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Consider a three-year project with the following information: initial fixed asset investment =...

Question:

Consider a three-year project with the following information: initial fixed asset investment = $698,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $34.15; variable costs = $22.60; fixed costs = $210,500; quantity sold = 96,500 units; tax rate = 40 percent.

How sensitive is OCF to changes in quantity sold? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

{eq}\Delta OCF/\Delta Q {/eq}

$__________

Operating Cash Flow:

The operating cash flow of a business refers to those cash inflows which are caused by ordinary business activities. Ordinary business activities include the production and selling of goods and services.

Answer and Explanation:

Provided information:

Initial fixed asset investment = $698,000

Price = $34.15

Salvage value = 0

Variable costs = $22.60

Fixed costs = $210,500

Quantity sold = 96,500 units

Tax rate = 40%

Life = 4 years

Evaluation:

{eq}Depreciation \ = \ \dfrac{Initial \ fixed \ asset \ investment}{Life} \\ Depreciation \ = \ \dfrac{698,000}{4} \\ Depreciation \ = \ 174,500 {/eq}


OCF = (Quantity sold * (Price - Variable costs) - Depreciation - Fixed costs) * (1 - Tax rate) + Depreciation


{eq}\Delta OCF \ = \ \Delta \left [ (Quantity \ sold \ \times \ (Price \ - \ Variable \ costs) \ - \ Depreciation \ - \ Fixed \ costs) \ \times \ (1 \ - \ Tax \ rate) \ + \ Depreciation \right ] \\ \Delta OCF \ = \ (\Delta Quantity \ sold \ \times \ (Price \ - \ Variable \ costs) \ - \ \Delta Depreciation \ - \ \Delta Fixed \ costs) \ \times \ (1 \ - \ Tax \ rate) \ + \ \Delta Depreciation {/eq}


{eq}\Delta OCF \ = \ (\Delta Quantity \ sold \ \times \ (Price \ - \ Variable \ costs) \ - \ 0 ) \ \times \ (1 \ - \ Tax \ rate) \ + \ 0 \\ \Delta OCF \ = \ \Delta Quantity \ sold \ \times \ (Price \ - \ Variable \ costs) \ \times \ (1 \ - \ Tax \ rate) \\ \dfrac{\Delta OCF}{\Delta Quantity \ sold} \ = \ (Price \ - \ Variable \ costs) \ \times \ (1 \ - \ Tax \ rate) \\ \dfrac{\Delta OCF}{\Delta Quantity \ sold} \ = \ (34.15 \ - \ 22.60) \ \times \ (1 \ - \ 0.40) \\ \dfrac{\Delta OCF}{\Delta Quantity \ sold} \ = \ \$6.93 {/eq}


Learn more about this topic:

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Operating Cash Flow: Definition & Examples

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4
10K

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