,000

Fixed costs 2,400,000

EBIT $ 1,600,000

5. (Leverage analysis) New Wave Pharmaceuticals (see description and data in problem #4) is concerned that recent unfavorable publicity about the questionable medicinal benefits of other vitamins will temporarily hurt NWP's sales even though such assertions do not apply to NWP's vitamin. Accordingly, Roberto has been asked to determine the company's level of risk based on the financial information for the year just ended. In addition to the data described in Problem #2 Roberto learned form the company's financial statements that the company incurred $800,000 of interest expense in the year just ended. What will Roberto determine the (a) degree of operating leverage, (b) degree of financial leverage, and (c) degree of combined leverage to be?

6. (Operating leverage) the B.H. Williams Company manufactures an assortment of wood-burring stoves. The average selling price for the various units is $475.00. The associated variable cost is $350 per unit. Fixed costs for the firm average $200,000 annually.

a.) What is the break-even point in units for the company?

b.) What is the dollar sales volume the firm must achieve to reach the break-even point?

c.) What is the degree of operating leverage for a production and sales level of $6,000 units for the firm? (Calculate to three decimal places.)

#### Solution Preview

(Payback period, net present value, profitability index, and internal rate of return calculations) You are considering a project with an initial cash outlay of $160,000 and expected free cash flows of $40,000 at the end of each year for 6 years. The required rate of return for this project is 10 percent.

ou are considering a project with an initial cash outlay of $160,000 and expected free cash flows of $40,000 at the end of each year for 6 years. The required rate of return for this project is 10 percent.

The payback rule is how long it takes to recover the initial investment.

a.) What is the project's payback period?

Initial cash outflow $160,000

Free cash flow per year 40000

Payback period= Initial cash outlay/Annuity 4 years

b.) What is the project's NVP?

Year Cash Flow A Discounted cash flow Cumulative Discounted cash ...

#### Solution Summary

This explains the concepts of capital budgeting and break even point through examples and case studies.