Consider a project to supply Detroit with 30,000 tons of machine screws annually

Question

  

  

Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $4,200,000 investment in threading equipment to get the project started; the project will last for three years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $250 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the three-year project life. It also estimates a salvage value of $650,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $360 per ton. The engineering department estimates you will need an initial net working capital investment of $420,000. You require a return of 15 percent and face a marginal tax rate of 38.

  

What is the percentage change in OCF if the units sold changes to 31,000? (Do not round intermediate calculations. Enter your answer as a percent rounded to 4 decimal places, e.g., 32.1616.)

  

What is the DOL at the base-case level of output? (Do not round intermediate calculations and round your final answer to 4 decimal places, e.g., 32.1616.)

If we consider the effect of taxes, then the degree of operating leverage can be written as:

Explanation / Answer

Answer:

a)

b) The best case level of output is 31,000 units

DOL = 1 + [FC × (1 – TC) – TC × D] / OCF

= 1+   [800,000(1-0.38) - 0.38*1,400,000] / $2,610,000 = 0.9862

Per Ton (in $) Total Total % change No of Tons 30000 31000 Sales price 360 10800000 11160000 Less: Variable Cost 250 7500000 7750000 Contribution 110 3300000 3410000 Less: Fixed Cost 800000 800000 Less: Depreciation ($4,200,000/3 years) 1400000 1400000 Operating profit 1100000 1210000 Add back: Depreciation 1400000 1400000 Operating CF 2500000 2610000 4.4000%

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