Question

Consider a four-year project with the following information: initial fixed asset investment = $375,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $56; variable costs = $23; fixed costs = $195,000; quantity sold = 84,000 units; tax rate = 34%.

How sensitive is OCF to changes in quantity sold? (Do not round intermediate calculations. Round the final answer to 2 decimal places. Omit $ sign in your response.) (Do not forget to include + or – sign)

Answer 1

we will find OCF at two different quantities

1.Q= 84,000

OCF = [(P – v)Q – FC](1 – t) + t(D)

P=Price=$56

v=Variable cost = $23

Q=84,000

FC=fixed cost=$195,000

t= tax rate = 0.34

D= depreciation = $375,000/4=$93,750

OCF = [($56-$23)84,000- $195,000](1-0.34) + 0.34($93,750)

=1,700,820+$31,875

=$1,732,695

Now we will try at 85,000 units

Q= 85,000

OCF = [($56-$23)85,000- $195,000](1-0.34) + 0.34($93,750)

=$1,754,475

sensitivity = change in OCF/Change in units

($1,754,475-$1,732,695)/(85,000-84,000)

OCF will increase by $21.78 for every additional unit sold

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