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Chapter 2: Question 5-4DQ (page 143)

What role does depreciation play in break-even analysis based on accounting flows? Based on cash flows? Which perspective is longer term in nature?

Short Answer

Expert verified

Break even analysis is done by dividing the fixed cost with the contribution per share. Fixed cost includes the depreciation cost when the break even analysis is based on accounting flows. But when the company uses the cash flow basis for break even analysis, depreciation amount should be excluded from the fixed cost.

Accounting flows perspective is longer term in nature because we must consider problems of fixed asset replacement.

Step by step solution

01

Role of depreciation in break even analysis

Depreciation is considered as the fixed cost while computing the break even point based on accounting flows.

02

Role of depreciation while computing break even point based on cash flows

While computing the break even point based on the cash flows, depreciation shall be excluded from the fixed cost. Because, the depreciation of the company is a non-cash transaction. Cash flows perspective is not longer in nature because it does not consider the problem of fixed asset replacement. However, it is considered under accounting flows perspective.

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Most popular questions from this chapter

The Manning Company has financial statements as shown next, which are representative of the company鈥檚 historical average.

The firm is expecting a 35 percent increase in sales next year, and management is concerned about the company鈥檚 need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among liabilities, only current liabilities vary directly with sales.

Using the percent-of-sales method, determine whether the company has external financing needs, or a surplus of funds. (Hint: A profit margin and payout ratio must be found from the income statement.)

Income statement

Sales

\(250,000

Expenses

192,000

Earnings before interest and taxes

\)58,000

Interest

7,500

Earnings before taxes

\(50,500

Taxes

15,500

Earning after taxes

\)35,000

Dividends

\(7,000

BALANCE SHEET

Assets

Liabilities and Stockholder鈥檚 equity

Cash

\)8,500

Accounts payable

\(26,400

Accounts receivable

63,000

Accrued wages

2,350

Inventory

91,000

Accrued taxes

3,750

Current assets

\)162,500

Current liabilities

\(32,500

Fixed assets

85,000

Notes payable

7,500

Long term debts

17,500

Common stock

125,000

Retained earnings

65,000

Total assets

\)247,500

Total liabilities and stockholder鈥檚 equity

$247,500

The Holtzman Corporation has assets of \(400,000, current liabilities of \)50,000, and long-term liabilities of \(100,000. There is \)40,000 in preferred stock outstanding; 20,000 shares of common stock have been issued.

a. Compute book value (net worth) per share.

b. If there is $22,000 in earnings available to common stockholders and

Holtzman鈥檚 stock has a P/E of 18 times earnings per share, what is the current

price of the stock?

c. What is the ratio of market value per share to book value per share?

Low Carb Diet Supplement Inc. has two divisions. Division A has a profit of\(156,000 on sales of \)2,010,000. Division B is able to make only \(28,800 onsales of \)329,000. Based on the profit margins (returns on sales), which divisionis superior?

What is the difference between book value per share of common stock and market value per share? Why does this disparity occur?

The Sterling Tire Company鈥檚 income statement for 20X1 is as follows:

STERLINE TIRE COMPANY

Income Statement

For the year ended December 31, 20X1

Sales (20,000 tires at \(60 each)

\)1,200,000

Less: variable costs (20,000 tires at \(30)

600,000

Less: fixed cost

400,000

Earnings before interest and taxes (EBIT)

\)200,000

Interest expenses

50,000

Earning before taxes (EBT)

\(150,000

Income tax expenses (30%)

45,000

Earning after taxe (EAT)

\)105,000

Given this income statement, compute the following:

b. Degree of financial leverage.
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