6. Consider the following project which costs $1,000,000 with a salvage value of

Question

6.

Consider the following project which costs $1,000,000 with a salvage value of $50,000 in 5 years. The project will produce a new type of running shoes which will be sold for $235 and have variable costs of $95 per pair. The company has fixed costs of $1,500,000 and a required return on projects of 12.5%. The company uses straight-line depreciation method. Suppose the firm sells 15,000 pairs of shoes. Ignoring the effects of taxes, what will happen to OCF if unit sales increases by 20%?

Select one:

a. OCF will increase by 50%

b. OCF will increase by 20%

c. OCF will increase by 70%

d. OCF will decrease by 20%

e. OCF will decrease by 70%

Explanation / Answer

c. OCF will increase by 70% Particulars Existing   If sales increase by 20% No of Units          15,000.00                                  18,000.00 SP per unit                235.00                                        235.00 VC per unit                  95.00                                          95.00 Cont per unit(SP-VC)                140.00                                        140.00 Total Cont(Cont per Unit*no of units    2,100,000.00                            2,520,000.00 Fixed Costs    1,500,000.00                            1,500,000.00 Cash Flows after tax        600,000.00                            1,020,000.00 Increase in Cash Flows = (1,020,000-600,000)/600,000 = 70%

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