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

Question:

Consider a three-year project with the following information:

initial fixed asset investment=$870,000

straight-line depreciation to zero over the five-year life

zero salvage value

price=$34.05

variable costs=$22.55

fixed costs=$210,000

quantity sold=96,000 units

tax rate=34%.

How sensitive is OCF to changes in quantity sold?

Operating cash flow:

Operating income is the total profit made by the business by selling goods and services after accounting for all the expenses incurred. Operating cash flow is determined by adding depreciation and other non-cash expenses from net income.

Answer and Explanation:

OCF at 96,000 units can be calculated as follow:

Accounts Title Amount ($) Working
Selling units 96,000
Sales 3,268,800 96,000 * 34.05
Less: Variable cost 2,164,800 96,000 * 22.55
Less: Fixed costs 210,000
Less: Depreciation 174,000 870,000/5
EBIT 720,000
Less: Taxes at 34% 244,800
Profit after taxes 475,200
Add: Depreciation 174,000
Operating cash flow 649,200


OCF at 100,000 units can be calculated as follow:

Accounts Title Amount ($) Working
Selling units 100,000
Sales 3,405,000 100,000 * 34.05
Less: Variable costs 2,255,000 100,000 * 22.55
Less: Fixed costs 210,000
Less: Depreciation 174,000 870,000/5
EBIT 766,000
Less: Taxes at 34% 260,440
Profit after taxes 505,560
Add: Depreciation 174,000
Operating cash flow 679,560


Sensitivity of the project OCF to changes in the quantity sold as follows:

{eq}OCF_{Sensitivity} \ = \ \dfrac{Change \ in \ OCF}{Change \ in \ quantity} \\ OCF_{Sensitivity} \ = \ \dfrac{OCF_{at \ 100,000 \ units} \ - \ OCF_{at \ 96,000 \ units}}{100,000 \ - \ 96,000} \\ OCF_{Sensitivity} \ = \ \dfrac{679,560 \ - \ 649,200}{4,000} \\ OCF_{Sensitivity} \ = \ \$7.59 {/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
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