Question

Consider a four-year project with the following information: initial fixed asset investment = $555,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $37; variable costs = $25; fixed costs = $230,000; quantity sold = 79,000 units; tax rate = 24 percent. How sensitive is OCF to changes in quantity sold? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

for every 1% increase in the quantity sold, OCF increases by 1.24%

for every 1% decrease in the quantity sold, OCF decreases by 1.24%

Explanation:

Consider a four-year project with the following information: initial fixed asset investment = $555,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $37; variable costs = $25; fixed costs = $230,000; quantity sold = 79,000 units; tax rate = 24 percent. How sensitive is OCF to changes in quantity sold?

initial outlay = $555,000

depreciation expense per year = $555,000 / 4 = $138,750

contribution margin per unit = $37 - $25 = $12

quantity sold = 79,000 units

tax rate = 24%

fixed costs = $230,000

OCF = {[(79,000 x $12) - $230,000 - $138,750] x (1 - 24%)} + $138,750 = $578,980

if sales increase by 10%, OCF = {[(86,900 x $12) - $230,000 - $138,750] x (1 - 24%)} + $138,750 = $651,028 ⇒ 12.44% increase

if sales decrease by 10%, OCF = {[(71,100 x $12) - $230,000 - $138,750] x (1 - 24%)} + $138,750 = $506,932 ⇒ 12.44% decrease