Question

In: Finance

Consider a project with a life of 3 years with the following information: initial fixed asset...

Consider a project with a life of 3 years with the following information: initial fixed asset investment = $350,000; straight-line depreciation to zero over the 3-year life; zero salvage value; price = $34; variable costs = $12; fixed costs = $133,000; quantity sold = 59,850 units; tax rate = 22 percent. How sensitive is OCF to changes in quantity sold?

Solutions

Expert Solution

Step 1 : Calculation of Operating Cash Flows

Particulars Amount
Nos of Units sold 59,850
Contribution @22 pu. $1,316,700.00
Less: Fixed Cost ($133,000.00)
Less: Depreciation ($116,666.67)
Income before tax $1,067,033.33
Less: Tax @22% ($234,747.33)
Income after tax $832,286.00
Add: Depreciation $116,666.67
Operating CF $948,952.67

Notes :

1 Contribution pu = Sale Price - Variable Cost = $34-$12 = $22

2. Calculation of Depreciation on Fixed Asset

Cost of Fixed Asset $350,000.00
Life 3 years
Depreciation $116,666.67

Step 2 :For sensitivity analysis we need to evaluate the impact of change on operating cash flows due to the change in quantity sold.

Now lets assume the quantity sold reduces by 10%

Revised quantity = 59,850*90%= 53,865

Calculation of operating cash flows at reduced level of Quantity Sold (53,865 units)

Particulars Amount
Contribution @22 pu. $1,185,030.00
Less: Fixed Cost ($133,000.00)
Less: Depreciation ($116,666.67)
Income before tax $935,363.33
Less: Tax @22% ($205,779.93)
Income after tax $729,583.40
Add: Depreciation $116,666.67
Operating CF $846,250.07

It can be notice that there is decrease in Operating cash flows as we reduce the number of units sold.

Step 3: Evaluation of Sensitivity

Sensitivity/Change in Operating cash flows = (948952.67-846250.07)/948952.67 =10.82%

Operating cash flows decrease (%)= 10.82%


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