Question

Consider a four-year project with the following information: initial fixed asset investment = $550,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $36; variable costs = $24; fixed costs = $225,000; quantity sold = 76,000 units; tax rate = 23 percent. How sensitive is OCF to changes in quantity sold?

Answer 1

Answer:

The OCF will increase $9.24 for every additional unit sold

Explanation:

OCF = ((price – Variable cost)*(Quantity – Fixed cost))(1 - tax rate) + Tax rate*Depreciation

OCF at 76000 units level = ((36 - 24)(76000 - 225000))(1 - 0.23) + 0.23*550000/4  

                                            = (912000 - 225000)*0.77 + 0.23 *137500

                                            = 528990 + 31625

                                            = $560615

OCF at 75000 units level = ((36 - 24)(75000 - 225000)(1 - 0.23) +0.23*550000/4

                                           = 519750 + 31625

                                           = $551375  

The sensitivity of changes in OCF to quantity sold

= $560615 - $551375/(76000 -75000)

= +9.24

Therefore, The OCF will increase $9.24 for every additional unit sold.