Question

Sun Brite has a new pair of sunglasses it is evaluating. The company expects to sell 7,200 pairs of sunglasses at a price of $167 each and a variable cost of $119 each. The equipment necessary for the project will cost $375,000 and will be depreciated on a straight-line basis over the 7-year life of the project. Fixed costs are $330,000 per year and the tax rate is 35 percent. How sensitive is the operating cash flow to a $1 increase in variable costs per pairs of sunglasses?

A) −$5,200

B) −$4,680

C) $4,680

D) −$4,212

E) $4,212

Answer 1

	Base case annual operating cash flow
	Sales=7200*167		1,202,400
	Variable cost = 7200*119		856,800
	Depreciation 375000/7		53,571
	Fixed cost		330,000
	Profit before tax		(37,971)
	Tax @ 35%		(13,290)
	Profit after tax		(24,681)
	Cash flow = Profit after tax + Depreciation		28,890
	with $1 increase in variable cost
	Sales=7200*167		1,202,400
	Variable cost = 7200*120		864,000
	Depreciation 375000/7		53,571
	Fixed cost		330,000
	Profit before tax		(45,171)
	Tax @ 35%		(15,810)
	Profit after tax		(29,361)
	Cash flow = Profit after tax + Depreciation		24,210
	Change in operating cash flow		(4,680)
	ans = option B)		(4,680)