A project currently generates sales of $3 million, variable costs equal 30% of s

Question

A project currently generates sales of $3 million, variable costs equal 30% of sales, and fixed costs are $0.6 million. The firm’s tax rate is 40%. Assume all sales and expenses are cash items.

a. What are the effects on cash flow, if sales increase from $3 million to $3.3 million? (Input the amount as positive value. Enter your answer in dollars not in millions.) Cash flow increases/decreases by _______

b. What are the effects on cash flow, if variable costs increase to 35% of sales? (Input the amount as positive value. Enter your answer in dollars not in millions.) Cash flow increases/decreases by ________

Explanation / Answer

Operating Cash Flow = (Sales - Costs)*(1-tax) + Tax*depreciaiton

Base = (3-0.3*3 - 0.6)*(1-0.4)+0 = 0.9 million.

i.

Sales increase:

OCF = (3.3-0.3*3.3 - 0.6)*(1-0.4) + 0 = 1.026 million

Cashflow increases by = 1.026-0.9 = 0.126 million = $126000

ii.

OCF = (3-0.35*3 - 0.6)*(1-0.4) + 0 = 0.81 million

Cashflow decreases by = 0.81-0.9 = -0.09 = -$90000

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