Consider a four-year project with the following information: initial fixed asset
ID: 2779560 • Letter: C
Question
Consider a four-year project with the following information: initial fixed asset investment = $500,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $35; variable costs = $26; fixed costs = $200,000; quantity sold = 80,000 units; tax rate = 35 percent.
How sensitive is OCF to changes in quantity sold? (Round your answer to 2 decimal places. (e.g., 32.16))
Consider a four-year project with the following information: initial fixed asset investment = $500,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $35; variable costs = $26; fixed costs = $200,000; quantity sold = 80,000 units; tax rate = 35 percent.
Explanation / Answer
Annual Depreciation = (cost of asset – salvage value)/ life
= (500,000-0)/ 4
= 125,000
Depreciation tax shield = Depreciation x tax rate
= 125,000 x 35%
= 43,750
Contribution per unit = Price – variable cost per unit
=35-26 = 9
Total contribution = 80,000 x9 = 720,000
Fixed cost = - 200,000
Pretax earnings = 520,000
Tax 35% = - 182,000
Net Income = 338,000
Depreciation tax shield = 43,750
OCF = 381,750
Let’s change quantity by 1000 units:
Total contribution = 79,000 x9 = 711,000
Fixed cost = - 200,000
Pretax earnings = 511,000
Tax 35% = -178,850
Net Income = 332,150
Depreciation tax shield = 43,750
OCF = 375900
Change in OCF = 381,750 -375900
= 5850
OCF/Q = 5850/1000
= 5.85
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