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 = $ 860,000; straight-line depreciation to zero over the five-year life; zero salvage value; price = $33.65; variable costs = $22.35; fixed costs = $208,000; quantity sold = 94,000 units; tax rate = 34 percent.

a. How sensitive is OCF to changes in quantity sold?

Operating Cash Flow:

Operating cash flow refers to the total cash flow generated from the ordinary business operation of a company. The business operations of the company include the manufacturing and selling of goods and services.

Answer and Explanation:

Base case operating cash flow is calculated as follow:

Accounts Title Amount ($) Working
Quantity sold 94,000
Sales per unit 33.65
Total sales (a) 3,163,100 94,000 * 33.65
Variable cost per unit 22.35
Total variable cost (b) 2,100,900 94,000 * 22.35
Fixed cost (c) 208,000
Depreciation (d) 172,000 860,000/5
Earnings before tax 682,200 ((e) = (a) - (b) - (c) - (d))
Less: Tax @ 34% 231,948 682,200 * 34%
Earning after tax $450,252
Add: Depreciation 172,000
Operating cash flow 622,252


Operating cash flow with 10% increase in quantity sold is calculated as follow:

Accounts Title Amount ($) Working
Quantity sold 103,400 94,000 * (1 + 10%)
Sales per unit 33.65
Total sales (a) 3,479,410 103,400 * 33.65
Variable cost per unit 22.35
Total variable cost (b) 2,310,990 103,400 * 22.35
Fixed cost (c) 208,000
Depreciation (d) 172,000 860,000/5
Earnings before tax 788,420 ((e) = (a) - (b) - (c) - (d))
Less: Tax @ 34% 268,062.80 788,420 * 34%
Earnings after tax 520,357.20
Add: Depreciation 172,000
Operating cash flow 692,357.20


Sensitivity of OCF to changes in quantity is calculated as follow:

{eq}Change \ in \ OCF \ to \ change \ in \ quantity \ sold \ = \ \dfrac{New \ OCF \ - \ Base \ OCF}{New \ quantity \ - \ Base \ Quantity} \\ Change \ in \ OCF \ to \ change \ in \ quantity \ sold \ = \ \dfrac{692,357.20 \ - \ 622,252}{103,400 \ - \ 94,000} \\ Change \ in \ OCF \ to \ change \ in \ quantity \ sold \ = \ \$7.46 {/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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