Question

Question#2 - Consider a four-year project with the following information: initial fixed asset investment = $575,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $36; variable costs = $17; fixed costs = $175,000; 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

Operating cash flow (OCF) when units are 84,000

= [(Price – Variable cost) Quantity –Fixed Cost] (1 – Tax rate) + Tax rate X (Initial investment / Number of years)

= [($ 36-$17)(84,000) - $175,000](1-0.34) + 0.34* ($575,000/4)

= ($ 1,596,000 - $ 175,000)0.66 + $ 48,875

= $ 937,860 + $ 48,875

= $ 986,735

Operating cash flow (OCF) when units are 84,001

= [(Price – Variable cost)Quantity –Fixed Cost ](1 – Tax rate) + Tax rate X (Initial investment / Number of years)

= [($ 36-$17)(84,001) - $175,000](1-0.34) + 0.34* ($575,000/4)

= ($ 1,596,019 - $ 175,000)0.66 + $ 48,875

= $ 937,872.54 + $ 48,875

= $ 986,747.54

Sensitivity of Operating cash flow = Change in OFC / Change in quantity

= ($ 986,747.54 - $ 986,735) / (84,001- 84,000)

= $ 12.54 / 1

= 12.54 (Answer)