140 Financial Management
setting up a new flour mill near Bangalore. Based on Naveenís previous
experience, the project staff of Naveen has developed the figures shown in
Exhibit 6.8
(ë000)
Year 0 Years 1-10- Investment (20,000)
- Sales 18,000
- Variable costs (66+% of sales) 12,000
- Fixed costs 1,000
- Depreciation 2,000
- Pre-tax profit 3,000
- Taxes 1,0000
- Profit after taxes 2,000
- Cash flow from operation 4,000
- Net cash flow (20,000) 4,000
Figure 6.8: Cash Flow Forecast for Naveenís Flour Mill Project
N ote that the ratio of variable costs to sales is 0.667 (12/18). This means that every
rupee of sales makes a contribution of Rs 0.333. Put differently, the contribution
margin ratio is 0.333. Hence the break-even level of sales will be:
Fixed Costs Depreciation
Contribution are in RatioRs million
+
=^1 +^2 =
0 3339
..By way of confirmation, you can verify that the break-even level of sales is indeed Rs
9 million.
Rs. in Million
Sales 9
Variable Costs 6
Fixed Costs 1
Depreciation 2
Profit Before Tax 0
Tax 0
Profit After Tax 0
A project that breaks even in accounting terms is like a stock that gives you a return
of zero per cent. In both the cases you get back your original investment but you are
not compensated for the time value of money or the risk that you bear. Put differently,
you forego the opportunity cost of your capital. Hence a project that merely breaks
even in accounting terms will have a negative NPV.
Financial Break-even Analysis
The focus of financial break-even analysis is on NPV and not accounting profit. At