For the calculation on break-even number in this case, I understand that we're capitalizing the required investment for equipment as an assest, and consider the depreciation expense as a fixed cost in this case. However, as it's highly likely that the investment for equipment must be fully paid in the first year, it could also be considered as a fixed cost in first year, which will change the answer of break-even amount. That being said, it will take the company several years to break even, and we will need to come up with a timeline, which will make the calculation more complicated. Does this approach make sense in this case? Or are supposed to capitalize the investment expenditure by default and only consider the depreciation expense in case interviews?
The break-even calculation: do we want to consider timeline of break-even
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Hello Ashley ,
Your point is fair and the interviewer would be happy to see that a candidate has such a critical reasoning.
In this case considering the depreciation as a fixed cost in the case is just a "mathematical trick" to simplify the calculation. I don't get why this would change the final solution, you could consider the 5-years period that will be repeat in the time with the same dynamic:
- First year P/L calculation: (Price – VC) * amount - overhead - investment
- 2-5 years P/L calculation: (Price – VC) * amount - overhead
- Total profit/loss calculation= "First year P/L" + 4* "2-5 years P/L"= 5* ((Price – VC) * amount - overhead ) - investment
Now you have to put this final expression equal to 0 and you have:
- 5* ((Price – VC) * amount - overhead ) - investment = 0
- Dividing by five --> (Price – VC) * amount - overhead - investment / 5 = 0
And this final expression is the same of the official solution ;)
I know that talking about math with this answer's format could be confusing, contact me if you need more help and I will explain you step by step using a proper visual.
Please notice that you could also take into account the NPV of each cash flow but this would over complicate the case (99% of interviewer will ask you not to consider that). BUt again, state clearly to your interviewer that you could also consider the NPV, he will be happy to know that you thought about this complication.
Hope it helps,
Luca
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Hi Luca, Thank you so much for the detailed response! This makes perfect sense, and thanks again for your time :) I do agree with the logic of the calculation and I did solve the case following this flow during my mock interview. However, as I reflected on the case , I think there are several points worth mentioning/reconsidering about the calculation: 1) The calculation indicates that NewCorp will not be able to breakeven until the 5th year of its entry into the Polish market, if the required investment on equipment is paid in advance in the 1st year, and the customer number is 300,000. Maybe it’s worth mentioning in the case interview that our client could take advantage of the 5-year breakeven timeline of NewCorp and try to prolong its breakeven timeline (eg. By having promotions and attracting more potential new customers)? 2) The underlying assumption of this calculation is that the customers of NewCorp (which is the “amount” in your equation) will not change during the first 5 years of its entry, which may not be the case in the real world. Another approach of tackling this case may be set a goal of breakeven timeline (eg. 3 years), assuming an annual growth rate (maybe ~5%), and then calculate the number of customers necessary for the 1st year of entry, if NewCorp wants to breakeven in 3 years with a growth rate of 5%. Maybe I’m getting into a rabbit hole and making this too complicated, but just want to check whether this approach make sense in case solving. Again, thank you so much for your explanation!
(edited)