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BE&H Manufacturing is considering dropping a product line. It currently produces a multi-purpose woodworking clamp in a simple manufacturing process that uses special equipment. Variable costs amount to $6.00 per unit. Fixed overhead costs, exclusive of depreciation, have been allocated to this product at a rate of $3.50 a unit and will continue whether or not production ceases. Depreciation on the special equipment amounts to $20,000 a year. If production of the clamp is stopped, the special equipment can be sold for $18,000; if production continues, however, the equipment will be useless for further production at the end of 1 year and will have no salvage value. The clamp has a selling price of $10 a unit. Ignoring tax effects, the minimum number of units that would have to be sold in the current year to break even on a cash flow basis is
The estimated incremental after-tax operating cash flows for each year of a capital project consist of two components: the after-tax cash inflows from operations and the depreciation tax shield arising from the purchase of new equipment. The first of these for Pauley can be calculated as follows:
Pauley's total after-tax operating cash inflow for each year of the project's life is thus $36,000 ($30,000 + $6,000). Ii the final year of the project, two additional cash flows must be taken into account, the after-tax proceeds from the disposal of the equipment purchased for the project, and the recovery of working capital devoted to the project. These two additional cash flows can be calculated as follows:
Pauley's total after-tax cash inflow for the final year of the project's life is thus $49,000
($36,000 + $13,000).