[Never_Give_Up1]

So I am taking progress tests and I keep running into an issue with depreciation. I hope someone can steer me straight.

When do you take depreciation into effect on your questions? So like I just answered this question:

A. Manufacturing has a tax rate of 40% and the following operating data:

Selling price unit $60

V.Cost Unit $22

F. Costs $504,000

They plan to improve the quality and as a result will:

increase cost from $3.50 to $5.50

Acquire a $180,000 machine

The machine will depreciate over 10 years S/L and the company wants and after tax income of $172,800, they must sell:

A) 19,300 Units

B) 23,800 U

C) 22,500 U

D) 21,316 U

I was treating the depreciation like and increase to cashflow at $7,200 like you would in NPV and could not get an answer. In the answer it takes the entire 18,000 and adds it to the cost base making your numerator higher.

Can someone help straighten me out on this? Why would you not treat depreciation like a cash flow item when you are calculating NPV?

Oh yeah, the answer is C.

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[Zaq]

Depreciation is never used as a cash inflow or outflow.

Depreciation tax shields, however, are non-direct cash inflows.

Edit: Just reread your question. You're taking the depreciation tax shield in your example. Let me look at the question once more, but this doesn't look like your common NPV problem.

Edit 2: barelyinsane to the rescue.

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[barelystayingsane]

They're asking for essentially a breakeven point but with profit included. That is a cost-volume-profit analysis and uses income.

Capital budgeting, on the other hand, uses cash flows, including the indirect effects of depreciation. Since this is not a question relating to capital budgeting/NPV, you would not look at cash flows.

[Zaq]

So yeah. SP – VC – FC = Net Income Before Tax will be your foundation here.

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[Never_Give_Up1]

Hmm… it must me the depreciation that is throwing me off because I usually nail break even questions. So on break even, you add depreciation into the mix because it is affecting your net income like you were doing your normal financials. So I need to think in terms of financial statement not product costs.

Got it! Thanks for the replies!

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[Nicc87]

Never_give_up1 thanks for posting this question. It's really interesting to cover this tricky question before my bec exam tomorrow. I try to use CVP analysis and plug in fix cost(504000+18000)+profit(172800/.6)/cm)(60-22) but I got D. Can anyone tell me where did I go wrong ? Thanks so much!!

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[Never_Give_Up1]

You need to account for the increase in 18,000 cost for depreciation and you also have to account for the $2 increase to variable costs.

Try that now.

Edit:

You have to account for all costs in a Break even analysis. Not just product costs. I was only using product costs. But because you are getting to a net income item you have to account for all costs.

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[Nicc87]

Got it !!thank u so much Never_give_up1!! Good luck with your review!

AUD 82(08/12/2013)
BEC 82(08/28/2013)
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REG 76(12/06/2013)
Becker Review and Final review.
You are only as strong as your weakest link.

[Whopper Warrior]

=172,800/.6

=288,00

TAX Consequences

=288,000+18000 = 306,000 (Income needed)

306,000=(60-(22+2)x-504,000

810,000=36x

x = 22,500

TEST (Fake Income Statement)

Sales: 22,500 * 60 = 1,350,000

COGS: 22,500 * 24 = (504,000)

Fixed Cost = (750,000)

Deprecation (18,000)

Income before Tax:288,000

It is easier to add the tax shield after you find your beginning taxable income. It would be different if it was asking for a Cash Flow of 172,800

Specifically, 172.8-7.2 (.4 * 18000) = 165,600

165,600/.6 = 276,00

780,000 = 36x

roughly 21,667 for Cash Flow (not income)

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[Author]

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